CFAP-6 - PK-2 Audit Execution and Conclusion

Audit, Assurance & Related Services
Audit Execution and Conclusion – Practice Kit

Table of contents
S. NO DESCRIPTION QUESTION ANSWER
PAGE NO. PAGE NO.
A. Internal Control & Weaknesses
Internal Controls – Cash & bank
1 EFAF Foundation – Summer 2014 Q6 6 81
2 Beta Construction Ltd – Summer 2010 Q6 6 82
3 Granger – Q41 7 83
Internal Controls – Inventory, Assets
4 READ Computers – Q94 8 85
5 Shahzad Limited – Q61 8 86
6 Rentals Limited – Winter 2015 Q4a 9 86
7 Elm Ltd 9 87
8 Jhelum Machinery (Private) Limited 9 87
Internal Controls – Sales & Receivable / Fraud
9 Iceberg Publishing – Q89 10 87
10 HAGM – Q41 10 88
11 Naveed Limited - Summer 2017 Q6b 11 90
12 Zubair & Shahid Limited 11 90
Internal Controls – Payroll
13 Waheed Engineering – Q62 12 91
Internal Controls – Others
14 Lahore Communications – Q71 13 92
15 Vision Limited – Q52 14 94
16 Internal Control 14 94
17 Speedy Shifters Plc 14 95
18 Audit Committees 15 96
B. Reporting Area
Audit Execution & Reporting Questions
19 Pulp – (IAS 24, ISA 550) 15 96
20 Aspersion (ISA 550, IAS 16, IAS 12) 16 97
21 Visean (IAS 36, 38, 37, IFRS 2) 17 100
22 Siegler (IAS 20, IAS 37, IAS 40) 18 104
23 Eagle Energy (IAS 38, IAS 20, IAS 37, IAS 16) 19 107
24 Keffler (IAS 38, IAS 37, IAS 16) 20 109
25 Harvard (IAS 38, IAS 37, IAS 10, IFRS 2) 21 111
26 Albreda (IFRS 5, IAS 37, IAS 10, IAS 16) 22 113
27 Seymour (IAS 38, IFRS 5, IAS 16) 23 116
28 Grape (IAS 16, IAS 2, IAS 37) 24 117
29 Poppy (IAS 40) 25 121
30 Clooney (IAS 10, IAS 36, IAS 37) 25 123
31 Lychee (IAS 10, IAS 37) 26 125
32 Axis & Co (IAS 8, ISA 720) 27 126
33 Bertie & Co (IFRS 5, IAS 8, IAS 37) 28 127
34 Indigo 29 129
Facilitator: Hasnain R. Badami, ACA Page |2

S. NO DESCRIPTION SOURCE QUESTION ANSWER
PAGE NO. PAGE NO.
Audit
34 Procedures
Indigo (ISA 510, IAS 2) ACCA 29 133
35 Pembroke Ltd 30 132
36 Efron & Co 31 132
37 Buzzwell Ltd 32 133
38 Turbo Ltd 33 133
39 Airedale Ltd 33 134
40 Kovash Ltd 34 135
41 Frazil (IAS 38) 35 136
42 Stokey – Q97 (ISA 560) 35 137
43 Sunshine – Q96 (Reporting on different matters) 36 138
44 Eddie Electronics – Q90 (ISA 580) 37 141
45 Barnet Removals – Q51 (Drafting MR; ISA 580) 37 142
46 Mubashir Limited – Q81 (ISA 550) 38 144
47 Steel Limited – Q73 (Reporting on interim FS) 38 145
48 Pendulum – Q60 (Two matters) 39 146
49 Nibbles – Q59 (Using IA work) 40 147
50 Herald PLC – Q62 (ISA 600 & Consolidation) 40 149
51 The Cinnamon Group – Q55 (ISA 600) 40 151
52 Saturn Holdings – Q56 (Planning ISA 600) 41 152
53 Flint Plc 42 154
54 Rockwell & Co 44 155
55 Adder Group 45 156
56 Jugnu Limited – Q47 (ISA 510) 46 159
57 Day Pharma – Q44 46 160
58 Dreams Yachting and Marina – Q17 (ISA 240) 47 161
59 Orionthale – Q39 (Inventory) 47 164
60 Grobbelar – Q25 48 165
61 Sehat Pharmaceutical Limited – Q69 (Confirmation) 49 166
62 Zafar Technology Limited – Summer 2012 Q2 50 167
63 Paidar Tameerat Limited – Summer 2012 Q6 51 168
64 HBBL – Summer 2014 Q1 (IFRS 15) 51 169
65 Five Star – Summer 2014 Q4 52 169
66 Akhtar Autos – Summer 2015 Q4 52 170
67 National – Summer 2016 Q5 53 172
68 Bhit Gas – Winter 2012 Q3a 54 173
69 Karim Limited – Winter 2012 Q7 54 174
70 XYZ and Company - Winter 2013 Q7 55 175
71 Farley Ltd 55 177
72 Petrie 56 178
73 Johnston And Titman 57 179
74 Qasmi Steels Limited 57 180
75 Dilawar Paints Limited 58 181
76 Haali Limited 58 183
77 HELSINKI LIMITED 59 183

78 Diversified – Summer 2014 (IAS 24) 59 185
79 Dreams Limited – Summer 2015 60 186
80 Alpha – Summer 2017 (Currency Swap) 60 186
81 GMP – Winter 2017 (Good will) 61 187
82 Tofind Ltd 61 188
83 Fraud 61 188
84 Snowball Ltd 62 188
85 Soprano & Co 62 189
86 Ventnor Estates Ltd 63 189
87 Budgie Ltd 64 192
88 Brown Ltd 64 192
89 Kristoff Ltd 65 193
90 Redtail Ltd 66 194
91 Thurman Co 67 195
92 Boston Co 68 198
93 Malevich & Co 69 200
94 Raphael & Co 71 203
B. Audit Report Modifications
General Modifications
95 Regulatory body – Summer 2012 72 205
96 Blue Sky Limited – Q76 (Draft modification) 72 206
97 Naveed Limited - Summer 2017 73 206
98 Mars Limited 73 207
Key Audit Matters
99 Rose Limited – Winter 2017 Q5 74 208
100 Key Audit Matters 74 210
101 Pixel Limited 75 210
102 Voltage Limited 75 211
Audit Report Appraisal
103 Cinnabar Group 75 212
104 Beige Interiors 76 213
105 Asiasport 76 214
106 Cleeves 77 215
107 Zia Yaqoob & Company - Summer 2018 78 216
108 Javed Limited – Winter 2012 78 216
109 Rockwell & Co 79 217

PRACTICE QUESTIONS
_____________________________________________________________________________

PRACTICE QUESTION # 1
EFAF FOUNDATION – (ICAP SUMMER 2014 Q6)
Education for All Foundation (EFAF) is a large charity-based organization, engaged in providing
education to needy children, at a token fee of Rs. 100 per child. It receives donations for its activities
both in cash and through its bank accounts. The major expenditure relates to payment to teachers and
petty cash.
Required:
Briefly describe the key controls which you as an auditor expect to find in respect of receipts and
payments.
BETA CONSTRUCTION LTD – (ICAP SUMMER 2010 Q6)
Beta Construction Company Limited (BCCL) is involved in the construction of large buildings and
shopping plazas. The company commenced its business in 2004 by establishing an office in Karachi and
has grown rapidly. It currently has offices in five major cities of the country and as many as 25 projects
are in various stages of execution.
A substantial portion of the work is done through sub-contractors. Payment to subcontractors is based
on certificate of work completion which is issued by the supervisor in charge of each project. The
certificate is sent through email to the finance department. The payment is credited directly into the
bank accounts of the sub-contractors.
Recently, the management has discovered that the project supervisor of a large project had issued a
fraudulent work completion certificate. The preliminary investigation indicated that some other sub-
contractors have also been paid fraudulently in the past and the practice was ongoing for the past two
years.
The management of BCCL has asked your audit firm to conduct an investigation into the matter.
Your initial discussion with the client has revealed the following:
(i) For the past four years the external auditors of the company are Alpha & Co., Chartered
Accountants. They had issued unqualified audit reports for all those years and had not reported
any internal control weakness in their management letters.
(ii) Prior to approaching your firm, BCCL wanted to give this assignment to Alpha & Co.
However, they expressed their inability to undertake the investigation work.
Required:
(a) State the matters your firm should consider and the procedures that should be followed prior to
the acceptance of this assignment.
(07)
(b) State the basic objectives of the above investigation.
(03)
(c) Recommend the controls which the management should put in place, to avoid such frauds in
future.
(09)

GRANGER
Granger is a privately-owned incorporated business that operates a garage which repairs and services
motor vehicles. Most customers are required to pay by cash or cheque on collecting their vehicle. Credit
accounts are available to business customers, these customers sign the invoice on collection of the
vehicle and their business is billed monthly. Separate series of pre-numbered invoices are drawn up by
the foreman for cash sales and for credit sales. All customer accounts are maintained by the
receptionist. His duties include the following:
Cash sales
Collect cash or cheques from customers on collecting their vehicle.
At the end of the day, check the numerical sequence of cash sales invoices, add the
sales total and agree the total to the amount of cash and cheques received.
Record the total cash sales in the cash receipts book.
Credit sales
Obtain the customer's signature on the copy invoice of business account customers.
Enter the invoices in numerical sequence in the sales journal and post the customer's account in the
account’s receivable ledger.
Send monthly statements to credit account customers and follow up overdue accounts.
List the balances on the accounts receivable ledger at the end of the month and reconcile the total with
the control account in the general ledger.
Write off uncollectible balances to bad debts.
Cash receipts
Open the mail, extract cheques from credit account customers, record them in the cash receipts book
and post the accounts receivable ledger,
Make up the day's banking of cash (and cheques) from both cash and credit sales, prepare the deposit
slip and bank the cash (and cheques).
All other accounting duties are the responsibility of two further accounts clerks and all are subject to
supervision by the garage manager.
Required:
(a) (i) Explain why the functions assigned to the receptionist result in an inadequate segregation of
duties. Your explanation should identify misstatements that could occur and indicate how those duties
could be reassigned to other staff members. (8)
(ii) Identify other control procedures you would consider necessary to ensure the completeness of the
recorded cash receipts and accounts receivable. (4)
(b) As a member of the audit staff of the company's external auditors, you visit the garage and make a
count of cash on hand. You subsequently compare details of unbanked cash receipts that you counted
with the entry in the cash receipts boots for that date. Although the total in the cash receipts book is
the same, the amount of banknotes and coins is less and there is a cheque from a business customer
that you did not record.
(i) Explain the procedures to be followed in making a cash-count for audit purposes. (4)
(ii) Explain the irregularity that the discrepancy between the cash count and cash receipts book might
lead you to suspect, and describe how you would investigate the discrepancy. (4)
(Total: 20 marks)

READ COMPUTERS
Read Computers sells personal computers (PCs) to independent shops. You are the external auditor of
Read Computers. Your interim audit revealed the following issues:
1. The half year physical inventory count revealed that some PCs supposed to be in inventory were
missing and that other machines which had been returned by customers were in inventory but had
not been recorded as having been returned. A few of the missing PCs have been traced to directors
who borrowed them for use at home.
2. Two customers had been allowed to exceed their credit limits and new customers in the last year
had not been allocated credit limits.
Required:
Draft the section of your report to management dealing with the above weaknesses. Set out the
weaknesses, their implications and your recommendations for improvement.
SHAHZAD LIMITED
Your firm is the auditor of Shahzad Limited (SL), a listed company, which is a wholesaler of consumable
products. SL records its sale on delivery of goods and maintains up to date computerised inventory
records.
A full inventory count was conducted at the year end. The senior who attended the physical stocktaking
at the central warehouse has observed the following matters:
(i) The inventory count took place on January 1, 20X3 under the supervision of the Inventory
Controller. No movement of inventory took place on that day.
(ii) Four counting teams were formed. Each team comprised of two persons. The floor area was
allocated by the teams among themselves.
(iii) Each team was instructed by the Inventory Controller to remember which inventory had been
counted.
(iv) Pre-numbered count sheets were provided to the staff involved in the inventory count. The count
sheets showed the inventory ledger balances, to facilitate reconciliation.
(v) Old, slow-moving or already sold inventories were highlighted on the count sheets at the time of
counting.
(vi) Items not located on the pre-numbered inventory sheets were recorded on separate sheets which
were numbered by the staff.
(vii) At the end of the count, all inventories against which advances from customers had been received
were removed from the physical inventory on the instruction of the Inventory Controller.
Required:
Identify the weaknesses in the system of inventory count. Give appropriate explanations to support
your point of view. (9)
(Total: 18 marks)

RENTALS LIMITED – (ICAP WINTER 2015 Q.4a)
Rentals Limited (RL) is a real estate company engaged in the business of renting of office buildings and
shopping centres across the country. The investment properties are carried at fair value. The fair values
are determined by an internal valuer at the end of each reporting period.
Required:
Considering the inherent complexities involved in the determination of fair values of investment
properties, discuss the key controls that RL is expected to employ while carrying out the valuation
internally. (09)
ELM LTD
During the audit of Elm Ltd, a building contractor, you discovered that references were not always
obtained when new plumbers and electricians were employed.
Outline the possible consequences of this internal control deficiency and provide recommendations to
remedy this deficiency. (4 marks)
JHELUM MACHINERY PRIVATE LIMITED (ICAP DECEMBER 2013)
Jhelum Machinery (Private) Limited (JMPL) is engaged in the manufacture of customized machinery.
Recently a fraud has been discovered which was perpetrated by Salahuddin, the purchase manager.
Salahuddin was responsible for approving the suppliers after obtaining and evaluating the competitive
quotes and placement of orders. Final approval was made by the managing director.
Salahuddin had set up a private limited company Neelum (Private) Limited (NPL) in which his brother
and wife are directors. NPL supplies spare parts to JMPL. The fraud was committed with the help of
Karamat, a production supervisor and Farhan, the store keeper.
The supplies delivered by NPL contained a large proportion of damaged spare parts.
However, full payments were made to NPL as Farhan never raised any objections on the quality of
goods received. On the other hand, Karamat issued inflated consumption reports to cover significant
part of the damaged spare parts.
The fraud was discovered when Farhan went on leave due to illness. A review of inventory sheets
indicates that large quantities of spare parts are still lying in inventory.
Required:
Identify the control weaknesses in the above situation which may have enabled the perpetration of
fraud.

ICEBERG PUBLISHING
You are the manager in charge of the audit of Iceberg Publishing which publishes a number of specialist
monthly magazines. Most readers take out an annual subscription, which can commence in any month
of the year. The company’s revenue is made up of 40% from sales of magazines and 60% from
advertising revenue.
On review of the audit working papers, you have come across the following file note points:
1. Details of readers and their subscription renewal dates are stored on the computerised database.
The client has allowed routine database maintenance work to slip badly behind schedule. At the
final audit there is a backlog of new subscriptions and notification of cancelled subscriptions and
changes of addresses which have not been input onto the database.
2. The advertising manager has been under considerable pressure due to staff shortages in the
advertising department. In order to sell sufficient advertising space he has been offering a variety
of special deals to advertisers. The negotiations all take place over the phone and the manager
keeps notes of the conversations in his desk drawer. Towards the year end, the manager was so
busy that he had no time to send out the usual confirmation letters. The confirmation letters are
used as the basis for allocating advertising space.
Required:
Set out, in a manner suitable for inclusion in a report to management, the weaknesses arising from the
above, the consequences of those weaknesses and recommendations for improvement.
HAROON ART GALLERY AND MUSEUM (HAGM)
The Haroon Art Gallery and Museum (HAGM) is in the centre of a city that is popular with tourists.
About 65% of its income comes from admission fees and annual memberships, and about 30% of its
income comes from sponsorship of special exhibitions by companies. Most of the remaining income
comes from a small café and gift shop in the art gallery and museum.
Admission fees come from sales of tickets to daily visitors and from annual membership subscriptions
from ‘Friends of HAGM’ who are entitled to free entry to the art gallery and museum at any time.
Day tickets can be purchased by credit card in advance, by a telephone ‘hotline’ or at HAGM’s website
on the Internet. Alternatively, day tickets can be bought with cash or credit card at the ‘door’ on the day
of the visit. Reduced prices are available for children, students and individuals aged over 65, and there
are also special reduced-price ‘family tickets’ for two adults and two children.
Sponsorship arrangements are agreed up to 18 months in advance. Some corporate sponsors,

particularly transport companies (bus companies and railway companies) sell advertising to HAGM.
Facilitator: Hasnain R. Badami, ACA P a g e | 10

The management of HAGM have identified the following applicable risks that need careful attention.
They believe that these risks should be managed actively.
1. There is a failure to attract more visitors because of the poor condition of many of the paintings in
the art gallery and of the items in the museum. Paintings must be restored regularly because their
condition deteriorates.
HAGM has just one specialist restorer, who is unable to keep up with the required volume of work.
The management of HAGM recognise that investment in new items and the restoration of existing
items is inadequate, but blame the lack of income for the problem.
2. Some corporate sponsorship agreements may not be invoiced due to poor communication between
the sponsors, HAGM’s sponsorship managers and the accounts department of HAGM.
3. Some sponsorship agreements are not invoiced at their correct amount. This happens often when a
sponsor is also a company that provides advertising for HAGM. Normal practice is for these sponsors
to deduct their advertising charges from the amount they pay to HAGM in sponsorship. However,
the accounts department in HAGM are not given the details of these set-off arrangements.
4. Some of the cash received from day visitors at the door may be stolen (or lost, or used by
management for business expenses) and does not reach HAGM’s cashier.
5. The on-line booking system for buying tickets in advance on the HAGM website is not always
available because the website is ‘down’.
Required
(a) Describe appropriate internal controls to manage each of the applicable risks described above.
(b) Explain the financial statement risks that arise from each of these applicable risks.
NAVEED LIMITED – (ICAP SUMMER 2017 Q.6b)
The Board of Directors of an insurance company is very concerned about the increasing incidents of
fraud in verification of claims by the surveyors.
Required:
Suggest controls that should be implemented by the company for claim verification.
(05)
ZUBAIR & SHAHID LIMITED (ICAP SUMMER 2013 Q.5)
Zubair & Shahid Limited is a distributor of personal care products. Its sales manager had committed a
fraud by making sales to fictitious customers. Cheques received from various genuine customers were
credited to these fictitious accounts to keep their balances within reasonable limits. The sales manager
had the outstanding amounts, appearing against fictitious and genuine customers, written off by
convincing the sales director that those customers were unable to pay their remaining balances. A total
of 38 invoices amounting to Rs. 7.2 million were issued over a period of seven months. The fraud was
detected when the sales manager had left the company’s employment.
Required:
Identify the usual controls which may have been lacking in the aforementioned situation.
(06)

WAHEED ENGINEERING
Your firm is the external auditor of Waheed Engineering, a listed company, which has revenue of Rs100
million. The head office site includes the manufacturing unit, the accounting functions and main
administration. There are a number of sales offices in different parts of the country. Waheed
Engineering does not have an internal audit department.
At the interim audit you have been assigned to the audit of the wages system. This will involve
obtaining an understanding of the wages system, testing the controls and performing substantive
procedures in order to verify wages transactions.
The wages records are maintained on a computer and all the wages information is processed at the
head office. Some of the employees in the manufacturing unit are paid in cash, and all other employees
have their wages paid directly into their bank account.
Manufacturing employees are paid their wages a week in arrears. All other employees are paid at the
end of each week or month.
There is a personnel department which is independent of the wages department. The personnel
department maintain records of the employees, including their starting date, grade, current wage rate
and leaving date (if appropriate).
Previous years' audits have revealed frauds by wages department staff facilitated by weaknesses in
controls in the wages system. These frauds have included:
• paying employees after appointment but before they commenced work;
• paying employees after they have left; and
• paying fictitious employees.
A check of current controls in the wages system has revealed that the company has failed to instigate
controls to prevent these types of fraud recurring. So the audit programme requires extensive
substantive procedures to be carried out to ensure that recorded wages transactions have not been
misstated by similar frauds taking place in the current year.
The existence of employees at the head office site can be verified by physical inspection. From a cost
effectiveness point of view, only a small sample of sales offices will be visited. The audit manager has
asked you to consider the audit procedures you would carry out to obtain sufficient appropriate
evidence of the existence of employees at sales offices not visited by the audit staff.
The audit manager has explained that 'unclaimed wages' (in part (c) below) arise when manufacturing
employees are not present to collect their wages (when they are paid out in part (b)). The unclaimed
wage packets are given to the cashier who records their details in the unclaimed wages book and is
responsible for their custody. Any employee who has not received his/her wage packet at the pay-out
can obtain it from the cashier. You have ascertained that there is no system of checking the operation
of the unclaimed wages system by a person independent of the cashier and the wages department.
Required:
(a) Describe the normal controls you would expect to see in a wages system and explain their
purpose. (10)

(b) Describe how you would verify that employees are not paid before they commenced work for the
company. (5)
(c) Describe the audit procedures you would carry out in connection with attending a pay out of
wages in cash to manufacturing employees. (5)
(d) Describe the substantive procedures on transactions you would carry out on the unclaimed wages
system. (5)
(e) Describe the evidence you would obtain to verify the existence of employees whose wages are
paid directly into their bank account, including those at sales offices. (5)
(Total: 30 marks)
LAHORE COMMUNICATIONS
Lahore Communications operates via a head office and several branches. The company has a
mainframe computer at its head office, which is linked via a communications network to terminals at its
branches.
You are a manager at a firm which has been asked to carry out a systems reliability review over the
general controls operating in Lahore Communications’ computer system. Your initial work has identified
the following weaknesses:
1. There is no physical restriction at every site to the rooms in which the terminals are kept.
2. Staff can change passwords at their discretion.
3. In the computer room at the head office there are no fire extinguishers or air conditioning.
4. There is no formal disaster recovery plan.
5. Back-up media is held on site.
Required:
Identify the possible consequences of the above weaknesses and suggest recommendations to remedy
them, clearly describing how the control procedures should operate.

VISION LIMITED
Following IT related controls are being employed at Vision Limited:

(i) The general ledger system is automatically updated with sub-ledger transactions (e.g. Accounts
Receivable) every night through batch processing.
(ii) The system automatically maintains second copies of all programs and data files.
(iii) Access to programs and data files is restricted using passwords.
(iv) Invoices that are entered into the system are physically counted.
(v) Firewalls (software and hardware) are installed to restrict unauthorized access.
(vi) Screen warnings are displayed as regards incomplete processing.
(vii) Vision Limited has service level agreements with reliable software companies, for technical
support.
(viii) Review of output against expected values.
Required:
(a) In respect of each control, determine whether it is a preventive, detective or corrective control.
(b) Also classify each of the above between general IT controls and application controls.
INTERNAL CONTROL
The risk of management override of internal controls is present in all audited entities.
State three procedures that should be included in external audit plans to address this risk. (3 marks)
SPEEDY SHIFTERS PLC
You are responsible for the external audit of Speedy Shifters plc (Speedy), a haulage contractor
operating from a head office and 65 depots throughout the UK. During the external audit for the year
ended 30 November 2014, you identified the following significant internal control deficiencies:
(1) Speedy does not keep a list of approved suppliers from which to purchase replacement parts for
its fleet of trucks and vans.
(2) Speedy does not have a business continuity plan to enable it to recover its management
information and finance systems quickly in the event of a systems failure.
(3) Drivers at some depots are regularly scheduled to exceed the legal limit for driving hours, because
of a shortage of drivers.
(4) The audit committee has not complied with its own terms of reference which require it to:
• approve annual plans of work to be undertaken by the internal audit function; and
• monitor the effectiveness of the internal audit function through the use of performance
measures.

Requirement:
Draft points for inclusion in your firm’s report to those charged with governance and management at
Speedy. For each internal control deficiency identified above, you should outline the possible
consequence(s) of the deficiency and provide recommendation(s) to address each deficiency.
You should present your answer in a two-column format using the headings:
(i) Consequences; and
(ii) Recommendations. (14 marks)
AUDIT COMMITTEES
Audit committees are responsible for monitoring the quality of the work of an internal audit function
within an audited entity. One of the ways this can be achieved is by the use of agreed performance
indicators.
List three performance indicators which could be used by audit committees to monitor the quality of an
internal audit function. (3
marks)
PULP – (LONG OUTSTANDING RECEIVABLE) 31
mins
You are an audit manager responsible for providing hot reviews on selected audit clients within your
firm of Chartered Certified Accountants. You are currently reviewing the audit working papers for Pulp
Co, a long standing audit client, for the year ending 31 January 2008. The draft statement of financial
position of Pulp Co shows total assets of $12 million (2007 - $11.5 million). The audit senior has made
the following comment in a summary of issues for your review:
‘Pulp Co’ statement of financial position shows a receivable classified as a current asset with a value of
$25,000. The only audit evidence we have requested and obtained is a written representation from
management stating the following:
(i) that the amount is owed the Pulp Co from Jarvis Co,
(ii) that Jarvis Co is controlled by Pulp Co’s chairman, Peter Sheffield, and
(iii) that the balance is likely to be received six months after Pulp Co’s year-end.
The receivable was also outstanding at the last year-end when an identical written representation was
provided, and our working papers noted that because the balance was immaterial no further work was
considered necessary.
No disclosure has been made in the financial statements regarding the balance. Jarvis Co is not audited
by our firm and we have verified that Pulp Co does not own any shares in Jarvis Co.’
Required:
(a) in relation to the receivable recognised on the statement of financial position of Pulp Co as at 31
January 2008:
(i) comment on the matters you should consider. (5 marks)
(ii) recommend further audit procedures that should be carried out. (4 marks)

ASPERSION 36 mins
You are the manager responsible for the audit of Aspersion, a limited liability company, which mainly
provides national cargo services with a small fleet of aircraft. The draft accounts for the year ended 30
September 2008 show profit before taxation of $2.7 million (2007 - $2.2 million) and total assets of
$10.4 million (2007 - $9.8 million).
The following issues are outstanding and have been left for your attention.
(a) The sale of a cargo carrier to Abra, a private limited company, during the year resulted in a loss on
disposal of $400,000. The aircraft cost $1.2 million when it was purchased in September 1999 and
was being depreciated on a straight-line basis over 20 years. The minutes of the board meeting at
which the sale was approved record that Aspersion’s finance director, lain Jolteon, has a 30%
equity interest in Abra. (7 marks)
(b) As well as cargo carriers, Aspersion owns two light aircraft which were purchased in 2005 to
provide business passenger flights to a small island under a three year service contract. It is now
known that the contract will not be renewed when it expires at the end of March 2009. The
aircraft, which cost $450,000 each, are being depreciated over fifteen years. (7 marks)
(c) Deferred tax amounting to $570,000 as at 30 September 2008 has been calculated relating to
accelerated capital allowances at a tax rate of 30% under the full provision method (IAS 12
Income taxes). In a budget statement in October 2008, the government announced an increase in
the corporation tax rate to 34%. The directors are proposing to adjust the draft accounts for the
further liability arising. (6 marks)
Required:
For each of the above points:
(i) Comment on the matters that you should consider; and
(ii) State the audit evidence that you should expect to find in undertaking your review of the audit
working papers and financial statements of Aspersion.
(Total = 20
marks)
Note: The mark allocation is shown against each of the three issues. Assume that it is 11 December
2008.

VISEAN 36 mins
You are the manager responsible for the audit of Visean, a limited liability company, which
manufacturers health and beauty products and distributes them through a chain of 72 retail
pharmacies. The draft accounts for the year ended 30 June 2008 show operating profit before taxation
of $1.83 million (2007 - $1.24 million) and total assets $18.4 million (2007 - $12.7 million).
The following issues are outstanding and have been left for your attention:
(a) Visean owns nine brand names of fragrances use for ranges of products (e.g. perfumes, bath oils,
soaps, etc), four of which were purchased and five self-created. Purchased brands are recognised
as an intangible asset at cost amounting to $589,000 and amortised on a straight-line basis over
10 years. The costs of generating self-created brands and maintaining existing ones are
recognised as an expense when incurred. Demand for products of one of the purchased
fragrances, ‘Ulexite’, fell significantly in July 2008 after a marketing campaign in June caused
offence to customers.
(8 marks)
(b) In June 2008 the directors announced plans to discontinue the range of medical consumables
supplied to hospital pharmacies. The factory manufacturing these products closed in July 2008. A
provision of $800,000 has been made as at 30 June 2008 for the compensation of redundant
employees and a further $450,000 for the three years unexpired lease term on the factory
premises. (7 marks)
(c) Historically the company’s statement of cash flows has reported net cash flows from operating
activities under the ‘indirect method’. However, the statement of cash flow for the year ended 30
June 2008 reports net cash flows under the ‘direct method’ and the corresponding figures have
been restated. (5 marks)
Required:
For each of the above issues:
(i) Comment on the matters that you should consider
working papers and financial statements of Visean.
Note. The mark allocation is shown against each of the three issues. Assume it is 11 December 2008.
(Total = 20 marks)

SIEGLER 36 MINS
You are the manager responsible for the audit of Siegler, a limited liability company. Siegler develops
products and technologies for the life industry. The draft accounts for the year ended 30 June 2008
show profit before taxation of $4.6 million (2007 - $4.2 million) and total assets $46.3 million (2007 -
$41.7 million).
The following issues are outstanding and have been left for your attention:
(i) A government grant of $800,000 was received in May 2008 to assist in operating a new pilot
plant that will use Siegler’s patented bio-technology. The amount of the grant has been deducted
from bio-technology development costs are included in intangible assets with a carrying value of
$4.5 million. In October 2008, Siegler’s order for specialist equipment, which was to have been
used in the pilot plant, was cancelled. A recent board minute shows that the company’s research
activities are to be focused on a new ‘smart-drug’ technology.
(8 marks)
(ii) Siegler closed and demolished one of its laboratories four years ago. The land on which it stood
has not been used since and is carried at a cost of $72,000. Results of tests by the local water
authority published in July 2008 show that the site is contaminated with hexavalent chromium,
which is known to be toxic. Although there is currently no legislation requiring Siegler to clean up
the site, a provision for $1 million has been made in the financial statements for the year ended
30 June 2008. (6 marks)
(iii) Siegler owns two properties as well as its laboratories, production facilities and head office. One
property is a residential apartment block and the other an office block. The apartments are leased
out on an annual basis and are currently fully let. However, many of the offices are vacant and
available for let on monthly as well as annual terms. On 30 June 2008, the apartment block was
valued at an open market value that was $3.3 m in excess of its carrying amount under the
benchmark treatment of IAS 16 Property, plant and equipment (i.e. at cost less accumulated
depreciation). This excess has been credited to a revaluation reserve.
(6 marks)
Required:
(a) Comment on the matters that you should consider
(b) State the audit evidence that you should expect to find, in undertaking your review of the audit
working papers and financial statements of Siegler.
(Total = 20 marks)

EAGLE ENERGY 36
mins
You are the manager responsible for the audit of Eagle Energy, an energy generation company. The
draft financial statements for the year ended 30 September 2008 show revenue of $287 million (2007 -
$262 million), profit before taxation of $7.2 million (2007 - $23 million) and total assets of $242 million
(2007 - $221 million).
The following issues arising during the final audit have been noted on a schedule of points for your
attention:
(a) During the year Eagle Energy put its technical staff through a new training program. On the basis
that this expenditure has been incurred for the purpose of generating future economic benefits
the chief executive is adamant that the costs, amounting to $4.3 million, be capitalised as an
intangible asset. (7 marks)
(b) During the year Eagle Energy assembles a laboratory on land which had been granted to it for 25
years, by the local authority, in 1999. Under the terms of the grant the laboratory must be
dismantled and the site decontaminated when the grant term expires. This is expected to cost
$18 million in 2024 and an annual provision of $1.2 million is being made.
(7 marks)
(c) Eagle Energy receives significant funding from government sources and is required to report,
monthly, on its financial performance and position. Every month end a journal entry is made,
‘Debit Sundry 1 account/Credit Sundry 2 account’. There is no narrative but the chief accountant
explained that the journal is approved by the chief executive to ensure that reported debt ratios
stay within government specified limits. The entries are then reversed at the beginning of the
following month. The net movement on these accounts over the year to 30 September 2008 was
$0.3 million.
(6 marks)
Required:
(ii) State the audit evidence that you should expect to find in undertaking you review of the audit
working papers and financial statements of Eagle Energy for the year ended 30 September 2008.
(Total = 20 marks)

KEFFLER 36 mins
You are the manager responsible for the audit of Keffler Co, a private limited company engaged in the
manufacture of plastic products. The draft financial statements for the year ended 30 September 2008
show revenue of $47.4 million (2007 - $43.9 million), profit before taxation of $2 million (2007 - $2.4
million) and total assets of $33.8 million (2007 - $25.7 million).
attention:
(a) In October 2007, Keffler bought the right to use a landfill site for a period of 15 years for $1.1
million. Keffler expects that the amount of waste that it will need to dump will increase annually
and that the site will be completely filled after just ten years. Keffler has charged the following
amounts to the statement of comprehensive income for the year to 30 September 2008:
• $20,000 license amortization calculated on a sum-of-digits basis to increase the charge over
the useful life of the site; and
• $100,000 annual provision for restoring the land in 15 years’ time.
(9 marks)
(b) A sale of industrial equipment to Deakin Co in November 2007 resulted in a loss on disposal of
$0.3 million that has been separately disclosed in the statement of comprehensive income. The
equipment cost $1.2 million when it was purchased in October 1998 and was being depreciated
on a straight-line basis over 20 years.
(6
marks)
(c) In October 2008, Keffler was banned by the local government from emptying waste water into a
river because the waster did not meet minimum standards of cleanliness. Keffler has made a
provision of $0.9 million for the technological upgrading of its water purifying process and
included $45,000 for the penalties imposed in ‘other provisions’.
(5 marks)
Required:
(ii) State the audit evidence that you should expect to find in undertaking you review of the audit
working papers and financial statements of Keffler Co for the year ended 30 September 2008.
(Total = 20 marks)

HARVARD 36 mins
Harvard, a company listed on a stock exchange, is a pharmaceutical company based in the south east of
England. The draft accounts for the year ended 30 September 2008 show profit before taxation of $5.4
million and total assets of $20.8 million. You are the audit manager and the senior on the audit has
brought the following items to your attention:
(a) During the year ended 30 September 2008 Harvard spent $800,000 on researching the
relationship between two chemicals. As a result of the research, Harvard identified a new vaccine
for the prevention of smallpox and has made substantial progress in the development of the
vaccine. During the year ended 30 September 2008 $1.5 million has been spent on project
‘Chicken Run’. The directors of Harvard have capitalised the costs of $1.5 million as an intangible
non-current asset. (8 marks)
(b) On 31 August 2007 Harvard received notification from its lawyers of a claim from users of a new
type of Hayfever capsule. At 30 September 2007 neither the likelihood of the success of the claim
nor the amount were known and as a result no provision was made in the accounts for the year
ended 30 September 2007. As at 30 September 2008 the case is still in progress but eh lawyers
now advise Harvard that the amount of the claim is an estimated $2.0 million and that the
claimants are very likely to be successful in court.
(7 marks)
(c) During the year an executive share option scheme has been set up with all directors being
granted options on 31 March 2011 subject to the directors still being employed by Harvard at that
date. (5 marks)
Required:
For each of the above points:
(ii) State the audit tests that will need to be performed prior to your meeting with the audit partner
next week.
(Total = 20 marks)

ALBREDA 36 mins
You are the manager responsible for the audit of Albreda Co, and its subsidiaries. The group mainly
operates a chain of national restaurants and provides vending and other catering services to corporate
clients. All restaurants offer ‘eat-in’, ‘take-away’ and ‘home delivery’ services. The draft consolidated
financial statements for the year ended 30 September 2008 show revenue of $42.2 million (2007 -
$41.8 million), profit before taxation of $1.8 million (2007 - $2.2 million) and total assets of $30.7
million (2007 - $23.4 million).
attention:
(a) In September 2008 the management board announced plans to cease offering ‘home delivery’
services from the end of the month. These sales amounted to $0.6 million for the year to 30
September 2008 (2007 - $0.8 million). A provision of $0.2 million has been made as at 30
September 2008 for the compensation of redundant employees (mainly drivers). Delivery vehicles
have been classified as non-current assets held for sale as at 30 September 2008 and measured at
fair value less costs to sell, $0.8 million (carrying amount, $0.5 million).
(8 marks)
(b) Historically, all owned premises have been measured at cost depreciated over 10 to 50 years. The
management board has decided to revalue these premises for the year ended 30 September
2008. At the end of the reporting two properties had been revalued by a total of $1.7 million.
Another 15 property have since been revalued by $5.4 million and there remain a further three
properties which are expected to be revalued during 2009. A revaluation surplus of $7.1 million
has been credited to equity.
(7 marks)
(c) During the year Albreda paid $0.1 million (2007 - $0.3 million) in fines and penalties relating to
breaches of health and safety regulations. These amounts have not been separately disclosed but
included in cost of sales.
(5 marks)
Required:
working papers and financial statement of Albreda Co for the year ended 30 September 2008.
(Total = 20 marks)

SEYMOUR 36 mins
You are the manager responsible for the audit of Seymour Co. The company offers information,
proprietary foods and medical innovations designed to improve the quality of life. (Proprietary foods
are marketed under the protected by registered names.) The draft consolidated financial statements for
the year ended 30 September 2008 show revenue of $74.4 million (2007 - $69.2 million), profit before
taxation of $13.2 million (2007 - $15.8 million) and total assets of $53.3 million (2007 - $40.5 million).
attention:
(a) In 2003, Seymour had been awarded a 20-year patent on a new drug. Tournose, that was also
approved for food use. The drug had been developed at a cost of $4 million which is being
amortised over the life of the patent. The patent cost $11,600. In September 2008 a competition
announced the successful completion of preliminary trials on an alternative drug with the same
beneficial properties as Tournose. The alternative drug is expected to be readily available in two
years’ time.
(7 marks)
(b) Seymour offers health-related information services through a wholly-owned subsidiary, Aragon
Co. Goodwill of $1.8 million recognised on the purchase of Aragon in October 2006 is not
amortised but included at cost in the consolidated statement of financial position. At 30
September 2008 Seymour’s investment in Aragon is shown at cost, $4.5 million, in its separate
financial statements.
Aragon’s draft financial statements for the year ended 30 September 2008 show a loss before
taxation of $0.6 million (2007 - $0.5 million) and total assets of $4.9 million (2007 - $5.7 million).
The notes to Aragon’s financial statements disclose that they have been prepared on a going
concern basis that assumes that Seymour will continue to provide financial support.
(7 marks)
(c) In November 2008 Seymour announced the recall and discontinuation of a range of petcare
products. The product recall was prompted by the high level of customer returns due to claims of
poor quality. For the year to 30 September 2008, the product range represented $8.9 million of
consolidated revenue (2007 - $9.6 million) and $1.3 million loss before tax (2007 - $0.4 million
profit before tax). The results of the ‘petcare’ operations are disclosed separately in the
statement of comprehensive income.
(6 marks)
Required:
(i) Comment on the matters that you should consider; and
working papers and financial statement of Seymour Co for the year ended 30 September 2008.
Note. The mark allocation is shown against each of the three issues.
(Total = 20 marks)

GRAPE 65 mins
You are a manager in Grape & Co, a firm of Chartered Certified Accountants. You have been temporarily
assigned as audit manager to the audit of Banana Co, because the engagement manager has been taken
ill. The final audit of Banana Co for the year ended 30 September 20X9 is nearing completion, and you
are now reviewing the audit files and discussing the audit with the junior members of the audit team.
Banana Co designs and manufactures equipment such as cranes and scaffolding, which are used in the
construction industry. The equipment usually follows a standard design, but sometimes Banana Co
designs specific items for customers according to contractually agreed specifications. The draft financial
statements show revenue of $12.5 million, net profit of $400,000, and total assets of $78 million.
The following information has come to your attention during your review of the audit files: During the
year, a new range of manufacturing plant was introduced to the factories operated by Banana Co. All
factory employees received training from an external training firm on how to safely operate the
machinery, at a total cost of $500,000. The training costs have been capitalised into the cost of the new
machinery, as the finance director argues that the training is necessary in order for the machinery to
generate an economic benefit. After the year end, Cherry Co, a major customer with whom Banana Co
has several significant contracts, announced its insolvency, and that procedures to shut down the
company had commenced. The administrators of Cherry Co have suggested that the company may be
able to pay approximately 25% of the amounts owed to its trade payables (creditors). A trade receivable
of $300,000 is recognised on Banana Co's statement of financial position in respect of this customer.
In addition, one of the junior members of the audit team voiced concerns over how the audit had been
managed. The junior said the following:
'I have only worked on two audits prior to being assigned the audit team of Banana Co. I was expecting
to attend a meeting at the start of the audit, where the partner and other senior members of the audit
team discussed the audit, but no meeting was held. In addition, the audit manager has been away on
holiday for three weeks, and left a senior in charge. However, the senior was busy with other
assignments, so was not always available.
I was given the task of auditing the goodwill which arose on an acquisition made during the year. I also
worked on the audit of inventory, and attended the inventory count, which was quite complicated, as
Banana Co has a lot of work-in-progress. I tried to be as useful as possible during the count, and helped
the client's staff count some of the raw materials. As I had been to the inventory count, I was asked by
the audit senior to challenge the finance director regarding the adequacy of the provision against
inventory, which the senior felt was significantly understated.
Lastly, we found that we were running out of time to complete our audit procedures. The audit senior
advised that we should reduce the sample sizes used in our tests as a way of saving time. He also
suggested that if we picked an item as part of our sample for which it would be time consuming to find
the relevant evidence, then we should pick a different item which would be quicker to audit.'

Required:
In respect of the specific information provided:
(a) Comment on the matters to be considered, and explain the audit evidence you should expect to
find during your file review in respect of:
(i) The training costs that have been capitalised into the cost of the new machinery; and
(ii) The trade receivable recognised in relation to Cherry Co. (12 marks)
(b) Evaluate the audit junior's concerns regarding the management of the audit of Banana Co.
(10 marks)
POPPY
You are the manager responsible for the audit of Poppy Co, a manufacturing company with a year
ended 31 October 20X8. In the last year, several investment properties have been purchased to utilise
surplus funds and to provide rental income. The properties have been revalued at the year end in
accordance with IAS 40 Investment Property, they are recognised on the statement of financial position
at a fair value of $8 million, and the total assets of Poppy Co are $160 million at 31 October 20X8. An
external valuer has been used to provide the fair value for each property.
Required:
(i) Recommend the enquiries to be made in respect of the external valuer, before placing any reliance
on their work, and explain the reason for the enquiries; (7 marks)
(ii) Identify and explain the principal audit procedures to be performed on the valuation of the
investment properties. (6 marks)
CLOONEY 36 mins
Clooney Co is one of the world's leading leisure travel providers, operating under several brand names
to sell package holidays. The company catered for more than 10 million customers in the last 12
months. Draft figures for the year ended 30 September 2010 show revenue of $3,200 million, profit
before tax of $150 million, and total assets of $4,100 million. Clooney Co's executives earn a bonus
based on the profit before tax of the company.
You are the manager responsible for the audit of Clooney Co. The final audit is nearing completion, and
the following points have been noted by the audit senior for your attention:
In July 2010, thousands of holiday-makers were left stranded abroad after the company operating the
main airline chartered by Clooney Co went into liquidation. The holiday-makers were forced to wait an
average of two weeks before they could be returned home using an alternative airline. They have
formed a group which is claiming compensation for the time they were forced to spend abroad, with
the total claim amounting to $20 million. The items which the group is claiming compensation for
include accommodation and subsistence costs, lost income and distress caused by the situation. The
claim has not been recognised or disclosed in the draft financial statements, as management argues
that the full amount payable will be covered by Clooney Co's insurance.
One part of the company's activities, operating under the Shelly's Cruises brand, provides cruise
holidays. Due to economic recession, the revenue of the Shelly's Cruises business segment has fallen by
25% this year, and profit before tax has fallen by 35%. Shelly's Cruises contributed $640 million to total
revenue in the year to 30 September 2010, and has identifiable assets of $235 million, including several
large cruise liners. The Shelly's Cruises brand is not recognised as an intangible asset, as it has been
internally generated.
On 15 November 2010, Clooney Co acquired Craig Co, a company offering adventure holidays for
independent travellers. Craig Co represents a significant acquisition but this has not been referred to in
the financial statements.
Required:
Comment on the matters that you should consider, and state the audit evidence you should expect to
find in your review of the audit working papers for the year ended September 2010 in respect of:
(a) The compensation claim, (8 marks)
(b) Shelly's Cruises, and (7 marks)
(c) The acquisition of Craig Co. (5 marks)
(Total = 20 marks)
LYCHEE 29 mins
You are the manager responsible for the audit of Lychee Co, a manufacturing company with a year
ended 30 September 20X9. The audit work has been completed and reviewed and you are due to issue
the auditor's report in three days. The draft audit opinion is unmodified. The financial statements show
revenue for the year ended 30 September 20X9 of $15 million, net profit of $3 million, and total assets
at the year end are $80 million.
The finance director of Lychee Co telephoned you this morning to tell you about the announcement
yesterday, of a significant restructuring of Lychee Co, which will take place over the next six months.
The restructuring will involve the closure of a factory, and its relocation to another part of the country.
There will be some redundancies and the estimated cost of closure is $250,000. The financial
statements have not been amended in respect of this matter.
Required:
In respect of the announcement of the restructuring:
(i) Comment on the financial reporting implications, and advise the further audit procedures to be
performed; and (6 marks)
(ii) Recommend the actions to be taken by the auditor if the financial statements are not amended.
(4 marks)
(Total = 16 marks)

AXIS & CO 36 mins
You are the manager responsible for four audit clients of Axis & Co, a firm of Chartered Certified
Accountants. The year end in each case is 30 June 20X8.
You are currently reviewing the audit working paper files and the audit seniors' recommendations for
the auditor's reports. Details are as follows:
(a) Mantis Co is a subsidiary of Cube Co. Serious going concern problems have been noted during this
year's audit. Mantis will be unable to trade for the foreseeable future unless it continues to
receive financial support from the parent company. Mantis has received a letter of support
('comfort letter') from Cube Co.
The audit senior has suggested that, due to the seriousness of the situation, the audit opinion
must at least be qualified 'except for'. (5 marks)
(b) Lorenze Co has changed its accounting policy for goodwill during the year from amortisation over
its estimated useful life to annual impairment testing. No disclosure of this change has been given
in the financial statements. The carrying amount of goodwill in the statement of financial position
as at 30 June 20X8 is the same as at 30 June 20X7 as management's impairment test shows that it
is not impaired.
The audit senior has concluded that a qualification is not required but suggests that attention can
be drawn to the change by way of an emphasis of matter paragraph. (6 marks)
(c) The directors' report of Abrupt Co states that investment property rental forms a major part of
revenue. However, a note to the financial statements shows that property rental represents only
1.6% of total revenue for the year. The audit senior is satisfied that the revenue figures are
correct.
The audit senior has noted that an unmodified opinion should be given as the audit opinion does
not extend to the directors' report. (4 marks)
(d) Audit work on the after-date bank transactions of Jingle Co has identified a transfer of cash from
Bell Co. The audit senior assigned to the audit of Jingle has documented that Jingle's finance
director explained that Bell commenced trading on 7 July 20X8, after being set up as a wholly-
owned foreign subsidiary of Jingle.
The audit senior has noted that although no other evidence has been obtained an unmodified
opinion is appropriate because the matter does not impact on the current year's financial
statements. (5 marks)
Required:
For each situation, comment on the suitability or otherwise of the audit senior's proposals for the
auditor's reports. Where you disagree, indicate what audit modification (if any) should be given instead.
Note. The mark allocation is shown against each of the four issues.
(Total = 20 marks)

BERTIE & CO 36 mins
You are the audit manager for three clients of Bertie & Co, a firm of Chartered Certified Accountants.
The financial year end for each client is 30 September 20X8.
You are reviewing the audit senior's proposed auditor's reports for two clients, Alpha Co and Deema Co.
Alpha Co. a listed company, permanently closed several factories in May 20X8, with all costs of closure
finalised and paid in August 20X8. The factories all produced the same item, which contributed 10% of
Alpha Co's total revenue for the year ended 30 September 20X8 (20X7 - 23%). The closure has been
discussed accurately and fully in the chairman's statement and Directors' Report. However, the closure
is not mentioned in the notes to the financial statements, nor separately disclosed on the financial
statements.
The audit senior has proposed an unmodified audit opinion for Alpha Co as the matter has been fully
addressed in the chairman's statement and Directors' Report.
In October 20X8 a legal claim was filed against Deema Co, a retailer of toys. The claim is from a
customer who slipped on a greasy step outside one of the retail outlets. The matter has been fully
disclosed as a material contingent liability in the notes to the financial statements, and audit working
papers provide sufficient evidence that no provision is necessary as Deema Co's legal counsel has stated
in writing that the likelihood of the claim succeeding is only possible. The amount of the claim is fixed
and is adequately covered by cash resources.
The audit senior proposes that the audit opinion for Deema Co should not be qualified, but that an
emphasis of matter paragraph should be included after the audit opinion to highlight the situation.
Hugh Co was incorporated in October 20X7, using a bank loan for finance. Revenue for the first year of
trading is $750,000, and there are hopes of rapid growth in the next few years. The business retails
luxury handmade wooden toys, currently in a single retail outlet. The two directors (who also own all of
the shares in Hugh Co) are aware that due to the small size of the company, the financial statements do
not have to be subject to annual external audit, but they are unsure whether there would be any
benefit in a voluntary audit of the first year financial statements. The directors are also aware that a
review of the financial statements could be performed as an alternative to a full audit. Hugh Co
currently employs a part-time, part-qualified accountant, Monty Parkes, who has prepared a year-end
statement of financial position and statement of comprehensive income, and who produces summary
management accounts every three months.
Required:
(a) Evaluate whether the audit senior's proposed auditor's report is appropriate, and where you
disagree with the proposed report, recommend the amendment necessary to the auditor's report
of:
(i) Alpha Co; (6 marks)
(ii) Deema Co. (4 marks)
(b) Describe the potential benefits for Hugh Co in choosing to have a financial statement audit. (4 marks)
(c) With specific reference to Hugh Co, discuss the objective of a review engagement and contrast
the level of assurance provided with that provided in an audit of financial statements. (6 marks)

INDIGO 47 mins
Your firm was appointed as auditor to Indigo Co, an iron and steel corporation, in September 20X8. You
are the manager in charge of the audit of the financial statements of Indigo, for the year ending 31
December 20X8.
Indigo owns office buildings, a workshop and a substantial stockyard on land that was leased in 20W6
for 25 years. Day-to-day operations are managed by the chief accountant, purchasing manager and
workshop supervisor who report to the managing director.
All iron, steel and other metals are purchased for cash at 'scrap' prices determined by the purchasing
manager. Scrap metal is mostly high volume. A weighbridge at the entrance to the stockyard weighs
trucks and vans before and after the scrap metals that they carry are unloaded into the stockyard.
Two furnaces in the workshop melt down the salvageable scrap metal into blocks the size of small bricks
that are then stored in the workshop. These are sold on both credit and cash terms. The furnaces are
now 10 years old and have an estimated useful life of a further 15 years. However, the furnace linings
are replaced every four years. An annual provision is made for 25% of the estimated cost of the next
relining. A by-product of the operation of the furnaces is the production of 'clinker'. Most of this is sold,
for cash, for road surfacing but some is illegally dumped.
Indigo's operations are subsidised by the local authority as their existence encourages recycling and
means that there is less dumping of metal items. Indigo receives a subsidy calculated at 15% of the
market value of metals purchased, as declared in a quarterly return. The return for the quarter to 31
December 20X8 is due to be submitted on 21 January 20X9.
Indigo maintains manual inventory records by metal and estimated quality. Indigo counted inventory at
30 November 20X8 with the intention of 'rolling-forward' the purchasing manager's valuation as at that
date to the year-end quantities per the manual records. However, you were not aware of this until you
visited Indigo yesterday to plan your year-end procedures.
During yesterday's tour of Indigo's premises you saw that:

(i) sheets of aluminum were strewn across fields adjacent to the stockyard after a storm blew them
away;
(ii) much of the vast quantity of iron piled up in the stockyard is rusty;
(iii) piles of copper and brass, that can be distinguished with a simple acid test, have been mixed up.
The count sheets show that metal quantities have increased, on average, by a third since last year; the
quantity of aluminum, however, is shown to be three times more. There is no suitably qualified
metallurgical expert to value inventory in the region in which Indigo operates.
The chief accountant disappeared on 1 December, taking the cash book and cash from three days' sales
with him. The cash book was last posted to the general ledger as at 31 October 20X8. The managing
director has made an allegation of fraud against the chief accountant to the police.
The auditor's report on the financial statements for the year ended 31 December 20X7 was unmodified.

Required:
(a) Describe the principal audit procedures to be carried out on the opening balances of the financial
statements of Indigo Co for the year ending 31 December 20X8. (6 marks)
(b) Using the information provided, state the risks of material misstatement arising and justify an
appropriate audit approach for Indigo Co for the year ending 31 December 20X8. (14 marks)
(c) Comment on t e matters to be considered in seeking to determine the extent of Indigo Co's
financial loss resulting from the alleged fraud. (6 marks)
PEMBROKE LTD
Described below are situations which have arisen at two unrelated external audit clients of your firm.
The year end in each case is 30 September 2010.
Pembroke Ltd (Pembroke)

The management of Pembroke has refused to provide written representations that:
- it has fulfilled its responsibility for the preparation of the financial statements in accordance with
the applicable financial reporting framework;
- it has provided the auditor with all relevant information and access as agreed in the terms of
engagement; and
- all transactions have been recorded and are reflected in the financial statements.
Snowdonia Ltd (Snowdonia)

On 12 October 2010, Snowdonia received an invoice for equipment costing £2.4 million which has an
estimated useful life of five years. The equipment was installed and brought into use on 1 September
2010. The invoice was dated 8 October 2010 and had been posted to the ledger accounts as an October
2010 transaction. It has not been included in the financial statements for the year ended 30 September
2010. The directors of Snowdonia have refused to amend the financial statements in respect of this
matter.
The draft financial statements for the year ended 30 September 2010 show profit before tax of
£750,000 and total assets of £16.5 million.
Requirement:
In each of the two situations outlined above, state whether you would modify the audit opinion. Give
reasons for your conclusions and describe the modification(s), if any, to each audit report.
(10 marks)

EFRON & CO
Described below are two situations that have arisen concerning unrelated clients of Efron & Co, an
audit and assurance firm. Zac Hudgen has worked at Efron & Co for six months and is involved in work
for both clients. The year end in each case is 30 June 2009.
(1) Mckessie plc

Mckessie plc (Mckessie) is considering acquiring all of the shares in Wild Ltd (Wild). The directors of
Mckessie have appointed Efron & Co to undertake a review engagement. The terms of the
engagement require Efron & Co to review Wild's financial statements, for the year ended 30 June
2009, for any material misstatements and provide a report, to the directors of Mckessie, expressing
the firm's conclusion.
Wild is a small company and is not required to have a statutory audit. In performing the review,
Efron & Co's procedures were limited to inquiries of company personnel and analytical procedures.
Zac has discovered that Wild failed to perform a physical inventory count at 30 June 2009. Wild's
inventory records were last updated three weeks before the year end. The inventory figure in Wild's
financial statements was estimated by the warehouse manager using the delivery notes and
despatch notes he had kept since the last count; however, he has not retained these. Efron & Co
has been unable to verify the quantity of inventory through any other means. The carrying amount
of inventory is material to Wild's financial statements.
(2) Danfurth Ltd

During Efron & Co's external audit of Danfurth Ltd (Danfurth) Zac discovered that a significant
number of temporary employees are paid each day in cash. These cash payments are recorded in
the accounting records under "cleaning cost” but the employees in question do not undertake
cleaning. None of the legally required income taxes or other mandatory taxes nave been paid to the
authorities in respect of these employees. The factory manager told Zac that this has been standard
practice for a number of years and, as a result, Efron & Co has calculated that Danfurth's tax liability
in respect of these employees is material to the financial statements. The directors are reluctant to
recognise any liability in the financial statements, as they are concerned it will mean the tax
authorities will ask them to pay the taxes due.
Requirements:
Discuss the implications for the report on the review of Wild's financial statements as requested by the
directors of Mckessie. Clearly explain the nature of the report conclusion that you consider Efron & Co
should provide.
(6 marks)

BUZZWELL LTD
Described below are situations that have arisen in three unrelated external audit clients of your firm.
The year end in each case is 31 December 2009.
Buzzwell Ltd (Buzzwell)

Buzzwell purchased inventory on 15 December 2009 at a cost of £678,000 in anticipation of fulfilling a
large order for a customer. However, the customer went into liquidation on 31 January 2010 and was
unable to complete any part of the transaction with Buzzwell. On 28 February 2010 Buzzwell sold the
inventory at a market value of £475,000. The directors intend to include this inventory in the year-end
financial statements at its original cost.
The draft financial statements show that Buzzwell's profit before tax is £5,075,000.
Pollen plc (Pollen)

Pollen is a pharmaceutical company specialising in the manufacture of drugs for hay fever sufferers. It
currently manufactures the market-leading drug, Hiveal, which accounts for 65% of the company's
annual revenue. High numbers of sufferers have recently experienced adverse side effects when using
Hiveal and a government committee is now investigating this. Pollen's licence to manufacture Hiveal
has been temporarily suspended until the investigation is complete.
The investigation by the government committee will not be concluded until after the financial
statements for the year ended 31 December 2009 have been published. The directors have disclosed
this matter in a note to the draft financial statements, stating that if the licence is not reinstated there
would be significant doubts over Pollen's ability to continue to trade.
Bloome pIc (Bloome)

Bloome purchased a new manufacturing plant on 1 January 2009 for £2.8 million. The plant was capable
of being operated at this date but production did not commence until 30 June 2009 due to a worldwide
shortage of an essential raw material for the production process. The plant is being depreciated, using
the straight-line method, over 10 years and the directors have charged six months' depreciation on cost
in the income statement for the year ended 31 December 2009.
The draft financial statements show that Bloome's profit before tax is £1.3 million.
Requirements:
In each of the situations outlined above, state whether you would modify the audit report. Give reasons
for your conclusions and outline the modifications, if any, to each audit report. (17 marks)

TURBO LTD
You are the senior in charge of the external audit of Turbo Ltd (Turbo), a company which assembles
turbines to customer specification. The draft financial statements for the year ended 30 September
2008 show profit before tax of £1.1 million and total assets of £24.4 million.
The following issues were identified during the course of the audit of the financial statements for the
year ended 30 September 2008.
1. On 6 October 2008, the company received an invoice for plant and equipment costing £3.5 million
with an estimated useful life of five years which was installed and brought into use on 1 September
2008. The invoice was dated 5 October 2008 and had been posted to the ledger accounts as an
October 2008 transaction and as yet not included in the financial statements for the year ended 30
September 2008.
2. On 12 November 2008, a batch of turbines which had been rejected by a customer were sold to
another customer for £450,000. The turbines are currently included in work in progress in the
financial statements for the year ended 30 September 2008 at a cost of £350,000. The turbines
were completed during the first week of October 2008 at a further cost of £150,000.
3. On 25 November 2008, the company was advised by a tax specialist that because of the complexity
of the issues involved in the HMRC enquiry into the company's tax affairs, which was launched in
September 2008, it is not possible to forecast the outcome of that enquiry. However, the specialist
has advised that the possible range of outcomes in respect of the additional tax liabilities ranges
between a zero liability and a £10 million liability. There is currently no reference to this matter in
the draft financial statements.
Requirements:
For each of the issues outlined above:
(i) state, with reasons, the action you would take; and
(ii) discuss the implications for the audit report on the financial statements of Turbo and, where
appropriate, describe the modifications you would make to the audit report. (20
marks)
AIREDALE LTD
Described below are situations which have arisen in three unrelated external audit clients of your firm.
The year end in each case is 31 March 2009.
(1) Airedale Ltd (Airedale)

On 1 January 2009, Airedale introduced a quarterly rebate scheme under which customers who
purchase a specified volume of products would receive a rebate which is paid quarterly in arrears. The
first rebates, relating to the quarter ended 31 March 2009, amounted to £35,000 and are due to be paid
on 30 June 2009. No entries have been made in the financial statements for the year ended 31 March
2009 in respect of these rebates. The directors, who are minority shareholders, have refused to amend
the financial statements as such an amendment will cause the earnings figures to fall below the level
that has to be achieved in order to earn their bonuses.
The draft financial statements show that Airedale’s revenue is £12.6 million and profit before tax is
£825,000 for the year ended 31 March 2009.

(2) Cairn plc (Cairn)
The directors of Cairn have prepared the draft financial statements on the going concern basis and have
included the following note in the draft financial statements:
“The company incurred a net loss of £2,697,770 for the year ended 31 March 2009 and at that date the
company’s current liabilities exceeded its current assets by £4,088,015. The directors are committed to
returning the company to profitability and have made a number of key changes in senior management
to lead the operational and financial turnaround of the company. The ability of the company to
continue as a going concern is dependent on several factors which include:
(i) the profitability and cash flows of the company over the next twelve months; and
(ii) the company continuing to receive support from financial institutions and other capital investors.
If the company is unable to continue in operational existence for the foreseeable future, the company
may be unable to discharge its liabilities in the normal course of business. Adjustments may have to be
made to reflect the fact that assets may need to be realised at amounts which could differ significantly
from the amounts at which they are currently recorded in the statement of financial position (balance
sheet). In addition, the company may have to reclassify non-current assets and liabilities as current
assets and current liabilities respectively and to provide for further liabilities that may arise.”
(3) Patterdale Ltd (Patterdale)

Your audit work identified that there was no system of control over cash sales that could be relied on
for the purpose of the audit and there were no satisfactory audit procedures that could be adopted to
confirm that such sales were properly recorded. Cash sales comprise 15% of recorded revenue.
Requirements:
(a) In each of the situations outlined above, state whether you would modify the audit report. Give
reasons for your conclusions and outline the modifications, if any, to each audit report. (15 marks)
KOVASH LTD
Kovash, an external audit client of your firm, produces satellite navigation systems (sat-navs), used to
provide on-board navigation to drivers of vehicles. Kovash supplies sat-navs to vehicle manufacturers
for installation in their vehicles. Each range of sat-navs has been designated to precise customer
requirements and cannot be installed in other manufacturers’ vehicles.
As part of your audit work on the trade receivables balance at 31 December 2008 you have discovered a
letter, dated 18 December 2008, from a car manufacturer, Sceptus plc (Sceptus). The letter states that
an unacceptably high proportion of sat-navs have been produced to an incorrect size, making it
impossible to install them into cars manufactured by Sceptus. The letter also states that Sceptus will not
pay the current outstanding invoices and threatens to terminate the contract with Kovash unless the
situation is resolved.
Your review of the contract with Sceptus identified that the contract is not due for renewal until 31
December 2010. In addition, it contains a clause that allows Sceptus to terminate the contract before
this date if returns of sat-navs, resulting from errors in production, reach specified levels.
Sales to Sceptus account for 30% of Sceptus’s revenue and, the balance due from Sceptus at the year-
end represents 54% of trade receivables and 2½% of gross assets.
An initial investigation of Kovash found one small batch of sat-navs had been manufactured incorrectly
but the finance director tells you that Kovash believes some problems with fitting relate to changes in
the manufacture of Sceptus vehicles and not to errors in the production of the sat-navs. Kovash is
continuing to discuss the issue with Sceptus and further investigation is being undertaken but a
conclusion as to the extent of the problem is unlikely to be reached before your audit report is signed.
Requirement:
Discus the possible consequences that the matter detailed above may have for your audit opinion on
the financial statements of Kovash for the year ended 31 December 2008. For each consequence
identified, describe how this should be presented in the auditor’s report.
(7 marks)
FRAZIL 27 mins
You are the engagement partner to Frazil, a private limited liability company. Frazil’s financial
statements for the year ended 30 September 2008, show total assets $107 million and profit before tax
$8.2 million. The following matters require your consideration:
(i) The basis of accounting notes states that the financial statements have been prepared in
compliance with International Reporting Standards. However, the accounting policy note for
development costs states that all development costs are expensed as incurred. Results of audit
tests showed that of the $3.7 million development cost expensed during the year, $1.4 million
should have been recognised as an asset in accordance with IAS 38 Intangible assets.
(ii) The management of Frazil has just informed you that, for the first time, the annual report is to
be published on the company’s website.
Required:
Identify and comment on the implications of the above matters for your auditor’s report on the
financial statements of Frazil for the year ended 30 September 2008. (10 marks)
STOKEY CO
Stokey Co (Stokey) is involved in supplying a range of fresh meat products (such as meat pies, sausages,
frozen beef burgers and minced meat) to 300 supermarkets located within 250 kilometres of Lahore.
Products are manufactured in a factory then stored in a nearby cold storage warehouse rented by
Stokey before being distributed to the supermarkets. Stokey’s meat products are perishable – they have
an average shelf-life of six days and maximum shelf-life of 14 days.
The annual audit for the year ending 31 December 20X6 is nearly complete. However, the audit work on
subsequent events has just uncovered the following issues:
a) In February 20X7 a consignment of meat pies produced by Stokey was found to contain traces of
poison. Over 350 consumers suffered food poisoning after eating one (or more!) of Stokey’s pies.
Understandably the press coverage has been hugely damaging. 150 supermarkets have already
cancelled orders for the foreseeable future and another 60 are considering their options.
Stokey has been served with a legal claim prepared by lawyers acting on behalf of the affected
consumers which may lead to a substantial claim for damages against Stokey.
b) On 26th January 20X7 around 55% of inventory held for resale in the rented warehouse spoilt and
was subsequently destroyed following local floods and a resultant 72-hour loss of power to the
refrigeration systems.
Required:
For each of the events above:
(i) Describe the further audit procedures that should be performed;
(ii) Explain the possible impact these events might have on the financial statements and the audit
report.
SUNSHINE
Yasir is the manager responsible for a portfolio of audit clients of Rodney & Co, a firm of Chartered
Accountants in Pakistan.
Yasir is currently reviewing the audit seniors’ recommendations for the auditors’ reports for a number
of clients with a 31 December 20X6 year-end as follows:
(a) The Chairman’s statement in the directors’ report of Sunshine Ltd., an international holiday
company, states that income from sub-letting long- term vacant real-estate in its hotel portfolio to
other businesses forms a major part of revenue. The report also states that that Sunshine Ltd. will
continue to exploit this lucrative and significant revenue stream.
The segmental information note in the financial statements shows that sub- let real-estate income
represents just 1.2% of current year revenue.
However, the audit senior recommends an unmodified audit report should be issued because the
segmental information is correct and the audit opinion only relates to the financial statements, not
the directors’ report.
(b) When reviewing after-date bank transactions as part of the audit work on trade receivables, the
audit senior noticed the transfer of an immaterial amount of cash to Twinkle Ltd., a company based
in Bermuda. When questioned about this, the finance director explained that Twinkle Ltd. had
been set up on 5 February 20X7 as a wholly-owned overseas subsidiary of Star as part of the
companies’ expansion into Central America.
Despite no other audit evidence having been obtained, the audit senior concluded that the
explanation was reasonable and recommends that an unmodified audit report is issued. This is
because the matter does not impact on the current year’s financial statements and the amount is
immaterial.
(c) Serious going concern problems have been identified during the audit of Manta Co (Manta). Manta
will be unable to trade beyond the next quarter unless it receives continued financial support from
its parent company, Shark Co (Shark).
Despite a letter of support (‘comfort letter’) having been issued to Manta by Shark, the audit
senior is insistent that, due to the seriousness of the situation, ‘at least’ a qualified opinion (on an
‘except for’ basis) should be issued due to the gravity of the situation.
Required:
Comment on the appropriateness (or otherwise) of the audit senior’s proposed audit report for each of
the situations above.
Indicate if/how the audit report should be modified where you disagree with the audit senior’s
proposals.

EDDIE ELECTRONICS
You are the external auditor of Eddie Electronics. A written representation letter has been prepared in
which the directors have been asked to confirm that all sales income has been included in the financial
statements and that when there is weak evidence of expenditure, the expenditure has been for the
benefit of the company and not for the personal benefit of any employee or director.
Required:
(a) Discuss the reliability of audit evidence provided by directors in the written representation letter
and whether you should rely wholly on the representations of the directors or whether you should
obtain other evidence.
(b) Describe the action you would take and the conclusions you would reach if the directors refused to
sign a written representation letter. Your answer should specifically consider the statements in the
letter concerning completeness of sales income and validity of expenditure.
BARNET REMOVALS
Barnet Removals is a removals company. In the year ended 31st December 20X5 the company made
trading
profit of Rs.800k. You are the manager in charge of the audit. The following issues have arisen:
(1) A customer is suing the company for Rs.1m for damage caused to antique furniture. The company
is defending the claim and believes that the furniture was reproduction as opposed to antique
and therefore worth only Rs.100k.
(2) A balance due from Safe Storage in respect of sub-contract work, of Rs.300k, has been
outstanding for over six months. Your firm has been asked by Barnet Removals’ accountant not to
write to Safe Storage for direct confirmation of this amount as the latter company objects to such
letters. You have been assured by the accountant that the relationship between the two
companies is good and that the outstanding balance will be paid.
(3) Barnet Removals has recently invested in four new removal vans and is currently carrying out
extensive refurbishment of its premises. As a result of this expenditure the company has reached
its overdraft limit of Rs.500k.
Required:
(a) state, with reasons, the audit work that you would expect to find in undertaking your review of the
audit working papers for the year ended 31 December 20X5
(b) draft the relevant sections dealing with these issues of the written representation letter you would
wish the directors to sign.

MUBASHIR LIMITED
As the audit partner responsible for the audit of Mubashir Limited (ML), you have recently issued an
audit report on ML’s annual financial statements.
The audit senior involved in the audit of another client Salman Limited (SL) has informed you that SL’s
records indicate that it has made purchases worth Rs. 37 million from ML. Since the same audit senior
was also involved in the audit of ML he knows that SL and ML are associated companies and ML had not
disclosed any related party transactions in its financial statements. This fact has also been confirmed
from the working papers of both the companies. Payments against these purchases were made in the
name of ML by way of crossed cheques.
Required:
Discuss the factors that you will consider with reference to above and specify the action that you would
take in this regard.
STEEL LIMITED
You are the audit engagement partner of a listed company, Steel Limited (SL). The firm is currently in
the process of completing limited scope review of SL’s interim financial statements for the half year
ended June
30, 20X6. The audit team has recently concluded their work with following findings for your decision:
(i) Inventory is a significant item of the balance sheet but the auditor was not asked to attend the
stock count at the end of the period. Consequently, the audit team relied on the count
communicated by the management.
(ii) SL has executed many contracts with its customers for long term future deliveries at different
prices, amounting to Rs. 1,200 million. To avoid loss on account of price fluctuation, short term
futures had been bought in international market against future deliveries valuing Rs. 300 million
only. Such futures are carried-over on maturity. Remaining deliveries have been left open.
(iii) A set up of the company in Lahore having carrying value of Rs. 235 million has been sold to an
associated undertaking for Rs. 240 million. The minutes of the Board of Directors show that the
transaction was carried out at an arm’s length price. No explanatory note has been given in the
financial statements in this regard.
(iv) As a percentage of total debts, the provision for bad debts are in accordance with the previous
history of the company. However, due to time constraints the practice of using age-analysis of
debtors has not been used this time.
Required:
Discuss the above issues and their implications on your report on the interim financial statements.

PENDULUM
You are the audit manager of Pendulum Ltd (Pendulum) and are planning the audit for the year ended
31 December 20X6.
Pendulum develops medicine for use on animals in both the commercial and consumer markets. In the
commercial market, medicine is used by veterinary practices during their daily treatment of animals, for
example in pet clinics and when visiting farms to tend sick animals. In the consumer market, Pendulum
sells certain medicines directly to consumers (i.e. pet owners) via mail order and through concessionary
stalls in a number of large supermarket chains.
Pendulum’s pre-tax profit for the year is Rs. 2.543 million.
During a recent visit to Pendulum to discuss the forthcoming audit, Pendulum’s finance director raised
the following issues:
(a) On 14 November 20X5, Pendulum was notified by its lawyers that a group of farmers had raised a
claim against Pendulum following the death of over 1 million chickens linked to one of Pendulum’s
medicines.
No provision was made in the financial statements for the period ending 31 December 20X5
because neither the likelihood nor success of the claim was known at that time.
The case remains ongoing as at December 20X6 year-end. However, the lawyers have now advised
Pendulum’s directors that the claimants are highly likely to succeed with their claim and that the
estimated award against Pendulum will be around Rs. 15 million.
(b) Pendulum launched a ‘love your pet’ voucher scheme during December 20X6. Each voucher entitles the ‘lucky rec
Vouchers are sold through veterinary clinics, directly to consumers over the internet and also via
the concessionary stalls across the supermarket network. Vouchers can be redeemed at any one of
Pendulum’s network of pet care centres.
Vouchers were promoted on a ‘buy one get one free’ basis during January targeting pet owners for
the forthcoming annual ‘National Pet’s Day’ in early February 20X7.
Previous voucher schemes have proved highly popular with a very high take-up. The directors
expect the total voucher issuance for the current scheme to reach Rs. 40 million with an 75% take-
up. They have therefore recognised Rs. 30 million in revenue for the year ending 31 December
20X6.
Required:
(i) What are the matters you should consider during planning for the audit? and
(ii) Describe the audit procedures you would plan to perform in response to each of the issues.

NIBBLES
You are the audit manager in charge of the audit of Nibbles, a company which runs a chain of snack bars
operating in a number of seaside holiday resorts. Your firm has been the auditor for a number of years
and has always had to substantively test cash sales because of a lack of control over the recording of
takings. The audit reports to date have been unmodified.
You have recently been informed that the company has taken on a newly qualified chartered
accountant as chief internal auditor and an unqualified assistant internal auditor. Since their
appointment half way through the year ended 31st December 20X5 the two have spent most of their
time carrying out substantive tests on cash sales.
The directors are hopeful that your audit fee this year will decrease because you will be able to rely on
the work carried out by the internal auditors.
Required:
Explain the issues that will be relevant to your firm in deciding:
• whether you can rely on the work performed by the internal auditors
• how much reliance to place on that work
HERALD PLC
Your firm, Harkness & Co, has recently been engaged as the group auditor of Herald Plc (Herald), a
listed company that produces a range of paints and varnishes used in home furnishings. Herald’s head
office and a number of subsidiaries are located in Pakistan whilst three subsidiaries are located
overseas.
The subsidiaries are involved in both the manufacture and distribution of paints and varnishes
specifically targeted at local markets.
During the year Herald acquired a 49% share of Angel Ltd, a medium-sized retailer of gardening
equipment. The next largest individual shareholder owns 18% of Angel.
Required:
As the audit senior responsible for planning the group audit, explain the critical areas you need to
consider during planning and the key audit procedures you would expect to perform on the
consolidation process.
THE CINNAMON GROUP
The Cinnamon Group is an international business, made up of ten subsidiaries and a head office. You
are the manager in charge at the firm undertaking the group audit, but there are separate local auditors
for the Cayenne subsidiary in the United States, the Habenaro subsidiary in Mexico and the Hybrid
subsidiary in Columbia. You are aware of the following information:
c) Hybrid is a loss-making subsidiary, with losses at the current year end totalling Rs.27 million. There
are significant control problems, high levels of bad debts and 25% staff turnover. The local auditors
have already stated their intention to give a qualified opinion for the year just ended because of the
material issues found.

d) Cayenne is operating to a different financial year to that of the group as a whole, being October
20X5 rather than December 20X5.
e) Shortly after the year end, in January 20X6, the Cinnamon Group announced the sale of Habenaro
for Rs.250 million and this disposal is currently underway.
f) The Cinnamon Group is guaranteeing loans of approximately Rs.100 million for its subsidiaries.
Required:
a) Set out how you would plan and control the group audit of the Cinnamon Group.
b) Consider the impact of each of the above issues on the group audit.
c) Explain the nature of the relationship between your firm and the auditors of the subsidiaries,
making particular reference to the extent to which your firm may rely on the component auditors’
work and to the considerations involved where joint audits are conducted.
SATURN HOLDINGS
The following diagram shows the structure of the Saturn Holdings group, a listed company with
subsidiaries both locally and overseas. All subsidiaries are wholly- owned. All of Saturn Holdings’
overseas operations are run via Trojan.
During the year ended 31 December 20X5 the board of Saturn Holdings decided to restructure the
group and the following events took place:
(a) Mars was sold on 1 August 20X5 to an Australian competitor, Venus. The consideration was in the
form of shares in Venus, such that Trojan now owns 30% of Venus.
(b) Pluto was sold on 30 November 20X5 to Helena. The consideration was Rs.100 million settled in
cash.
(c) To stimulate the operations of Helena and Pluto, 26% of the Helena group was sold to Interesting
Investments on 1 December 20X5.
You are the audit manager on the Saturn Holdings audit. In addition to the main group financial
statements, Helena is also required by Interesting Investments to prepare group financial statements.
Your office audits the Saturn Holdings group, Helena and Pluto. Your Swiss associate audits Trojan.
Mercury (which is not material to the group) is not audited, and Venus and Mars are audited by a small
Australian practice. With the exception of Mercury, all members of the group are material.
Required:
Prepare notes for a planning meeting with the engagement partner setting out the significant matters
which need to be considered at this stage in respect of:
(a) the Helena audit
(b) the Saturn Holdings audit.
FLINT PLC
Your firm is the external auditor of Flint plc (Flint), a listed company, for the year ending 31 July 2016.
Flint manufactures aeroplane engines and replacement spare engine parts in the UK. The spare parts
are stored in Flint’s UK warehouse and then shipped to its worldwide subsidiaries for installation in
customers’ engines.
You are planning the audit for the year ending 31 July 2016. Susan Green, the engagement partner, has
asked you to consider the following key areas of audit risk in Flint’s individual company financial
statements:
(1) Going concern
(2) Inventory of spare parts stored in the UK.
Additionally, Susan said that she is concerned about the risk of material misstatement due to fraud.
She has provided you with the following information about the company:
• Flint agrees contracts with governments and customers in the aviation industry following a bidding
process. In many of the countries where Flint operates, the use of commercial intermediaries
(agents) in contract bidding is either required by law or is standard practice. The contract states a
fixed price for the supply of new engines and a fixed price for the spare parts over the life of the
engine which can be many years. Engines are manufactured to order once a contract is agreed.
• In 2013, a competitor released a new generation of more efficient engines and, as a result, Flint has
experienced a fall in demand for its engines and spare parts. Consequently, Flint has recently
published a number of downward revisions to its profit forecasts during the year and there have
been significant falls in its quoted share price. In response, Flint has invested heavily in the
development of its own range of more efficient engines and it expects these to be ready by 2018.
• The management of Flint is now seeking to increase the company’s overdraft and loan facilities and
the company’s bank requires the audited financial statements to be available prior to considering
Flint’s request for the increased facilities. Flint’s finance director has carried out an assessment of
the company’s ability to continue as a going concern, including preparation of profit and cash flow
forecasts which indicate that the company can meet its debts as they fall due. The forecasts assume
the bank facilities will be increased to the level requested.
• Components used in the manufacture of spare parts are sourced from around the world and
suppliers invoice in their local currency. Flint operates a perpetual inventory system for spare parts
which is checked by periodic sample counting throughout the year by Flint’s employees. As a result,
the company does not undertake a full inventory count at the year end.
• The inventory system is fully integrated with the cost accounting system. Spare parts are
manufactured to a standard specification. The cost accounting system records the cost of
components, labour and production overheads for each spare part. Each week, the inventory
system generates an inventory valuation listing. The inventory valuation listing includes the cost and
quantity on hand for each spare part.
• In December 2015, the UK Serious Fraud Office commenced an investigation into bribery and
corruption in Flint’s worldwide activities. In March 2016 an internal audit review found a number of
payments to new customers and agents which were made before the contracts were awarded.

Susan has provided you with the following extracts from Flint’s individual company financial
statements:
Extracts from the statement of profit or loss for the year ending 31 July
2016 2015
(forecast) (audited)
£m £m
Revenue 4,850 6,277
Cost of sales (3,900) (4,632)
Gross profit 950 1,645
Loss before tax (1,200) (10)
Extracts from the statement of financial position as at 31 July

2016 2015
(forecast) (audited)
£m £m
Current assets
Inventory of spare parts 1,050 858
Non-current liabilities
Bank loan 0 990
Current liabilities
Bank overdraft (facility £500m) 475 10
Bank loan (repayable 30 September 2016) 990 0
Net current liabilities 2,750 153
Flint is required to prepare group financial statements for the year ending 31 July 2016 and your firm
will also act as group auditor. Flint has five subsidiary companies operating overseas, with minimal
supervision from UK management and with their own local external auditors. The subsidiaries are
responsible for servicing the aeroplane engines, installing the spare parts in aeroplane engines and
maintaining customer and agent relationships. Two of the subsidiary companies’ external auditors were
changed during the year following a tender exercise to reduce audit costs. Susan has asked that you
draft instructions to be sent to the subsidiaries’ auditors and draw up proposals for the review of their
audit work. Each of the subsidiaries' financial statements are material to the group financial statements.
Requirements:
In respect of the audit work of the subsidiaries’ auditors:
a) List five items that should be included in the instructions to be sent to the subsidiaries’ auditors that
are relevant to the planning of their audit work and for each item state, briefly, the reason why it
should be included.
b) Explain why your firm should evaluate the sufficiency and appropriateness of the audit evidence
obtained by the subsidiaries’ auditors and outline how your firm should undertake this evaluation.
(10 marks)

ROCKWELL & CO
You are an audit manager at Rockwell & Co, a firm of Chartered Certified Accountants. You are
responsible for the audit of the Hopper Group, a listed audit client which supplies ingredients to the
food and beverage industry worldwide.
The audit work for the year ended 30 June 2015 is nearly complete, and you are reviewing the draft
audit report which has been prepared by the audit senior. During the year the Hopper Group purchased
a new subsidiary company, Seurat Sweeteners Co, which has expertise in the research and design of
sugar alternatives. The draft financial statements of the Hopper Group for the year ended 30 June 2015
recognise profit before tax of $495 million (2014 – $462 million) and total assets of $4,617 million
(2014: $4,751 million). An extract from the draft audit report is shown below:
Basis of modified opinion (extract)

In their calculation of goodwill on the acquisition of the new subsidiary, the directors have failed to
recognise consideration which is contingent upon meeting certain development targets. The directors
believe that it is unlikely that these targets will be met by the subsidiary company and, therefore, have
not recorded the contingent consideration in the cost of the acquisition. They have disclosed this
contingent liability fully in the notes to the financial statements. We do not feel that the directors’
treatment of the contingent consideration is correct and, therefore, do not believe that the criteria of
the relevant standard have been met. If this is the case, it would be appropriate to adjust the goodwill
balance in the statement of financial position.
We believe that any required adjustment may materially affect the goodwill balance in the statement of
financial position. Therefore, in our opinion, the financial statements do not give a true and fair view of
the financial position of the Hopper Group and of the Hopper Group’s financial performance and cash
flows for the year then ended in accordance with International Financial Reporting Standards.
Emphasis of Matter Paragraph

We draw attention to the note to the financial statements which describes the uncertainty relating to
the contingent consideration described above. The note provides further information necessary to
understand the potential implications of the contingency.
Required:
The audit of the new subsidiary, Seurat Sweeteners Co, was performed by a different firm of auditors,
Fish Associates. During your review of the communication from Fish Associates, you note that they
were unable to obtain sufficient appropriate evidence with regard to the breakdown of research
expenses. The total of research costs expensed by Seurat Sweeteners Co during the year was $1·2
million. Fish Associates has issued a qualified audit opinion on the financial statements of Seurat
Sweeteners Co due to this inability to obtain sufficient appropriate evidence.
Required:
Comment on the actions which Rockwell & Co should take as the auditor of the Hopper Group, and
the implications for the auditor’s report on the Hopper Group financial statements. (6 marks)

ADDER GROUP
The Adder Group (the Group) has been an audit client of your firm for several years. You have recently
been assigned to act as audit manager, replacing a manager who has fallen ill, and the audit of the
Group financial statements for the year ended 31 March 2015 is underway. The Group’s activities
include property management and the provision of large storage facilities in warehouses owned by the
Group. The draft consolidated financial statements recognise total assets of $150 million, and profit
before tax of $20 million.
The audit engagement partner, Edmund Black, has asked you to review the audit working papers in
relation to two audit issues which have been highlighted by the audit senior. Information on each of
these issues is given below:
(i) In December 2014, a leisure centre complex was sold for proceeds equivalent to its fair value of
$35 million, the related assets have been derecognised from the Group statement of financial
position, and a profit on disposal of $8 million is included in the Group statement of profit or
loss for the year. The remaining useful life of the leisure centre complex was 21 years at the
date of disposal.
The Group is leasing back the leisure centre complex to use in its ongoing operations, paying a
rental based on the market rate of interest plus 2%. At the end of the 20-year lease
arrangement, the Group has the option to repurchase the leisure centre complex for its
market value at that time.
(ii) In January 2015, the Group acquired 52% of the equity shares of Baldrick Co. This company has
not been consolidated into the Group as a subsidiary, and is instead accounted for as an
associate. The Group finance director’s reason for this accounting treatment is that Baldrick
Co’s operations have not yet been integrated with those of the rest of the Group. Baldrick Co’s
financial statements recognise total assets of $18 million and a loss for the year to 31 March
2015 of $5 million.
Required:
In respect of the issues described above:
Comment on the matters to be considered, and explain the audit evidence you should expect to find in
your review of the audit working papers.
Note: The marks will be split equally between each part. (16 marks)

JUGNU LIMITED
Your firm has been appointed as the auditor of Jugnu Limited (JL), which is a manufacturer of
consumer products. The auditor’s report on the preceding year’s financial statements was unmodified.
The draft financial statements for the year ended April 30, 20X6 disclose a profit before taxation of Rs.
75 million (20X5: Rs. 155 million) and total assets of Rs. 2,100 million (20X5: Rs. 1,910 million).
You are the audit manager at JL. The following issues arose during the audit and now require your
attention:
(i) JL incurred an expenditure of Rs. 25 million on the development of five new products. It is
expected that these new products would generate future economic benefits.
(ii) On July 1, 20X3 JL had acquired four high-tech machines for Rs. 200 million which are being
depreciated over a period of 10 years on the straight line method. JL did not have the expertise to
operate the machines and had entered into an agreement with Umer Limited to operate the
machines. The contract is expiring on June 30, 20X6 and Umer Limited has shown its inability to
continue after the expiry of the contract.
Required:
a) Describe the principal audit procedures to be carried out for verifying the opening balances of the
financial statements of Jugnu Limited for the year ended April 30, 20X6.
b) For each of the above issues, comment on the matters that you should consider and state the audit
evidence that you expect to be available.
DAY PHARMA
You are the manager in-charge responsible for the audit of Day Pharma Limited, a subsidiary of a
multinational pharmaceutical company. One of the drugs being imported/marketed by the company is
VITABE. It was introduced a few months back but contributes significantly to the company’s revenues.
While the audit was in progress, you came across a news item in a well-known publication, according to
which the authorities in many countries have banned the use of VITABE as some of its ingredients were
considered dangerous for human health and required further testing. While going through some files
you have discovered that the parent company had informed Day Pharma Limited about the harmful
effects of the drug. However, it had not given any further instruction in this regard.
You have discussed this matter with the CEO who has informed you that the company had not called off
the medicine nor has it provided any information in this regard to the users of the drug or the general
public as the management is of the view that there is very limited risk of any harm being caused by the
drug.
However, you had discussed this matter with a senior physician who believes that these types of
products are also banned in Pakistan.
Required:
Assess the above situation and describe what measures the auditor should take in such circumstances.

DREAMS YACHTING AND MARINA
Dreams Yachting and Marina (DYM) have a marina on the South Coast of Pakistan and a large sales
operation dealing in yachts and speedboats. You are responsible for the audit of DYM and have found
some potential causes of concern that could indicate fraudulent activity or financial misconduct within
the company. In particular:
• 30% of the yachts on sale by DYM are supplied through one of the major international boating
companies with a special finance arrangement deal. However, DYM have also obtained separate
finance on these yachts, which are therefore in effect being ‘double financed’.
• Ten yachts shown as assets by DYM cannot be located, with no explanation other than that they
have not been sold. These yachts together are worth approximately Rs.50 million.
• Long delays have occurred in performing reconciliations with the last four months of reconciliations
still not completed. At the time of the last reconciliation, material differences had been identified
upon which no action appears to have been undertaken.
Sales have been overstated by Rs.100 million in the current financial statements.
The finance director has been off sick with stress for the last five months and therefore has not been
available to discuss any of the issues identified.
Required:
(a) Explain the difference between fraud and error and how the issues shown here could be
categorised as fraud or error.
(b) Discuss the role of management and the role of the auditor in the prevention and detection of
fraud and error.
(c) Describe what steps you would take to further investigate and then report on the matters referred
to above.
ORIONTHALE
You have been assigned to the audit of Rumblers, a limited liability company in Pakistan, for the year
ending 30 November 20X5. The principal activities of the company include the assembly, retailing,
servicing and hiring out of mobile and portable generators used in the building and construction
industry. The generators are assembled from components bought in from suppliers, most of which are
located overseas. In addition to its assembly plant, Rumblers has six trading outlets, each of which has a
retailing, servicing and hiring out section. The managing director who started the business five years
ago is very keen to innovate and as a result, is constantly striving to enhance the existing range of
generators and develop new models.
An area identified at the planning stage as high risk is the overstatement of inventory. Inventory
comprises:
Components used in the assembly of generators and as spares for the servicing and repairing of
customers’ generators.
Finished goods consisting of a range of models of generators; and Generators transferred to retail
inventory from the hire section.

The generators used in the hire section are treated as non-current assets while available for hire. They
generally have a useful life of two years for hiring out purposes, after which they are transferred to
inventory in the retail section where they are sold at heavily discounted prices.
Historically, the company has ascertained the inventory figure for the monthly and year-end accounts
by undertaking a full physical count. During the year the company introduced an inventory control
system consisting of computerised inventory records supported by continuous counting of the
components. As a result, there will be no physical count of components at the year end. The inventory
control system in respect of finished goods has yet to be introduced and consequently there will be a
full physical count of finished goods at the year end.
Cost records are maintained, for each model of generator, detailing costs of components and direct
labour. For inventory valuation purposes, a percentage is allocated to cover overheads. Work in
progress at any point in time is not material.
Required:
a) (i) Identify the ways in which Rumblers’s inventory of components and finished goods might be
overstated; and
(ii) Outline the audit procedures, other than obtaining directors’ representations, you would
undertake in order to obtain evidence that inventory is not overstated.
b) Rumblers is considering making an acquisition in Indonesia that should give better margins. What
further auditing issues might this present?
GROBBELAR
You are senior manager in Grobbelar & Co (Grobbelar), a firm of Chartered Accountants in Pakistan. You
have recently been seconded to the audit quality monitoring team to assist them in performing annual
reviews of a number of existing clients.
The following situations were noted regarding recent clients:

(i) Hikmet Ltd. exports high quality sports equipment for use in corporate and hotel gyms across
Africa. A junior member of the audit team noticed that Hikmet pays Rs. 820,000 per month into
an account in Macau, describing the transactions in the general ledger as ‘payments for security
consultancy services’. Other than the security services, Hikmet has no other business dealings
with Macau.
The client explained this relates to extra security for the sports equipment of a particularly
important customer to ensure it is not impounded on arrival in central Africa. Whilst the
expense does not appear in Hikmet’s tax return the audit junior, Umar, closed the working
paper as he considered the item immaterial. Materiality for the last three audits has been set at
Rs. 10 million.
(ii) Grobbelar was appointed as auditor of Shadow Ltd. (Shadow) last year. Grobbelar also provided
tax advice and valuation services for Shadow for the last two years.
Grobbelar recently issued an unmodified audit report on the financial statements for the year
ended 31 December 20X5. Subsequently it came as a shock to Mr Khan, the CEO of Shadow, to
receive a letter from the tax authorities announcing the launch of an investigation into

Shadow’s tax affairs following an anonymous tip from a whistleblower regarding the
overstatement of tax-deductible expenses.
Required:
Explain any ethical or professional issues raised by each of these matters and the action, if any, that
Grobbelar should now take.
SEHAT PHARMACEUTICALS
The audit of Sehat Pharmaceutical Limited (SPL) is in progress. Based on the previous experience with
the client and the initial tests of control, the auditor has assessed a low risk of material mis-statement in
the area of debtors.
The debtor’s circularization summary depicts the following information:

Customer No. of Balance Confirmations Amount Nature of Confirmations
segment customers outstanding sent covered confirmations received
----------------------------------Rs----------------------------------------------
Distributors 12 75,200 8 70,500 Positive 7
Wholesalers 105 52,500 30 12,500 Positive 28
Hospitals 250 31,200 75 20,300 Negative 4
and clinics
Retailers 130 12,500 50 7,000 Negative 12
Analysis of confirmations received is as follows:

• 3 out of 7 confirmations received from distributors did not agree with the amount outstanding in
SPL’s ledger.
• One of the distributors, Saleem Distributors (Private) Limited (SDPL) has gone into winding up. The
balance receivable from SDPL is outstanding since last one year.
• Replies received from the hospitals did not agree with the balance outstanding in SPL’s records.
However, the differences were reconciled by the audit staff.
• All the 12 confirmations received from the retailers showed disagreement with the records of SPL.
However, only 2 could be reconciled.
Required:
(a) Evaluate the decision regarding sending of negative confirmations.
(b) Determine the course of action the auditor should consider in case of balances agreed, balances not
agreed and replies not received.
(c) State the procedures that need to be performed in case of amount due from SDPL.

ZAFAR TECHNOLOGY LIMITED – (ICAP SUMMER 2012 Q.2)
The following situations have arisen at different audit clients of your firm:
(a) Zafar Technology Limited (ZTL), a listed company, is engaged in the manufacture of compressors
used in electrical appliances. During the conduct of the audit for the year ended 31 March 2012, a
team member has discovered a letter dated 18 March 2012 from Sartaj Electronics Limited (SEL)
which states that SEL will not pay the current outstanding invoices as according to it the
compressors supplied by ZTL are of an incorrect specification.
ZTL’s Technical Director believes that the problem arose due to changes in the design of appliances
produced by SEL and not because of faulty production by ZTL. However, both the companies have
agreed to refer the matter to arbitration.
Sales to SEL account for approximately 25% of the revenue of ZTL and the balance due from SEL as
at 31 March 2012 amounted to Rs. 3.12 million. The profit after taxation of ZTL is Rs. 25 million
with an asset base of Rs. 150 million.
(07 marks)
(b) The directors’ report of XCP Limited states without any further explanation that the 20% increase
in profit as compared to the previous year is due to increase in sales and austerity measures
introduced by the management. The income statement for the year shows an increase in profits
and sales amounting to Rs. 20 million and Rs. 8 million respectively whereas the costs have
reduced by Rs. 12 million. A review of your working papers however indicates that costs have
reduced mainly on account of reduction in import duty on certain raw materials.
(04 marks)
(c) IPL is a manufacturer of diversified products and has factories in seven major cities of the country.
The demand for some of its products has been falling and the company wants to concentrate on its
core products only. Consequently, it has decided to close three of its factories and has made a
provision of Rs. 30 million in respect of redundancies and restructuring. The directors’ report for
the year ended 31 May 2012 comprehensively discusses the restructuring plan and states that the
factories in Lahore and Multan would be closed in the months of July and September 2012
respectively. The third factory will be closed before December 2012 however, the location of that
factory will be decided in November 2012.
The profit after taxation of IPL according to its draft financial statements for the year ended 31
May 2012 is Rs. 80 million. (06 marks)
Required:
Discuss the matters which the auditor should consider for each of the above situations and the possible
impact thereof on the respective audit reports.

PAIDAR TAMEERAT LIMITED – (ICAP SUMMER 2012 Q.6)
You are the audit manager of Paidar Tameerat Limited (PTL) for the year ended 31 May 2012. PTL is a
listed company and is engaged in the construction of high rise buildings including residential and
commercial complexes.
Last year serious differences of opinion had arisen with the management of PTL while determining the
stage of completion of certain projects. The matter was ultimately resolved after an independent valuer
had rendered a report and on which the auditor had placed reliance. This year the management has
employed an engineer to monitor the various projects. The engineer has reported minor discrepancies
in the estimates provided by various project managers.
Required:
Assess the above situation and discuss how you would address the related issues during the course of
the audit. (07 marks)
HBBL – (ICAP SUMMER 2014 Q.1)
You are the manager responsible for the audit of Health and Beauty Brands Limited (HBBL) for the year
ended 31 March 2014. HBBL has been selling its products through its own retail outlets only. However,
during the year under review, HBBL had entered into an agreement for sale of its products at JDS, a
chain of departmental stores.
Following information is available in respect of the above:

▪ According to the agreement, JDS would make payments within 30 days of the sale to customers.
Any unsold/expired products would be returned to HBBL.
▪ The stock sheets provided by JDS to HBBL revealed differences as compared to the balances
appearing in the HBBL’s inventory system. According to JDS these were due to posting errors in the
system of JDS, and have been subsequently corrected. HBBL’s management is of the view that such
differences are not material as compared to sales made through JDS.
▪ There is a significant improvement in the operating results of HBBL. The management considers
that the agreement with JDS has played a major role in such improvement.
▪ The confirmation sent to JDS was not received. Alternatively, the audit team had examined partial
payment amounting to 65% of the outstanding balance upto 31 May 2014.
Required:
Discuss with reasons, what course of action you would adopt in the above situation and the possible
impact thereof on the audit report. (14 marks)

FIVE STAR – (ICAP SUMMER 2014 Q.4)
You are the audit manager responsible for audit of consolidated as well as separate accounts of Five
Star Limited (FSL) and its subsidiaries. In the initial meeting, the financial controller has informed you
that during the year:
(i) the group has changed its policy for valuation of plant and machinery from cost to revalued
amount. The revaluation has been carried out by a global firm of professional valuers, who have
been advising FSL for the last several years.
(08 marks)
(ii) one of FSL’s subsidiary has incurred substantial losses. Deferred tax has been recognized on these
losses. The financial projections prepared by the CFO show that as a result of planned re-
structuring, the subsidiary would be able to recoup the losses during the next three years.
(05 marks)
Required:
Describe the steps that you would take in each of the above situations.
AKHTAR AUTOS – (ICAP SUMMER 2015 Q.4)
You are carrying out the audit of Akhtar Autos Limited (AAL) for the year ended 31 March 2015, a
listed company, engaged in the business of manufacture of spare parts for trucks, buses and tractors.
Extracts from the draft financial statements are as follows:
2015 2014
---------- Rs. In ‘000 ----------
Sales 1,250,000 1,440,000
Loss before taxation (70,000) (15,000)
Current assets 325,000 350,000
Other assets 145,000 135,000
Total assets 470,000 485,000
Current liabilities 345,000 305,000
Other liabilities 175,000 160,000
Total liabilities 520,000 465,000
Previous year’s audit report was qualified on account of inability to obtain sufficient and appropriate
audit evidence with respect to stores and spares, as ledger of stores and spares contained many
negative balances.
The following further information has been obtained during the audit:
(i) Agreements with two local distributors contain clauses that offer a significantly higher percentage
of discounts which are above normal market rates. Due to the tough competition in the local
market, the management of the company is currently negotiating with certain foreign customers
for export of company’s products.
(ii) In May 2015, court notices from two major customers were published in the newspapers, alleging
the company of supplying inferior quality spare parts in the month of April 2015 and claiming
damages of Rs. 150 million. The management is of the view that the allegations are baseless.
(iii) A supplier of the company has become bankrupt. The company owes an amount of Rs. 138
million to the supplier. However, the liquidator has lodged a claim of Rs. 140 million.
(iv) AAL is a family owned company. Out of its seven directors, four are executive directors. The non-
executive directors have been elected on the board for the 4th time.
(v) The Board has formed a three member Audit Committee, which is chaired by a non-executive
director, who is also the maternal uncle of the chief executive.
(vi) The half yearly accounts were not finalised because of a legal dispute. The company had informed
SECP in respect of such non-compliance.
(vii) Internal audit department includes only one person who is a chartered accountant and is engaged
on a part time basis.
(viii) The warehouse from where goods are dispatched is under the management of sales department.
Required:
(a) Specify the procedures to be performed in case of litigation and claims with respect to matters
mentioned above. (Impact on auditor’s report is not required) (04)
(b) What further information/documents would you require from the management in respect of
matters described in (i), (ii) and (iii) above? State the main reason for acquiring such
information/documents. (05)
(c) Discuss the possible implications on audit report with respect to previous year’s modification.
(05)
(d) Suggest appropriate measures to improve compliance with the Code of Corporate Governance.
(08)
(e) Explain the impact of information contained in para (vi) on the reporting responsibilities of the
auditor with respect to Code of Corporate Governance. (03)
NATIONAL – (ICAP SUMMER 2016 Q.5)
a) You are the engagement manager of National Pharmaceuticals Limited (NPL). The company’s
intangible assets include patents amounting to Rs. 100 million belonging to the company’s Health
Care Division.
It is the company’s policy to value the intangible assets at cost less accumulated impairment. NPL
has recorded an impairment loss on the basis of impairment review which contains certain
projections regarding future profits.
Required:
List the procedures which you would perform to verify the working prepared by the management.
(10 marks)
b) While reviewing the draft of the director’s report of NPL you have observed that projections of
future profitability in the director’s report with respect to the Health Care Division show much higher
amounts as compared to the amounts shown in the working related to the impairment of patents.
The CFO has explained that on the basis of prudence and to avoid any overstatement of intangible
assets, projections in the working related to impairment have been kept on the lower side.
Required:
Evaluate the above scenario and explain how the auditor should deal with the above situation.
(07 marks)

BHIT GAS – (ICAP WINTER 2012 Q.3A)
The audit report of Bhit Gas Limited (BGL) was qualified on account of recognition of mark-up on
delayed payment from Salim Enterprises Limited (SEL) amounting to Rs. 2.7 billion, because at the time
of signing of audit report, SEL had not acknowledged its liability towards mark-up due to BGL and the
matter was pending in the Court.
After the issuance of the financial statements, the matter was decided by the Court and SEL was
ordered to settle the mark-up by paying Rs. 1.5 billion. After the Court’s decision, BGL had filed an
appeal against the order for the remaining amount of Rs. 1.2 billion and the management has requested
the auditor to remove the qualification and issue a revised audit report. The management has also
informed the auditor that subsequent to the Court’s decision, it has decided to revise the financial
statements by making a 25% provision against the remaining amount of mark-up.
Required:
Discuss the factors that the auditor should consider with reference to the above and specify the steps
that he should take under each of the following circumstances:
(i) The management and those charged with governance are prohibited by law and regulation from
restricting the amendment and approval of the financial statements to the effect of the above
event.
(ii) The management and those charged with governance are not prohibited by law and regulation
from restricting the amendment and approval of the financial statements to the effect of the
above event.
(17 marks)
KARIM LIMITED – (ICAP WINTER 2012 Q.7)
The audit of Karim Limited (KL) is in progress. The audit team has requested you to advise on the
following issues:
(a) The confirmation request sent to a customer who owed Rs. 35 million was responded by an e-mail
addressed to KL’s CFO.
(b) The management of KL is not allowing auditors to send confirmation to Fareed Limited (FL), on
account of certain disputes, as the sending of confirmation will undermine the ongoing negotiations
with FL. However, the management has offered to provide specific written representation on the
matter.
Required:
Discuss how the auditor should deal with the above situations. (17 marks)

XYZ & COMPANY – (ICAP WINTER 2013 Q.7b)
ABC and Company, Chartered Accountants, have been requested to give their consent for appointment
as the auditor of Sindh Limited (SL), in place of XYZ and Company, Chartered Accountants. The matter of
appointment of ABC and Company is to be placed in the annual general meeting of SL.
Assume that XYZ and Company had qualified the previous year’s audit report because it was unable to
physically verify the factory building and to observe physical inventory count, due to law and order
situation. However, during the course of current year’s audit, ABC and Company was able to observe
the physical inventory count and also carry out physical verification of the factory building as the law
and order situation has improved.
Required:
Discuss the matters which you would consider in the above situation and the possible impact thereof on
the audit report. (09 marks)
FARLEY LTD
You are the external auditor of Farley Ltd (Farley), a manufacturer of car brake pads. You have recently
completed the majority of your audit fieldwork in respect of the year ended 31 December 2007 and are
undertaking your audit completion procedures. The company's pre-tax profit for last year was £1.3
million and its total assets at 31 December 2007 were £8.5 million.
The following matters came to light during the course of the audit:
1. During February 2008, Farley was informed that an administrator had been appointed at Spade Ltd
("Spade"), one of its customers. Sales to Spade accounted for less than 1% of the total sales of
Farley last year, and the sum outstanding from Spade at the year end is £25,000.
Spade was due to a commence a large five year contract in April 2008, supplying motor parts to a
major car manufacturer. The brake pad component of this contract was to be subcontracted to
Farley, in anticipation of which Farley had by 31 December 2007 invested £1.5 million in new
specialist plant and machinery and £350,000 in raw material inventory ordered to Spade's
specifications. The plant and machinery was financed by bank loans, repayment of which is due in
six-monthly instalments commencing June 2008. Farley presented a business plan to the bank in
support of its application for funding, including profit and loss and cash-flow forecasts, prepared
on the assumption that the new contract would commence in April 2008. This business plan has
since been amended to reflect recent developments. You are aware that the directors of Farley are
currently in discussion with the company which has now taken over the contract from Spade.
2. During your audit the directors of Farley informed you of a potential legal action being brought by
a competitor for the alleged infringement of the patent on one of their brake pad designs. The
competitor claims that the infringement has been going on for two years and is claiming £2 million
in damages. The directors of Farley have taken advice from their patent attorney who considers
that the competitor's case is at best weak. Farley's solicitors have told the directors that if the
matter is pursued further by the competitor, the case is unlikely to come to court for at least
eighteen months. For these reasons the directors have not provided for the claim in the financial
statements but have made reference to it in the notes.
Requirements

(a) Describe the possible effects of the above matters on the financial statements of Farley for the year
ended 31 December 2007 and explain how they might affect your subsequent events review.
(14 marks)
(b) Discuss the effect, if any, that the matter detailed in (2) above will have on your audit report on the
financial statements of Farley for the year ended 31 December 2007. (6 marks)
PETRIE 27 mins
You are the audit manager of Petrie Co, a private Company, which retails kitchen utensils. The draft
financial statements for the year ended 31 March 2008 show revenue $42.2 million (2007 - $41.8
million), profit before taxation of $1.8 million (2007 - $2.2 million) and total assets of $30.7 million
(2007 - $23.4 million).
You are currently reviewing two matters that have been left for your attention on Petrie’s audit working
paper file for the year ended 31 March 2008.
(i) Petrie’s management board decided to revalue properties for the year ended 31 March 2008 that
had previously all been measured at depreciated cost. At the end of the reporting period three
properties had been revalued by a total $1.7 million. Another nine properties have since been
revalued by $5.4 million. The remaining three properties are expected to be revalued later in 2008.
(5 marks)
(ii) In 1 July 2007 Petrie introduced a 10-year warranty on all sales of its entire range of stainless steel
cookware. Sales of stainless steel cookware for the year ended 31 March 2008 totalled $18.2
million. The notes to the financial statements disclose the following:
‘Since 1 July 207, the company’s stainless steel cookware is guaranteed to be free from defects in
materials and workmanship under normal household use within a 10-year guarantee period. No
provision has been recognised as the amount of the obligation cannot be measured with sufficient
reliability.’ (4 marks)
Your auditor’s report on the financial statements for the year ended 31 March 2007 was unmodified.
Required
Identify and comment on the implications of these two matters for your auditor’s report on the
financial statements of Petrie Co for the year ended 31 March 2008.
Note. The mark allocation is shown against each of the matters above.
Note. Assume it is 10 June 2008.
(Total = 15 marks)

JOHNSTON AND TITMAN 27 mins
You are the audit manager of Johnston Co, a private company. The draft consolidated financial
statements for the year ended 30 September 2008 show profit before taxation of $10.5 million (2007 -
$9.4 million) and total assets of $55.2 million (2007 - $50.7 million).
Your firm was appointed auditor of Titman Co when Johnston Co acquired all the shares of Titman Co in
September 2008. Titman’s draft financial statements for the year ended 30 September 2008 show profit
before taxation of $0.7 million (2007 - $1.7 million) and total assets of $16.1 million (2007 - $16.6
million). The auditor’s report on the financial statements for the year ended 30 September was
unmodified.
You are currently reviewing two matters that have been left for your attention on the audit working
paper files for the year ended 30 September 2008:
(i) In June 2007 Titman installed a new computer system that properly quantified an overvaluation
of inventory amounting to $2.7 million. This is being written off over three years.
(ii) In November 2008, Titman’s head office was relocated to Johnson’s premises as part of a
restructuring. Provisions for resulting redundancies and non-cancellable lease payments
amounting to $2.3 million have been made in the financial statements of Titman for the year
ended 30 September 2008.
Required
Identify and comment on the implications of the above matters for your auditor’s report on the
financial statements of Johnston Co for the year ended 30 September 2008. (10 marks)
QASMI STEELS LIMITED (ICAP SUMMER 2013 Q.1)
Qasmi Steels Limited (QSL) is a manufacturer of steel and iron products. During the year the company
has incurred a net loss of Rs. 306 million. The following information is also available:
(i) At the year end, the company’s accumulated losses amounted to Rs. 17 million whereas its net
equity was Rs. 283 million.
(ii) During the year, QSL has defaulted in repayment of a loan. The management is however quite
hopeful that the lender would agree to a rescheduling.
(iii) The management believes that the company’s profitability has been hampered on account of
soaring electricity prices along with a fall in demand for steel which have had a negative impact on
the prices of its finished products. Moreover, its production has also suffered on account of the
prevailing energy crisis.
Consequently, the management has decided to discontinue its operations temporarily.
(iv) To counter the impact of high electricity prices, the company intends to convert its plant to run on
gas as well.
(v) The management has informed you that it would need to install a gas converting unit which would
be imported at a cost of Rs. 30 million. However, as the process of installing the gas conversion
unit and completing the necessary formalities would take at least a year, therefore the
management is negotiating to lease the plant to Nadeem Enterprises for a period of one year.
Required:

a) Evaluate the above situation and state the procedures which you would perform as an auditor in
the above situation.
(10 marks)
b) Describe the implications of the above issues on the audit report. (10 marks)
DILAWAR PAINTS LIMITED (ICAP SUMMER 2013 Q.2)
You are the manager responsible for the audit of Dilawar Paints Limited (DPL). The draft financial
statements for the year ended 31 March 2013 show revenue of Rs. 1,250 million (2012: Rs. 1,175
million), profit before taxation of Rs. 100 million and total assets of Rs. 1.2 billion.
The audit incharge has noted the following points for your consideration:
(i) In May 2012 a chemical leakage from one of the tanks in the factory caused a fire which damaged
the plant and machinery and the premises. DPL has incurred Rs. 3 million in cleanup costs, Rs. 10
million for modernisation of tanks to prevent future leakages and a fine of Rs. 500,000 to a
regulatory agency. The fine has been expensed whereas the remaining costs have been capitalised.
(08 marks)
(ii) While the tanks in the factory were undergoing modernisation, DPL had made arrangements with
a nearby factory for storage of its chemicals. At the time of stock check you were informed that it
is not possible to segregate DPL’s stock from that of the other factory. According to DPL’s record,
the value of its stock of chemicals as at 31 March 2013 which is lying in the nearby factory is Rs.
200 million. The value of stock of chemicals as at 31 March 2012 was Rs. 120 million.
(08 marks)
Required:
Discuss the matters that you would consider and how would you obtain the necessary audit evidence.
HAALI LIMITED (ICAP SUMMER 2013 Q.7)
(a) Haali Limited has a policy to carry its buildings at revalued amounts. At the balance sheet date i.e.
31 December 2012, the valuer had finalised the valuation reports of only 3 out of a total of 8
properties. According to these reports these properties were assigned a valuation of Rs. 50
million as against the carrying amount of Rs. 62 million.
Required:
Evaluate the above condition and discuss the impact on the audit report in each of the following
situations:
(i) The impairment of Rs. 12 million is recorded in the financial statements.
(ii) The impairment is not recorded. (06 marks)
(b) During the year ended 31 December 2012 Chiragh Limited has changed its policy for valuation of
investment in a subsidiary from the ‘fair value’ to ‘cost’. Had the company continued with its
previous policy for valuation of investment at ‘fair value’, the subject value would have been
reduced by Rs. 50 million.
Required:
Discuss the matters which you should consider in respect of the above situation and the possible impact
thereof on the audit report. (04 marks)

HELSINKI LIMITED (ICAP WINTER 2019 Q.5)
Your firm has been appointed as the auditor of Helsinki Limited (HL), a listed company, for the year
ended 30 September 2019. The previous year’s audit was performed by another firm of chartered
accountants who expressed an unmodified opinion. In a recent meeting with the client, it has been
agreed that audit report will be signed on or before 20 December 2019.
The materiality has been determined at Rs. 10 million. Your audit team has brought the following
significant matters to your notice on the completion of audit field work:
(i) A receivable balance of Rs. 6 million with a related party has been identified which has not been
disclosed in the financial statements. HL’s management is of the view that since the balance is
not significant, there is no need to disclose the amount, nature of transaction and nature of
relationship.
(ii) While reviewing the previous year’s annual report, your team has noticed that there were
number of reports and analysis which formed part of the annual report. On asking the
management regarding the date when the current year’s information would be available to the
audit team, the management responded that directors’ report would be provided on 10
December 2019 and all remaining reports would be provided on 18 December 2019.
(iii) While reviewing the provision for employees’ compensated absences, the audit team has noticed
that the working is prepared on the basis of basic salary, whereas the employees are entitled for
compensated absences on the basis of gross salary. On further investigation it is found that the
same error was made in the last year as well. The management has agreed to adjust the entire
amount in current year.
Required:
Evaluate the above matters and discuss your firm’s course of action along with implications on the audit
report, if any.
(20)
DIVERSIFIED BUSINESSES LIMITED – (ICAP SUMMER 2014 Q.3)
Diversified Businesses Limited is a listed company engaged in the business of manufacturing paints,
pharma and chemicals. During the planning stage of an audit, the auditor has found that:
The company has advanced a significant amount of Rs. 2.5 billion to a related party, for construction of
an office tower. In the notes to the financial statements, it has been stated that transactions with
related parties were carried out on arm’s length basis. (08 marks)
Required:
Evaluate and discuss how the auditor should deal with the above situations.

DREAMS LIMITED – (ICAP SUMMER 2015 Q.2)
You are the audit manager of Dreams Limited (DL), a listed company, for the year ended 31 May 2015.
DL has significant investments in two securities, which are listed on the Over the Counter (OTC) market.
While planning the audit procedures, it has been observed that there was a liquidity concern in the OTC
market and therefore no trading has been witnessed in these securities since 26 March 2015.
Consequently, DL has finalised the valuation of these securities on the advice of a company, which
specialises in providing pricing services. The company has used a pricing model which it uses at majority
of its clients.
Required:
Explain how the auditor would obtain sufficient and appropriate audit evidence in the above scenario.
(Implications on audit report are not required) (12 marks)
ALPHA – (ICAP SUMMER 2017 Q.2)
Alpha Petroleum Limited (APL) has obtained a loan in foreign currency from Asian Development Bank.
APL has entered into currency swaps contract to hedge foreign currency risk. APL carries it’s currency
swap contract at fair value in the financial statements.
APL also has significant amount of staff retirement benefit liability (defined benefit plan) on the
statement of financial position.
Required:
(a) Specify the matters to be considered by the auditor in planning the audit of currency swap contract.
(06 marks)
(b) Recommend the audit procedures in respect of the defined benefit plan liability and for valuation of
currency swap contract. (09 marks)

GMP – (ICAP WINTER 2017 Q.3)
You are the audit manager in GMP Chartered Accountants. The following matters are under your
consideration for the year ended 30 September 2017:
(i) Kamran Limited (KL) is in the business of manufacturing generators. On 1 October 2016, KL
acquired 750,000 ordinary shares of HL (which supplies generator components to KL), constituting
75% of the issued, subscribed and paid-up capital against a gross consideration of Rs. 700 million. KL
paid Rs. 500 million on the date of acquisition whereas Rs. 200 million was paid on 1 October 2017.
At the acquisition date, the identifiable net assets were recognized at their carrying amount which
was approximately equal to the fair value of Rs. 670 million, except the building and leasehold land
whose fair value was assessed at Rs. 130 million above their carrying amount. The fair value of NCI
at the date of acquisition was assessed at Rs. 155 million.
KL recognised goodwill amounting to Rs. 45 million on acquisition of HL, under the full goodwill
method.
(ii) Waris Limited has changed its accounting policy for property, plant and equipment from historical
cost to revaluation model.
Required:
Guide your audit team on key audit procedures with regard to the above information. (Audit
procedures related to verification of property, plant and equipment are not required)
(15 marks)
TOFIND LTD
You are responsible for planning the external audit of Tofind Ltd (Tofind), a mobile phone service
provider. You see a news report that Tofind has suffered a cyber-attack resulting in the theft of some of
its customers’ personal data. Outline the audit procedures you would plan to perform in relation to this
cyber-attack.
(3 marks)
FRAUD
The testing of journal entries is one of the procedures used by external auditors to respond to the risk
of fraud at audited entities.
List the characteristics of journal entries that external auditors should select for testing to identify any
fraudulent activities. (3 marks)

SNOWBALL LTD
You are working on the external audit of Snowball Ltd (Snowball) for the year ended 31 August 2017.
You are responsible for performing the planned procedures in respect of trade receivables. Your
analytical procedures identified that receivables days have increased from 35 days at 31 August 2016 to
43 days at 31 August 2017. On enquiry, Snowball’s financial controller explained: “The increase is due to
a contract for the supply of goods to a new customer, Pets Ltd (Pets). The contract allows Pets 60 days’
credit rather than our standard 30 days’ credit. We despatched a large order to Pets 50 days before the
year end.”
Outline the additional audit procedures you would perform in respect of the financial controller’s
explanation. (4 marks)
SOPRANO & CO
You are an audit manager in Soprano & Co, working on the audit of the Tony Group (the Group), whose
financial year ended on 31 March 2015. This is the first time you have worked on the Group audit. The
draft consolidated financial statements recognise profit before tax of $6 million (2014 – $9 million) and
total assets of $90 million (2014 –$82 million). The Group manufactures equipment used in the oil
extraction industry.
Goodwill of $10 million is recognised in the Group statement of financial position, having arisen on
several business combinations over the last few years. An impairment review was conducted in March
2015 by Silvio Dante, the Group finance director, and this year an impairment of $50,000 is to be
recognised in respect of the goodwill.
Silvio has prepared a file of documentation to support the results of the impairment review, including
notes on the assumptions used, his calculations, and conclusions. When he gave you this file, Silvio
made the following comment:
‘I don’t think you should need any evidence other than that contained in my file. The assumptions used
are straightforward, so you shouldn’t need to look into them in detail. The assumptions are consistent
with how we conducted impairment reviews in previous years and your firm has always agreed with the
assumptions used, so you can check that back to last year’s audit file. All of the calculations have been
checked by the head of the Group’s internal audit department.’
Silvio has also informed you that two members of the sales team are suspected of paying bribes in
order to secure lucrative customer contracts. The internal audit team were alerted to this when they
were auditing cash payments, and found significant payments to several new customers being made
prior to contracts being signed. Silvio has asked if Soprano & Co would perform a forensic
investigation into the alleged bribery payments.
Required:
Explain the principal audit procedures to be performed on the impairment of goodwill.
(5 marks)

VENTNOR ESTATES LTD – (ICAEW Q8 J17)
Your firm is the external auditor of Ventnor Estates Ltd (VE) which owns and manages a portfolio of
commercial properties from which it receives rental income. VE is responsible for repairs and
maintenance of each property. In addition to properties, VE has non-current assets comprising vehicles,
office equipment and high value tools used to carry out property repairs. Properties are purchased
using bank loans which are repayable over periods of five to seven years and are subject to covenants.
Funding to buy new properties is increasingly difficult to obtain because of recent falls in the market
value of commercial property.
The audit plan in respect of the external audit of VE, for the year ended 31 March 2017, requires the
use of substantive analytical procedures to calculate expected rental income, using data independent of
the current year’s rental income figure. You have been asked to perform these procedures using the
following information:
• Rental periods cover quarters ended 31 March, 30 June, 30 September and 31 December.
• Rental agreements in place on 1 April 2016 increased by 2% on that date.
• The same rental agreements remained in place for the year ended 31 March 2017 compared with
the prior year except for:
o a tenant paying rent of £250,000 per quarter, was placed into administration on 30 June 2016.
A revised rent of £150,000 per quarter was agreed with the administrator from that date.
o a tenant vacated a property on 30 June 2016 and there was a period of six months before the
property was rented to a new tenant on 1 January 2017, at the same rental of £75,000 per
quarter. No rental income was received on the property during this six-month period.
o a property was sold on 30 September 2016. Rental income for that property was £400,000 per
quarter.
• The draft financial statements for the year ended 31 March 2017 include rental income of
£15,151,000. Prior year audited rental income was £15,687,000.
During the audit for the year ended 31 March 2017, you identified the following deficiencies in internal
control:
1. Comparison of the non-current asset register with physical assets was last undertaken in January
2016. Company policy stipulates that an annual asset verification exercise must be performed.
2. Directors are presented with management accounting information at their monthly board
meetings. The management accounting information does not include cash flow forecasts nor details
of whether VE complies with the bank covenants.
Requirement:
(a) Explain the purpose of performing substantive analytical procedures. (3 marks)
(b) (i) Calculate the expected rental income, for the year ended 31 March 2017, as required by the audit
plan for VE. Show each step in your calculation.
(ii) Identify the audit evidence that you would obtain to test the reliability of the data used at each
step of your calculation.
(iii) List the enquiries you would make based on the result of your analytical procedures in 8.2(a).
Explain why you would make these enquires and identify any additional information that you would
need to complete your audit work. (10 marks)
(c) For each internal control deficiency listed as (1) and (2), draft points for inclusion in your firm’s
report to those charged with governance and management at VE. For each internal control deficiency
identified, you should outline the possible consequence(s) of the deficiency and provide

recommendation(s) to address it.
(7 marks)
Total: 20 marks
BUDGIE LTD – (ICAEW Q6 S17)
The financial statements of Budgie Ltd (Budgie) include an investment in Viper Ltd (Viper) stated at £7.8
million. The external auditor has concluded that the investment in Viper should be recognised at £2
million. The directors of Budgie have refused to recognise the reduction in the value of the investment.
The profit before tax of Budgie is £46.7 million and gross assets are £824 million.
State, with reasons, the implications for the auditor's report. (3 marks)
BROWN LTD – (ICAEW Q9 M16)
Described below are situations which have arisen at four unrelated clients of your firm.
Brown Ltd (Brown)
During the external audit of Brown for the year ended 31 December 2015 you discover a letter dated 1
February 2016 from the administrator of Duffel Ltd (Duffel), a customer of Brown. The letter informs
Brown that Duffel is in administration and that the amounts due to Brown will not be paid. Brown’s
financial statements include a trade receivable due from Duffel of £750,000. The directors refuse to
make an allowance against this because the administrator’s letter was not received until after the year
end. Brown’s draft financial statements for the year ended 31 December 2015 show profit before tax of
£3.8 million and total assets of £29.6 million.
Bear plc (Bear)

During the external audit of Bear for the year ended 31 December 2015 you have read the information
contained in the Chairman’s Statement which includes a statement that all Bear’s products are fair
trade certified. However, a number of new product lines introduced by Bear during 2015 have not been
certified by the independent fair trade body. The directors refuse to amend the Chairman’s Statement
as they claim they are currently in the process of obtaining certification and are concerned about the
impact on the company’s reputation if they do not include this statement.
Windsor Ltd (Windsor)

Your firm has been appointed as the external auditor of Windsor for the year ended 31 December 2015.
Windsor is required to have an audit of its financial statements for the first time as it had previously
satisfied the criteria for exemption from mandatory audit. The financial statements for the year ended
31 December 2014 were not audited. However, your firm has obtained sufficient appropriate evidence
that the current year's financial statements and the opening balances do not contain material
misstatements.
Peru Ltd (Peru)

Your firm has completed an engagement to review prospective financial information, prepared by the
directors of Peru, for submission to the company's bank in support of a loan application. The bank
requested an independent examination of the profit forecasts for the three years ending 31 December
2018. Your firm has concluded that, whilst the prospective information is correctly prepared on the
basis of management’s assumptions, the assumptions made in respect of revenue growth are highly
unrealistic.

Requirements
(a) For each of the situations described above, outline, with reasons, the implications for your firm’s
audit or assurance reports.
(10 marks)
(b) Describe the caveat, concerning the achievability of results indicated by Peru’s prospective financial
information, that your firm should include in its assurance report and state the reasons for its inclusion.
(3 marks)
(c) Explain how audit and assurance firms can reduce their exposure to claims from unforeseen parties
who rely on the firm’s audit or assurance reports.
(5 marks)
(Total: 18 marks)
KRISTOFF LTD – (ICAEW Q.9b M15)
Described below are three situations which have arisen at three unrelated audit clients of your firm.
The year end in each case is 31 December 2014.
Kristoff Ltd (Kristoff)

Kristoff has made payments to a trust fund set up for the benefit of Anna Oaken, the niece of Hans
North, Kristoff’s managing director and majority shareholder. Your firm has concluded that the
payments should be disclosed as a related party transaction in Kristoff’s financial statements. Hans has
refused to include the necessary disclosures as he considers the payments to be of a sensitive nature
and does not wish the rest of his family to be aware of them. He has threatened your firm with removal
from office if it pursues this issue any further.
Reindeer Ltd (Reindeer)

Reindeer has included a note in its financial statements disclosing a possible tax liability of £22 million.
HMRC (the UK tax authority) claims Reindeer has evaded taxes on some of its overseas activities.
Reindeer plans to appeal against the claim before an appeals tribunal but the outcome of the tribunal
will not be determined until after the auditor's report has been signed. The directors have assessed that
it is possible, but not probable, that the claim will be upheld by the tribunal and your firm agrees with
this assessment. A provision has not been included in Reindeer’s financial statements in respect of the
claim. Your firm has concluded that a provision is not required and that the note, describing the
uncertainty, in Reindeer’s financial statements is adequate. The directors of Reindeer have requested
that your firm provides a team of tax experts to support them through the appeals tribunal.
The total assets of Reindeer at 31 December 2014 are £450 million and the profit before tax for the year
ended 31 December 2014 is £18 million.
Pabbie Group plc (Pabbie)

Pabbie is your firm’s largest listed audit client. On 31 October 2014, Pabbie expanded by acquiring a
significant overseas subsidiary, Queen SARL (Queen). Your firm is the group auditor, but Queen’s
financial statements for the year ended 31 December 2014 have been audited by an overseas auditor,
Blizzard. Your firm planned to rely on Blizzard’s work. However, during the audit Blizzard refused to
cooperate. Your firm has no alternative audit procedures it can perform in respect of Queen’s financial
statements. Queen’s results are highly material to a large number of items in Pabbie’s group financial
statements. The directors of Pabbie have requested that your firm accepts appointment as external
auditor of Queen for the year ending 31 December 2015 in order to avoid this issue arising next year.
Your firm estimates the total fee for the 2015 audit of the Pabbie group will be £1.4 million and your
firm’s total annual fee income is likely to be £20 million.

Requirements:
For each of the situations outlined above:
State whether you would modify the audit opinion. Give reasons for your conclusions and describe the
modification(s), if any, to each auditor’s report. (8 marks)
REDTAIL LTD – (ICAEW S17 Q 9.2, 9.3)
SLP LLP (SLP) is the external auditor of Redtail Ltd (Redtail) which prepares financial statements to 30
September each year. Redtail assembles turbines, in its UK factory, for customers based in the UK and
mainland Europe. Contracts with its customers are agreed many years in advance and prices are
denominated in sterling.
Components for turbines are sourced from international suppliers. Redtail negotiates fixedterm, fixed-
price contracts for the supply of components which are denominated in the supplier’s local currency.
Redtail’s contract with Hawk Gmbh (Hawk), its largest supplier, expired in June 2017. A new contract is
being negotiated but Redtail and Hawk cannot agree on prices. Recent falls in the value of sterling make
Hawk’s products more expensive and Redtail is demanding a higher discount from Hawk to compensate
for this. Redtail has been paying full list price for components purchased from Hawk since the contract
expired. List prices are significantly higher than previous contract prices. Redtail’s management
accounts for the period June to August 2017, show a fall in the gross profit margin from 23% to 18%.
Redtail is unable to source some components, supplied by Hawk, from alternative suppliers.
Redtail is purchasing smaller quantities of components from Hawk whilst the new contract is
negotiated. This has resulted in stockouts which have caused a significant delay in the supply of turbines
to Tiberius SRL (Tiberius). Tiberius is threatening to action a penalty clause in its contract with Redtail
due to the delay.
Redtail’s directors have prepared a revised cash flow forecast to reflect the above issues. The revised
forecast shows that Redtail expects to significantly exceed its overdraft limit in November 2017.
Redtail’s directors have approached the company’s bank to request an extension to its current
overdraft facility. The bank has requested Redtail’s audited financial statements for the year ending 30
September 2017 before making a decision.
Redtail’s finance director, Chloe Duke, has insisted that the audit is completed by 31 October 2017.
Resources for this year’s audit have already been scheduled, in line with timetables for prior years, to
allow the audit work to be completed by 16 December 2017. Chloe also informed the engagement
partner that Redtail is undertaking a large project which requires a tax adviser. She suggested that SLP’s
support in meeting the 31 October deadline would result in SLP being appointed as the tax adviser.
Requirements:
(a) Identify and explain the factors which give rise to an uncertainty about the going concern status of
Redtail. (12 marks)
(b) Assuming SLP concludes there is an uncertainty about the going concern status of Redtail, explain
the implications for the auditor's report on the financial statements of Redtail for the year ending 30
September 2017 if the directors:
(i) make appropriate disclosures; or
(ii) do not make any disclosures. (6 marks)

THURMAN CO
You are the manager responsible for the audit of Thurman Co, a manufacturing company which supplies
stainless steel components to a wide range of industries. The company’s financial year ended on 31
July 2016 and you are reviewing the audit work which has been completed on a number of material
balances and transactions: assets held for sale, capital expenditure and payroll expenses. A summary
of the work which has been performed is given below and in each case the description of the audit
work indicates the full extent of the audit procedures carried out by the audit team.
(a) Assets held for sale

Due to the planned disposal of one of Thurman Co’s factory sites, the property and associated assets
have been classified as held for sale in the financial statements. A manual journal has been posted by
the finance director to reclassify the assets as current assets and to adjust the value of the assets for
impairment and reversal of depreciation charged from the date at which the assets met the criteria to
be classified as held for sale. The finance director asked the audit senior to check the journal before it
was posted on the basis of there being no one with the relevant knowledge to do this at Thurman Co.
The planned disposal was discussed with management. A brief note has been put into the audit working
papers stating that in management’s opinion the accounting treatment to classify the factory as held
for sale is correct. The manual journal has been arithmetically checked by a different member of the
audit team, and the amounts agreed back to the non-current as set register.
(9 marks)
(b) Capital expenditure
When auditing the company’s capital expenditure, the audit team selected a material transaction to
test and found that key internal controls over capital expenditure were not operating effectively.
Authorisation had not been obtained for an order placed for several vehicles, and appropriate
segregation of duties over initiating and processing the transaction was not maintained.

The audit team noted details of the internal control deficiencies and updated the systems notes on the
permanent audit file to reflect the deficiencies. The audit work completed on this order was to agree
the purchase of the vehicles to purchase invoices and to the cash book and bank statement. The rest of
the audit work on capital expenditure was completed in accordance with the audit programme.
(7 marks)
(c) Payroll expenses
The payroll function is outsourced to Jackson Co, a service organisation which processes all of Thurman
Co’s salary expenses. The payroll expenses recognised in the financial statements have been traced
back to year-end reports issued by Jackson Co. The audit team has had no direct contact with Jackson
Co as the year-end reports were sent to Thurman Co’s finance director who then passed them to the
audit team.
Thurman Co employs a few casual workers who are paid in cash at the end of each month and are not
entered into the payroll system. The audit team has agreed the cash payment made back to the petty
cash records and the amounts involved are considered immaterial.
(9 marks)
Required:
In respect of each of the three matters described above:
(i) Comment on the sufficiency and appropriateness of the audit evidence obtained;
(ii) Recommend further audit procedures to be performed by the audit team; and
(iii) Explain the matters which should be included in a report in accordance with ISA 265
Communicating Deficiencies in Internal Controls to Those Charged with Governance and
Management.
Note: The split of the mark allocation is shown against each of the matters above. (25 marks)
BOSTON CO
You are the manager responsible for the audit of Boston Co, a producer of chocolate and confectionery.
The audit of the financial statements for the year ended 31 December 2015 is nearly complete and you
are reviewing the audit working papers. The financial statements recognise revenue of $76 million,
profit before tax for the year of $6·4 million and total assets of $104 million.
The summary of uncorrected misstatements included in Boston Co’s audit working papers, including
notes, is shown below. The audit engagement partner is holding a meeting with the management team
of Boston Co next week, at which the uncorrected misstatements will be discussed.
Statement of profit Statement of
or loss financial position
Summary of uncorrected Debit Credit Debit Credit
misstatements: $ $ $ $
(i) Impairment 400,000 400,000
(ii) Borrowing costs 75,000 75,000
(iii) Irrecoverable debt 65,000 65,000
(iv) Investment 43,500 43,500
Totals 465,000
465,000 118,500 118,500 465,000
(i) During the year Boston Co impaired one of its factories. The carrying value of the assets
attributable to the factory as a single, cash-generating unit totalled $3·6 million at the year end.

The fair value less costs of disposal and the value in use were estimated to be $3 million and $3·5
million respectively and accordingly the asset was written down by $100,000 to reflect the
impairment. Audit procedures revealed that management used growth rates attributable to the
company as a whole to estimate value in use. Using growth rates attributable to the factory
specifically, the audit team estimated the value in use to be $3·1 million.
(ii) Interest charges of $75,000 relating to a loan taken out during the year to finance the
construction of a new manufacturing plant were included in finance charges recognised in profit
for the year. The manufacturing plant is due for completion in November 2016.
(iii) One of Boston Co’s largest customers, Cleveland Co, is experiencing financial difficulties. At the
year-end Cleveland Co owed Boston Co $100,000, against which Boston Co made a 5% specific
allowance. Shortly after the year end Cleveland Co paid $30,000 of the outstanding amount due
but has since experienced further problems, leading to their primary lender presenting a formal
request that Cleveland Co be liquidated. If successful, only secured creditors are likely to
receive any reimbursement.
(iv) During the year Boston Co purchased 150,000 shares in Nebraska Co for $4·00 per share. Boston
Co classified the investment as a financial asset held at fair value through profit or loss. On 31
December 2015, the shares of Nebraska Co were trading for $4·29. At the year end the carrying
value of the investment in Boston Co’s financial statements was $600,000.
Required:
(a) Explain the matters which should be discussed with management in relation to each of the
uncorrected misstatements, including an assessment of their individual impact on the financial
statements; and (14 marks)
(b) Assuming that management does not adjust any of the misstatements, discuss the effect on the
audit opinion and auditor’s report. (6 marks)
MALEVICH & CO
Malevich & Co is a firm of Chartered Certified Accountants offering audit and assurance services to a
large portfolio of clients. You are a manager in the audit department responsible for the audit of two
clients, Kandinsky Co and the Rothko University, both of which have a financial year ended 31 July 2015.
The audits of both clients are being completed and you are reviewing issues which have been raised
by the audit seniors.
Kandinsky Co is a manufacturer of luxury food items including chocolate and other confectionery which
are often sold as gift items individually or in hampers containing a selection of expensive items from the
range of products. Due to an economic recession sale of products have fallen sharply this year, and
measures have been implemented to support the company’s cash flow. You are aware that the
company only has $150,000 in cash at the year end.

Extracts from the draft financial statements and other relevant information are given below.
Note July-2015 July-2014

(Draft) (Actual)
$’000 $’000
Revenue
2,440 3,950
Operating expenses (2,100) (2,800)
Finance charge (520) (500)
––––––– –––––––
(Loss)/profit before tax (180) 650
––––––– –––––––
Total assets 10,400 13,500
Long-term liabilities – bank loan 1 3,500 3,000
Short-term liabilities – trade payables 2 900 650
Disclosed in notes to financial statements:
Undrawn borrowing facilities 3 500 1,000
Contingent liability 4 120 –
Notes:
1) The bank loan was extended in March 2015 by drawing on the borrowing facilities offered by the
bank. The loan carries a fixed interest rate and is secured on the company’s property including the
head office and manufacturing site. The first repayment of loan capital is due on 30 June 2016 when
$350,000 is due to be paid.
2) Kandinsky Co renegotiated its terms of trade with its main supplier of cocoa beans, and extended
payment terms from 50 days to 80 days in order to improve working capital.
3) The borrowing facilities are due to be reviewed by the bank in April 2016 and contain covenants
including that interest cover is maintained at 2, and the ratio of bank loan to operating profit
does not exceed 4:1.
4) The contingent liability relates to a letter of support which Kandinsky Co has provided to its main
supplier of cane sugar which is facing difficult trading conditions.
Required:
In respect of the audit of Kandinsky Co:
(i) Identify and explain the matters which may cast significant doubt on the company’s ability to
continue as a going concern; and (9 marks)
(ii) Recommend the audit procedures to be performed in relation to the going concern matters
identified. (6 marks)

RAPHAEL & CO
You are a manager in the assurance department at Raphael & Co, a firm of Chartered Certified
Accountants. Your firm has been appointed by Sanzio Co to perform a due diligence review of a
potential acquisition target, Titian Tyres Co. As part of the due diligence review and to allow for
consideration of an appropriate offer price, Sanzio Co has requested that you identify and value all the
assets and liabilities of Titian Tyres Co, including items which may not currently be reported in the
statement of financial position.
Sanzio Co is a large, privately owned company operating only in this country, which sells spare parts and
accessories for cars, vans and bicycles. Titian Tyres Co is a national chain of vehicle service centres,
specialising in the repair and replacement of tyres, although the company also offers a complete range
of engine and bodywork services as well. If the acquisition is successful, the management of Sanzio Co
intends to open a Titian Tyres service centre in each of its stores.
One of the reasons for Titian Tyres Co’s success is their internally generated customer database, which
records all customer service details. Using the information contained on the database software, the
company’s operating system automatically informs previous customers when their vehicle is due for its
next service via email, mobile phone text or automated letter. It also informs a customer service
team to telephone the customer if they fail to book a service within two weeks of receiving the
notification. According to the management of Titian Tyres Co, repeat business makes up over 60% of
annual sales and management believes that this is a distinct competitive advantage over other service
centres.
Titian Tyres Co also recently purchased a licence to distribute a new, innovative tyre which was designed
and patented in the United States. The tyre is made of 100% recycled materials and, due to a new
manufacturing process, is more hardwearing and therefore needs replacing less often. Titian Tyres Co
paid $5 million for the licence in January 2015 and the company is currently the sole, licenced
distributor in this country.
During a brief review of Titian Tyres Co’s financial statements for the year ended 30 June 2015, you
notice a contingent liability disclosure in the notes relating to compensation claims made after the
fitting of faulty engine parts during 2014. The management of Titian Tyres Co has stated that the fault
lies with the manufacturer of the part and that they have made a claim against the manufacturer for
the total amount sought by the affected customers.
Required:
(a) Describe the purpose of a due diligence assignment and compare the scope of a due diligence
assignment with that of an audit of historical financial statements. (6 marks)
(b) (i) Recommend, with reasons, the principal additional information which should be made
available to assist with your valuation of Titian Tyres Co’s intangible assets.
(ii) Explain the specific enquiries you should make of Titian Tyres Co’s management relevant to the
contingent liability disclosed in the financial statements.
Note: The total marks will be split equally between each part. (14 m a r k s )
(Total: 20 marks)

REGULATORY BODY – (ICAP SUMMER 2012 Q.5)
A regulatory body has recently revised certain requirements pertaining to the information to be
disclosed in the financial statements of one of your existing clients. These requirements may be in
conflict with the financial reporting framework being followed by the client.
You have informed the client that in view of the possible conflict, the audit report may require a
modification. However, the client has expressed its reservations over the issue and requested you to
avoid modifying the report.
Required:
(i) Based on the requirement of relevant ISA, draft an appropriate response to the client, explaining the
possible reasons for modification and the circumstances in which such a modification may be
avoided. (05 marks)
(ii) Assuming that you decide to modify the audit report, on grounds as you consider appropriate, draft
the basis for modification paragraph to be included in that report.
(06 marks)
BLUE SKY LIMITED
You are the auditor of Blue Sky Limited (BSL). The draft consolidated financial statements of BSL and its
subsidiary Sea Green Limited (SGL) for the year ended September 30, 2009 show a profit before
taxation of Rs. 10.5 million (2008 : Rs. 9.4 million) and net assets of Rs. 55.2 million (2008 : Rs. 50.7
million). You have performed the audit procedures you considered necessary for the year ended
September 30, 2009 and are satisfied with the results of those procedures.
However, your firm is also the auditor of Sea Green Limited (SGL). You were appointed as SGL’s auditors
for the year ended September 30, 2009 after BSL acquired 90% shares of SGL on June 30, 2008. SGL’s
draft financial statements for the year ended September 30, 2009 show profit before taxation of Rs. 0.7
million (2008: Rs. 1.7 million) and net assets of Rs. 16.1 million (2008: Rs. 16.6 million). Both the
companies are exempt from tax.
The previous auditors’ report on SGL’s financial statements, for the year ended September 30, 2008 was
unmodified. However, during the audit of SGL it was discovered that due to an error, the inventory as
appearing in the audited financial statements for the year ended September 30, 2007 was overvalued
by Rs. 5.7 million. This amount is now being adjusted by SGL over a period of three years i.e. over the
years ended September 2008 to 2010.
You have approached the management advising them to adjust the full amount in the current year.
However, the management is not willing to accept your point of view.
Required:
Draft the modification paragraph of the report which you would issue on the consolidated financial
statements, in the above situation.

NAVEED LIMITED – (ICAP SUMMER 2017 Q.6a)
You have recently completed the audit of Naveed Limited, a listed company. Significant matters
concerning the audit include classification of certain debts as long term. The debt covenants of the
loans have been breached but subsequent to the year end the banks have confirmed verbally that they
will not demand immediate repayment.
Required:
Evaluate the above situation and draft the modification, if required, for inclusion in the audit report.
You may assume necessary details.
(06 marks)
MARS LIMITED (ICAP WINTER 2014 Q.2)
You are the engagement partner on the audit of Mars Limited, for the year ended 30 September 2014.
On commencement of the review of working paper file, the audit manager has informed you that the
audit report would need modification. The following draft modification is available in the file:
“We draw attention to note 10 to the financial statements that fully explains that amount of Rs. 70
million due from Utopia Limited (UL), that is outstanding since September 2013, is not recoverable as UL
is in the process of winding up from 20 December 2013. Therefore, the said amount has been fully
provided for in the financial statements of the current year due to which the company has incurred loss
during the year. As the revenue from UL amounts to 40% of total revenue of 2013, we are of the view
that it is fundamental to users’ understanding of the financial statements. Our opinion is not qualified in
respect of this matter.
The financial statements for the year ended 30 September 2013 were audited by another auditor who
expressed an unmodified opinion on those statements on 25 December 2013.”
The draft financial statements show a loss of Rs. 92.4 million (2013: Profit of Rs. 16.4 million) and total
assets of Rs. 395 million (2013: Rs. 410 million).
Required:
a) Evaluate all the facts from the information available above and state the actions the auditor needs to
take on the basis of evaluation. (12 marks)
b) Making necessary assumptions on the basis of the above information, draft an appropriate
modification on any one matter, to be included in the audit report. (05 marks)

ROSE LIMITED – (ICAP WINTER 2017 Q.5)
You have recently completed the audit of the financial statements of Rose Limited (RL), a listed
company having a net profit of Rs. 1,500 million. You have identified following matters which will be
reported as key audit matters in the audit report:
(i) RL has pending tax litigation in which tax department has raised demand aggregating Rs. 175
million. The demand has been challenged by RL and the decision in respect of this matter is
currently pending. The amount is disclosed as a contingent liability in the financial statements.
(ii) RL makes significant purchases from related parties and also incurs significant advertising expenses
through related parties. These transactions are properly disclosed as related party transactions in
(iii) RL has decided to sell a manufacturing facility located in Faisalabad having a carrying value of Rs.
300 million and would replace it with another facility in Gujranwala. The manufacturing facility has
been classified as non-current assets held for sale.
Required:
Draft the key audit matters section to be included in the audit report of RL relating to the above
matters. (You may assume necessary details where required)
(15 marks)

KEY AUDIT MATTERS (ICAP WINTER 2016 Q.1)
You are a partner in a firm of Chartered Accountants. Annual audits of various clients are at finalization
stage and since this is the first time that ISA related to Key Audit Matters is to be applied, several issues
have been referred to you for guidance. These include:
(a) An adverse report is being issued in the case of Muneer Limited. The draft report also contains
certain matters as Key Audit Matters.
(02 marks)
(b) A qualified report has been drafted by the audit manager of Nadir Limited as the company has
failed to make adequate provision of contingency. The details of qualification are mentioned in the
Key Audit Matters section.
(03 marks)
(c) The Key Audit Matters section of audit report of Zia Limited includes details of Key Audit Matters of
only the current period. However, the opinion has been expressed on current as well as prior year.
(03 marks)
(d) At one of the listed clients, investigation by a Government agency against some of its staff members
is in progress. Due to sensitivity of the matter the management has requested you to not to include
such information in the Key Audit Matters section. (03 marks)
Required:
Advise the concerned partners/managers with respect to the above matters.

PIXEL LIMITED (ICAP SUMMER 2018 Q.6 b)
During the audit of a listed client Pixel Limited (PL), you became aware that a legal action has been
instituted against PL by a competitor, on account of infringement of patent rights. The company’s
lawyer was not able to give any estimate about the outcome of the case.
No provision was made in the financial statements for the possible loss as a result of the claims (which
are considered to be material), although details of those legal claims were fully disclosed in the notes.
Required:
Draft how the above matter would be reported in the key audit matter section of the audit report. (You
may assume necessary details) (05 marks)

Voltage Limited (ICAP Summer 2019 Q.7)
During the audit of consolidated financial statements of Voltage Limited (VL), for the year ended 31
May 2019, you have identified the following matters which will be reported as key audit matters in the
audit report:
(i) VL has acquired 65% shares in Pyrus Limited.

(ii) VL has entered into a major project in relation to the development and maintenance of its
electricity transmission infrastructure which is expected to be completed over a three year
period.
Required:
Draft the key audit matters section to be included in the audit report of VL’s consolidated financial
statements. (You may assume necessary details where required)
(10)
CINNABAR GROUP 27 mins
You are a manager in the quality control review department of Scheel, a firm of Chartered Certified
Accountant. You are currently responsible for reviewing the appropriateness of your firm’s proposed
auditor’s reports on financial statements.
Opinion
‘In our opinion the financial statements give a true and fair view of the state of the company’s affairs as
at 31 March 2007 and its financial performance and its cash flows for the year ended in accordance with
International Financial Reporting Standards.
‘The company’s liabilities exceed its assets at 31 March 2007 creating an adverse situation which the
directors believe is reversible over the coming twelve months. The directors further believe that the
company is capable of continuing to trade for twelve months from the date of this report.
’19 July 2008’
Required:
Identify and explain the shortcomings of this report. (10 marks)

BEIGE INTERIORS 27 mins
You are the manager in charge of the audit of Beige Interiors, a limited liability company, your auditors’
report for the year to 30 September 2007 was signed, without modification, in January 2008.
The scope of the audit for the year to 30 September 2008, taking the accounting records with him. As a
training exercise you have asked one of the trainees assigned to the audit, Jade, to draft the extracts for
the basis of opinion and opinion paragraphs that would not be standard wording in an unmodified
auditors’ report. Jade has drafted the following:
Basis of opinion (extract)

However, the evidence available to us was limited because accounting records were missing at the
beginning of the period and it was not possible to completely reconstruct them.
Opinion (extract)
Because of the possible effect of the limitation in evidence available to us, we do not express an opinion
on the financial statements.
Required:
Discuss the suitability of Jade’s draft. Your answer should identify and comment on the principal
matters relevant to forming an appropriate opinion on the financial statements of Beige Interiors for
the year ended 30 September 2008. (9 marks)
Note. You are NOT required to redraft the extracts. Assume it is 11 December 2008.

ASIASPORT 27 mins
WorldSport, a company listed on a stock exchange, recently expanded its overseas operations by
entering into an agreement on 1 April 2008 with the government of a developing Asia country. The
intention was to open up the market for its products of sporting goods in that part of the world. A new
company called AsiaSport was set up with a share capital of $30 million owned equally by WorldSport
and the government of the Asia country. WorldSport would provide finance, equipment (sold at cost to
AsiaSport) and expertise; the government would provide premises, a ready supply of material and
labour, and the potential market for the goods.
AsiaSport has been incorporated for an initial five year period and will operate under the local
government’s foreign investment laws and regeneration scheme. After this period either party can
insist on the business being wound up, or its operating terms may be renegotiated. In the event of a
winding up after five years, or earlier if the business is not viable the government has a priority in the
repayment of its share of the original capital. WorldSport will only receive a maximum of its original
capital.
The board of AsiaSport is made up of equal numbers of directors from WorldSport and the government.
The Chairperson, who has the casting vote, is rotated annually between the two parties. In the first
year, WorldSport will nominate one of its representatives as the Chairperson. On this basis, the
accountant of WorldSport has decided to treat AsiaSport as a subsidiary of WorldSport in the
consolidated financial statements.
You are the audit partner reviewing the audit file. You find the following note from the audit senior on
the report to partner file:
Treatment of AsiaSport as subsidiary
The accountant’s treatment appears reasonable given the facts, on an unqualified opinion is
appropriate. However, given that it is a complex investment, I suggest the following emphasis of matter
paragraph in the auditors’ report:
Emphasis of matter paragraph – investment in AsiaSport
In forming our opinion, we have considered the treatment of the investment in AsiaSport, details of
which can be found in note 18 to the financial statements. We confirm the accountant’s view that as
WorldSport has a casting vote on the board of AsiaSport, it has control of the entity and it si justifiable
to treat the investment as a subsidiary.
Opinion
In our opinion, the financial statements give a true and fair view...’
Required:
Comment on the audit senior’s proposed audit report. Your comments should include comments on the
proposed audit opinion and the format of the report. (10 marks)
(Total = 15 marks)

CLEEVES 27 mins
You are an audit manager in a firm of Chartered Certified Accountants currently assigned to the audit of
Cleeves Co for the year ended 30 September 2008. During the year Cleeves acquired a 100% interest in
Howard Co. Howard is material to Cleeves and audited by another firm, Parr & Co. You have just
received Parr’s draft auditor’s report for the year ended 30 September 2008. The wording is that of an
unmodified report except for the opinion paragraph which is as follows:
Audit opinion
As more fully explained in notes 11 and 15 impairment losses on non-current assets have not been
recognised in profit or loss as the directors are unable to quantify the amounts. In our opinion,
provision should be made for these as required by International Accounting Standard 36 (Impairment).
If the provision had been so recognised the effect would have been to increase the loss before and after
tax for the year and to reduce the value of tangible and intangible non-current assets. However, as the
directors are unable to quantify the amounts we are unable to indicate the financial effect of such
omissions.
In view of the failure to provide for the impairments referred to above, in our opinion the financial
statements do not present fairly in all material respects the financial position of Howard Co as of 30
September 2008 and of its loss and its cash flows for the year then ended in accordance with
International Financial Reporting Standards.
Your review of the prior year auditor’s report shows that the 2007 audit opinion was worded identically.
Required:
(i) Critically appraise the appropriateness of the audit opinion by Parr & Co on the financial statements
of Howard Co, for the years ended 30 September 2008 and 2007.
(7 marks)
(ii) Briefly explain the implication of Parr & Co’s audit opinion for your audit opinion on the
consolidated financial statements of Cleeves Co for the year ended 30 September 2008.
(3 marks)
(Total = 15 marks)

ZIA YAQOOB & COMPANY – (ICAP SUMMER 2018 Q.3)
You are the audit manager of Zia Yaqoob & Company Chartered Accountants. You have asked Aslam,
one of the team members assigned on the audit of Black Sugar Limited to draft the audit report for the
year ended 31 May 2018. The extracts from the draft report are as follows:
Adverse Opinion
In our opinion, except for the effects of the matter described in the Basis for Adverse Opinion section of
our report, the accompanying financial statements present fairly, in all material respects the financial
position of the Company as at 31 May 2018, and its financial performance and its cash flows for the
year then ended.
Basis for Adverse Opinion

The Company’s stores and spares consist of capital spares of machineries for smooth and uninterrupted
production of sugar during the crushing season. These are carried at lower of cost and net realisable
value as per IAS–2. The Company’s Chief Financial Officer has refused to reclassify it as capital stores
and spares as per IAS–16 as it would adversely affect the current ratio, as prescribed by the financial
institutions. We verified the Company’s records and ascertained conclusively the value of the capital
spare at Rs. 100 million. Had the management stated them as capital spares, Non–Current assets would
have increased by Rs. 100 million and consequently Current Assets would have reduced by the same
amount.

We draw attention to note 2 to the financial statements, which describes the early adoption of IFRS–2.
However, due to time limitation, certain disclosures required by IFRS–2 could not be provided in the
financial statements. Our opinion is not modified in this respect.
Required:
Critically analyse the audit report drafted by Aslam. (11 marks)

JAVED LIMITED – (ICAP WINTER 2012 Q.3b)
Identify and explain the shortcomings in the following paragraph of the draft audit report of Javed
Limited:
Emphasis of Matter:
We draw attention to the fact that the company has accumulated losses of Rs. 115,436,540 (2011: Rs.
85,365,479) and certain payments against long term loans were overdue as at the reporting date. As at
30 September 2012, its total liabilities exceeded its total assets by Rs. 15,450,300 (2011: Rs.
11,542,200). These conditions indicate the existence of a material uncertainty that the company may be
unable to continue as a going concern.
(04 marks)

ROCKWELL & CO
You are an audit manager at Rockwell & Co, a firm of Chartered Certified Accountants. You are
responsible for the audit of the Hopper Group, a listed audit client which supplies ingredients to the
food and beverage industry worldwide.
The audit work for the year ended 30 June 2015 is nearly complete, and you are reviewing the draft
audit report which has been prepared by the audit senior. During the year the Hopper Group
purchased a new subsidiary company, Seurat Sweeteners Co, which has expertise in the research and
design of sugar alternatives. The draft financial statements of the Hopper Group for the year ended 30
June 2015 recognise profit before tax of $495 million (2014 – $462 million) and total assets of $4,617
million (2014: $4,751 million). An extract from the draft audit report is shown below:
Basis of modified opinion (extract)

In their calculation of goodwill on the acquisition of the new subsidiary, the directors have failed to
recognise consideration which is contingent upon meeting certain development targets. The directors
believe that it is unlikely that these targets will be met by the subsidiary company and, therefore, have
not recorded the contingent consideration in the cost of the acquisition. They have disclosed this
contingent liability fully in the notes to the financial statements. We do not feel that the directors’
treatment of the contingent consideration is correct and, therefore, do not believe that the criteria of
the relevant standard have been met. If this is the case, it would be appropriate to adjust the goodwill
balance in the statement of financial position.
We believe that any required adjustment may materially affect the goodwill balance in the statement of
financial position. Therefore, in our opinion, the financial statements do not give a true and fair view of
the financial position of the Hopper Group and of the Hopper Group’s financial performance and cash
flows for the year then ended in accordance with International Financial Reporting Standards.

We draw attention to the note to the financial statements which describes the uncertainty relating to
the contingent consideration described above. The note provides further information necessary to
understand the potential implications of the contingency.
Required:
Critically appraise the draft audit report of the Hopper Group for the year ended 30 June 2015,
prepared by the audit senior.
Note: You are NOT required to re-draft the extracts from the audit report.
(10 marks)

ANSWERS
_____________________________________________________________________________

ANSWER # 1 - EFAF FOUNDATION
Overall controls – statement showing donations, fee and income and payments are reviewed by senior
management personnel on a monthly basis (i.e. business performance review covering all assertions)
CONTROL OVER DONATIONS:

(i) Cash
• For cash received at counters, the cashier counts the cash and prepares a receipt voucher
(Completeness, Accuracy, Rights/Obligation, Cut off)
• For donation boxes – donation boxes are unlocked / opened in the presence of two / three
persons and then a cash count is performed following which a receipt voucher is prepared
showing details about the date, time, place of box and the total cash collected. (Completeness,
Accuracy)
• Cash count is performed on regular basis by a person independent of the custodian of cash and
results are matched with the daily receipt record maintained in the system (Existence)
• Cash is kept in safe custody and at day end the cash is deposited with bank. (Existence)
• Surprise cash counts are also conducted by the persons independent of the custodian of cash
(Existence)
• Appropriate segregation of duties exists, i.e. person receiving the cash, maintaining its custody
and recording the transactions is not the same
Bank accounts
• Bank reconciliation statements are prepared and reviewed on a regular basis and unadjusted /
reconciling items are investigated and recorded on timely basis. (Completeness, Accuracy, Rights /
Obligations, Cut off)
Controls over fee income

• The cashier counts the cash and prepares a receipt voucher showing details about the date, time,
name of student and the cash collected. (Completeness, Accuracy, Rights / Obligations, Cut off)
• A student wise fee outstanding report is prepared and reviewed on a monthly basis and the
schedule of overdue fee is presented to the management for appropriate action as per policy.
CONTROLS OVER PAYMENTS:

(i) Teachers
• Payroll process is initiated by the payroll department based on the master data maintained by HR
department.
• The attendance record reviewed by the Head of the Department before the processing of payroll.
• A month-to-month payroll reconciliation is prepared before the distribution of payroll.
• Changes to master data is made by the HR department only after due authorization.
(ii) Petty cash

• Pre-numbered / sequentially controlled petty cash vouchers are maintained.
• Cash on the basis of IOUs is not disbursed.
• Surprise cash counts are conducted by the persons independent of the custodian of cash
(Existence)
• Payments are recorded in general ledgers after the details are reviewed by the Finance Manager.

ANSWER # 2 - BETA CONSTRUCTION LTD
a) Before accepting the assignment, your firm should consider the following factors: (i) Whether the
firm possesses technical competence to perform such services. (ii) Whether required resources
would be available to carry out the engagement. (iii) Could there be any threats to compliance with
the fundamental principles? (iv) Are there any professional reasons for not accepting the
engagement?
Procedures to be followed by the Audit Firm The non-acceptance by the existing auditor to carry out
the assignment may represent a threat to the fundamental principles.
The necessary procedures to avoid this treat may be as follows:

(i) After informing the client approach to the existing auditor to ascertain any professional reason
for not accepting their assignment.
(ii) Acquire an appropriate understanding of the nature of the BCCL’s business, the complexity of
its operation and the relevant industries.
(iii) Understand the specific requirements of the engagement and the purpose, nature and scope of
the work to be performed.
(iv) Possess or obtain experience with relevant regulatory or reporting requirements.
b) Basic Objectives of the above investigation

- To ascertain a deliberate fraud has actually taken place.
- To discover the perpetrator(s) of the fraud, and ultimately to assist in their prosecution.
- To quantify the financial loss suffered by the company as a result of fraud.
c) Control measure for dealing with sub-contractors

(i) An authentic list of approved sub-contractors should be maintained.
(ii) All sub-contracting work should be awarded only to the approved sub-contractor.
(iii) There should be a proper procedure for inclusion / deletion from the list of approved
subcontractors.
(iv) A company senior official visit to the sites and monitoring the performance of the sub-
contractors on a regular interval.
(v) Compliance of above procedures should be monitored regularly.
Control procedure for payments to sub-contractors

(i) Work completion certificates should be issued on specific pre-printed forms (SPP) which should be
controlled sequentially.
(ii) Books of SPPs should be supplied only to authorized supervisors with instructions for their
safekeeping.
(iii) The stock of unused SPPs should be kept in the custody of an authorized senior management
official.
(iv) Original SPPs should be sent directly to Finance Department. Copies may however be sent earlier
(by fax or e-mail) to save processing time. The actual SPPs must be sent by courier immediately
after sending fax/scanned copy.
(v) All alterations on SPPs should be authenticated by the concerned supervisor.
(vi) Strict budgetary control should be exercised in respect of each project. Variances between the
actual and budgeted expenditure should be analyzed and explained. Monthly cash outflow forecast
of each project should be prepared and monitored.

ANSWER # 3 - GRANGER
Inadequate segregation of duties and proposed reassignment

A basic principle of segregation of duties is that an individual employee should not be able to make
errors and be in a position to conceal the fact. Proper segregation means that, if an error or
misstatement is made, it will be detected by another employee in the ordinary course of his or her
duties. A general rule of segregation is that the functions of processing transactions, recording
transactions and maintaining records over the subsequent assets or liabilities, should be performed by
different individuals.
The receptionist’s duties should be restricted to processing cash receipts transactions. All other
functions should be assigned to other staff members.
Function to be Possible misstatement Reassignment
reassigned
Checking the numerical The receptionist could deliberately This should be
continuity of invoices, understate the total in order to assigned to Clerk 1.
determining the total cash misappropriate the cash or conceal a (See additional
sales and entering the shortage of cash. procedure 1.)
cash receipts journal.
Posting the accounts An invoice could be deliberately omitted and Clerk 1 should post the
receivable ledger. the subsequent cash receipt accounts receivable
misappropriated if done by the same person. ledger from credit sales
Errors, such as transaction errors, made in invoices whose
entering the sales journal are likely to be numerical sequence is
repeated in entering the accounts receivable checked.
ledger.
Cash receipts could be temporarily
misappropriated and the shortage
concealed by delaying recording the
receipt. (See the answer to part (b)).
Function to be Possible misstatement Reassignment

reassigned
Sending out monthly If there are errors in the accounts This function should be
statements and chasing receivable ledger the monthly statements assigned to Clerk 2 since
overdue accounts. could be altered or suppressed. Clerk 1 could also falsify
If payments by customers have been statements to conceal
misappropriated and not credited to the errors in recording sales
customer account, customers’ suspicions in the accounts
would not be aroused by chasing apparent receivable ledger. (See
overdue balances. additional procedure 2.)
Reconciling accounts This procedure detects errors, deliberate or Clerk 2 should perform
receivable with the control accidental, in the maintenance of accounts the reconciliation as
account in the general receivable records. If the receptionist has having no responsibility
ledger. made errors in processing sales and cash for recording either cash
receipts transactions to accounts receivable or sales transactions or
then he would have an incentive to conceal maintaining the
their discovery by falsifying the reconciliation. accounts receivable
ledger. (See additional
procedure 3.)
Writing off uncollectible If errors have been made resulting in an Clerk 2 should advise the
balances. understatement of cash received from credit manager of overdue
customers, their accounts will appear to be balances that may need to
overdue. The error can be concealed by writing be written off. (see
off the balance. Such an error could arise from additional procedure 4.)
the deliberate misappropriation of cash
received from
credit customers.
(ii) Other control procedures needed

1. A bank reconciliation should be performed at least monthly by Clerk 1 to ensure that cash
deposited is in agreement with amounts recorded in the cash receipts book the bank
reconciliation should be scrutinised and signed by the manager.
2. The garage manager should review the list of customer account balances (which should, if
practicable, be aged), enquire into steps being taken to collect overdue balances and consider
whether further credit may be allowed.
3. The reconciliation of accounts receivable balances with the control account in the general
ledger should be scrutinised by the garage manager to ensure that it appears to be properly
drawn up.
4. Final decisions on bad debt write offs must be approved in writing by the garage manger.
5. The opening of mail should be done in the presence of a second clerk who should confirm the
total amount of cash receipts enclosed therein to minimise the likelihood of such receipts being
misappropriated.
(b) (i) Procedures to be followed in making cash count

• Control all cash funds until completion of the count to prevent cash from a counted fund
being transferred to an uncounted fund to conceal a deficiency.
• Count funds in the presence of the custodian to prevent any suggestion, in the event of a
shortage, that the funds were complete when released to the auditors.
• List each item in the fund, such as the denominations of notes, details of cheques and, for
petty cash funds, of vouchers so that the count can subsequently be agreed with the deposit
slip and other accounting records.
• Have the custodian sign the record of the count as being in agreement in the event of any
subsequent disagreement.
(ii) Discrepancy
If the details of the items counted differ from the cash receipts book I would suspect a
misappropriation of cash by failing to record a receipt from a receivable. To conceal this from
the receivable, cash received several days later from another customer is credited to the first
customer’s account. The first customer will not notice anything wrong, the delay in the receipt
being attributed to postal delays or just delays in processing cash receipts. Failure to credit
payment by the second customer will be concealed by using a payment received from a third
customer and so on. Providing the amounts involved are reasonable, the perpetrator can
usually conceal the fraud indefinitely. Such a fraud is only possible if the person responsible for
maintaining the accounts receivable ledger also has access to cash received from customers
before any control is established over that cash.
This fraud is sometimes called ‘teeming and lading’ or ‘lapping’.
It will be necessary to undertake a further investigation by comparing deposit slips receipted by

the bank with details recorded in the cash receipts book and postings to the accounts
receivable ledger for a series of consecutive days. If a pattern of differences emerges consistent
with the pattern associated with this type of fraud, then the existence of the fraud must be
suspected.
ANSWER # 4 - READ COMPUTERS
(1) Inventory records and PCs held by directors

Weaknesses
The inventory records are not a reliable record of actual inventory held because:
• customer returns have not been recorded
• some items recorded as being in inventory are missing Some ‘missing’ items are held at directors’
own homes. Implications
• Year end inventories may be misstated if reliance is placed on year- end inventory records instead
of a year-end count.
• Inventory losses may go unnoticed until the next physical count delaying insurance claims and
making theft more likely.
• Customers may not be given credit for goods returned such that trade receivables will be
overstated and there may be a loss of customer goodwill.
• PCs ‘borrowed’ by the directors are unlikely to still be suitable for resale at their full value and may
need to be written down in the financial statements.
• Orders could be accepted which cannot be fulfilled if decisions are taken based on incorrect
inventory records.
Recommendations
• All inventory despatches should be recorded on sequentially numbered despatch notes and be
subsequently matched with a sales invoice.
• All inventory returns should be recorded on sequentially numbered returns notes and be
subsequently matched with a credit note.
• A responsible official (e.g. warehouse manager) should authorise any movement out of inventory
other than for sales. These items should either be removed from the inventory records and
transferred to the non-current assets register (e.g. PCs used by directors) or retained within the
inventory records with a note as to their location.
• Physical security over inventory should be improved.
• Until the accuracy of the inventory records is established, monthly counts should be performed.
(2) Customer credit limits

Weaknesses
The system in operation over credit limits has been broken down as:
• credit limits are being exceeded
• credit limits are not being allocated to new customers.
Implications
• Customers may make purchases for which they are then unable to pay, resulting in bad debts.
• Customers may take advantage of the deterioration in credit control and delay payment.
Recommendations
• A credit limit must be set by a responsible official (e.g. sales director) before a new customer can be
accepted.
• Before an order is accepted from a customer, a check should be made to see if that order, together
with the outstanding balance on that customer’s account, exceeds that customer’s credit limit. If
that is the case then either the order should not be accepted at that time, or an increased limit
should be authorised.

ANSWER # 5 – SHAHZAD LIMITED
Following weaknesses in inventory count are identified from audit senior’s

observations:
(i) Lack of segregation of duties
The Inventory Controller is responsible for the physical control of the inventory and is also
supervising the stock count.
(ii) Non availability of detailed plan

Allocation of counting area by the teams themselves indicates non availability of detailed plan
which may lead to certain inventory items being counted more than once while some items may
not be counted at all.
(iii) No system of marking on counted items

This again may lead to double counting or omission completely.
(iv) Perpetual inventory records available on count sheets

The person responsible for counting may try to match the numbers provided instead of carrying out
an independent count.
(v) Additional count sheets are not pre-numbered

If the separate sheets are numbered as they are used, there is no means of identifying that all
sheets issued have been returned and the last count sheet(s) may go unnoticed.
ANSWER # 6 - RENTALS LIMITED
Following could be the examples of relevant controls while determining the fair value through internal
evaluation:
(i) Proper procedures are in place to ensure completeness, relevance and accuracy of the data used
to determine the fair value of investment properties.
(ii) Proper procedures are in place for evaluation of competence, capabilities and objectivity of that
expert.
(iii) The valuation including the assumptions or inputs used in their development are reviewed and
approved at an appropriate level or when required by those charged with governance.
(iv) Proper procedures are in place to refine the estimate when comparisons of the actual to the
estimated results indicate such a need.
(v) Proper segregation of duties exists between persons committing the entity to underlying
transactions and those responsible for determining the fair value of investment properties.
(vi) Specific policies and procedures are in place for specific models used for making accounting
estimates. Relevant controls may be established over:
• The design and development, or selection, of a particular model for a particular purpose
• The use of the model
• The maintenance and periodic validation of the integrity of the model

ANSWER # 7 - ELM LTD
Consequences
• Staff may not have appropriate skills, leading to:
o poor quality work
o costs to rectify
o adverse impact on reputation
• Staff may lack integrity, leading to:
o theft
• Staff may have falsified information about identity or qualifications, leading to:
o claims and legal action
• Staff may be breaking the law
o e.g. right to work in UK, leading to:
o fines
• Adverse impact on cash flow /going concern risk
Recommendations
• Communicate policy to staff
• Obtain two references
• At least one reference from a former employer
• Inspect proof of qualifications
• All offers of employment made subject to satisfactory references
• Formal approval to appoint new employees
• Monitoring of procedures
• Disciplinary procedures for failing to comply with the policy
ANSWER # 8 - JHELUM MACHINERY
Control weaknesses in the System:

• There is a lack of segregation of duties as the functions of obtaining and evaluation of bids, approval
of supplier and placement of orders are performed by Salahuddin.
• Controls over authorization and approval of supplier, as purchase manager was able to get the
approval of NPL, without any detailed background checking.
• There appears no system of stock inspection by an independent person when it is received in the
store.
• There appears to be no system of physical verification of stock to identify any damage stock, so that
it can be identified on timely basis.
• It appears that there are no benchmarks/standards or other controls over stock consumption i.e.
identification of over consumption/under consumption as no concern is raised when production
supervisor charges extra costs as to the consumption reports.
• it appears that there are no benchmarks/standards regarding the quantities of inventory that are to
be maintained.
ANSWER # 9 - ICEBERG PUBLISHING
(1) Database maintenance

Weakness
Routine maintenance work is behind schedule resulting in a backlog of input for new subscriptions,
cancellations and changes of addresses.
Consequences
• Accounting errors and loss of revenue could arise through
o not invoicing new subscribers
o invoicing cancellations
o sending invoices to incorrect addresses.
• Customer goodwill may be lost if subscribers no longer receive their magazine through it being sent
to the wrong address.
• New subscribers, failing to receive their magazine promptly, may cancel their subscription.
Recommendations
• Extra staff should be used to bring the database up to date as soon as possible. Thereafter it could
be kept up to date by a part-time employee. The cost of this should be outweighed by the benefit
gained through avoiding lost revenue and customer goodwill.
(2) Advertising deals Weakness

As a result of staff shortages, some deals with advertisers are not being recorded and order
confirmations are not being sent out.
Consequences
• A loss of revenue and customer goodwill could result, as order confirmation letters are used as the
basis for allocating advertising space.
• Advertisers may be unable to place adverts because no space has been allocated.
• Advertising space may be allocated in error and then left without an advertisement.
• The lack of written confirmation of the terms may lead to incorrect invoicing, resulting in a loss of
revenue or customer goodwill.
• There may be delays in receiving monies from advertiser’s whist invoicing disputes are being dealt
with.
Recommendations
• A pre-printed, pre-numbered document should be used for recording all deals. These should be
filed and referenced to the order confirmation letters and reviewed on a regular basis.
• Alternatively, a suitable multi-part document could provide a copy to replace the confirmation
letter.
• Extra staff should be temporarily allocated to the department to record and confirm all deals are
still current.
ANSWER # 10 - HAGM
(a) Internal controls

1 The lack of investment, and the associated lack of income, is a major problem for HAGM. Internal
controls that might help to deal with the problem include the following:
• Closer monitoring of income from the various different sources and from different types of day
visitor.
• The total numbers of day visitors, analysed by type.
• Annual membership (analysed into new members and members who have renewed their
membership).
• Non-renewals of membership.
• Sponsorship income.
• Revenue from the café and shop.
There should be a budgeting system, so that management can compare actual income with budget.
This system may help management to plan for higher levels of income in the future and take
appropriate measures when actual income is less than budget.
2 Internal controls may be applied to improve the detection risk and prevention risk of unrecorded
sponsorship income.
Detection risk can be improved by making regular comparisons between the expected and the actual
recorded amounts of sponsorship income. Expected sponsorship income should be estimated from
agreements that have been reached and other sponsorship records. These comparisons should help
to identify significant differences between actual and expected amounts.
Errors may also be prevented, over time, by recording instances of failure to recognise sponsorship
income, the reasons for the mistake and the corrective measures that were taken to deal with the
failure. By recording cases of error and the corrective measures taken the frequency of errors should
lessen over time.
3 HAGM should separate sponsorship income from advertising expenditure and account for them
separately. A detective control to ensure that these items are recorded separately might be to check
sponsorship income that has been accounted for with the sponsorship payments that were
negotiated with each sponsor, to make sure that the agreed sponsorship amount was actually
invoiced.
In addition, there should be regular checks between the budgeted advertising expenditure and the
actual advertising expenditure recorded (i.e. a detective control), to identify any unusual
discrepancies.
4 A variety of internal controls are needed to reduce the risk of cash being lost, mainly stolen.
Preventative controls might include the following:
• All cash desks at the door of HAGM should be occupied during all opening hours, and desks with
cash must never be left unattended. Assistants working at cash desks should record the time
they begin and the time they finish their work at a desk.
• All cash receipts from ticket sales and in the café and shop must be counted and recorded in a
register. A receipt must be produced for the customer, with a copy for HAGM.
• Cash registers should be able to distinguish between different types of customer or different
types of sale, and different methods of payment.
• Cash and a copy of receipts must be transferred securely to the cashier’s department.
• There should be an additional physical check on entry into the art gallery and museum, between
the cash desks and the museum. This is to make sure that everyone entering HAGM is either an
annual member or has bought a ticket.
The following detective control would also be appropriate:

• There should be a daily reconciliation between quantities sold (tickets and café/shop items) with
actual cash takings.
5 There should be a contingency plan or back-up plan for when the internet booking system is
unavailable to customers to prevent a high incidence of lost sales.
This may be provided by the telephone booking system, although customers need a way of obtaining
the HAGM telephone number for bookings. This might be provided by advertising on a web search
engine such as Google.
There should also be regular maintenance and servicing arrangements to reduce the downtime of
the booking system to a minimum, again to help prevent a high incidence of lost sales.
(b) Financial statement risks

1 If HAGM is earning insufficient revenue to invest in new exhibits and maintenance and repairs, a
related risk may be failure risk (going concern risk). If HAGM is unable to meet the requirements
of IAS 1, the significant doubts about its going concern status would have to be disclosed. The
financial statement risk is the risk of failure to disclose this fact when disclosure should be
required.

2 Income may be materially understated because of a failure to account for all sponsorship
income.
3 By failing to separate sponsorship income from advertising expenditure, because sponsors have
set one amount against the other, the financial statements are at risk of understating
(sponsorship) income and understating (advertising) expenditure.
4 The risk for HAGM is mainly that cash income will be understated because it has been stolen. If
cash is taken by management and used for business purposes, there is a risk that both cash
income and expenditure will be understated. There is also some risk that if visitors are able to
get into HAGM without buying a ticket, income from ticket sales will be lost.
5 The risk of the booking system being unavailable does not give rise to any obvious financial
statement risk, provided that there are no significant risks with the back-up booking system. The
main risk is the business risk that HAGM will lose sales income during the period that the on-line
booking system is unavailable, because potential customers are unable to buy tickets when they
want to.
ANSWER # 11 - NAVEED LIMITED
Suggested controls for claim verification:

(i) Employ a panel of qualified surveyors with good reputation.
(ii) Segregation of duties relating to the claim process.
(iii) Monitoring the time lag between policy issuance and claim reported and between the claim lodge
and settlement date, and investigate unusual cases.
(iv) A second survey may be conducted on a test basis especially in unusual cases.
(v) Surveyors should be required to submit pictures of the damaged assets whenever possible.
(vi) Monitor which agent and insuree has the highest claim ratio.
(vii) Review the total claims verified by each surveyor and compare it with value of assets insured to
identify unusual ratio.
ANSWER # 12 - ZUBAIR & SHAHID LIMITED
Controls which may have been lacking in the given situation:

• Control over authorization and approval of customer, as the sales manager was able to make the
sale to fictitious customers which means that no proper investigation or processes were followed
during approval of said customers.
• Lack of segregation of duties as the write off of receivable balance should have been approved by
credit control department/section, instead of or in addition to sales director.
• Controls over write off of debts seem to be lacking. Debts should only be written off when the legal
department confirms that they are not recoverable.
Moreover the legal department should also notify as to what action was taken before deciding that the
debts are not recoverable and why a suit was not being filed against the customer. This process does
not seem to have been followed.
• Control over accounting of customer’s cheques is lacking as the sales manager manages to credit
the fictitious customers’ accounts with other customers’ cheques.

• Controls over preparation, checking and dispatching of debtor’s statements to customers is lacking
as sales manager manages to manipulate the debtor’s accounts for seven months, without any
check and balances.
ANSWER # 13 - WAHEED ENGINEERING
Control Purpose
Payroll data is approved by a senior To prevent any unauthorized inaccurate deductions
official. being made.
Payroll transactions should be The correct amount is paid over to employees or the
recalculated. relevant authorities.
Official notification of starters and To prevent employees being paid after they have left or
leavers i.e. tax documentation. before they have started.
All hours worked are authorized. To prevent the company paying for work not done.
All employees to collect their wages in To prevent loss/theft.

person.
(b) Verifying that employees are not paid prior to commencing work
(i) Two payrolls should be selected from different periods in the year.
(ii) Employees not listed on the second payroll should have left during the year and employees not
listed on the first payroll should have started during the period.
(iii) This can then be verified by examining the permanent payroll information
(iv) where there should be a copy of each employee’s contract of employment.
(v) Also, tax authority official forms should confirm departure and start dates. The main reason for
carrying out this exercise is to ensure that all employees are bona fide i.e. payments are being
made to authorised employees.
(c) Attendance at the wages pay-out

(i) Before attendance I will review the payroll to ensure that a pay packet exists for all employees.
(ii) Each employee should sign for the pay package when they collect it. As they sign, the auditor
should verify the signature to the contract of employment.
(iii) It should be ensured that no one employee collects more than one pay packet.
(iv) All unclaimed wages should be listed; the payroll date, name and amount noted.
(v) The unclaimed wages should then be stored in the safe until collected.
(d) Procedures re unclaimed wages

(i) All unclaimed wages should be recorded in an unclaimed wages book and it should be checked
that a wage packet physically exists for each entry in the book.
(ii) If someone has collected wages on behalf of somebody else then it should be ensured that a
letter of authorisation exists allowing the pay packet to be collected.
(iii) After a certain period, say a month, all unclaimed wages should be returned to the bank so the
details for each pay package should be agreed from the unclaimed wages book to the banking
slip.
(iv) Any significant delay in banking unclaimed wages should be noted and investigated.

(e) Verification of direct bank payments
(i) Carry out a physical verification of employees to ensure that they actually exist.
(ii) Check employee details to the personal records from payroll information.
(iii) The finance directors could be asked to sign a copy of the payroll to verify that all the
employees are bona fide.
(iv) Employees’ existence can be verified by confirmation of signatures on expense claims.
(v) Also, annual tax authority returns can be reviewed.
ANSWER # 14 - LAHORE COMMUNICATIONS
(1) No access restriction to terminal rooms

Consequences
• Unauthorised personnel may gain access to the terminals, resulting in loss of hardware or
corruption of software (deliberate or otherwise).
• This could cause financial loss and/or other costs arising from disruption to the business.
Recommendations
• Terminals should be kept in locked rooms, preferably with keypad or swipe-card access limited to
authorised persons only.
• Where only key access is feasible, keys should be held by authorised officials and a record of their
issue to staff maintained.
• Any security codes should be changed regularly by a senior official.
(2) Passwords changed by staff

Consequences
• If passwords are changed infrequently unauthorised members of staff may learn the passwords of
their colleagues.
• This could allow unauthorised members of staff access to parts of the system to which they should
not have access.
• This could lead to confidential information being accessed or unwanted changes being made.
Recommendations
• The system should be programmed to force users to change their passwords on a monthly basis.
(3) No fire extinguishers/air conditioning for main computer

Consequences
• This may lead to hardware overheating, resulting in systems failure, damage to equipment and loss
of data.
• The lack of fire extinguishers could mean that damage to equipment could not be lessened in the
event of a fire.
• It may also mean that insurance cover/hardware manufacturer’s warranties are invalid and that
Health and Safety Regulations are being breached.
Recommendations
• Air conditioning should be installed in the computer room, in accordance with the hardware
manufacturer’s recommendations.

• The authorities should be contacted to inspect the offices to ensure they comply with regulations.
This is likely to lead to the installation of fire extinguishers.
(4) No disaster recovery plan

Consequences
• In the event of a systems failure, continuity of operations may not be possible.
• The disruption may cause financial loss if:
▪ extra costs are incurred in recovering data
▪ customer goodwill is lost
▪ asset records may be lost, making insurance claims difficult. Recommendations
• A formal disaster recovery plan should be approved by the board covering interim processing
arrangements and steps to be taken to resume normal operations.
• The plan should be:
▪ documented
▪ set out responsibilities
▪ stored at multiple locations
▪ periodically tested.
(5) Back up media held off site

Consequences
• Back-up media must be available for use in case the original data is lost/damaged.
• If the only copy is kept on site then if there was a fire/flood/theft of such media the business would
not be able to use the back-up copy and would incur substantial costs to recreate/recover the data.
Recommendations
• Regular back-ups should be taken and stored off site in a secure and appropriate location.

ANSWER # 15 - VISION LIMITED
CONTROLS TYPE OF CONTROLS GENERAL IT CONTROLS /

APPLICATION CONTROLS
The general ledger system is automatically Preventive Application controls

updated with sub-ledger transactions (e.g.,
Accounts Receivable) every night through batch
processing.
The system automatically maintains second Corrective Application controls
copies of all programs and data files.
CONTROLS TYPE OF CONTROLS GENERAL IT CONTROLS /

APPLICATION CONTROLS
Access to programs and data files is restricted using Preventive General IT controls
passwords.
Invoices are physically counted that are entered Detective Application controls
into the system.
Firewalls (software and hardware are installed to Preventive General IT controls
restrict unauthorized access).
Screen warnings about incomplete processing. Detective Application controls
Service level agreements. Corrective General IT controls
Review of output against expected values Detective Application controls
ANSWER # 16 – INTERNAL CONTROL
Audit procedures to address the risk of management override of internal controls

• Substantiate journal entries
• Investigate reconciling items
• Review significant accounting estimates and judgements for bias
• Investigate transactions outside the normal course of business
• Review ‘whistle-blowing’ arrangements
• Review internal audit reports
• Interview management to assess its attitude towards the control environment
• Review minutes of management meetings.

ANSWER # 17 - SPEEDY SHIFTERS PLC
No approved supplier lists

Consequences Recommendations
Poor quality parts may be purchased resulting • Compile an approved supplier list by researching:
in damage to trucks and long periods of o suppliers’ prices for best rates
downtime whilst trucks are repaired. The o quality of products from each supplier
company may pay higher prices for parts and o availability of bulk purchase discounts
there is an increased scope for fraudulent acts o suppliers’ ability to meet delivery
by those ordering parts (for example, kickbacks
from suppliers). The above points will lead to requirements
an adverse impact on profits and cash flow. • The final list to be approved by senior
management/directors
• Communicate the approved supplier list to those
responsible for ordering
• When ordering, the supplier should be checked
against the approved supplier list
• Suppliers’ performance should be monitored
• Update approved supplier list regularly.
No business continuity plan
A systems failure could result in the loss of • Business continuity plans, specifying interim
accounting data and management information. arrangements, should be:
Employees may not be aware of their o in place/fully documented
responsibilities in the event of a systems o communicated to employees
failure. This will hinder the efficiency of
o approved by the audit committee
operations such as payment of suppliers and
the invoicing of customers. Customer and o periodically tested to ensure works as
supplier goodwill will be damaged leading to a intended
loss of reputation impacting on future trading. o reviewed and updated as the needs of the
Furthermore, there will be additional costs business change
involved in recovering data, thereby reducing • Responsibility for every task to be assigned to an
profits. Ultimately, the going concern status individual or outsourced to a service provider
may be at risk and the company could cease • Computer files to be backed up on a regular basis
trading.
• Backup stored at a separate location
• Insurance should be sufficient to facilitate
recovery and cover loss of profits.
Truck drivers exceed legal limit for driving
This may result in accidents, fines and litigation. • Make more driving resource available by
The company may be in breach of insurance recruiting more drivers or using a service provider
terms and conditions. If the purpose of • Reports detailing drivers hours produced on a
breaching the legal limit for driving hours was
to save costs, the company could be considered regular basis
to be involved in money laundering. The above • Monitoring of reports by Head Office
could result in loss of reputation and an • Communicate policy to depot managers and
adverse impact on profits and cash flow. drivers
Ultimately going concern issues may arise if, for • Make a whistleblowing facility available
example, the company loses its license to
• Disciplinary action for non-compliance.
trade.

Approval of annual internal audit plans and
monitoring of the internal audit function
The failure to approve internal audit plans Annual work plan should be scrutinised and agreed
means that there is no independent scrutiny in by the audit committee, prior to the
advance of planned internal audit work. This commencement of work
may mean that the scope of internal audit work • Audit committee to monitor its own
does not cover all of the company’s operations performance, for example, to see if it is
or that inappropriate internal audit work is complying with its own terms of reference
undertaken. There is an increased risk that
deficiencies in internal control may not be • Agree performance indicators for internal audit
identified resulting in a higher risk of fraud and such as:
error. All of these consequences may be o work done compared with plan
indicative of a weak control environment. o time spent compared with plan
o number of recommendations accepted by
The failure to monitor the effectiveness of the management
internal audit function may mean that the o the number of qualified staff
function is ineffective or represents poor value o feedback forms for completion by the areas
for money. The internal audit function may be reviewed by internal audit
under or over resourced and planned internal
• Monitor performance indicators on a regular
audit work may not be completed.
External audit may not choose to rely on work basis
completed by the internal audit function • Feedback to the internal audit function on areas
leading to increased costs. for improvement.
ANSWER # 18 – AUDIT COMMITTEES
• Actual time compared to budget

• Actual work completed compared to planned work
• Number of reports produced within target dates
• Number of recommendations accepted
• Savings identified
• Feedback from users
• Results of third party reviews
• Number of staff in post against planned requirement/staff turnover rates
• Number of qualified staff.
ANSWER # 19 – PULP 31 mins
(i) Matters to consider

Disclosure
The rules of IAS 24 state a party is related to an entity when the party ‘controls, is controlled by, or is
under common control with, the entity’. Since Jarvis Co is controlled by Peter Sheffield, it seems a
related party relationship exists. Further audit procedures should be undertaken to confirm that this is
the case. If so, the $25,000 received with Jarvis Co is part of a related party transaction.
IAS 24 requires the following to be disclosed for a related party transaction.

• Names of the transacting related parties
• A description of the relationship
• A description of the transaction and the amounts included
• The amounts due to or from the related party at the end of the year
• Any other element of the transaction necessary for an understanding of the financial statements

Pulp Co financial statements should be amended so that the correct disclosure of the related party
transaction with Jarvis Co is made. If Pulp Co do not make this change, the audit report should be
modified to qualified with an ‘except for’ disagreement paragraph.
Materiality
The receivable balance is 0.02% ($25,000/$12m) of total assets so would not be classified as material by
its amount. However, as the transaction is with a related party it may be material in nature and so it
should be considered whether it has been made on normal commercial terms.
Recoverability
The receivable has been in existence for over a year and so its recoverability needs to be taken into
account. The represents from Pulp Co should be viewed with professional scepticism since the same
representation was made in the previous year. If found to be a bad debt, then the balance should be
written off, and the statement of comprehensive income debited with the expense.
Misclassification
If Pulp Co are able to prove that the receivable is recoverable in the long term it may be reclassified as a
non-current receivable. However, it could be argued that the balance is effectively a non-current asset
investment, and if so, should be reclassified as such.
One-off transaction
The transaction between Pulp Co may not be a one-off and there could be further undisclosed related
party transactions between the companies.
(ii) Further audit procedures

• Written representations should be obtained from Peter Sheffield which contain:
- The exact nature of his control over Jarvis Co. For example, his percentage shareholding if he is
a shareholder
- Whether he believes the $25,000 receivable with Jarvis Co to be recoverable and a specific
date by which the amount is be expected to be repaid
- Confirmation there are no more transactions between Jarvis Co and Pulp Co or any further
outstanding balances
ANSWER # 20 – ASPERSION 36 mins
(a) Sale of cargo carrier to Abra

A cargo carrier has been sold to a party which is potentially related to Aspersion under the
requirements of IAS 24. A loss has been made on that disposal of a non-current asset.
Materiality
The loss on disposal has reduced profit before tax by $400,000. This 14% reduction is
material to profit.
Related party transaction?

Iain Jolteon, the finance director who approved the sale of the cargo carrier, has a
substantial equity interest in Abra, the company to whom it was sold. As such, Abra appears
to fall within the criteria of a related party under IAS 24.
This connection would appear stronger if Mr Jolteon owned shares in Aspersion or was a
director in Abra, and if Abra was controlled by his close family members.
Implication
The transaction should be disclosed in the financial statements as a related party
transaction. This disclosure should include:
• The names of the transacting related parties
• A description of the relationship between the parties
• A description of the transactions
• The amounts involved
• Any money outstanding due to the company/related party
Other related parties

The auditors should consider, and be alert for evidence of, other related parties and
transactions.
Reasons for the sale

The fact that a large los has been made on the sale raises other matters for the auditor to
consider:
• Whether the sale has been made at an undervalue (this may have tax implications)
• Why the machine was sold:
- Maintenance problem
- Reduction in operations
- Movement in technology rendering others obsolete
• Whether the depreciation policy was incorrect (over 20 years)
These questions will lead the auditor to review the remaining non-current assets to ensure
that they are not impaired and that the depreciation policies are reasonable.
Disclosure of loss on sale

As this item is material it would be disclosed separately in accordance with IAS 1
Presentation of financial statements.
(ii) Audit evidence

The following evidence will be sought:
• A copy of the sales agreement
• A copy of any valuation report carried out on the asset
• Evidence of receipt of the proceeds through the bank
• The calculation of the loss (this should be checked for accuracy)
• Notes of discussions with management about procedures and the related internal
controls for the identification of related party transactions
• Results of reviews of board meetings, share registers and other statutory records
• Written representations from management regarding the completeness and accuracy
of related parties and transactions and that they have been accounted for appropriately
• A copy of the disclosure note which is to be included in the financial statements.
(b) Light aircraft

Aspersion owns two light aircraft which are used to service a contract which will not be
renewed when it comes up in six months’ time.
Materiality
The total cost of the aircraft was $900,000. They have been owned in the region of 3 years,
and have been depreciated over 15 years. Therefore, their carrying value is in the region of
$720,000. This represents 7% of total assets and is therefore material to the statement of
financial position.
Impairment
The aircraft were purchased to service a contract which will not be renewed when it expires
6 months after the end of the reporting period. The significant change in the market in
which the assets operate indicates impairment of the assets and requires management to
carry out an impairment review under IAS 36. The auditors need to establish whether this
has been carried out.
Management intentions
The auditors need to discover what management’s future intentions for the assets are:
• Sale
• Alternative use
These intentions will impact on the impairment review.
Impairment loss
If an impairment loss has been identified, the auditors need to discover.
• Whether it is material ($100,000, say)
• Whether it has been properly disclosed in the financial statements
(ii) Audit evidence

• A copy of the service contract and any correspondence
• Results of inspection of the aircraft (to ascertain condition)
• Notes of enquiries of management to ascertain
- Future intentions
- Whenever an impairment review was carried out
• Evidence from the impairment review – for example, any draft sales agreements, cash
flow projections relating to value in use, any contracts relating to new uses for the
aircraft.
(c) Deferred tax

Deferred tax has been provided for in respect of accelerated capital allowances in
accordance with IAS 12.
Materiality
The tax provision amounts to 21% of profit before tax and is therefore material. Increase in
the provision, of $76,000 is not material to profit before tax.
IAS 12 – rate of tax to use

IAS 12 requires that deferred tax is calculated at a rate of tax that is ‘substantively enacted’
and expected to apply to the period when the deferred is to be settled. Substantively
enacted generally means that it has been made into law, not merely suggested or
announced.
In this instance, therefore, the directors are proposing to amend the provision to apply a tax
rate that is not substantively enacted, but has merely been announced.
Implication
If the directors do make the provision bigger, they will no longer be complying strictly with
the requirements of IAS 12. The auditors should discuss the matter with the directors and
dissuade them from making such an addition to the provision.

However, the additional provision is immaterial to the financial statements, so the auditors
are unlikely to conclude that the deferred tax balance does not give a true and fair view.
(ii) Audit evidence

• A copy of all the calculations made in relation to the tax balances
• The client’s schedules relating to the tax basis used
• Agreement of tax rate to tax legislation
• Schedules of non-current assets used in tax calculations agreed to non-current asset
register/general ledger
• Audit program for non-current assets with evidence of verification of changes (e.g.,
additions)
• A reconciliation of the tax expense with the accounting profit
• Minutes of directors’ meetings confirming details of any major additions etc. in non-
current assets
ANSWER # 21 – VISEAN
(a) Brands
Matters
(i) Risk
The key risk is that the Ulexite brand has suffered an impairment as a result of the poor
advertising campaign.
(ii) Materiality
The cost of purchased brands represents 3.2% of total assets and 32.2% of profit before tax.
Amortisation represents approximately 3.2% of profit before tax. Net book value would be
a more appropriate figure to use, however based on the information available it would
appear that brands overall are material to the accounts.
The key issue, however, is whether any adjustment required as a result of any impairment
to the Ulexite brand would be material. Assuming material based on 5% of profit before tax
any write down in excess of approximately $92,000 would be material.
(iii) Accounting treatment

• Whether the recognition of brands is in accordance with IAS 38
Purchased brands including Ulexite are capitalised. Self-created brands are expensed.
This satisfies the basic requirements of the accounting standard.
• The extent to which management believe the Ulexite brand to have suffered an
impairment
In accordance with IAS 36 an impairment occurs where the recoverable amount of the
asset falls below the carrying amount. This is normally the result of a change in
circumstances, in this case the fall in sales due to the advertising campaign.
• The amount of any impairment

This will depend on the recoverable amount of the asset which is the higher of the fair
value less costs to sell (not selling price). If known, and value in use. The way in which
management have calculated the net realisable value and value in use will need to be
considered.
(It may be difficult to calculate the fair value of the brand, unless there is a binding sale
agreement to sell the asset. Value in use should be more straightforward. It is likely that
each brand will be treated as an income generating until as it should be possible to

identify the income streams which it generates i.e. sales independently of those
generated by other brands.)
• Valuation of inventories of Ulexite products

Information obtained in July 2008 regarding the fall in sales of Ulexite products
represents an adjusting subsequent event as it provides information about the value of
the inventory at the year-end date. This information suggests that the net realisable
value of this inventory has fallen below cost in which case an allowance would be
required.
• Valuation of other brands

The effect of the bad publicity could have a knock-on effect on other brands and
products. Customer confidence and goodwill may have been lost in which case other
brands may have suffered an impairment and other lines of inventory may require
provisions.
• Proposed action to be taken by management

This might include:
- The possibility of suing the advertising company responsible for the campaign. If it
is probable that Visean will win the case a contingent gain would be disclosed.
- Future plans for Ulexite, for example whether it might be sold or discontinued or
alternatively any plans to counteract the bad publicity.
• Period over which brands are amortized

Currently this is over 10 years on a straight-line basis. In a business which is subject to
fashion and the unpredictable tastes of the general public the useful economic life of
the assets may need to be reduced.
Evidence
• Cost of Ulexite brand at 30 June 2008 agreed to prior year working papers
• Accumulated amortization on Ulexite brand agreed to prior year working papers and current
year’s amortization charge
• Schedule showing the basis for any impairment write down of the Ulexite brand. Assuming
this is based on value in use this would be cash flow projections over the remaining useful life
of the brand. This period would not be expected to exceed five hears.
• Analytical review of after-date sales and inventory turnover by fragrance (in comparison to
budget). This will show the extent to which the publicity campaign has affected the sales of
Ulexite or otherwise and the impact this may be having on other fragrances
• Records and analysis of sales returns after the year-end
• Results of review of the cash book and after-date invoices to identify any expenses incurred in
order to rectify the damage caused e.g. advertisement with apology, new advertising
campaign
• The initial advert and any press/media comment to gauge the scale of the impact and the
strength of felling
• Board minutes noting any future plans for Ulexite, for example a plan to discontinue it
• Correspondence with legal advisors in respect of any claim which might be made against the
advertising company
• Industry information regarding average product lives and analysis of Visean’s sales trends to
assess the useful economic life of the brands
(b) Discontinued operation

Matters
(i) Risk
There is a risk that results relating to the factory are disclosed incorrectly ie
continuing/discontinuing. There is also a risk that costs surrounding the closure are
inappropriately provided for.
(ii) Materiality
Although the results of the factory are not specifically provided the disclosure (or not) of
this information as a discontinued activity is likely to have a material effect on the accounts.
The provisions represent 68.3% of the profit before tax and are therefore material to the
accounts.
(iii) Accounting treatment

• Whether the plans to discontinue medical consumables constitute a discontinued
operation. This depends on whether:
- It meets the criteria to be classified as ‘held for sale’ in accordance with IFRS 5
- Represents a separate major line of business
- Is part of a single co-ordinated plan to dispose of a separate major line of business
• Assuming the plans constitute a discontinued operation whether disclosures are
adequate. As a minimum the statement of comprehensive income should as a single
figure:
- The post-tax profit or loss of the discontinued operation
- The post-tax gain or loss on remeasurement of assets classified as held for sale or
on disposal.
• An analysis of the above amounts should be shown as follows:
- Revenue, expenses and pre-tax profit or loss
- Income tax expense
- Gain or loss recognised on the measurement to fair value less costs to sell or on the
disposal of the assets
- Net cash flows by category
• Whether related assets need to be classified as held for sale, for example the factory.
These would be disclosed in aggregate as a separate line item within current assets.
This will depend on whether the following criteria are met:
- Available for immediate sale in their present condition
- Management are committed to the plan to sell
- An active programme to locate a buyer has been initiated
- Assets are being actively marketed for sale at a reasonable price
- They are expected to be sold within one year of classification
- It is unlikely that significant changes will be made to the plan.
• Whether any assets ‘held for sale’ have been valued correctly.
• Non-current assets should be valued at the lower of their carrying amount and fair
value less costs to sell.
• Whether provisions for redundancy costs and the unexpired lease term should be
recognized.
• In accordance with IAS 37 a provision should only be recognized if a constructive
obligation exists.
• The company does seem to have a detailed and formal plan and by making the
announcement in December is likely to have raised a valid expectation that the
restructuring will occur.
• Whether the costs provided for are allowed.
A restructuring provision should include only those directly arising from the
restructuring and not associated with ongoing activities. The redundancy costs

(excluding any retaining or relocation of continuing staff) and obligations under the
onerous contract appear to met those criteria.
• Impact on Visean’s relationship with hospitals.
Visean may lose the hospitals completely as a customer if they no longer supply medical
consumables. The extent of the impact will depend on the nature and amount of any
other sales.
Visean may be liable to penalties if the cessation of supply constitutes a breach of
contract.
Evidence
• Board minutes approving the closure of the factory and the decision to discontinue the
medical consumables range
• Copy of the announcement made to the press/employees/customers
• Segmental analysis to support the contention that medical consumables represent an
identifiable market
• Schedule/accounts showing disclosure of the medical consumables operation as discontinued
and assets as ‘held for sale’
• Details of the values attributed to assets ‘held for sale’ and the basis on which those
valuations have been made
• Ledger accounts/budgets and prior year accounts for comparison with separate disclosure in
the current period
• Documentation supporting a detailed and formal plan for closure
• Schedule showing the calculation of the provisions including a breakdown of the nature of the
costs (e.g. redundancy or training) and any assumptions made
• Employment contracts for agreement of redundancy terms
• Factory lease and any correspondence with the lessor for confirmation of the penalty for
surrendering the lease
• Sales agreements for plant and equipment entered into post year-end to determine
impairment of assets
• Contracts with hospitals and other suppliers to determine the extent of any other penalty
clauses
(c) Statement of cash flows

Matters
(i) Accounting treatment
Whether Visean can report net cash flows from operating activities using the indirect
method.
Under IAS 7 operating cash flows can be shown either under the direct method or the
indirect method. Although the direct method is encouraged by IAS 7 it is not a requirement.
Visean can adopt either method therefore and the change from one method to the other
does not contravene IAS 7.
(ii) Whether the comparative figures should have been restated

These figures are used for comparison purposes and as such they need to be prepared on a
consistent basis with the current year’s figures. In accordance with IAS 8, where a change in
policy is voluntary it should be applied retrospectively. The auditor has a responsibility to
ensure that if comparatives have been adjusted this properly disclosed. Provided this is the
case the treatment is acceptable.
(iii) Potential impact on the audit report

Although they form part of the financial statements the auditor does not specifically
express an opinion on the comparatives. Even though in this case they have been restated,

provided that this has been done correctly and disclosed adequately, no reference would
be made to this in the audit report.
Evidence
• Agreement of figures in revised comparative cash flow to previous years financial statements.
(Even though the presentation of cash flows from operating activities will have changed,
ultimately the final results should be the same.)
• Schedule of cash received from customers agreed to receivables ledger control account
• Schedule of cash paid to suppliers agreed to payables ledger control account
• Schedule of payments to employees agreed to payroll control account
• Analysis of any other cash payments
ANSWER # 22 - SIEGLER 36
mins
(a) Matters
(i) Government grant
There is a risk that the grant has been accounted for incorrectly leading to an understatement of
intangible assets. There is also a risk that the grant is repayable.
The grant is material as it represents 17.4% of profit before tax, 1.7% of total assets and 17.8% of
intangible assets.
The accounting treatment of the grant

This depends on the following:
• Whether the conditions for receipt have been met
• Whether the grant relates to capital expenditure
• Whether the grant relates to revenue expenditure
Assuming that the grant conditions have been met any grant received in respect of assets may be
presented as deferred income in the statement of financial position or deducted in arriving at the
carrying value of the asset. If the grant relates to income it should be recognized in the statement
of comprehensive income.
Why the order for specialist equipment has been cancelled
This may result in penalties if cancelled by Siegler. Alternatively there may be a possibility of
making a claim against the supplier.
Potential repayment of the grant

There is a suggestion that the new pilot plant may not continue. If this is the case the conditions
for the receipt of the grant may cease to be met. Any amount payable should be added back to
the development costs (assuming it was deducted from these in the first place) and a matching
liability recognized, i.e., the repayment is treated as a revision of an accounting estimate.
Impairment of intangibles
The change in focus to ‘smart-drug’ technology may indicate that intangibles relating to other
project may be impaired. This will be the case if the recoverable amount is below book value.
(ii) Provision
There is a risk that liabilities are overstated by $1m if a provision is recognized inappropriately.
There is a risk that tangible assets are overstated if the value of the land does not take into
account the effect of the contamination.

The provision represents 21.7% of profit before tax and 2.2% of total assets. it is therefore
material.
The land represents 1.6% of profit before tax and 0.15% of total assets. Therefore even if it were
to be written down to zero the effect would not be material.
Recognition of the provision

A provision should only be recognized if there is a legal or constructive obligation. In this case
there is no legal requirement to clean up the site. A constructive obligation would exist if for
example the company had a widely publicized environmental policy and it had a record of
honouring this policy. On the basis that nothing has been done about the contamination for the
last four years this does not seem likely (assuming that management were aware of the problem).
The reasons for the closure four years ago

If it could be demonstrated that the management were aware of the contamination at this stage
this would be an indicator that a constructive obligation does not exist (see above).
The basis on which the $1m has been calculated

This may be a management estimate or may be based on expert advice. The source of the
information will affect its reliability.
What instigated the local water authority investigation?

This may determine whether there are to be any additional consequences of the contamination,
for example, the incurring of any fines.
(iii) Investment properties

There is a risk that profits are overstated if the investment properties are inappropriately
accounted for. The $3.3 million surplus represents 7.1% of total assets and 71.7% of profit before
tax. On this basis it is material.
• Whether the revaluation is appropriate under IAS 16
IAS 16 does allow items of property to be revalued and for the revaluation surpluses to be
credited to the revaluation surplus. If this treatment is to be adopted it should be applied
consistently to all assets within the same class. The issue here is the nature of the apartment
block. It appears to be an investment property as it is being held in order to earn rentals. As
such it should be accounted for under IAS 40. Initially the property would be held at cost.
Subsequently it can be valued using the fair value model or the cost model (the benchmark
treatment under IAS 16). All investment properties have to be treated on the same basis
which would mean that the office block should also be revalued in spite of the fact that it is
likely to have suffered an impairment.
• Under IAS 40 all gains and losses should be recognized in the net profit for the year
It appears that this is the first year that the fair value model has been applied. If fair value
information has previously been disclosed the entity should adjust the opening balance of
retained earnings and restate the comparatives.
If the entity has not previously disclosed fair value information, comparatives will not be
restated.

(b) Evidence
(i) Government grant
• The grant application and/or the grant contract
• The terms and conditions should be reviewed to determine in particular the basis on which
the money is granted and the circumstances under which any repayment would be required
• Documentation accompanying actual receipt of the $800,000 to confirm that cash was
received and that the amount is correctly stated
• Paying-in documentation showing that the cash has been banked and the account into which
it has been paid
• Correspondence from the government agency relating to the grant
• This might indicate the company’s ongoing ability to satisfy the grant conditions and any
requests for repayment
• Any legal advice on the possibility that the grant may need to be repaid
• Post year-end of the cash book to determine whether any amounts have been paid back to
the government in respect of the grant
• Correspondence between Siegler and the specialist equipment supplier to determine whether
any penalties/claims are likely
• Written representations from management regarding the future focus of the business
(ii) Provision
• Copy of the report and conclusions of the water authority to determine that the land is in fact
contaminated and the extent of the problem
• Any correspondence between Siegler and the water authority regarding any consequences of
the report
• Minutes of discussions with management about their decision to close the laboratories and
their knowledge or otherwise of the contamination at that time
• Documents providing evidence of historical environmental policies, for example in the annual
report
• Any estimates received from contractors regarding the cost of the cleanup/contracts
evidencing that the cleanup has actually started
• Board minutes approving the clean up
• Written representations from management confirming that the cleanup will be undertaken
(iv) Investment properties

• Notes of discussions with managements regarding the reason behind the decision to revalue
properties
• Copy of the valuation report looking in particular at the basis of the valuations and any
assumptions made
• Results of the assessment of the reliability of the report i.e. qualifications, experience,
independence
• Confirmation of investment property status of the office block by inspection
• Details of any office lets which are due to come into force. This will assist in determining the
extent of the problem regarding the office block and therefore whether it is impaired.

ANSWER # 23 - EAGLE ENERGY
(a) Intangible asset

• At $4.3 million, the proposed intangible asset is not material to the statement of financial
position, but if it were written off as an expense for the year it would be material to the
statement of comprehensive income as it would reduce profit by 60%, to $2.9 million.
• Generally speaking, an intangible asset is an identifiable monetary non-current asset without
physical substance but which is identifiable and controlled by the entity through custody or legal
rights.
• IAS 38 states that an internally generated intangible asset which meets certain criteria such as
control and identifiability should be capitalized.
• Eagle Energy does not have control over the supposed asset, as t is training invested in its
employees, which the company does not own. Therefore, any one of these trained staff could
leave Eagle Energy and take that skill to a different company.
• The training given to Eagle Energy’s own employees does not have a readily ascertainable
market value. It cannot, as such, be sold on to a different company unless Eagle Energy itself was
sold, in which case any staff skill would be included in the value of goodwill created by the sale.
• Therefore, it is not appropriate to capitalize the expense, which would be written off through the
statement of comprehensive income.
• However, the details of what the cost comprises should be scrutinized. It is possible that some
elements of it could be capitalized (for example if it relates to manuals now owned by the
company).
• If the chief executive will not amend the accounts to expense this item then the auditors would
have to qualify their audit report on the grounds of disagreement over accounting treatment.
(ii) Audit evidence

• A breakdown of what the $4.3 million comprises
• A sample of individual costs checked back to related invoices
• An inspection of any elements of the cost which can be classified as assets (for example,
manuals)
• A review of the terms of the contracts with the staff to confirm that the company does not have
sufficient control over the technical knowledge
• A review of leavers to support arguments to the Chief Executive that the ‘asset’ is not controlled
by the company
(b) Laboratory and provision

• According to IAS37, where an entity has a present obligation as a result of a past event which is
probable to result in the transfer of economic benefits which can be reliably estimated, then a
provision should be made.
• Such a provision should be the best of the expenditure required to settle the present obligation
at the date of the statement of financial position. Where the effect of the time value of money is
material, the amount of this provision should be the present value of the expenditures required
to settle the obligation.
• Eagle Energy should recognize the full provision of $18 million in the statement of financial
position, as they have a present obligation as a result of a past event (accepting the government
grant that was subject to the condition of clean up).
• $18 million is material to the statement of financial position.
• The effect of the time value of money is likely not to be material so it is appropriate to made
provision for $18 million.
• The cost of dismantling the sale is a direct cost of the asset and should be included in the value
of the asset, according to the rules of IAS 16.
• Whether the company has estimated the cost themselves or it has been done by an external
expert.
(ii) Audit evidence

• Details of the terms of the grant from the council (likely to be on the permanent audit file)
• Details of the project cost of cleanup (report by an external expert?)
• Inspection of the building to ensure it has been built, causing the present obligation
(c) Journal entry

• Auditors are required by IAS 330 The auditor’s response to assessed risks to scrutinize journal
entries.
• Auditors are required to exercise professional skepticism and the alert to instances of fraud.
• The net impact of the journal entry is not material
• However, the issue might be material by nature, and should be investigated.
• The journal is made between two odd documents and s made solely to present the figures in a
better light.
• This is fraudulent financial reporting being done to deliberately mislead the government about
whether Eagle Energy is meeting the debt ratio requirements.
• The fact that the journal is carried out by the Chief Executive and is fraudulent financial reporting
raises questions about the integrity of the management of the company which might have wider
implications for the audit.
• As a minimum, the auditors should consider whether this indicates they should not trust
representations made to them by the Chief Executive during the course of the audit.
• In addition, auditors should consider the effect on the general inherent risk of the audit.
• They should consider the likelihood of any potential liability to the government if they are aware
the government relies on audited accounts and the need to disclaim such liability.
(ii) Audit evidence

• The terms of the funding from government sources
• The management accounts
• A copy of all the journals made to assess the effect of each journal
• Recalculation of the debt ratio monthly to assess whether the requirement was met or not
• Review of prior year files to see how the matter was addressed
• Written representations that there have been no other similar transactions which have not been
brought to the attention of the auditor

ANSWER # 24 - KEFFLER
(a) Landtill site

• The purchase of the right to use the landfill side represents 3.3% of total assets and is therefore
material to the statement of financial position.
• The amortization should be charged over the period during which the site will be used, i.e. 19
years rather than 15 years. The charge of $20,0000 for the year has been based on 10 years (the
sum of digits is 55 so the first year’s charge will be 1/55 x 1.1m = $20k). The charge for the year
represents 1% of profit before tax and so is not material.
• The sum of digits method has been chosen on the basis that the company has estimated that the
amount of waste dumped will increase each year and this method charges higher amortization
each ear. IAS 38 intangible assets states that the straight line method should be use if the
pattern of future economic benefits of the right cannot be determined reliably. A straight line
method would charge $110K of amortization to the statement of comprehensive income – the
difference of $90k represents 4.5% of profit before tax so is just below materiality, but the
cumulative effect would be material.
• If there is no evidence to support Keffler’s expectations of the amounts of waste to be dumped
each year, the accounts should be qualified on the basis of disagreement.
• The annual provision for restoring the site represents 5% of profit before tax and 0.3% of total
assets so is bordering on material. However annual provisioning is not permitted by IAS 37
Provisions, contingent liabilities and contingent assets so the provision should be based on the
best estimate of the total costs required to restore the site at the end of the reporting period.
Therefore the present value of the total costs should have been recognized as a provision in the
financial statements. This would be added to the cost of the right to use the landfill site. This will
in turn affect the amortization charge.
(ii) Audit evidence

• Agreement document to confirm date of purchase of right to use landfill site for 15 years and
price paid and terms of the agreement
• Confirmation of amount paid to cash book and bank statements
• Calculation schedule for depreciation using sum of digits method
• Costs schedules showing estimated costs to restore the land in 15 years’ time
• Senior management board minutes regarding the purchase of the right
• Physical inspection of the landfill site to confirm its use to dump waste
• Schedule showing estimated waste to be dumped each year compared to pattern of sum of
digits depreciation
(b) Sale of industrial machinery

• The machinery was being depreciated over 20 years on straight line basis (i.e. a charge of
$60,000 per year assuming a full year’s charge in the year of acquisition and no charge in the
year of disposal) therefore its net book value at the start of the financial year would have been
$660k. a loss of $0.3m means that the proceeds from the sale were $360k.
• The loss of $0.3m represents 15% of the profit before tax and 0.6% of revenue so is material to
• The loss has been separately disclosed in the statement of comprehensive income. This is in
accordance with IAS 16 Property, plant and equipment and also with IAS 1 Presentation of

financial statements which states that material profits or losses on disposal should be presented
separately either in the statement of comprehensive income or in the notes.
• The reason for the sale needs to be established and also the reason for the loss. Originally the
machinery was being depreciated over 20 years. It may be that this estimate of useful life was
incorrect and there may be other similar machinery in the accounts which would result in assets
being overstated because they are being depreciated over a period longer than their actual
useful lives.
• If the sale has been made to a related party, this needs to be disclosed in the accounts in
accordance with IAS 24 Related party disclosures.
• The machinery was sold two months into the financial year. It may therefore have been
identified as a non-adjusting event in the previous financial year in accordance with IAS 10
Events after the reporting period in which case it should have been disclosed in those accounts.
If it had been impaired at the end of the prior financial year, a prior period adjustment would be
required in accordance with IAS 8 Accounting policies, changes in accounting estimates and
errors. The loss would have been material in the prior year as it represents 12.5% of the profit in
that ear and 0.7% of revenue.
(ii) Audit evidence

• Authority for the sale to Deakin in senior management board minutes
• Cash receipt on sale confirmed in the bank statements and the cash book
• Sales invoice to Deakin for the asset
• Schedule to calculate the profit or loss arising on disposal
• Non-current asset register showing cost and accumulated depreciation removed on disposal
• Written representation letter from management includes point to confirm that Deakin is not a
related party of the company
(c) Provision
• The provision represents 45% of profit before tax, 1.9% of revenue and 2.7% of total assets and
is therefore clearly material to the financial statements.
• The provision for the penalties is not material, since it represents only 2.3% of profit before tax
and 0.13% of total assets.
• According to IAS 37 Provision, contingent liabilities and contingent assets a provision can only be
recognized if there is a present obligation as a result of a past event, there will be a probable
transfer to economic benefits and the amount can be estimated reliably.
• The penalties meet the requirements for the provision to be recognized but the provision for the
water purification system does not meet the first requirement and so should not be recognized
in the financial statements for the year.
• Failure to write back the $0.9 million provision will result in a qualified audit opinion on the basis
of a disagreement since the amount is material to the accounts.
• The need for the upgrade to the water purification system may indicate impairment with the
existing system. Any impairment should be recognized in the accounts.

(ii) Audit evidence
• Correspondence from the local authority relating to the ban and to confirm the amount of the
penalties imposed
• Newspaper and other reports relating to the ban
• After date review of cash book and bank statements to confirm payment of fines
• Estimates from suppliers confirming the cost of the upgrade
• Senior management board minutes relating to the ban and action to be taken
ANSWER # 25 - HARVARD
(a) Chicken Run

• Whether or not the expenditure incurred on project Chicken Run meets the criteria as specified
in IAS 38 for the project to be capitalized as development costs
• Whether or not the expenditure incurred is $1.5 million
• Whether or not the directors have made appropriate disclosure in accordance with IAS 38
• When the vaccine will go into commercial production (that is, might it also be development
costs?)
• What the estimated revenue is from the vaccine
• How long the vaccine will be on the market for
(ii) Audit Tests

• Obtain details of how Harvard allocates costs to individual projects
• Review the system of cost allocating to project
• Check that adequate controls are in place to ensure that only separately identifiable costs are
allocated to each project
• Obtain an analysis of the $1.5 million and check that costs relate to project Chicken Run
• Vouch materials to invoices
• Vouch labour costs to payroll
• Ascertain how the directors allocate overheads and review method for reasonableness
• Obtain details of project Chicken Run and ascertain that there is a clearly identifiable project
• Obtain details of the results of trials to date and discuss with the project is commercially viable
• Obtain cashflow forecasts and assess assumptions for reasonableness and ascertain whether
future inflows will exceed costs to date and future marketing and selling costs
• Review sales forecasts and agree back to market research to confirm reasonableness
• Review the level of funding required to complete the project and discuss with the directors how
they intend to meet the funding needs
• Review board minutes for details of discussions on the progress of project Chicken Run
• Obtain written representations from management as to the commercial viability, technical
feasibility and adequacy of funding for project Chicken Run
• Confirm with management that they will meet the disclosure requirements of IAS 38
• Review progress of the project in the post year-end period and review press for any details of
any similar products from competitors

(b) Litigation
(i) Matters to Consider
• Whether or not the directors intend to make a provision in the accounts for the year ended 30
September 2008
• Whether or not a provision of $2.0 million is adequate
• The basis of the calculation of $2.0 million
• Likely date of settlement
• Whether or not $2.0 million would need to be separately disclosed in accordance with IAS 1 in
the accounts for the year ended 30 September 2008
• Whether or not the directors will make adequate disclosure in the financial statements
(ii) Audit Tests

• Obtain details of the audit work done in respect of the year ended 30 September 2008
• Obtain copies of correspondence from the lawyers on the trial and review for details of
likelihood of outcome of the trial and basis of the calculation of $2.0 million
• Discuss with the directors their reaction to the lawyers assessment of outcome of the case and
value of the claim
• Obtain permission from the directors to contact the lawyers
• Contact the lawyers and ask for confirmation of their assessment of the outcome and value of
the claim
• Recalculate the calculation of $2.0 million
• Review the post year-end period for further correspondence in connection with this claim
• Review the post year-end cash payments to ascertain whether there have been any out of court
settlements and compare to the amount provided
• Review board minutes for discussions of the clams and ascertain the directors comments
• Discuss with management if they intend to make a provision in the financial statements for the
year ended 30 September 2008
• Ascertain from management the nature of disclosures they intend to make in the accounts for
the year ended 30 September 2008
• Confirm that the disclosures meet the requirements of IAS 37 and IAS 1
• Discuss with management whether there are any implications for any other products
manufactured by Harvard
• Carry out a post year-end review of all legal correspondence and board minutes to verify
whether or not there are further claims in respect of other products
(c) Share Option scheme

(i) Matters to Consider
• Whether the directors have recognized an expense for the scheme in the statement of
comprehensive income
• Terms of the scheme, such as number of options granted
• Whether the value of the options has been calculated using a method that complies with IFRS 2
Share-based payment
• Whether estimates of numbers of directors who will be entitled to options have been updated if
any have left the company by the year end
• Whether details of the scheme have been fully disclosed in the financial statements

(ii) Audit Tests
• Inspect the scheme documentation to verify the terms, numbers of option granted, dates of
grant and vesting and any conditions attaching to vesting.
• Obtain the calculations of the fair value of the options and agree components of the calculation,
such as fair values of shares to published market information.
• Recalculate expense for the current year, ensuring that only 6 months expense has been
recognized.
• Review the journal entry for the share option expense and check that it has been credited to
equity rather than to liabilities as this is an equity-settled share-based payment.
ANSWER # 26 - ALBREDA
(a) Cessation of home-delivery service

• At 1.4% revenue, the income from the home delivery services is material to the statement of
comprehensive income.
• If the home delivery service qualifies as a component of Albreda’s business, then the it would
qualify as a discontinued operation according to IFRS 5 and discontinued operations disclosures
would be necessary in the financial statements (including the comparatives)
• However, in order to be a component, the operations and cash flows would have to be clearly
distinguished from the rest of the entity. Operationally, the home delivery service is not clearly
distinguished from the rest of operations (it is likely to be carried out by the same chefs in the
same kitchens) and so this does not count as a discontinued operation
• The provision for redundancy costs of $0.2 million is material to the statement of comprehensive
income as it represents 11.11% of profit before tax
• The auditors should consider the timings associated with the redundancy costs to ensure that
the provision meets the criteria of IAS 37, but if the division has completely closed down by 30
September, then there would be a liability arising as a result of a past event, so it appears
reasonable
• The provision should have been tested for understatement
• IFRS 5 state that assets should be classified as held for sale if it is highly probable that they will
be sold
• Highly probable is suggested by management having a committed plan to sell the assets, which
includes plans to locate buyers having been started, active marketing and the expectation that
the assets will be sold in a year’s time
• The standard also states that assets held for sale should be carried at the lower of the carrying
amount and the fair value less costs to sell. In this instance, the company is carrying them at fair
value, which is higher than the carrying value
• The difference between the carrying value and the fair value is not material to the statement of
financial position at just under 1% of total assets
• However, if the credit entry is to the statement of comprehensive income, it is material to the
statement of comprehensive income (16.7% of profit) and should be reversed

(ii) Audit evidence
• Details of the decision to close the division (board minutes/press notices/ communications with
employees)
• Management accounts and schedules showing the amount of revenue attributed to home
delivery
• Terms of the redundancy packages (contracts of employment for the drivers)
• Proof in total of the reasonableness of the redundancy provision (number of drivers x years
employed x payment per year of service)
• Schedule of the delivery vehicles per the non-current asset register
• Details of agreements to market/sell the assets held for sale (sale particulars for instance)
• Any after-date sales proceeds compared to the estimated fair values
• Physical inspection of unsold vehicles (for condition/agreement to sales particulars)
• Separate disclosure of the vehicles in the statement of financial position or the notes
(b) Revaluation
• IAS 16 states that when assets are revalued, the entire class of those assets must also be
revalued
• It is permissible to carry out rolling basis revaluations, once the revaluation basis is in place, but
a company should not carry assets in the same class under different valuation bases, so all assets
should be revalued in the first instance
• It appears that Albreda is seeking to revalue its properties on a rolling basis and that two
properties have been revalued in the year to 30 September 2009
• The revaluations which have been carried out subsequent to the yearend would be material to
the statement of financial position for 2008, as they would represent 17.5% of total assets in
2008, and as there are three other properties to be revalued, this percentage would rise
• The corresponding credit in equity will also be material to the statement of financial position
• If Albreda did not revalue all the assets in the class in the financial statements to 30 September
2007, then the auditors would have to qualify the audit report on this issue
• The financial statements should also include the disclosure required by IAS 16 when a company
revalues assets:
- The date of the revaluation
- Whether an independent valuer was involved
- The methods and significant assumptions applied in estimating the items’ fair values
- The extent to which the fair values were determined by reference to observable prices on
the open market or other techniques
- The carrying amount that would have been recognised under the cost model
- The revaluation surplus, indicating the change for the period and any restrictions on the
distribution of the balance to the shareholders
(ii) Audit evidence

• The schedule of depreciated cost of owned buildings
• Calculation of the difference between depreciated cost and revaluation per property
• The valuation reports for each of the properties
• Physical inspection of the properties with the largest surpluses to confirm condition
• Sale particulars of comparable assets to verify valuation
• The disclosure in the financial statements

(c) Disclosure of fines
• $0.1 million is 5.5% of profit before tax and is therefore material to the statement of
comprehensive income. The corresponding amount in the previous year was considerably more
material to profit.
• The nature of these fines may also make them material if they indicate continual non-
compliance with law and regulations which could result in more serious action than a fine
• Disclosure should be consistent with the previous year unless change is necessary to show a fair
view or to comply with a standard
• IAS 1 states that when items of income and expense are material their nature and amount shall
be disclosed separately
• Therefore, these fines should probably be disclosed separately, either in the statement of
comprehensive income or by way of a note to the financial statements
• The reasons for the breaches giving rise to the fines
• Under ISA 250, the auditor has to consider whether the effect of non-compliance with laws and
regulations will impact the financial statements and the possible effects of that non-compliance
• The auditors should therefore consider if the non-compliance with the health and safety
regulations giving rise to the fines has a potential greater impact on the financial statements,
perhaps in terms of going concern or greater future liability
• If the auditor believes that non-compliance is intentional he should discuss it with those charged
with governance
• If the breaches are international and for the purpose of money saving, they might be classified as
a money laundering offence
(ii) Audit evidence

• Schedule of amounts making up the total of $0.1 million with larger amounts agreed to cash
book
• Review against prior year to see if there are any obvious omissions resulting in the figure being
lower this year
• Correspondence attaching to the fines, for example, penalty notices
• Details of the company’s internal health and safety polices
• Review of ‘other information’ to ensure it is not inconsistent/materially misstated in the context
of these fines
• Written representations from management that there are no other penalties/fines which have
not been disclosed in the financial statements

ANSWER # 27 - SEYMOUR
(a) Drug patent

• The carrying value of the development costs at the start of the year will be $3m (assuming that
amortization is charged over 20 years, i.e. $200k per year) which represents 5.6% of total assets
– this is material to the statement of financial position.
• Management must consider whether the drug is still likely to go on sale given that a competitor
has announced the successful completion of preliminary trials on an alternative drug with the
same properties as Tournose.
• The announcement by the competitor may indicate impairment of the capitalized development
costs of Tournose. If this is the case, the costs must be written back to the statement of
comprehensive income.
• The management of Seymour Co should examine the unamortised balance of development
expenditure on this project to ensure that it still fulfils the criteria in IAS 38 Intangible assets for
capitalizing developments costs.
(ii) Audit evidence

• Patent agreement for Tournose to confirm length, cost and approval.
• Documentation to support the development costs of $4m.
• Press announcement of competitor drug.
• Written representation from management on key assumptions for the future regarding
development costs of Tournose.
• Management’s projections of future cashflows from Tournose for evidence of useful life of
development costs.
(b) Goodwill
• The goodwill on acquisition of Aragon is material to accounts – it represents 3.4% of total assets
in the consolidated accounts.
• The goodwill should be subject to annual impairment reviews in accordance with IAS 36
Impairment of assets.
• The results of Aragon indicate that the investment in Aragon is also impaired.
• The investment is also material to Seymour Co’s individual accounts and should be tested for
impairment
(ii) Audit evidence

• Purchase documents to confirm purchase price of Aragon Co and value of purchased goodwill.
• Prior year and current year financial statements of Aragon Co to confirm statement of financial
position and statement of comprehensive income figures.
• Impairment reviews carried out by the directors of Seymour Co for both the investment and the
goodwill.
• ‘Comfort letter’ from Seymour referring to continued financial support of Aragon.

(c) Discontinuation
• The revenue from the petcare operations represent 12% of total revenue and is therefore
material to the accounts.
• The high level of customer returns may prompt lots of clams against the company and it should
consider setting up a provision if the criteria in IAS 37 Provisions, contingent liabilities and
contingent assets are met. Contingent liabilities may also need to be recognised.
• Inventory returned to the company will have to be written down to net realizable value.
• The announcement of the recall and discontinuation of the range of petcare products occurred
after the year-end. This is an example of a non-adjusting event after the date of the statement of
financial position in accordance with IAS 10 Event after the reporting period, so should be
disclosed in the accounts. As there is no indication that management are committed to selling
the business at the end of the reporting period, it does not meet the definition of a discontinued
operation per IFRS 5 Non-current assets held for sale and discontinued operations so should be
classed as continuing in the statement of comprehensive income.
• If the directors continue to disclose it separately as a discontinued operation it may be necessary
to qualify the audit opinion on the grounds of disagreement.
(ii) Audit evidence

• A copy of the announcement of the recall and discontinuation of the petcare products.
• Customer correspondence on returns to assess the level of likely claims against the company.
• Correspondence from the company’s legal advisors regarding any claims and the potential pay-
outs.
• Assessment of value of returned inventory.
• Calculation of any provision made in regard to returns from customers.
ANSWER # 28 - GRAPE
(a) (i) Matters to consider:

Materiality
$500,000
Materiality on revenue: = 4%
$12.5m
$500,000
Materiality on net profit: = 125%
$400,000
$500,000
Materiality on total assets: = <1%
78m
The training costs are not material to the statement of financial position. They would, however, be
material to revenue and profit if they were reclassified as expenses, turning a profit into a loss.

Accounting treatment
The training costs are currently recognised as non-current assets. This is not in accordance with IAS 16
Property, plant and equipment, which states that the costs of training staff should always be treated as
an expense, as they do not meet the definition of an asset, which requires that the entity has control of
the asset. This is very unlikely to be the case with training costs, as the staff will probably have the right
to leave the company, meaning that Banana Co would not receive any subsequent economic benefit
from having trained them.
The training costs should be treated as an expense in the income statement.
Audit opinion
If Banana Co does not amend its financial statements, the audit opinion will be modified due to a
material misstatement. This would probably be an 'except for' qualification as the misstatement is
material but not pervasive.
Evidence
The file should contain:
- A review of the nature of the expenses themselves to verify that they are classified correctly and
that they are in fact training costs.
- Testing of entries selected according to sampling procedures detailed in the audit plan to
supporting documentation, such as purchase invoices, and agreement of payment of related
payables to the cashbook and to bank statements.
- Evidence that a sample (selected according to audit plan) of entries are included in the accounts in
the correct period.
- Testing for completeness and that all invoices that should have been accrued for were in fact
accrued for.
(ii) Matters to consider

Materiality for whole receivable
$30,000
Materiality on revenue: = 2.4%
$12.5m
$300,000
$400,000
$300,000
Materiality on total assets: = <1%
78m
The receivable is not material to the statement of financial position. It would, however, be material to
the income statement if an impairment loss were recognised in relation to it.
IFRS 9 Financial instruments requires receivables to be recognised at fair value. The fair value of the
Cherry Co receivable is the 25% that the administrators suggest it may be able to pay, i.e. $75,000.
$225,000 should therefore be recognised as an impairment loss in the income statement.

Calculating materiality for the impairment loss:
$225,000
Materiality on revenue: = 1.8%
$12.5m
$225,000
$400,000
This is clearly material to net profit.
Inventory
As Cherry Co is a customer, it is possible that Banana Co is holding inventory or work in progress that
was ordered by Cherry Co. Grape & Co needs to ascertain whether this is the case, and if so whether the
inventory can in fact be sold. If it cannot be, then it may be impaired and should be written down,
recognising the loss in profit for the year.
Audit opinion
If Banana Co does not amend its financial statements, the audit opinion will be modified due to a
material misstatement. This would probably be an 'except for' qualification as the misstatement is
material but not pervasive.
If the misstatement in respect of the receivable is taken together with the misstatement in respect of
the training costs, the overall result may be that Grape & Co judges the income statement to be
rendered meaningless (pervasive effect). In this case it would issue an adverse audit opinion.
Audit evidence
- External documentation confirming the insolvency of Cherry Co and the possible repayment of only
25% of the receivable.
- Confirmation from the administrator of the 25% to be paid, including an indication of when this is
likely to happen.
- Agreement of the amount owed from the receivables listing to the ledger.
- Review of inventory documentation and evidence of enquiries made of management, regarding the
value and the potential recoverability of any inventory relating to contracts with Cherry Co.
- Calculations regarding the amount to be recognised as an impairment loss.
(b) Selection of engagement staff

The fact that the junior had only worked on two audits before this is not a problem. However, it is
important that they be given work appropriate to their level of skill and experience. This does not
appear to have happened here, as detailed below.
No audit planning meeting

The audit planning meeting, led by the partner, is a crucial part of the audit. It is the best way of
giving the team an understanding of the client, and should discuss both the overall strategy and
the detailed audit plan, perhaps going into difficulties that have been experienced in previous
years and which could come up again. The discussion should focus on what individual members of
the team need to do. This is particularly important for less experienced and junior members of
the team.

Audit manager away
The manager should not have given the senior responsibility for the audit while they were away
on holiday for three weeks. It is important that an audit is properly supervised, and it may have
been more appropriate for another manager to take responsibility for the audit.
Senior busy
Not only is there a question mark over whether they have the experience to manage the audit,
but the senior is also busy with other assignments and thus unable to devote sufficient time to
this one. It is very important that someone is available to supervise junior members of the audit
team. This is not happening here.
It is also possible that the lack of attention paid by both the manager and the senior has led to the
misstatements in respect of the trading costs and trade receivables not being picked up by the
audit team.
Junior auditing goodwill and inventory

Goodwill is a complex accounting area to audit, and should not be given to a junior to do. The
same can be said of inventory and in particular work-in-progress. A junior is very unlikely to have
developed the judgement needed to audit these areas. This seems to be the case here, as shown
by the junior's error at the inventory-take (see below).
Inventory-take
The junior helped the client's staff to count raw materials at the inventory-take, when they should
instead have been observing that the client's staff were counting them correctly and in
accordance with the count procedures. This would seem to imply that the junior had not been
properly briefed on their responsibilities at the inventory-take, as this is a relatively basic error.
It is likely that more audit evidence will be needed to be done on inventory as a result of this
error.
Junior asked to challenge FD

It is not appropriate for a junior to be asked to challenge a client's finance director regarding an
accounting issue that they are unlikely to understand fully. This should have been done by either
the audit manager or the partner, as they would be in a position to understand the technical
issues involved, and would carry sufficient authority with the client to make the challenge
effective.
Running out of time to complete procedures

Pressure of time is an important contributor to audit risk. Audit time budgets should allow staff
enough time to complete the audit to the required quality. It is also possible that the lack of
supervision of the audit team's work has led to the audit being conducted inefficiently, with
inadequate monitoring of progress and discussion of issues as they arise.
Reduction of sample sizes

It is clearly unacceptable to reduce sample sizes as a way of saving time. The sample sizes detailed
in the audit plan should have been designed to gather sufficient appropriate audit evidence.
Reducing the sample size beneath this point increases detection risk, and the risk of the auditor
giving the wrong opinion.

Basis of sample selection
Selecting a sample on the basis of the ease of finding evidence for an item, is not an appropriate
basis. Indeed, this might actively increase detection risk as it means by definition that those items
for which evidence is not readily available, or might not even exist, are not tested.
Conclusion
The litany of failures above suggests that this engagement has not been adequately supervised,
and that the audit work performed is inadequate in some areas. A detailed review should be
performed so that any other shortcomings can be addressed.
Doubt is also cast over the sufficiency of the firm's quality control procedures. This matter should
be referred to the relevant partner for consideration.
ANSWER # 29 - POPPY
(i)
Enquiry Reason
What is the professional certification of the valuer? To determine the competence of the valuer so the
reliability of the valuation can be assessed
Is the valuer a member of a recognised professional
body/industry association, such as an institute of
chartered surveyors, and how long has the valuer
been a member for?
Do any professional or other standards, and

regulatory or legal requirements apply?
What assumptions and methods are used by the

management's expert, and are they generally
accepted within that expert's field and appropriate
for financial reporting purposes?
The nature of internal and external data or

information the expert uses
Is there any relevant evidence regarding the

reputation of the valuer of which the auditor should
be aware? For example, professional references.
Does the valuer hold a licence to carry out a To establish that the valuer is suitably experienced
valuation of investment properties (if applicable)? in valuing the type of investment property held by
Poppy Co
What experience does the valuer hold in the To ensure that fair values have been reached
valuation of investment properties and their using methods permitted by IAS 40 Investment
recognition at fair value? property

Is the valuer related to the entity in any way, for To determine the objectivity of the valuer so that
example, by being a close family member of a the auditor can judge the independence of the
director at Poppy Co? valuation
Does the valuer have any financial interest in Poppy To assess the method by which Poppy Co has
Co, such as shares? appointed the valuer
Is the fee received by the valuer reasonable and at If the fee was not at market price (for example too
market price? high) the valuer's independence may have been
threatened in order to provide the required result
(ii) Procedures
• Inspection of the written instructions given to the valuer by Poppy Co which should
include the objectives and scope of the work, the intended use of the valuer's work and
the extent of the valuer's access to records and files
• Consideration of the assumptions and methods used by the valuer to ensure they are
reasonable based on other audit evidence and the auditor's previous knowledge of
Poppy Co
• An evaluation of the method used to measure fair value to ensure consistency with IAS
40
• Examination of the valuation report to ensure each property has been valued
consistently and that the date of valuation is reasonably close to Poppy Co's year-end
• Physical inspection of the valuation properties to ensure their condition is in line with
the valuation report
• Inspection of purchase documentation for the investment properties to ensure that any
revaluations made in the year of purchase are reasonable and not significantly different
from the purchase price
• A review of subsequent events for additional evidence on the valuation of the
investment properties
• Written representations from management concerning the reasonableness of any stated
assumptions in determining fair value
• Evaluate the appropriateness of that expert's work as audit evidence for the relevant
assertion.

ANSWER # 30 - CLOONEY
(a) Matters to consider

The claim is material to profit at 13.3% of profit before tax (20/150 x 100%). It is not material to
the statement of financial position at only 0-49% of total assets (20/4,100 x 100%).
Management have an incentive to manipulate the financial statements through fraudulent

financial reporting, as their bonus is based on profit before tax. There is a risk that profit may be
overstated. They may not want to provide for the claim because this would reduce profit.
IAS 37 Provisions, contingent liabilities and contingent assets requires a provision to be

recognised where, as a result of a past event, an outflow of economic benefits is probable, the
amount of which can be estimated reliably. If such an outflow is only possible but not probable
then it is a contingent liability, and should be disclosed in a note to the financial statements.
Further evidence is required to determine whether the compensation claim should be provided
for or not.
If Clooney can make a claim on its insurance policy in respect of the legal case, then per IAS 37
this is treated as a separate event, in accordance with IAS 37's requirements on contingent assets.
For an asset to be recognised, IAS 37 states that it should be certain to be received. As in this case
receipt of an insurance payment is only probable, no asset should be recognised. The insurance
claim should be disclosed by way of a note.
In addition to the provision that must be created, it may be necessary for Clooney to provide for
any legal costs associated with defending the claim, which would further reduce its profit for the
year.
Evidence
• Copy of claim made by the group of holiday-makers, detailing the $20 million claimed and the
basis of the claim.
• Review of correspondence between 'claim group' and the company.
• Correspondence from Clooney's legal counsel, showing their opinion on the likely outcome.
• Copy of any press releases made by Clooney, which could help establish there is a
constructive obligation.
• Review of press coverage of the situation, to assess any comments made in public by
company representatives regarding the claim.
• Review of the standard terms and conditions that holiday-makers agree to on booking a
holiday - this could help to establish any legal obligation, e.g. to cover the cost of
accommodation before being returned home.
• Details of any help line or other means by which the stranded holiday-makers were given
advice at the time of the incident (e.g. if the company advised them to book alternative
accommodation this may imply that the company is liable for the cost).
• Copy of insurance contract detailing level of cover, if any, provided for this situation, and any
amount that will not be covered (e.g. an excess on the policy).
• Correspondence between insurance company and Clooney to establish whether an insurance
claim has been made.
• Written management representation stating management's opinion on the outcome of the
court case, and the likelihood of reimbursement from the insurance cover.
• Review of invoices received pre- and post- year-end in respect of legal costs, to ensure
adequately included in expenses and accrued for if necessary.

(b) Matters to consider
The Shelly's Cruises (SC) operation is material to the financial statements, contributing 20% to
revenue (640/3,200 x 100%). The identifiable assets of the business segment represent 5.7% of
total assets (235/4,100 x 100%), and are thus material to the statement of financial position.
The brand is (correctly) not recognised as an intangible asset in accordance with IAS 38 Intangible
assets, so there is no intangible asset that may be impaired. However, in accordance with IAS 36
Impairment of assets, SC's assets represent a cash generating unit as they are independent of the
assets of the rest of the entity. The question is whether these are impaired.
The drops in revenue and profit are indicators of impairment per IAS 36. Management must have
conducted an impairment test, calculating the value-in-use of the cash generating unit, and also
the fair value less cost to sell, to determine the recoverable amount of the SC assets collectively.
Any impairment loss should be expensed. Management will want to avoid recognising an
impairment loss as it will reduce their bonus payment.
The impairment test will involve a number of subjective elements, e.g. the discount rate used to
determine the present value of cash flows. Management's assumptions here should be approach
with professional scepticism.
Evidence
Review management's impairment test, including:
- Assessment that an appropriate discount rate has been used
- Agreement that the assumptions to determine future cash flows are reasonable
- Agreement that correct carrying value of assets has been used for comparison of recoverable
amount
- Agreement that all identifiable assets have been included in the cash generating unit
- Recalculation of all figures
- Discussion with management of the expected future performance of SC.
- Review of post year-end management accounts for the performance of Shelly's Cruises.
- Review of the level of bookings made in advance for cruises to be taken in the future.
(c) Matters to consider

In accordance with IAS 10 Events After the Reporting Period, this acquisition is a non-adjusting
event because it does not relate to conditions in place at the end of the reporting period.
However, if it is judged to be sufficiently material then it should be disclosed in a note to the
financial statements, along with an estimate of its financial effect. As this note has not been
included, we should ask management to include such a note. If they do not do so, then the
auditor's opinion must be modified, in this case to an 'except for' qualification in respect of a
disclosure required by IAS 10.
Evidence
- Copy of press release announcing the acquisition, including the date of the announcement.
- Copy of any legal agreement relating to the acquisition, including the date control passes to
Clooney.
- Review of any due diligence report received, detailing the value of assets purchased, and the
consideration paid.
- Review of the financial statements of Craig, to determine that it represents a significant
acquisition for the group which requires a disclosure note.
- Review of any note provided by management to be included in the financial statements

ANSWER # 31 – LYCHEE
(i) The restructuring does not relate to conditions at the reporting date, so under IAS 10 this is not an
adjusting event. IAS 10 requires that this event be disclosed in the financial statements, usually by way
of a note explaining the event and its financial effect.
Audit procedures would include:

- Verify that management have included a note disclosing this event in the financial
statements, and that it is drafted in line with IAS 10.
- Agree the estimated cost of the closure to underlying calculations and supporting
documentation, such as staff employment contracts.
- Review the announcement for details, and agree these details to the disclosures made in the
- Review board minutes for details of the plan and to verify that it has been approved by the
board.
- Discuss the reasons for the plan with management and consider whether it is consistent with
the auditor's knowledge of the business.
(ii) If the financial statements are not amended then they are not in accordance with IAS 10.
Considering the materiality of the cost of closure:
$250,000
Based on revenue: = 1.67%
$15m
$250,000
Based on profit: = 8.3%
$3m
$250,000
Based on assets: = <1 %
$80m
The cost of closure is material to the income statement, so non-disclosure of this event is a material
misstatement. In line with ISA 705 Modifications to the Opinion in the Independent Auditor's Report,
the auditor should express a qualified 'except for' opinion, as the misstatement is material but not so
pervasive as to render the income statement meaningless.
The auditor's report should contain a paragraph discussing the reasons for the modified opinion, in
which the auditor would explain the nature of the costs not disclosed, state the financial effect of the
costs and state that this is in breach of IAS 10. It would also be helpful for the auditor to state that this
does not affect profit for the year, but is a disclosure only.

ANSWER # 32 - AXIS & CO
(a) Mantis Co
Since Cube has confirmed its continuing support for Mantis and this is evidenced in the letter of
support, then provided that this and any other audit evidence (such as written representations
from management) are considered sufficient and appropriate, and this has been disclosed
appropriately in the financial statements, a modified opinion would not be required.
A modified opinion would be suitable if a letter of support from the parent company had not
been received. If the letter of support were considered insufficient then the matter would be
highlighted in the auditor's report in an emphasis of matter paragraph.
(b) Lorenze Co
The company has changed its accounting policy for goodwill during the year and failed to disclose
this in the financial statements. In accordance with IAS 8 Accounting policies, changes in
accounting estimates and errors, the change in policy should be disclosed in the accounts.
An unmodified opinion on the financial statements with the inclusion of an emphasis of matter
paragraph is therefore not suitable as the opinion should be modified on the grounds of a
misstatement regarding disclosure - depending on the materiality of the issue, the modification
would either be qualified ('except for') (if material) or adverse (if pervasive).
(c) Abrupt Co
Although the auditors are not required to provide an opinion on other information in documents
containing financial statements, they are required to read the other information and consider its
consistency with the accounts in accordance with ISA 720 The auditor's responsibility in relation
to other information in documents containing audited financial statements.
As there is a material inconsistency between what has been reported in the financial statements
and what is stated in the directors' report, if the directors refuse to make any amendments to the
directors' report so that it is consistent with the accounts, then although an unmodified opinion
on the financial statements can be issued, an emphasis of matter paragraph should also be
included to highlight this inconsistency.
(d) Jingle Co
A wholly-owned subsidiary of Jingle has commenced trading on 7 July 20X8, subsequent to
Jingle's year-end. It is not clear whether the company was incorporated prior to 30 June 20X8.
The auditors should obtain more information about Bell. It should be possible to obtain details
about its registration from the companies' registry. If this information is unavailable, this would
represent an inability to obtain sufficient appropriate audit evidence in respect of which the
auditors would have to qualify their auditor's opinion in respect of it.
If the company was incorporated after 30 June 20X8, it requires disclosure in the financial
statements as a non-adjusting event after the end of the reporting period. If these disclosures are
not made, the auditors would have to qualify the auditor's opinion for 20X8 due to a
misstatement regarding the disclosure. However, assuming the subsidiary was accounted for
correctly in the 20X9 financial statements, the 20X9 auditor's report would be unaffected.
If the company was incorporated before 30 June 20X8 then the subsidiary needs to be
consolidated in Jingle's financial statements and the relevant disclosures have to be made. If this
is not the case, then the auditor's opinion for 20X8 would have to be qualified over a
misstatement in respect of the accounting treatment of the subsidiary Bell. This would also result
in the 20X9 auditor's opinion having to be qualified over the same issue if it was not corrected, as
the problem would affect the comparative financial information in the following year.
ANSWER # 33 - BERTIE & CO

(a) Auditor's reports
Alpha
The major matter to consider in respect of Alpha's financial statements is whether the
discontinued operations meet the criteria to require separate classification in the statement of
comprehensive income per IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.
As the closures were finalised in the year, there may not be any assets held for sale at the year
end, but if there are, these should also be accounted for correctly under IFRS 5. If these matters
are not accounted for and disclosed correctly, the auditor would have to modify the auditor's
opinion on the grounds of a material misstatement, as at 10% revenue, the closures are material.
In order to be separately disclosed, the discontinued operations should be a component that is

separately identifiable from the rest of the business. All the factories produced the same product.
If that product is different from the products continuing to be made, then it is arguable that a
component has been closed part of a single co-ordinated plan to dispose of a separate major line
of business. As such it should be disclosed separately.
If the item produced by the closed factories was the same as the item produced by the other
factories which have not been closed, then the discontinued operations are not separately
identifiable unless they are in the same geographic region and the closure represents a single co-
ordinated plan to dispose of a separate geographical area.
If the discontinued operations are not separately identifiable either by product or geographical
location, there is no need to make separate disclosure and the financial statements are fairly
stated in respect of this matter, therefore the auditor's report is appropriate.
Deema
If the matter has been appropriately disclosed in the financial statements as suggested then the
audit senior is right not to modify the auditor's opinion as there is no material misstatement in
respect of accounting treatment and no inability to obtain sufficient appropriate audit evidence.
An emphasis of matter paragraph is used when an unmodified opinion is being given in respect of
a particular issue but, in the auditor's judgment, the matter is of such importance that it is
fundamental to users' understanding of the financial statements. For example, an emphasis of
matter paragraph will be used where there is a fundamental uncertainty, such as over the going
concern status of a company.
In this case, there is no fundamental uncertainty and an emphasis of matter is unnecessary. The
item has been correctly disclosed in the financial statements and an unmodified auditor's opinion
with no further information can be issued.
(b) Potential benefits of audit to Hugh

Hugh may find having a voluntary audit provides the following benefits:
(i) Confidence for the entrepreneurs in their part-qualified accountant. An 'audit would give
the two owner-directors a degree of assurance that their accountant was on the right tracks
and that the management and financial statements produced by him that they are legally
responsible for are appropriate and reasonable. In addition, it would give them added

confidence to make the types of operational and finance decisions they will have to make
as they grow their business.
(ii) Confidence given to banks/other Investors. The existence of an external audit gives
confidence to banks and other investors when they are asked to provide finance,
particularly to a new business, such as Hugh. As Hugh is expanding rapidly, it may find it
needs new finance and quickly, in order to maintain operations. Many new companies are
affected by overtrading, when they cannot finance their operations in order to meet the
high sales demand for their product, and ultimately fail as a result.
(iii) Secondary benefits of additional finance expertise. Hugh might also benefit from having an
audit in terms of the secondary benefits an audit gives, such as systems review. Although
Hugh has a part-qualified accountant, having other finance professionals being involved
with it from the start will benefit the company in terms of how its systems develop to cope
with expanding operations and keep them on a good track. In addition, as the business
expands, it will have to take on more staff and more complex controls and systems will be
required to protect the entrepreneurs from error and fraud.
(iv) Getting things right in the first place. An extension of the above argument is that if Hugh's
business is rapidly expanding, it will be required to have an audit soon enough and having
auditors involved from the start will ensure there is not a shock down the line, when
auditors do get involved and encourage changes when systems have started to settle and
be established. In addition, when audits become mandatory there will be no risk of having
to qualify due to lack of evidence about opening balances.
(v) Acceptability for tax. The company will be subject to income tax whether or not it has an
audit, but the tax authorities may be more inclined to rely on audited accounts than not,
and be less inclined to make inspections themselves, which a new business might prefer to
avoid.
(c) Objective of a review engagement

A review engagement is an engagement designed to enable an auditor to state whether anything
has come to his attention to believe that the financial statements are not prepared in accordance
with an identified financial reporting framework. This is on the basis of fewer procedures than
would be necessary for an audit.
In the case of Hugh therefore, this option would cost them less than an audit but the assurance
given to them would be useful. The usefulness of a degree of assurance has been discussed
above. In a review engagement, the type of assurance given would be negative. This means that
the reviewer would state there was no reason to suppose that anything was wrong rather than I
positively believe that nothing is wrong.
The reviewer would approach the engagement with professional scepticism, for example, as the
accountant is part-qualified, the reviewer would believe that the risk that the financial statements
were subject to error would be higher.
The types of procedures to be carried out would largely be enquiries of the directors and the
accountant.

The cost benefit of a review might be good for the two directors, as they would gain a degree of
assurance at a much lower cost. However, other parties seeking assurance, such as potential
finance providers, might request the higher level of assurance that audit provides.
ANSWER # 34 – INDIGO
(a) Opening balances

The following audit procedures should be carried out:
• Agree the opening balances per Indigo's records to the financial statements for the year
ended 31 December 20X7
• Review accounting policies applied in 20X7 and 20X8 to ensure that they are consistent and
appropriate
• If relevant working papers have been made available from the previous auditors, review to
ensure that sufficient evidence was obtained to state that opening balances are fairly stated.
(However, there is no requirement on the previous auditors to make this information
available.)
• If working papers are not available, carry out other procedures where possible:
o Verifying receivables by after-date payments
o Verifying payables by reference to supplier statements or after-date payments
o Verifying bank balances to bank statements or requesting the balance from the bank
o Verifying inventory by after-date sales
• An area which might cause concern for the new auditor is opening inventory which might be
difficult to verify if evidence is not available from the previous auditor. Given the risks
associated with inventories this year, and the evidence of problems associated with it, it is
possible that the new auditor will need to qualify the audit report due to a lack of evidence in
respect of opening inventory.
• Analytical procedures month on month for the year ending 31 December 20X8 may indicate
problems with opening balances if the figures are distorted in the first month.
(b) Risks of material misstatement and audit strategy

Risks
(i) Inventories. There are various risks associated with the inventories balance.
(1) Evidence. 1t appears that there are restrictions on evidence with regard to inventory,
certainly for the closing balance and possibly for the opening balance as well, if
information is not available from the previous auditors. Rolling forward an inventory
count is acceptable, if there are restrictions on a count at the year-end, but not ideal,
as there is greater risk of error arising. The auditors should also determine the motive
behind not counting at the year-end, as this could also impact risk, if it shows that the
management are careless in their attitude to getting the right figure for the year-end.
(2) Nature of the inventories. Scrap metal inventory is reduced to small bricks. It is not
clear what the value of a brick is, but it is likely to be low value. Thus inventories,
which is likely to be the most significant balance, consists of a high number of low
value small items, and a number of piles of metal, not distinguished by type of metal.
Although the metals can be distinguished from each other simply, this adds
complexity to the count. Given that small bricks are portable, and controls over metal
inventories seem weak (aluminium sheets have been allowed to 'escape' to a nearby
field) the risk of the amount and therefore value of inventories in the statement of
financial position not being correct appears very high.

(3) Obsolescence. Some of the iron is rusty. It is unclear whether, in a scrap business, this
makes it obsolescent, but it does imply a degree of obsolescence. This adds to the risk
of the value of inventories being misstated.
(4) Value. There is likely to be a degree of specialism involved in valuing the metal due to
considerations of quality and volume having an effect on value. However, there is no
local specialist available, and it is not clear whether Indigo Co intends to obtain a
suitable specialist or value the metal itself. It is likely that the auditor would need
specialist assistance in determining whether inventories had been valued correctly.
(ii) Controls. The fact that the cash book is not posted to the general ledger promptly suggests
that controls over recording could be weak, which increases the risk that the financial
statements are generally misstated due to error.
(iii) Missing records/fraud. The fact that a fraud has been perpetrated and records stolen from
the company also increases the risk that the financial statements will be misstated, as there
are no cash records for the company for November.
(iv) Cash transactions. In addition to the general control problems noted, Indigo has a high
number of cash transactions, both sales and purchases, and cash transactions are more
inherently risky than credit transactions. There is motive to overstate cash purchases as the
subsidy is calculated on the basis of cash payments. This also adds to the risk that the
financial statements will contain errors.
(v) Opening balances. As the auditor is new this year, there is a risk that the auditor will not be
able to obtain sufficient audit evidence about the opening balances, particularly inventories
as noted above.
(vi) Furnace linings. It is inappropriate to have a provision for the cost of the furnace linings,
which should be included in the carrying value of the asset. This is unlikely to have a
material impact on the statement of comprehensive income (as the net impact of expense
being removed but depreciation on the asset being included is likely to be immaterial). The
issue is also likely to be immaterial to the statement of financial position (being a small
aspect of non-current assets).
(vii) Illegal dumping. The company dumps metal illegally which indicates that management have
a casual attitude to some laws and regulations. If this is their attitude to other laws and
regulations relevant the company, it also gives rise to the risk that the financial statements
may be misstated due to the financial effects of non-compliance with legislation.
(viii) Government subsidy. The company receives a government subsidy which must be
accounted for correctly in the financial statements (in line with IAS 20). In addition, this
adds to the risk of the audit generally, as the local government may be relying on the
audited figures for the purposes of their subsidy grant.
Audit strategy
(i) Risk. The auditors should take a risk-based approach to the audit given the risks noted
above, because inherent risk is high and there is a substantial chance of material errors
arising in inventory in particular.
(ii) Controls. It would not be appropriate to take a controls approach to the audit due to the
evidence the controls are ineffective and lacking, particularly over the key areas of
inventory and cash.
(iii) Transactions. Although it is common to take a transactions approach to an audit where
controls are identified as weak, in this instance, it does not seem appropriate to take a
cyclical or transactional approach, as there are missing records, and due to the high risk
associated with cash and inventory which necessarily are at the heart of the cycles that
would be tested. Given that the business is largely a cash business, there is an absence of
third party evidence (such as supplier statements, customer remittances) in the cycles.
(iv) Statement of financial position. In the circumstances therefore, it does seem appropriate
to take a statement of financial position approach to the audit, with particular emphasis on
the risk area of inventory. Key audit work will include attending an inventory count (if
possible), verifying bank balances with the bank and vouching the value of the subsidy by
verifying the quarterly returns to the local government.
(c) Matters to consider In determining the extent of loss from alleged fraud
• The regularity with which cash was banked and the date of the previous banking
• The details given to the police by the managing director
• Any apparent change in lifestyle associated with the accountant before he absconded
• An estimate of the loss being based on three days of an average month's sales
• The extent to which last year's unmodified audit report suggests the fraud started in the
current year
• The likelihood of the alleged fraud proceeds being recovered
• The opinions of other staff members about the activities of the accountant
• The opinion of the police on the case against the accountant

ANSWER # 35 - PEMBROKE
The opinion should be modified due to the limitation on scope imposed by the directors, as the auditor
is unable to obtain sufficient appropriate evidence. International Standard on Auditing 580 Written
Representations (ISA 580) requires the auditor to disclaim an opinion on the financial statements when
the directors refuse to provide representations regarding the fulfilment of their responsibilities in
relation to the preparation of the financial statements.
Consequently, as the matter is material and pervasive, the auditor should specify in the opinion section
of the report that "we do not express an opinion” or "we are unable to express an opinion".
Immediately above the opinion, there should be an explanation of the reasons for the disclaimer of
opinion.
In the matters on which auditors are required to report by exception section of the report, the auditors
should refer to the fact that they:
- have not received all information and explanations considered necessary for the audit; and
- were unable to determine whether adequate accounting records had been kept.
Snowdonia
The opinion should be modified, due to disagreement over accounting treatment. The transaction
should be accounted for in the year ended 30 September 2010 because it was received and in use prior
to the year end. As a result, non-current assets, liabilities and depreciation are understated.
As the equipment represents 14.5% of total assets and the depreciation of £40,000 represents 5.3% of
profit before tax, the matter is material and the opinion should be qualified (except for). The matter is
not pervasive as it is confined to specific items in the financial statements and does not represent a
substantial proportion of the financial statements.
Immediately above the opinion, there should be an explanation of the issue including the reasons and
the amounts involved.
ANSWER # 36 - EFRON & CO
The evidence to support the quantity of inventory at year end has not been retained by Wild. The firm
cannot verify the quantity of inventory at the year-end or any material misstatements that may have
arisen. This represents a limitation on scope of the engagement.
Inventory is material to the financial statements and therefore the firm is unable to provide any
assurance on inventory, the assurance report should explain the circumstances in which the inventory
figure was arrived at and, given the matter is not pervasive, continue to provide negative assurance on
the rest of the financial statements. This would be expressed as follows:
‘Except for the financial effects of any adjustments that might have been determined to be necessary
had we been able to satisfy ourselves as to the physical inventory quantities, nothing has come to our
attention that causes us to believe.........'

ANSWER # 37 - BUZZWELL LTD
Buzwell Ltd.
Inventory should be included in the financial statements at the lower of cost and net realisable value. As
the directors have included the inventory at its original cost this represents a disagreement over the
accounting treatment. Inventory is overstated by £203,000 which is 4% of profit before tax and the
error is therefore not material to the financial statements. The audit report will not need to be modified
in respect of this matter.
Pollen Plc
A material uncertainty exists over the going concern presumption as the investigation by the
government committee will not be concluded until after the financial statements are published. If the
auditor is satisfied that the disclosures included by the directors are adequate then an unmodified audit
opinion can be given. An emphasis of matter paragraph should be included in the audit report
explaining the nature of the uncertainty. If the auditor is not satisfied as to the adequacy of the
disclosures made by the directors then a qualified opinion will be given due to disagreement.
Bloome Plc
The new manufacturing plant should be depreciated from the date when it is capable of being used, i.e.
1 January 2009. The directors have not depreciated the plant over a sufficiently long enough period and
this represents a disagreement over accounting treatment. Six months of depreciation has been
charged, amounting to £140,000. A full year’s depreciation charge of £280,000 should have been made.
Depreciation is therefore understated by £140,000. This amounts to 10.8% of profit before tax and is
therefore material, but not pervasive, to the financial statements of Bloome. The audit opinion should
be modified in this situation with a qualified opinion ('except for').
ANSWER # 38 - TURBO LIMITED
1. Plant and equipment

(i) Actions/reasons
Request the directors to amend the financial statements because the asset was received and in use
prior to the year end. The non-current assets, current liabilities and depreciation figures should be
amended. The amounts are material as the cost of the equipment of £3.5 million is 14.3% of total assets
and the depreciation of £58,333 is 5.3% of profit before tax.
(ii) Report implications

If the directors agree to amend the financial statements, the report will be unmodified. However, if the
directors refuse to amend, the report will be modified with a qualified opinion due to disagreement
over accounting treatment. It will be an "except for" qualification as the misstatement is not pervasive.
There should be an explanation in the opinion section of report indicating the reason for the
qualification and the amounts involved.

2. Work in progress
(i) Actions/reasons
The amount should be noted on the schedule of individually immaterial errors and the directors should
be informed. The subsequent sale is an adjusting post balance sheet event providing additional
evidence of the value of the work in progress at the year end. As the NRV is lower than the cost, the
work in progress should be valued at NRV. However, the difference between the cost and NRV is
£50,000 and is not material as it is only 4.5% of profit before tax and 0.2% of total assets.

Even if the directors refuse to amend the financial statements, there will be no modification to the audit
report in respect of this matter alone. However, it must be considered with other individually
immaterial items, in case they are material when aggregated.
3. Enquiry
(i) Actions/reasons
Request the directors to include a note describing the situation in the financial statements as the
circumstances give rise to a significant uncertainty which could have an impact on the financial
statements. The amount involved is potentially material as £10 million is 41% of total assets. However,
a provision is not required as the outflow is possible rather than probable.

If the directors agree to include a note explaining the issue, the report will be modified, but unqualified.
An emphasis of matter paragraph should be added to the report after the opinion section drawing the
users' attention to the note in the financial statements. There should be a specific statement that the
opinion is not qualified and a brief description of the circumstances. If the directors refuse to include a
note in the financial statements or the note is inadequate, the opinion should be qualified due to
disagreement over disclosure. The reason for the disagreement should be described in the opinion
section of the audit report.
ANSWER # 39 - AIREDALE LIMITED
(1) Airedale
The audit report should be modified on the grounds of disagreement as the rebates should be
accounted for under the accruals concept. Although the amount of the rebate is not material by size, as
it is only 0.25% of revenue and 4.2% of profit before tax, it is material b nature as it affects the
requirement for the award of the directors’ bonuses. The modification would take the form of an
“except for” qualification as it is unlikely to be pervasive. The opinion section of the report should an
explanation detailing the amount by which receivables and revenue are overstated and if provided, the
amount by which the bonus and liabilities are overstated.
(20 Cairn
If the auditor agrees that there is a significant uncertainty about the going concern status of the
company, the report should be modified but not qualified as full disclosure has been made in the notes
to the financial statements. The modification should take the form of an emphasis of matter paragraph
following the opinion section of the report. This paragraph should include a brief description of the
circumstances and a specific statement that the opinion is not qualified. It should also draw the users’
attention to the note in the financial statements.
If the auditor disagrees with the basis of preparation of the financial statements, the report should be
modified with an adverse opinion, stating that the financial statements do not give true and fair view, as
the issue is likely to be pervasive. The opinion section should include the reasons for the adverse
opinion and state any amounts involved.
(3) Patterdale
The report should be modified with an “except for” qualification due to limitation on scope as evidence
reasonably expected to be available is not available. 15% of revenue is material but probably not
pervasive. Reference to the limitation on scope should be made in the basis of opinion (scope) section
of the report and also in the opinion section. Under the requirements of the UK Companies Act there
should also be a reference to the lack of proper accounting records and the fact that all information
necessary for the audit had not been received.
ANSWER # 40 - KOVASH LIMITED
Two significant uncertainties exist for Kovash’s financial statements; the recoverability of the receivable
due from Sceptus and whether the going concern presumption is appropriate in light of the possible
termination of the contract by Sceptus.
The Sceptus receivable balance is material at the account balance level (54% of receivables) and to the
financial statements as a whole (2½% of total assets). The loss of the Sceptus contract is material to
whether Kovash is a going concern as it accounts for 30% of Kovash’s total revenue. It appears that
Sceptus could terminate the contract if the production by Kovash is found to be defective.
Uncertainty will continue to exist when the financial statements and audit report are signed. The
directors should disclose these uncertainties in the notes to the financial statements.
If adequate disclosures are made then an unqualified opinion can be given. The auditor should include
an emphasis of matter paragraph to draw attention to the significant uncertainties.
If the directors fail to make adequate disclosures then the opinion will be qualified on the basis of the
disagreement. An ‘except for’ opinion would be given unless it is felt by the auditor that the absence of
disclosure over the uncertainty surrounding going concern renders the financial statements misleading
as a whole. In which case an adverse opinion may be expressed. In both cases the opinion paragraph
will explain the disagreement and effects on the financial statements.

ANSWER # 41 – FRAZIL
Frazil’s audit report

(i) Development costs
In order to comply with IAS 38, development costs which meet its criteria should be
capitalised. Frazil’s development costs have been treated as an expense in the statement of
comprehensive income and therefore they do not comply.
The error is not material to the statement of financial position. However, costs of $3.7
million are material to the statement of comprehensive income, as adding back the
expenses would increase profit by 45%. This is a major non-compliance with the
International Financial Reporting Standard.
However, the problem of non-compliance appears to be restricted to IAS 38.
Therefore, the auditors should qualify their audit report (except for) on the grounds of a
material disagreement regarding accounting for development costs.
(ii) Annual report to be published on the website
As the audit report is included in the annual report, the company should ask the audit firm’s
permission to publish the audit report on the website. The auditors might want to refer to
the matter in the engagement letter between the firm and the company.
If the audit report is published on the website, the auditors should ensure that their report
is worded so that it is suitable for that media. For example, it might not be a appropriate to
refer to page numbers indicating what items their report is in respect of, but file names or
other links might be more suitable.
It is important that the audit report does not become misleading when presented in this
way, so it is vital that the auditors ensure that it clearly shows what financial statements it
does relate to and for which years.
The auditors are likely to want to be involved in the process of publishing the audit report
and may want to test controls over how the audit is uploaded and protected from hacking.
Once the audit report as bee uploaded, the auditors should check that the audit report on
the website is the same as the paper version and check that the presentation has not been
distorted.

ANSWER # 42 - STOKEY
(a) Poisoned meat pies

(i) Audit procedures
• Discuss the matter with the directors to establish their view of where the fault lies e.g. was it a
problem with the manufacturing process, perhaps an issue with subcontracted distribution
transport?
• Inspect a copy of the legal claim. Review legal correspondence and discuss the matter with the
company’s lawyers to establish the potential loss (if any) due to the lawsuit.
• Inspect insurance documentation and discuss the matter with the directors to establish
whether Stokey was insured against such an event.
• Establish the latest position regarding the 60 ‘at risk’ customers through further discussions
with management and reviewing correspondence with a sample of those customers.
• Discuss the significant lost orders (at least 50%) with the directors and consider the overall
impact of lost customers on Stokey’s ability to continue as a going concern.
• Discuss the impact of the negative press coverage on Stokey’s brand and reputation and any
related going concern implications. Taking all the evidence together this may warrant extended
representation from the directors regarding their views on going concern.
(ii) Impact on financial statements and the audit report

• The poisoning and subsequent legal claim should be disclosed in a note to the accounts as a
non-adjusting subsequent event (IAS 10) and contingent liability per IAS 37 Provisions,
Contingent Liabilities and Contingent Assets. This is necessary given the significant impact of the
event on Stokey’s business (loss of at least 50% of its customers) and potential size of the legal
claim.
• The event itself can be considered as a non-adjusting event as the poisoning had not occurred
as at the year-end.
• However, should the impact on custom, brand and reputation be so significant that Stokey can
no longer be considered a going concern, then the event would trigger an adjusting event by
necessitating the use of an alternative basis (e.g. break-up basis) to be used for the preparation
of the accounts.
• Should the conclusion be that significant uncertainty exists regarding the going concern
assumption but that the going concern basis remains appropriate, then the directors should
explain that uncertainty in a note to the accounts.
• If the going concern basis remains appropriate:
o If the auditors consider the explanations in the notes as adequate they should include a
paragraph following the opinion paragraph emphasising the material uncertainty around
going concern as a result of the subsequent event.
o If the auditors do not consider the notes as adequate they should give either a qualified
(‘except for’) or adverse opinion (if they consider the inadequacy as pervasive) as the
financial statements are materially misstated.
• If the going concern basis is not appropriate:
o If Stokey has used the break-up basis and adequately disclosed the fact then the auditor
should modify their report with the inclusion of an emphasis of matter paragraph explaining
the use of break-up basis. The auditor should explain that their opinion is not modified in
this matter.
o If Stokey has continued to use the going concern basis then an adverse opinion should be
given (as the use of the wrong basis is pervasive) stating that Stokey is not a going concern.

(b) Destroyed inventory
(i) Audit procedures
• Discuss the matter with the directors to establish the impact of the loss on business, for
example:
o Does Stokey still have sufficient inventory to fulfil orders in the short term?
o Have the refrigeration facilities been fully repaired?
o What has been the impact on custom – has Stokey had to cancel orders and has it
subsequently lost customers to competitors?
o Is the impact so great that Stokey may struggle to continue as a going concern in the future
e.g. due to lost custom? (Further written representation may be required from the directors
to support their claims).
o Establish whether an insurance claim has been lodged through further discussion with
directors and inspecting a copy of the claim and any subsequent correspondence with the
insurers. Consider whether the inventory listed on the claim appears reasonable in the
context of past production schedules.
(ii) Impact on financial statements and the audit report

• The loss of power and refrigeration leading to the spoiling of 55% of inventory occurred on 26th
January. This this would not have impacted any of the year-end inventory given the maximum
shelf-life for inventory is 14 days.
• Subsequently it is unlikely that disclosure is required in the financial statements and there
would be no impact on the audit report.
• However, should the auditors conclude that the operational issues generate uncertainty around
the going concern assumption then the directors should explain the uncertainty in a note to the
o If the auditors consider the going concern uncertainty disclosure to be adequate they
should modify their report (but not the opinion) with the inclusion of a paragraph drawing
the users’ attention to the material uncertainty. The auditors should state that their opinion
remains unmodified.
o If the auditors consider the disclosure to be inadequate then they should qualify their
opinion (‘except for’) on the grounds of disagreement (i.e. the financial statements are
materially misstated due to the inadequate disclosure on the going concern uncertainty).
ANSWER # 43 - SUNSHINE
(a) Sunshine Ltd.

The audit senior is correct in his assertion that the scope of the audit opinion provides an assessment of
the truth and fairness (or fair presentation) of the financial statements. When financial statements are
prepared in accordance with IFRS, the directors’ report does not form part of those financial statements
and hence falls outside the scope of the audit opinion.
As the audit senior is satisfied that the revenue figures in the financial statements, including the
segmental information note, are ‘true and fair’ (i.e. not materially misstated), the audit opinion should
not be modified.
However, ISA 720 (Revised) The Auditor’s Responsibilities Relating to Other Information places a
professional duty on the auditor to read other information alongside which the audited financial
statements are presented (e.g. the directors’ report in an annual report). This is necessary to identify:
o any material inconsistencies in the ‘other information’ with the audited financial statements;
and/or

o any material misstatements of fact in the ‘other information’ given the auditors’ overall knowledge
of the client and its industry.
In the case of Sunshine Ltd. it is misleading for the Chairman to describe the sub-let income as a “major
part of revenue” and talk about “continuing to exploit this lucrative and significant revenue stream”. A
material inconsistency exists when other information contradicts information contained in the audited
financial statements. Clearly the Chairman’s message is inconsistent with the financial statements
which show this revenue stream only represents 1.2% of overall revenue (i.e. hardly ‘major’!).
Conclusion
The inconsistency must be discussed with the directors who should be asked to amend the Chairman’s
statement to resolve the inconsistency.
o If the directors agree to amend the Chairman’s statement and the material inconsistency is resolved,
an unmodified audit report (including an unmodified audit opinion) can be issued.
o If the directors fail to amend the Chairman’s statement sufficiently and a material inconsistency
remains, the auditors should refer to this as a misstatement of other information by adding a
separate paragraph in the audit report.
Furthermore, if the directors refuse to resolve the material inconsistency, Rodney & Co must re-
consider the integrity of management and consider whether their refusal to amend the directors’ report
raises uncertainty about the reliance that has been placed on management during the audit (e.g. with
their written representations).
(b) Star Co
The lack of other audit evidence regarding the new overseas subsidiary, Twinkle Ltd., is an issue of
unknown magnitude. This indicates that sufficient and appropriate evidence has not yet been
generated.
The lack of evidence may have arisen due to:

o the auditors having demonstrated insufficient professional scepticism in failing to appropriately
challenge management’s explanations, and arguably negligence in failing to seek further
corroborating evidence about the creation and function of Twinkle; and/or
o the directors having refused to provide further evidence.
When considered in isolation, the cash-transfer is a non-adjusting subsequent event and provides
strong evidence that Twinkle existed and was trading after year-end. However, this does not preclude
the possibility that Twinkle may have been set up pre- year-end and should have been consolidated.
The audit team must request further evidence about Twinkle’s creation such as registration certificates
and legal papers. Should this not be forthcoming this would represent an inability to obtain sufficient
appropriate audit evidence (imposed by Star rather than circumstances). In this case a modified audit
report would need to be issued with either a qualified opinion or a disclaimer of opinion, depending on
how severe (i.e. pervasive, or not) the auditor concludes the issue to be. Should the auditor conclude
that the lack of evidence causes suspicion over other audit evidence, in particular management’s
representations, then a disclaimer of opinion is almost certainly warranted.
Had Twinkle existed at year-end and contained material assets and liabilities, then arguably the
misstatement through lack of consolidation would be considered pervasive and an adverse audit
opinion would be appropriate.
Had Twinkle not existed at year-end and been set up in February 20X7 as claimed by the finance
director, there still may be an issue. Whilst the cash amount is immaterial by size, it may still be
considered material by nature which would necessitate the disclosure of the transaction (i.e. the
‘subsequent event’) in a note to the accounts. The absence of such a note would be further grounds for
modifying the audit report, this time on the basis of disagreement. Depending on how severe the
auditor concludes the issue to be, the disagreement would lead to either a qualified audit opinion (if
not considered pervasive) or an adverse opinion (if considered pervasive). On balance, a qualified
opinion would be more likely.
Conclusion
Further audit evidence is required to support an unmodified opinion. If this were not forthcoming a
disclaimer may be appropriate.
(c) Manta Co
Without receiving continued support from its parent company, Manta would not be a going concern. In
such a case, the preparation of Manta’s financial statements on a going concern basis would be
fundamentally misleading (i.e. the misstatement would be considered pervasive in nature).
Had Manta still prepared its financial statements on the going concern basis without a support letter
then the auditors would have needed to modify the audit opinion with an adverse opinion.
Had Manta used an alternative basis for preparing its financial statements in the absence of a support
letter (e.g. the break-up basis) there would have been no disagreement from the auditors, although an
emphasis of matter paragraph would have been necessary to draw the users’ attention to the use of the
alternative method of preparation.
However, in this instance a support letter had been received by Manta from its parent, Shark, which
appears to enable Manta to continue trading as a going concern.
If Rodney & Co are satisfied that the support letter (together with other corroborating evidence such as
management’s written representations) provides sufficient evidence to support the appropriateness of
the going concern presumption in preparing Manta’s financial statements, then no modification to the
opinion would be necessary.
However, this assumes that the nature of the support is adequately disclosed in the notes to the
financial statements. If the notes do not adequately disclose the nature of support then the auditors
would need to modify their audit report and opinion by issuing either a qualified opinion (‘except for’)
or an adverse opinion (if considered pervasive) on the basis of disagreement.
If the auditors conclude that the letter of support and other corroborating evidence do not provide
sufficient evidence to support the going concern presumption then a material uncertainty around
Manta’s ability to continue as a going concern exists. This material uncertainty should be explained in a
note to the accounts.
If the auditors are satisfied as to the adequacy of the description of the material uncertainty in the
notes then there is no need to modify their audit opinion. However, they would need to modify their
audit report by the inclusion of an emphasis of matter paragraph immediately after the opinion
paragraph drawing the users’ attention to the note describing the material uncertainty about going
concern. The emphasis of matter paragraph should mention that the auditor’s opinion is not modified
in this instance.
If the auditors are not satisfied as to the adequacy of the description of the material uncertainty in the
notes then they will need to modify their audit opinion on grounds of disagreement. This will require
the issuance of either a qualified opinion (‘except for’) or adverse opinion (if the inadequate note is
considered pervasive in nature).
ANSWER # 44 - EDDIE ELECTRONICS
(a) Written representation letter – reliability and need for other evidence
Normally, the written representation letter is drafted by the auditor, but it is written on the
client’s headed notepaper and signed by the directors. Alternatively, the letter may be written by
the directors, but contain matters requested by the auditors.
As audit evidence, it is written evidence (which is better than oral evidence) but it is evidence
from within the company and thus it is not as independent a source of evidence as most other
evidence obtained by the auditor (e.g. third party evidence and evidence obtained directly by the
auditor).
Arguably, evidence from the directors may be less reliable than evidence from the company’s
employees, as there may be more pressures and motivation for the directors to mislead the
auditor (e.g. because of external pressures on them to produce good results). However,
statements from the directors may be more reliable than those from employees, as they will
have a better understanding of the situation and, in their position as directors, should be aware
of the importance of the statements they make to the auditor. Under most systems of company
law, a company director commits an offence if he knowingly or recklessly makes a misleading,
false or deceptive statement to the auditor. The directors should be aware of such provisions and
this should make them cautious of what they say to auditors, particularly when it is later put
down in writing.
In some relatively immaterial areas, the auditor may accept the directors’ statements without
seeking further evidence. However, in most situations, the auditor should attempt to find
alternative evidence to support (or refute) the directors’ representations. Thus, in determining
whether all sales income has been recorded in the financial statements, the auditor should
obtain other evidence and would probably be negligent if the directors’ representations were
relied on entirely.
In addition, the auditor must consider whether the directors’ representations are consistent with
the
other information he has obtained. If this evidence is consistent, then the directors’
representations will reinforce the evidence obtained by the auditor. However, if the other
evidence obtained by the auditor is not consistent with the directors’ representations, the
auditor should be extremely careful before accepting what the directors say. The auditor should
seek further evidence to either refute or confirm the directors’ statements. If there is a material
difference between the other evidence and the directors’ representations, the auditor will
probably have to qualify his audit report.
(b) If the directors refuse to sign the written representation letter

The auditor should ask the directors why they are refusing to sign the letter. The auditor should
explain the following:
• It is a normal procedure for the auditor to draft the written representation letter and ask the
directors to sign it.
• The audit opinion will be based mainly on audit work which does not involve representations
from directors. However, directors’ representations are helpful in providing further evidence
that the financial statements are free from material error.
• Company law requires the directors to sign the financial statements. This provides evidence
that the directors believe the financial statements are free from material error. Thus, this is
similar to the directors signing the written representation letter.
If the directors are still unwilling to sign the letter, the auditor should ascertain which paragraphs
they are unhappy about. The wording of these paragraphs should be discussed to see if
alternative wording can be agreed. However, it would probably be unacceptable to remove the
paragraphs where the directors confirm completeness of income or the validity of expenditure.
If the directors continue to refuse to sign the letter, the auditor should be put on his guard that
the directors may be hiding something. Both of these areas create strong suspicion of potential
fraud. Cash sales could be misappropriated and the directors could be putting personal expenses
through as business expenditure.
The auditor should therefore carry out additional audit procedures in the areas over which the
directors are refusing to sign.
If these additional procedures fail to provide adequate evidence then:
• the audit report should be qualified on the grounds of a scope limitation, and
• the auditor should consider the reliability of other representations obtained from the
directors during the course of the audit.
ANSWER # 45 - BARNET REMOVALS

(a)
Audit work Reasons
(1) Damages claim
◼ Ask the directors how they propose to treat ◼ The matter is potentially material –
the claim in the financial statements (and on even a claim of just Rs.100k represents
what grounds). 12.5 % of trading profit.
◼ Inspect the invoice/contract with the ◼ The customer’s claim may be invalid if
customer to ascertain the terms and they were responsible for insurance or
conditions and whether the antiques if high-value items should have been
collection is identified. specified.
◼ Review correspondence with the customer ◼ In order to obtain consistent third party
and with solicitors and the accident evidence to support internal evidence.
report/damage record.
◼ Examine Barnet Removals’ own insurance ◼ Barnet Removals may have its own
cover documentation. insurance cover to cover such claims
from customers.
◼ Enquire whether the damage was an isolated ◼ To ascertain whether there may be
incident. other similar claims for which provision
is needed.
(2) Bad/doubtful debt

◼ Ask Barnet Removals’ directors for their views ◼ The matter is material as full provision
on the recoverability of the debt. would reduce trading profit by 37.5%.
◼ Analyse Safe Storage’s account to ascertain This may highlight specific matters for
whether it is still active and whether any cash investigation. If current invoices are being
has been received. settled, this could indicate that the Rs.300k
is being disputed or is invalid (and
therefore irrecoverable).
◼ Select a small sample of transactions and To ensure that a bona fide debt exists.
vouch to supporting documentation (e.g.
invoices and remittance advices).
◼ Inspect Barnet Removals’ contract with Safe Special credit terms may exist (though
Storage and the correspondence file. these are unlikely to extend to six months).
Correspondence may reveal disputed
amounts and steps taken to recover them
(e.g. warning letters).
◼ Conduct a company search on Safe Storage. To confirm that the company exists and
appears solvent. To ascertain whether the
two companies are related parties.
◼ Review the equivalent balance (if any) in last If Safe Storage’s balance has previously
year’s working papers. been circularised (without any
repercussions), permission to confirm the
balance directly with Safe Storage may be
sought from a higher authority (than the
financial accountant).
(3) Overdraft limit

◼ Ask the directors why they consider Barnet ◼ If it is not possible to determine that the
Removals to be a going concern. going concern presumption is
appropriate then there will be an
impact on the audit report.
◼ Review the current refurbishment programme ◼ The going concern presumption may
and related finance arrangements. not be appropriate if finance is not
forthcoming to finish the refurbishment
project (e.g. if the company is unable to
trade).
◼ Review correspondence with the bank and ◼ The company should take steps to
prospective lenders seeking additional increase its borrowing facilities as long-
borrowing facilities. term investment cannot be sustained
on an overdraft facility.
◼ Discuss with directors any alternative courses ◼ If the recent investment in new removal
of action to alleviate the cash flow problem. vans was for outright purchase, sale and
leaseback may be arranged to raise
funds.
(b) Written representations (extracts)

(1) No provision is considered necessary in respect of a legal claim by Mr X for damage to
reproduction furniture. No amounts are expected to be paid, and no similar claims have
been received or are expected to be received.
(2) We confirm our considered view that the company has adequate resources to continue
operations for the foreseeable future (i.e. is a going concern). This conclusion has been
reached based on forecast expenditure and current and future borrowing arrangements.

Tutorial note
In part (b), the representation for the legal claim assumes that audit work will validate the
assertion that the collection is not antique.
Written representations on the debt from Safe Storage are not appropriate. If sufficient evidence
cannot be obtained to confirm the recoverability or otherwise of this debt, the inability to obtain
sufficient appropriate audit evidence (limitation on scope) will result in a qualified audit opinion.
ANSWER # 46 - MUBASHIR LIMITED
Factors that should be considered and actions to be taken:

(i) The amount of sales made to SL a related party is material (by nature) to the financial statements.
(ii) We need to consider the reason for this event. The possible reasons are as follows:
a) It may be a deliberate attempt by ML to fraudulently siphon off funds by suppressing the
sales probably by the management itself or by any other employee.
b) ML may have recorded the sale in the name of any other party with the intention of non-
disclosure of related party transaction.
c) The non-disclosure of related party transactions may be due to unintentional error made
by the management.
(iii) We shall discuss the issue with the management and if necessary with those charged with
governance and ask them to:
a) revise the financial statements
b) take steps to ensure that those in receipt of the previous financial statements are informed
of the situation.
(iv) If we establish that the revised audit report should be issued and the management has not yet
issued the financial statements to the shareholders, in this case we shall:
a) Carry out the audit procedures necessary for verification of amendment in the financial
statements.
b) Extend the audit procedures regarding subsequent events, to the date of the new audit
report.
c) Provide a new auditor’s report on the amended financial statements.
d) Include an emphasis of matter paragraph or other matter paragraph reflecting such
amendment.
(v) If financial statements have already been issued to the shareholders then we should, in addition
to the above audit procedures: Answers
a) Review the steps taken by the management to ensure that those in receipt of the previous
financial statements together with the auditor’s report thereon are informed of the
situation.
b) Notify the management and where necessary those charged with governance that we
would seek to avoid future reliance on the audit report, if the management does not take
appropriate steps to ensure that those in receipt of previously issued financial statements
are informed of the situation and does not amend the financial statements.
c) Seek legal advice in order to prevent the reliance on the audit report on the financial
statements, if in spite of our communication, ML’s management or those charged with
governance fail to take necessary steps to prevent reliance on the audit report issued on
(vi) Under the specific law, regulation or the financial reporting framework where we are permitted
to restrict the audit procedures on subsequent event specific to the amendment, we will mention
an additional date in the audit report restricted to the amendment that indicates that the audit

procedures on subsequent events are restricted to that specific amendment as mentioned in the
relevant note. We would also mention the fact in the emphasis of matter paragraph or the other
matter paragraph that our audit procedures on subsequent events are restricted solely to the
amendment of the financial statements as described in the relevant note to the financial
statements.
(vii) If as a result of a misstatement resulting from fraud or suspected fraud, we feel that our ability to
continue performing the audit has been affected, we should:
a) Determine the professional and legal responsibilities applicable in the circumstances,
including the requirement to report the matter to the shareholders or the regulatory
authorities.
b) Consider whether it is appropriate to withdraw from the engagement, and if we decide to
withdraw:
o Discuss with appropriate level of management and those charged with governance,
our withdrawal from the engagement and the reasons for the withdrawal.
o Determine whether there is a professional or legal requirement to report to the
shareholders about the withdrawal from the audit or the responsibility to report it to
the regulatory authorities.
o Discuss with the legal advisor about withdrawal from the engagement.
Being an associated company the management of ML may be in a position to influence the

decision of SL also. Therefore the auditor should reassess the risk of material misstatement in SL.
ANSWER # 47 - STEEL LIMITED
The implications of the various issues referred to in the question, on the auditor report, are discussed
hereunder:
(i) Failure to observe stock count:
o Ordinarily the auditor is not required to perform the procedure of observation for obtaining
evidence in a review engagement.
o Analytical procedure will be sufficient in this case.
o There will be no implication on auditor’s review report.
(ii) Exposure to significant exchange rate risk:
o Auditor is not supposed to give any assurance on the adequacy of the management’s risk
management activities.
o Auditor is responsible to assess whether the derivatives, as discussed, have been accounted
for and presented according to the requirement of the International Financial Reporting
Standards.
o However, if open position casts a significant threat to the viability of the company’s business,
the auditor may draw the attention of the reader of conclusion report by adding an
emphasis of matter paragraph in the report.
(iii) Sale of one of the company’s set-up to an associated undertaking:
o The information about the sale of the business segment to a related party is necessary for
understanding the changes in financial position. Therefore, an explanatory note should be
included in the condensed financial statements.
o Ordinarily the auditor is not required to corroborate the evidence provided by the
management.
o In case management refuses to disclose this information, suitable modification will be
considered.
(iv) Discontinuation of the practice of using Age Analysis for bad debts estimation:
o Apparently, bad debt provision is following the historical trend. The auditor is required to
use inquiry and analytically review procedures in a review engagement.

ANSWER # 48 - PENDULUM
(a) Legal claim (re: chickens)

(i) Matters
• 10% x pre-tax profit = Rs. 254,300. 5% x pre-tax profit = Rs.127.150. Therefore the matter is
material at almost 6 times pre-tax profit.
• What is the basis of the Rs. 15 million estimated claim? Would a Rs. 15 million provision be
adequate? Could there be exposure to other similar claims raised?
• What is the expected timing of the resolution of the case? How would Pendulum fund the cash-
flow for settling the claim? Do they have cash set-aside? Would Pendulum need to raise funds
to settle the claim?
• How do the directors plan to account for the claim? Do they plan to make a provision? If so,
how much? Do they plan to make adequate disclosure about the case in the financial
statements?
(ii) Audit evidence

• Inspect correspondence with the lawyers for evidence of timings, amounts and the likelihood of
success or failure of the litigation.
• Inspect board minutes for evidence of timings, amounts and the likelihood of success or failure
of the litigation.
• Discuss the matter with directors to establish their opinion regarding the likelihood of the
outcome of the case and exposure to other similar cases.
• Review work performed during the prior year audit for background information and regarding
opening balances (it appears no provision was made in prior year – consider whether disclosure
was made and whether it was adequate).
• Recalculate the Rs. 15 million.
• Discuss with the directors their plans for accounting for the litigation (e.g. does it satisfy the
definition of a provision per IAS 37 Provisions, contingent liabilities and contingent assets – i.e.
is it a ‘liability of uncertain timing or amount?’). Discuss their plans for including an explanatory
note in the financial statements.
• Inspect bank statements and the cash book to establish whether payments have been made
post year-end, either to settle in full or as evidence of an ‘out-of-court’ settlement.
• Consider seeking written representation of the board’s view regarding the outcome of the
litigation.
• Consider whether a modified audit report is necessary (i.e. an emphasis of matter paragraph,
assuming the auditors are happy with the proposed treatment) and discuss any proposed
modification immediately with those charged with governance and management.
(b) ‘Love your pet’ scheme

(i) Matters
• 10% x pre-tax profit = Rs. 254,300. 5% x pre-tax profit = Rs.
• 127.150. Therefore, the matter is material at over 10 times pre-tax profit.
• What were the ‘previous schemes’?
• What is the basis of concluding 75% take-up?
• What is the appropriate accounting treatment for the vouchers?
• What marketing is currently in place / will be established for the National Pet’s Day’ promotion?
(ii) Audit evidence

• Obtain and inspect details of previous schemes and discuss with the directors how those
schemes were accounted for in previous financial statements.
• Obtain and inspect details of the current scheme and discuss with the directors why they
believe it to be similar to previous schemes.
• Consider whether the proposed accounting treatment is in line with IAS 18 Revenue. E.g.
o When and how do the risks and rewards of ownership of the voucher transfer from
Pendulum?
o At what stage does Pendulum generate a liability (obligation) to deliver the pet-pampering
and health check.
o Is it probable that economic benefit will flow to Pendulum?
o Can the costs of the scheme including the pet-pampering and health check be measured
reliably?
• Consider whether the proposed accounting treatment is consistent with how similar schemes
have previously been accounted for.
• Consider the matching principle and ensure that sales of the vouchers and cost of sales
(delivering the health checks and pet-pampering sessions) are reflected in the same accounting
period.
• If it is appropriate to account for the issuance of Rs. 30m during year-end 31 December 20X6
ensure that this is matched with the appropriate cost of sales, including any provisions for the
delivery of health checks and pet-pampering.
• Identify the volume of returned or cancelled vouchers post year- end to establish whether
revenue/cost-of-sales/profit has been overstated in the year to December 20X6.
ANSWER # 49 - NIBBLES
(a) Issues relevant to deciding whether the firm can rely on the work performed by the internal
auditors
Objectivity
The chief internal auditor is a newly qualified chartered accountant, so he will be bound by ethical
guidance which requires him to carry out his work with independence and objectivity. He should also be
expected to have briefed his assistant on the importance of an objective approach.
The internal audit function will have greater independence if the chief internal auditor reports directly
to the board.
The scope of the internal audit function should be unrestricted. If put upon enquiry, the internal
auditors should be able to conduct non-routine investigations. It is more likely that reliance can be
placed on the internal audit work if findings are reported directly to the board and management make a
positive response to those findings.
Technical competence and due professional care

Although the function has accounting experience its experience of internal auditing and the snacks
industry may be limited. The audit firm will need to assess the effectiveness of the internal audit
function via discussion and a review of working papers.
The internal audit work should be properly planned, reviewed, supervised and recorded. In particular,
the substantive procedures on the cash sales system should adequately cover the different locations.
Working papers should set out audit objectives, tests performed, results and conclusions. The work of
the assistant should show evidence of monitoring and review.
Effective communication
It is more likely that reliance can be placed on the internal audit work if the function is allowed to
communicate freely with the external auditors. There should be regular meetings between the two and
one should notify the other of any significant matters discovered which might affect the other’s work.

(b) Issues relevant to deciding how much reliance can be placed on that work
Responsibility
Although the work of the audit firm may be reduced by placing reliance on the work of the internal
auditors the responsibility of the firm is not reduced by such reliance. The audit firm must be able to
draw its own conclusions.
If it is decided that the work of the internal auditors can be relied on, the audit firm should consider the
following in determining the extent of its use of the internal auditors’ work in the area of substantive
testing of cash sales.
Materiality and information available

Although cash sales are a material area, some reliance can be placed on the work of internal audit.
It may be possible for the firm to reduce the amount of substantive testing on cash sales because of the
extensive testing carried out by the internal auditors. However, in doing so the firm is not really relying
on the internal audit function as a part of the internal control system – more using them to provide
assistance.
Risk
There is a high risk that cash sales are understated. Although some reliance can be placed on the work
of internal audit the audit firm’s involvement must be sufficient to allow them to reach their own
conclusions.
Judgement
The area is not a particularly judgemental one so reliance would not be precluded on these grounds.
Availability of other audit evidence

The availability of complementary evidence (e.g. from analytical procedures) may increase the extent of
reliance.

ANSWER # 50 - HERALD PLC
Critical areas to consider during planning

• Understand the substance of the new investment in Angel to establish whether Herald has gained
control of Angel (which looks likely given the size of the next largest shareholder’s investment being
only 18%) and whether the investment should subsequently be accounted for as a subsidiary or
associate. IFRS 10 has expanded the understanding of control to include situations where less than
50% of the equity shares are held, but where the quantity and distribution of other shareholdings
give the investor so-called de-facto control.
• Inquire of management as to any other changes in group structure that will impact how the group
financial statements should be consolidated, including dates of transactions and amounts of
consideration.
• Ascertain whether all components share co-terminus year-ends or whether accounts for sub-
periods need to be prepared. If sub-period accounts are required, ascertain management’s plans to
ensure the sub-accounting is controlled and performed accurately. In this respect IFRS 10 allows
non- co-terminus year-ends provided they differ by no more than 3 months either side of the
parent year-end.
• Establish which of the components are individually significant, and for those that aren’t establish
which contain elements that are significant to the group financial statements and hence require a
full audit.
• For any components that are neither individually significant nor contain elements that are
significant to the group financial statements, consider the extent of audit work required, for
example a full audit of a sample of those individually insignificant components, or whether a review
is sufficient.
• Consider the amount of involvement the group engagement team needs to have in any component
audits. For the three overseas components of Herald Plc consider in particular:
o whether group engagement team involvement can be largely or wholly performed remotely
from Pakistan (e.g. via teleconference), and if not then consider planning logistics to attend;
o the need to re-confirm the independence of the local auditors and their confirmation to comply
with ethical standards at the group audit level.
• Agree delivery and reporting timetables with the management of Herald. Develop audit plans,
including those for any work required on components, that will ensure group reporting timetables
are met.
• Establish an initial estimate of overall materiality at the group level and component materiality
relevant to the various components.
• Discuss group-wide controls with group management to understand the extent and strength of the
system of internal controls over the group, in particular controls over the consolidation process.
This will assist in developing an overall strategy at the group audit level.
• Request a list of related-parties from management and communicate the list to component
auditors.
Key audit procedures on the consolidation process

• Check the transposition from the accounts of each component to the consolidation schedules for
accuracy.
• Ensure that consolidation adjustments are appropriate, consistent with prior year, and in line with
IFRS 3, IFRS 10, IFRS 11 and IFRS 12 including:
o understanding the dates and cost of acquisitions of subsidiaries and the assets acquired.
o ensuring goodwill and pre-acquisition reserves arising on consolidation are accurately
calculated and appropriately accounted for.
o checking the overall reconciliation of movement on reserves and minority interest for accuracy.
o ascertaining if accounting policies of the subsidiaries differ because foreign subsidiaries might

be operating under different rules, and ensuring that appropriate consolidation adjustments
have been posted.
o confirming that inter-company transactions and balances have been correctly eliminated.
o In respect of IFRS 12 in particular, ensure the financial statements give adequate disclosure of
how the parent adjudged that they had control over the new subsidiary despite owning less
than 50% of the equity capital.
• For business combinations ascertain:
o whether combinations have been appropriately treated as acquisitions in line with IFRS 3. IFRS 3
scopes out the application of acquisition accounting in the circumstance that the transaction is
an acquisition of assets, rather than a business, although this appears to be an unlikely
conclusion in this case.
o the appropriateness of the date used as the date of combination. The date from which
consolidation commences is usually the date that consideration passes, but facts and
circumstances may indicate that an earlier or later date be identified as the date of acquisition
(IFRS 3).
o assuming that acquisition accounting has been used, that the fair value of acquired assets and
liabilities is reasonable, when compared with the ascertainable market value.
o if goodwill has been calculated correctly and if amortised, whether the amortization period is
reasonable.
o whether there are indications of goodwill impairment.
o that the expenses incurred in achieving the acquisition (legal, accounting and bankers) have
been expensed as required by IFRS 3.
• Vouch the figures used for accounting for Angel back to purchase documentation such as signed
contracts, share register entries (if part/all settled by issuing shares in Herald) and bank transfers.
• For disposals:
o inquire of management the appropriateness of the date used in accounting for the disposal.
Vouch dates and amounts back to disposal documentation (agreements and contracts);
o check whether the results of the investment have been included up to the date of disposal and
whether figures used are reasonable.
• Consider whether previous treatment of existing components is still correct or not, taking the level
of influence and degree of support into consideration.
• Verify the arithmetical accuracy of the consolidation workings by recalculating a sample of entries.
• Review the consolidated accounts for compliance with the Pakistani legislation, prevailing
accounting standards and other relevant regulation such as the listing and corporate governance
rules.
• Check that appropriate operating segments are presented in the consolidated financial statements
in compliance with IFRS 8, particularly in light of the 49% acquisition of Angel Ltd. Inquire of
management as to how they segment the business for management purposes and confirm this by
reviewing internal management accounting. Segments might be reported by geography (given there
are three overseas subsidiaries) and/or by product (paint, varnish, gardening equipment).

ANSWER # 51 - THE CINNAMON GROUP
(a) Approach to planning and controlling the group audit Planning

• Obtain the instructions issued by head office for the preparation of the group’s financial
statements.
• Obtain the timetable for the production of the individual financial statements and the group
• Ensure that there is a standard format and layout of subsidiary financial statements to facilitate
consolidation.
• Consider audit staffing and skills required.
• Liaise with component auditors of subsidiaries.
• Consider potential problems that may arise, for example with Hybrid.
• Consider the risks arising from the group relative to the subsidiaries.
• Consider any additional procedures that may be required for subsidiaries being audited by
component auditors.
• Consider whether materiality levels are acceptable.
• Use questionnaires for the subsidiaries to establish accounting policies, accounting details
needed for consolidation but not available from the accounts and information relevant for group
accounts but not for subsidiaries’ own accounts.
Controlling
The group audit will be subject to the same control and quality checks as any other audit, including
maintenance of documented files with auditors’ decisions documented, file review, supervision and
discussion with management. Effective planning, allocation of staff and review procedures for group
audits are all important elements of control.
(b) Impact of each issue on the group audit

(1) Hybrid
If Hybrid continues to make losses, the directors of Cinnamon may consider there to have been an
impairment in the value of the holding company’s investments. If that is the case, the auditor will
need to confirm that any write-down is adequate by examining:
• the extent of support to Hybrid by Cinnamon/what element of the Rs.100 million guarantees
relates to Hybrid
• Hybrid’s cash flow projections
• the extent of disclosure of guarantees in Cinnamon’s financial statements.
There are clearly material problems for the subsidiary itself but consideration needs to be made as
to whether these issues are also material to the group as a whole and whether the subsidiary
control problems are symptomatic of a wider problem.
If the issues are material to the group, then the impact on the audit report will need to be
considered.
(2) Cayenne
Cayenne’s year-end precedes that of the group by two months and therefore figures used for this
subsidiary will either be estimated or out of date in the group financial statements.
IAS 27 Consolidated and separate financial statements requires the consolidated financial
statements to be prepared as at the same reporting date. Therefore, Cayenne should be made to
prepare additional financial statements as at the group year end – unless it is impracticable to do
so.

If it is impracticable, provided the difference is no more than three months (as is the case here), the
October 20X5 financial statements may be used provided adjustments are made for any significant
transactions or events occurring in November and December. The auditor will need to consider
whether any such adjustments need to be and have been made.
(3) Habenaro
As the announcement was not made until after the year end, this is a non-adjusting subsequent
event that will have a significant impact on the group statement of financial position. The auditor
will need to ensure adequate disclosure in the financial statements.
(4) Guarantees
These loans are an important liability for Cinnamon Group and the auditor will need to ensure that
there is appropriate disclosure in the financial statements.
(c) Relationship with component auditors

The group auditor has overall responsibility for expressing an opinion on the group financial
statements and therefore needs to confirm that he is satisfied with the work undertaken by the
subsidiary auditors (referred to by ISA 600 as ‘component auditors’ where they are not also the
group auditor).
In reviewing the work of the component auditors, the group auditor needs to confirm the
following:
• That all significant risks of material misstatement of the group financial statements have been
addressed in the audit of the components.
• Whether there are any reasons why he cannot rely on the work of the component auditors
(for example, a lack of competence, independence, or local regulation of auditors).
• The materiality of the issues raised in the component financial statements in relation to the
group materiality level (in particular Hybrid, which seems to be of most significant concern).
If a joint audit is to be undertaken, then it is important that the scope and responsibilities are
agreed and documented. This will involve a preliminary meeting to agree approach, timing,
staffing, responsibilities and working papers.
ANSWER # 52 - SATURN HOLDINGS
Planning notes: year ended 31st December 20X5

(a) The Helena audit
• Engagement letter for Helena will need revising now that group financial statements are to be
prepared.
• In respect of the acquisition of Pluto from Trojan.
o Method of finance used to raise the Rs.100 million and any impact thereof.
o Whether special accounts were prepared at 30th November 20X5. If so, these may be of
use for the audit.
o Whether a fair value exercise was carried out.
o Check that Helena is applying the Saturn group accounting policies re goodwill, foreign
exchange etc.
• The timetable for the Helena audit and consolidation needs to be linked into the Saturn
consolidation/audit.
• Consider the level of assistance/information required by the auditors of Interesting
Investments (Helena may be classified as an associate of Interesting Investments).
• The results of Pluto need to be consolidated by Helena from 30th November 20X5 and
disclosed appropriately in the Helena group income statement/statement of comprehensive

income.
• Discussion of the effect on group structure and operations of Interesting Investments taking a
non-controlling interest in Helena.
(b) The Saturn Holdings audit
General
• Agreement of year-end timetable with client.
• Given the various events during the year, discussions need to be held with the board of the
reasons behind each change, as there may be further (going concern?) implications for the
group.
• This year’s audit is likely to be higher risk than last year’s. We need to assess the implications
for audit approach/staffing.
• Ensure usual information re intra-group trading/balances is available in order to eliminate on
consolidation.
• Everything that follows suggests that the work will need to be budgeted very carefully. A fee
increase would seem likely to be necessary.
Helena
• Authorisation of disposal of shares by shareholders of Saturn.
• Correct calculation of any profit/loss on disposal.
• Disclosure of that profit/loss.
• Correct calculation of non-controlling interests.
Trojan
• Contact Swiss office re audit approach/deadlines.
• Confirm Swiss office still following firm’s world-wide audit/ethical standards.
• Require usual proforma accounts for consolidation.
• Correct calculation of any profit/loss on disposal of Pluto.
• Any profit/loss on sale of Pluto will need to be eliminated on consolidation.
• Enquire re use of cash from sale of Pluto by Trojan.
• Consider what involvement we need in the work performed by the Swiss office. As a
minimum:
o prepare a letter of instruction and organise a review of the Swiss office’s report of work
performed
o discuss the business activities of Trojan that are significant to the group
o discuss the risk of material misstatement of Trojan’s financial statements with the Swiss
office, and
o review the Swiss office’s documentation of identified significant risks of misstatement.
Mercury
• Although Mercury has not previously been material, we need to confirm this is still the case.
• In any case we should encourage the board to appoint auditors.
• If a firm other than our associate is appointed, and we decide we need to be involved in the
audit, as a minimum, prepare a letter of instruction and organise a review of the auditor’s
report of work performed.

Venus and Mars
• Need to establish the degree of influence that Trojan can exert over the Venus group. If
significant the group will need to equity account for the Venus group from 1st August.
• The results of Mars will need to be consolidated up until 1st August and may need to be
classified as discontinued, together with any profit/loss on disposal.
• We will need to be satisfied that the work of the (small) Australian firm can be relied upon.
Assuming that it can be, then, as a minimum, perform the work listed under Trojan above. If
further audit procedures are considered necessary, decide whether that work can be carried
out by the Australian firm or should be carried out by ourselves.
• If their work cannot be relied upon consider what procedures we need to perform ourselves
in order to obtain sufficient appropriate evidence and reach an opinion on the group financial
statements.
Working
ANSWER # 53 - FLINT PLC
(a) Instructions to be sent to the subsidiaries’ auditors

• Request confirmation that the component auditor will co-operate with the group audit team
to ensure that sufficient appropriate evidence is likely to be available and that there is no
limitation on scope.
• Timetable to allow component auditors to plan and project manage their work and meet
deadlines.
• Reporting requirements to ensure consistency across all component auditors and that group
auditors get complete information.
• Detail of the work to be performed and the use to be made of the work to ensure that nothing
is overlooked and to allow the component auditor to plan audit procedures.
• Ethical and independence requirements to ensure that the component auditor acts with
objectivity and integrity and that the group auditor can rely on the work of the component
auditor.
• Materiality levels for the component to help with planning of work and ensure items material
to the group are audited.

• Significant risks that are relevant to the component auditor (such as bribery and going
concern) to allow component auditors to focus work on areas assessed as high risk of
misstatement.
• A list of related parties and a request that component auditor notifies the group audit team of
any other related parties to allow collation of related party transactions for disclosure and
written representation purposes.
• Work to be performed on intra-group transactions, unrealized profits and intra-group account
balances to ensure no duplication or omission of transactions.
• Instructions on subsequent events audit work to ensure that the component auditors extend
subsequent events procedures beyond the normal period if there is a delay between
completion of audit work in respect of the subsidiaries and signing of the group auditor's
report.
• A list of key contacts at Flint and at the group audit firm to facilitate communication.
(b) Evaluation
The group auditor is responsible for the auditor’s opinion on the consolidated financial statements.
Consequently, the evaluation of the sufficiency and appropriateness of the audit evidence
obtained by component auditors is mandatory under ISA 600 Special Considerations – Audits of
Group Financial Statements. Any material misstatement in the subsidiaries' financial statements
poses a risk of material misstatement in the group financial statements which, if undetected, could
lead to an inappropriate
opinion. Therefore, there is a need to determine whether the work undertaken by the subsidiaries'
auditors is reliable and whether additional audit procedures are necessary.
The evaluation is undertaken by the use of questionnaires, visits to and discussions with the
component auditors and a review of working papers and audit plans. The summary of the
component auditors' conclusions should be reviewed and an evaluation of uncorrected
misstatements made.
ANSWER # 54 - ROCKWELL & CO
Communication from the component auditor

The qualified opinion due to insufficient evidence may be a significant matter for the Hopper Group
audit. While the possible adjustments relating to the current year may not be material to the Hopper
Group, the inability to obtain sufficient appropriate evidence with regard to a material matter in Seurat
Sweeteners Co’s financial statements may indicate a control deficiency which the auditor was not
aware of at the planning stage and it could indicate potential problems with regard to the integrity of
management, which could also indicate a potential fraud. It could also indicate an unwillingness of
management to provide information, which could create problems for future audits, particularly if
research and development costs increase in future years. If the group auditor suspects that any of these
possibilities are true, they may need to reconsider their risk assessment and whether the audit
procedures performed are still appropriate.
If the detail provided in the communication from the component auditor is insufficient, the group
auditor should first discuss the matter with the component auditor to see whether any further
information can be provided. The group auditor can request further working papers from the
component auditor if this is necessary. However, if Seurat Sweeteners has not been able to provide
sufficient appropriate evidence, it is unlikely that this will be effective.
If the discussions with the component auditor do not provide satisfactory responses to evaluate the
potential impact on the Hopper Group, the group auditor may need to communicate with either the
management of Seurat Sweeteners or the Hopper Group to obtain necessary clarification with regard to
the matter.
Following these procedures, the group auditor needs to determine whether they have sufficient
appropriate evidence to draw reasonable conclusions on the Hopper Group’s financial statements. If
they believe the lack of information presents a risk of material misstatement in the group financial
statements, they can request that further audit procedures be performed, either by the component
auditor or by themselves.
Ultimately the group engagement partner has to evaluate the effect of the inability to obtain sufficient
appropriate evidence on the audit opinion of the Hopper Group. The matter relates to research
expenses totaling $1·2 million, which represents 0·2% of the profit for the year and 0·03% of the total
assets of the Hopper Group. It is therefore not material to the Hopper Group’s financial statements. For
this reason no modification to the audit report of the Hopper Group would be required as this does
not represent a lack of sufficient appropriate evidence with regard to a matter which is material to the
Group financial statements.
Although this may not have an impact on the Hopper Group audit opinion, this may be something the
group auditor wishes to bring to the attention of those charged with governance. This would be
particularly likely if the group auditor believed that this could indicate some form of fraud in Seurat
Sweeteners Co, a serious deficiency in financial reporting controls or if this could create problems for
accepting future audits due to management’s unwillingness to provide access to accounting records.
ANSWER # 55 - ADDER GROUP
(i) The sale and leaseback transactions are material to the Group statement of financial position. The
proceeds received on the sale of the property, equivalent to the fair value of the assets, represents
23·3% of Group assets, and the carrying value of the assets disposed of were $27 million ($35 million
– $8 million), representing 18% of Group assets. In addition, the profit recognised on the disposal
represents 40% of the Group’s profit for the year, so it is highly material to the statement of profit
or loss.
The accounting treatment may not be in accordance with IAS 17 Leases. The property has been
derecognized and a profit on disposal recognized, but this is only appropriate where the leaseback
is an operating lease arrangement, whereby the risk and reward of the asset has been transferred
to the purchaser.
However, in this case it appears that the leaseback may actually be a finance leaseback, which is
essentially a financing arrangement, and should be accounted for following the substance of the
transaction. The leaseback appears to be a finance lease because the Group is bearing the risk and
reward of ownership – it bears the risk of adverse changes in the market price of the property up to
the point of repurchase, and also bears the risk of adverse changes in the market interest rate. It is
also benefitting from the continued use of the property and the profit which it may generate. In
addition, the lease is for a major part of the asset’s remaining useful life.
If the leaseback is a finance lease, the asset should remain recognized in the Group’s financial
statements, and the apparent profit made on disposal should be deferred and amortized over the
lease term.

Therefore the Group’s profit is materially overstated, and the total assets and liabilities are
materially understated. An adjustment should be recommended to management, whereby the asset
would be reinstated, measured at fair value, with a finance lease liability established, and the
apparent profit moved to the statement of financial position and recognized as deferred income.
The following adjustments should be recommended to management:

DR Property, plant and equipment $35 million
CR Obligations under finance lease $35 million
(Being the recognition of finance leased assets and obligations.)
DR Statement of profit or loss $8 million

CR Deferred income $8 million
(Being the removal of profit on disposal from profit, and recognition as deferred income.)
If the adjustment is not made, the Group financial statements will contain a material misstatement,
with implications for the auditor’s opinion, which would be modified due to a material misstatement
following the misapplication of IAS 17 to the sale and leaseback transaction.
The finance charge which has accrued since the inception of the lease should be quantified, its
materiality determined, and the appropriate adjustment communicated to management.
The auditor should also consider the impact of the accounting treatment on depreciation, as this
should now be recalculated based on the higher carrying value of the asset and the shorter useful
life of 20 years. If an adjustment is not made to depreciate the property complex from the date of
the sale and leaseback transaction based on the new, higher depreciation charge, then operating
expenses will be understated.
Tutorial note: Credit will be awarded for calculations which determine the new depreciation charge and its
materiality to Group profit.
Evidence:
- A copy of the lease, signed by the lessor, and a review of its major clauses to confirm that risk and
reward remains with the Group, and that the arrangement is a finance leaseback.
- Review of forecasts and budgets to confirm that economic benefit is expected to be generated
through the continued use of the property complex.
- Physical inspection of the property complex to confirm that it is being used by the Group.
- Confirmation of the fair value of the property complex, possibly using an auditor’s expert, in which
case the expert’s report should be included in the audit working papers.
- Where fair value has been established using an auditor’s or management expert, evaluation of the
expert’s work including confirmation that the fair value is determined according to the applicable
financial reporting framework, and that all assumptions are reasonable.
- Agreement of the $35 million cash proceeds to bank statement and cash book.
- Minutes of a discussion with management regarding the accounting treatment and including an
auditor’s request to amend the financial statements.
- A copy of insurance documents stating that the Group is responsible for insuring the property
complex.
- Recalculation of finance charge and depreciation expense in relation to the leased asset.

(ii) The Group’s interest in Baldrick Co is material, as the company’s assets are equivalent to 12% of total
Group assets, and its loss is equivalent to 25% of the Group’s profit.
It is questionable whether Baldrick Co should have been accounted for as an associate. An associate
arises where there is significant influence over an investee, according to IAS 28 Investments in Associates
and Joint Ventures. Significant influence is typified by an equity shareholding of 20–50%, so the Group’s
shareholding of 52% would seem to indicate that the Group exercises control, rather than significant
influence.
However, it may be that even with a 52% shareholding, the Group cannot exercise control, for example,
if it is prevented from doing so due to agreements between other shareholders, or because it cannot
appoint members to the board of Baldrick Co. This would be unusual though, so audit evidence must be
sought on the nature of the shareholding in Baldrick Co and whether the Group actually exercises
control or significant influence over the company. Baldrick Co not having been integrated into the
Group’s activities is not a valid reason for its non-consolidation as a subsidiary.
If the Group does have a controlling interest, and Baldrick Co remains recognized as an associate, the
Group financial statements will be materially misstated, with implications for the auditor’s opinion,
which would be modified due to the application of an inappropriate accounting treatment.
If Baldrick Co should be treated as a subsidiary rather than an associate, then the company’s loss for the
year should be consolidated from the date of acquisition which was 1 January 2015. Therefore, a loss of
$1·25 million ($5 million x 3/12) should be consolidated into Group profit. The loss which has already
been recognized, assuming that equity accounting has been correctly applied, would be $650,000 ($5
million x 3/12 x 52%), therefore an additional loss of $600,000 needs to be recognized.
In addition, there are presentation issues to consider. Equity accounting requires the investment in the
associate to be recognized on one line in the statement of financial position, and the income from the
associate to be disclosed on one line of the statement of profit or loss. Treating Baldrick Co as a
subsidiary will require a line-by-line consolidation, which will have a significant impact on numerous
balances within the financial statements.
The combination of adjustments in relation to the sale and leaseback transaction and the consolidation
of Baldrick Co as a subsidiary may be considered pervasive to the Group financial statements, and if so,
and the necessary adjustments are not made, then the audit opinion could be adverse.
Evidence:
- Agreement of the cash paid to acquire Baldrick Co to cash book and bank statements.
- Review of board minutes for discussion of the change in Group structure and for authorisation of
the acquisition.
- Review of legal documentation pertaining to the acquisition of Baldrick Co, to confirm the number of
equity shares acquired, and the rights attached to the shareholding, e.g. the ability to appoint
board members.
- Inspection of other supporting documentation relating to the acquisition such as due diligence
reports.
- Notes of discussion with management regarding the exercise of control over Baldrick Co, e.g. the
planned level of participation in its operating and financial decisions.
- Review of forecasts and budgets to assess the plans for integrating Baldrick Co into the Group.
- Ensure that correct time apportionment has been applied in calculating the amount of losses
recognised in the consolidation of Baldrick Co.
- Evaluation and recalculation of amounts recognised in Group equity in respect of Baldrick Co, in

particular the determination of pre- and post-acquisition results.
ANSWER # 56 - JUGNU LIMITED
(a) The following audit procedures should be carried out on opening balances:
(i) Determine whether the prior year’s closing balances have been correctly brought forward
to the current period or, where appropriate have been restated.
(ii) Review accounting policies applied in the previous year and the current year to ensure
consistency and appropriateness of the policies applied.
(iii) If working papers of previous auditors are available, review them to obtain evidence
regarding the opening balances.
(iv) If working papers are not available, carry out appropriate audit procedures regarding the
opening balances.
(v) Evaluate whether the audit procedures performed in the current year provide evidence
relevant to the opening balances.
(vi) Perform additional procedures as are appropriate in the circumstances, if the above
procedures provide audit evidence that the opening balance contain material
misstatement that could materially affect the current period’s financial statements.
(vii) If it is concluded that such misstatement exists in the current period’s financial statements,
the auditor shall communicate the misstatements with the appropriate level of
management and those charged with governance and consider their impact on the audit
report, if any.
(b) (i) Matters to be considered:

• Although IAS-38 allows the recognition of internally generated intangible assets, the auditor
should ensure that all the requirements of IAS-38 would be complied with, while
capitalizing the development expenditures.
• Assess the basis of management’s expectation to ensure that future economic benefits will
flow to the enterprise.
• Rs. 25 million, the proposed intangible asset is not material to the financial statement, but if
it were written off as an expense for the year it would have been material to the income
statement as it would have reduced profit by 33.33%.
▪ Audit Evidence:
• A breakdown of amount of Rs. 25 million.
• An assessment of various elements of the cost to assess whether any part thereof can be
classified as expense (e.g. research).
• Supporting invoices and other documents related to the cost of asset.
• Workings showing determination of the value in use, based on projections of revenue from
new products, to evaluate impairment, if any.

(ii) Matters to be considered:
• The auditors need to discover what management’s future intentions for the assets are.
Whether they want to dispose of or want to continue to use.
• If management intends to dispose of the machine then an impairment review under IAS 36
must be carried out.
• If management intends to continue to use these machines, find out whether JL:
o would be able to find another service provider to operate these machines; or
o has developed internal expertise to operate the machines.
If the answer to each of the above questions is in the negative, an impairment review may
need to be carried out.
• The carrying amount of the machines as of April 30, 2011 is approximately Rs. 143 million.
This represents 6.8% of total assets and is therefore material to the balance sheet.
Audit Evidence:
• Documentation of the discussion with the management and written representation as
regards future use of the machines.
• Evidence supporting the test of impairment e.g. draft sales agreements, cash flow
projections relating to value in use, any contract relating to new uses of machines in the
company.
Working showing computations related to impairment review (if required) as discussed in
preceding paragraphs.
ANSWER # 57 - DAY PHARMA
Auditor should perform audit procedures to further confirm this noncompliance of health/safety
regulation. That is
• Inquiring from the original manufacturer of the product.
• Requesting assistance from the audit firm’s branches or associates in the countries where authorities
have banned the product.
If it is probable that the product is harmful or there is potential noncompliance with health and safety
regulations, the auditors should consider the following actions:
(i) Communicate with those charged with governance/ audit committee/ supervisory board about
the potential noncompliance with the safety regulations. Consider whether such a communication
is a key audit matter requiring disclosure in the audit report; this is because it is indicated that
Vitabe contributes a significant amount to the company’s revenues and is hence likely to be a
material item. Its possible discontinuance may be affecting the financial performance of the
company.
(ii) With the permission of client, seek legal opinion from company’s lawyer.
(iii) Encourage the management of Day Pharma Limited to announce the problem publicly. There will
obviously be reluctance to do this. However, the auditors should try to explain and hopefully
convince the management that this would be the ethically correct way to proceed.
(iv) Consider the impact of the above situation on the financial statements related audit procedures
and on the auditor’s report specially with respect to the following:
• Any hazardous inventory that would need to be written off.
• Provisions that may become necessary for refund of returned products, when the matter
becomes known.
• Disclosures relating to contingent liabilities that may need to be recognised in respect of
damages that may be claimed by the customers.

(v) If the auditor concludes that the noncompliance has a material effect on the financial statements,
which has not been properly reflected in the financial statements, the auditor should express a
qualified or an adverse opinion.
(vi) If the company refuses to disclose the matter itself the auditor should consider whether it needs
to communicate with regulatory and enforcement authorities. While making such a decision, the
auditor should consider the requirements of the code of ethics according to which information
discovered while performing a professional engagement must not be disclosed without proper
and specific authority to do so, or unless there is a legal or professional right or duty to disclose.
(vii) The auditor may need to seek legal advice in such circumstances, giving due consideration to the
auditor’s responsibility to the public interest.
(viii) Obtain clarification on view of parent company.
(ix) The auditor may conclude that withdrawal from the engagement is necessary if the entity does
not take the remedial action that the auditor considers necessary in the circumstances. Factors
that would affect the auditor’s decision in this regard include the following:
• implications on the integrity of the highest authority within the entity which may affect the
reliability of management representations;
• the effects on the auditor, of continuing association with the entity.
If the firm finally decides to resign, it may circularise a ‘statement of circumstances’ which
would describe the reason for the resignation. However, in reaching such a conclusion, the
auditor would ordinarily seek legal advice.
ANSWER # 58 - DREAMS YACHTING AND MARINA
(a) Difference between fraud and error and how the given issues could be categorized
ISA 240 is concerned with the issues of fraud. Fraud relates to intentional acts that may involve
falsification of documents and records, misappropriation of assets or misapplication of
accounting policies. Error relates to unintentional acts that may result in misapplication of
accounting policies, oversights or misinterpretations of fact and clerical errors. Failure to correct
an identified material error results in an unintentional act becoming an intentional one. The audit
procedures for fraud or error may be the same but fraudulent activity may result in the need to
disclose illegal acts to the regulatory authorities.
(1) Double financing of yachts
There may be a significant issue with DYM’s procedures resulting from this. The auditor will
need to ascertain whether this was an unintentional act caused by poor record keeping or
a lack of understanding of the financing arrangements. However, with the amount of
money involved, this could be a major fraudulent activity or a mechanism to disguise the
seriousness of the company’s financial position.
(2) Missing yachts
The missing yachts may be a clear case of deliberate misappropriation of assets and
therefore fraud. However, they could also arise from erroneous accounting and asset
records and due to the poor arrangements for capturing sales.
(3) Reconciliation differences
These may have arisen through error rather than fraud, but failure to act on such
differences could mean that the situation becomes more in the nature of an irregularity.
(4) Overstatement of sales
This could arise from unintentional application of policies or poor records. However, it may
also arise from fraudulent activity.
The reasons behind the absence of the financial director need to be considered. His absence
could indicate guilt (with the stress being caused by the worry of being caught or the pressure he
has been placed under to commit fraud). However, his absence could be unrelated to fraud and
these issues could have arisen in his absence as staff struggle to deal with the accounting system
and controls.
(b) Roles in the prevention and detection of fraud and error

Management is responsible for the prevention and detection of fraud and error through the
implementation and operation of effective control systems and accounting policies.
The auditor has no responsibility for the prevention and detection of fraud and error although
the annual audit may act as a deterrent.
The auditor’s role is to assess the potential for financial misstatement and to establish with
management whether there are any factors such as fraud that may result in such a misstatement.
To do this requires effective planning and control, assessing risks associated with the company
and directing audit attention to the areas of risk. Audit procedures should be designed to obtain
reasonable assurance that material errors have not occurred or that where they have occurred,
they have been corrected or properly disclosed in the financial statements.
(c) Further steps for investigation

(1) Double financing of yachts
Clearly, this could have a material effect on the financial statements, since it involves
double financing of around 30% of yachts. The auditor will need to perform additional
procedures to establish how and why this occurred, and whether it was a one-off
intentional situation. These problems should be factored into the risk assessment process
and consideration given to the reliability of management evidence. The timing of the
problems will be important, in particular, in establishing whether there is a link with the
absence of the finance director on sickness leave for the last five months. The full scale and
impact of the problem needs to be established and whether this problem leads to a
question mark over the company’s future viability.
(2) Missing yachts
The level of assets missing is Rs.50 million, which is likely to be material to the financial
statements. The auditor will need to carry out further audit procedures and in particular,
understand how assets are controlled and whether missing yachts are an isolated
occurrence.
The auditor will need to understand whether these are ‘missing’ because of poor
accounting, poor inventory control or fraudulent activity. It may be that the yachts were
sold but not correctly reflected in the accounts. It will be important to establish the true
facts as far as possible. It will also be important to understand what controls should
normally operate to prevent such occurrence, how these controls have been operating
(particularly in the absence of the financial director) and the length of time since the
problems have occurred.
Yachts are large assets – not ones that would be easy to mislay or miscount.
From a reporting point of view, it may be important to highlight this matter to those
charged with governance as per ISA 260 (Revised). This is because the anomaly arises from
a significant control deficiency. In addition, the auditor may consider adding this as a key
audit matter in the audit report, in accordance with ISA 701 Communicating key audit
matters in the independent auditor’s report.
(3) Reconciliations
Reconciliations have not been performed for four months – so may be linked to the finance
director going on sick leave. The lack of control over reconciliations including the failure to
investigate and address differences that have occurred suggests poor management of risk
in the company.
The auditor needs to:

o establish responsibilities within DYM for undertaking reconciliations ensure that
reconciliations are completed and that the full differences are identified
o review whether the other problems identified with inventories and financing are
linked to these reconciliation problems
o establish whether the lack of reconciliations provides further evidence of fraud
o fully understand the impact on the financial statements.
(4) Overstatement of sales

Again, the auditor needs to conduct additional audit procedures to understand the impact
of this situation. Sales are overstated by Rs.10 million in the current financial statements,
which is likely to be material. The auditor needs to:
o confirm when and how this problem has occurred
o ascertain the reasons for the overstatement
o confirm what prior year investigations were undertaken and whether there were any
earlier indications
o establish what controls exist over sales and to what extent these are in operation.
Overall impact on the financial statements

For all of the items referred to, the auditor will need to consider the overall impact on the
financial statements. The significant nature and size of the problems may impact on the
going concern status of the company and added together, may be an indication of lack of
control, poor risk management or fraudulent activity. It is important that the auditor
discusses the issues with management to keep them informed of his concerns and to
ascertain:
o whether they were aware of the problems
o how they have addressed their concerns
o what other issues may have arisen
o the impact of these issues and the likelihood of other risks materialising
o what reports they have received on the management of risk and the operation of
internal controls
o how the role of the finance director has been managed since his absence on sick leave
o what explanations have been received for the absence of the finance director and
what contact has been maintained in the five months of absence
o whether the absence is linked to fraudulent activity or to stress arising from the
control issues that have subsequently been discovered.

ANSWER # 59 - ORIONTHALE
Tutorial note: the below notes are in the form of an answer plan (rather than model answer).
(a) (i) Overstatement of components
o Physical movements out not reflected in inventory records
o Post year-end purchases of components treated as pre-year end purchases
o Obsolete items if no longer used in improved models.
o Overstatement of finished goods
o Inaccurate counting procedures (i.e. double counting)
o Inclusion of customers’ generators
o Inclusion of items which are hire items (not yet transferred to inventory)
o Pre-year-end sales of generators included in inventory count
o Ex-hire inventory included at amounts which exceed NRV
o Superseded models included at amounts in excess of NRV
o Incorrect costs, i.e. incorrect treatment of inclusion of overheads.
(ii) Audit procedures
Components
o Sample check inventory records to physical inventory
o Review results of client’s continuous counting procedures
o Consider volume of differences
o Check costs to suppliers’ invoices
o Review age of inventory lines/inventory movements report
o Consider number of months’ usage and compare to previous year.
Finished goods
o Attend inventory count to ensure items owned by customers and hire items are excluded
o Test check cost details for components and direct labour and ensure only relevant items
included
o Review basis of allocation of overheads ensuring only production overheads are included
o Ensure inventory is in good condition and not damaged
o Review selling prices after year end in order to ascertain whether NRV is below cost
o Inspect correspondence for evidence of customer dissatisfaction with products
o Inspect order books to ensure demand for products
o Calculate inventory turnover and compare with previous year.
(b) Auditing issues

• Calculation of goodwill correct (per IFRS 3)?
• Has there been an impairment review of goodwill?
• Check the bank statement for consideration
• Consider the fair values of the assets and liabilities of the Indonesian company
• Will Rumblers retain the services of the auditor of the Indonesian company?
• Do the year-ends coincide?
• Audit planning timetable will need to include the Indonesian company
• Language difficulties
• Geographical difficulties
• The need for a consolidation questionnaire

o Do we audit a sufficiently material part of the group in order to continue acting as principal

auditor?
o Obtain satisfactory evidence that the work of the other auditor is sufficient
o Consider the findings of the other auditor
o Competence (i.e. staffing issues).
ANSWER # 60 – GROBBELAR
(i) Security consultancy services

▪ The annual expense is immaterial by size: Rs. 820k x 12 = Rs. 9,840k.
▪ By excluding this expense from the tax return, Hikmet would more likely be over-paying tax
rather than underpaying. This leads to the business risk that the tax bill would be higher than
it should be, although penalties from the tax authorities would be unlikely.
▪ There appears to be a lack of business rational in paying fees for African security through an
offshore account in Macau, particularly when the payments are excluded from the tax return
at a level which generates an annual expense just below materiality (perhaps to try to avoid it
from the auditors?).
▪ This suggests that the payment is potentially some kind of bribe associated with securing the
business of the important customer, and hence could represent money laundering by virtue
of Hikmet benefitting from the proceeds of crime (i.e. a lucrative contract facilitated by
paying a bribe). Bribery is designated as a money laundering offence by the ‘Financial Action
Task Force on Money Laundering’ (FATF).
▪ Grobbelar has a duty to report any suspicion of money laundering to the appropriate
authorities. Rather than sign-off the audit working paper as ‘immaterial’ Umar should have
escalated his concern to the engagement partner who should then have discussed the matter
with Grobbelar’s money laundering reporting officer (MLRO).
▪ The MLRO should consider all the facts and make a judgement as to whether this represents a
suspicion of money laundering which should then be reported to the Financial Monitoring
Unit, State Bank of Pakistan or Securities and Exchanges Commission of Pakistan (as
applicable).
▪ Grobbelar must be careful not to alert (‘tip off’) Hikmet regarding the suspicion. They should
further consider the importation process and restrictions to Africa before taking the matter
further.
▪ Should Grobbelar make a decision to report the suspicion of money laundering to the
authorities this would not be considered a breach of confidentiality per ICAP’s code of ethics
as the duty to report overrides client confidentiality. On the contrary, to not report the
suspicion would be an offence.
▪ Grobbelar should review its internal policies, procedures and training to ensure all staff
understand their responsibilities and the appropriate protocol when a suspicion of money
laundering is encountered.

(ii) Tax investigation
▪ The directors of Shadow are primarily responsible for the prevention and detection of fraud.
The auditors are responsible for identifying material misstatements whether due to fraud or
error. If there has been a tax fraud the balances affected may not be material to the financial
statements.
▪ Fraud involves the intentional concealment of proceeds from crime and often incorporates
the override of controls. This makes it more difficult for the auditors (and directors) to detect
fraud.
▪ Notwithstanding the above, Grobbelar should review the audit files to ensure it performed
adequate procedures to generate sufficient appropriate evidence regarding both fraud and
the tax expense/liability (otherwise it may be guilty of negligence).
▪ Should the investigation uncover tax fraud this may manifest as Shadow being involved in
disguising the proceeds of crime (tax evasion) which would also fall within the scope of
money laundering. This could lead Grobbelar to being held criminally liable under money
laundering legislation if it could be proven that they knew, or should have known, about the
crime. Grobbelar may need to seek legal advice.
▪ This is a relatively new client. Grobbelar should review whether its new client procedures
were performed diligently and in accordance with ethical standards and its own policies and
procedures. There is significant reputational risk when associated with audit clients who are
found to have breached law or regulations or been involved in a fraud.
▪ Grobbelar must consider whether something was overlooked during the new client
acceptance (such as taking references and considering the character of the directors, or
reflecting appropriately on correspondence with the outgoing auditor which may have
indicated suspicious activity or significant disagreements with the directors), and whether it
needs to:
- review its client acceptance policies and procedures;
- undertake disciplinary proceedings against any staff involved;
- implement further training on new client acceptance.
▪ There are self-review and self-interest threats involving the provision of both tax advice and
valuation services to an audit client. Grobbelar should review whether appropriate safeguards
had been implemented such as the use of separate teams and Chinese walls. Grobbelar will
also need to consider whether it remains appropriate to retain either the non-audit services
and/or the audit in light of the outcome of the tax investigation.
▪ Grobbelar should review its quality control procedures over the audit of new clients and
check whether a separate partner review (e.g. an engagement quality control review) was
performed (and adequately documented) on Shadow.
ANSWER # 61 - SEHAT PHARMACEUTICAL LIMITED

(a) (i) Hospitals and clinics:
The decision to send negative confirmation was appropriate as all the conditions for sending negative
confirmation i.e. Large number of small account balances, low risk of material misstatement, low
exception rate as only four customers have disagreed with the balances due and that have been also
reconciled and there was no knowledge of circumstances that would cause recipient to disregard the
confirmation request.
(ii) Retailers:
Results of confirmations depict high risk of material misstatement and high exception rate. However,
since the decision to send negative confirmation was taken on the basis of initial assessment, the
decision under the circumstances seems correct.

(b) Balance agreed: No further audit work is required.
Balance not agreed: In this case:
• The client should be asked to review the replies and reconcile the balances in its records
with the balances confirmed by the customer.
• The reconciliation prepared by the client should be checked.
• The reconciling items depicting errors in the client’s records should be investigated and
corrected.
• The client should be asked to resolve the difference in case the reconciling items depicting
errors on part of the customers.
No reply received: In these cases, alternative procedures should be performed (e.g. subsequent
payments and checking of invoices/ dispatch notes in order to obtain evidence to confirm the
customer’s balances.
(c) From the winding up event it appears that the amount receivable from SDPL is irrecoverable.
Therefore, the auditor needs to ensure that the amount of irrecoverable receivables are written off or is
duly provided for.
The following substantive procedures should also be performed:

• Review any correspondence of the SPL with the liquidator/management of SDPL (if any), relating to
recovery of the amount due.
• Review the calculation of amount of provision/write off and basis thereof.
ANSWER # 62 - ZAFAR TECHNOLOGY LIMITED
(a) ❑ Two significant uncertainties exist for ZTL i.e. recoverability of balance due from SEL and
whether the going concern assumption is appropriate in light of the possible termination of
the contract by SEL.
❑ The Accounts receivable balance is material to the financial statements as it is 12.48% of
profit after tax.
❑ The possible loss of contract from SEL is material to the financial statements as the revenue
from SEL contributes about 25% of total revenue.
❑ It appears that the uncertainty relating amount receivable balance and
termination of contract will not be resolved till the time of signing off the financial
statements and audit report.
❑ If uncertainties are adequately disclosed in the financial statements then an unqualified
opinion can be given, however an emphasis of matter paragraph is to be included in the
auditor’s report to draw user’s attention to the significant uncertainties. In case appropriate
disclosure is not given a qualified opinion or adverse opinion as appropriate.
(b) ❑ If there are material inconsistencies in the other information presented with the financial
statements the auditor should discuss the reasons thereof with the
management and ask them to revise the other information.
❑ In case of disagreement, the auditor shall communicate the matter to those charged with
governance.
❑ Include in the auditor’s report an ‘other matter paragraph’ describing the material
inconsistencies.

(c) ❑ A provision of Rs. 30 million has been made in the financial statements and it represents
37.5% of the profit after tax and is material to the financial
statements.
❑ A constructive obligation to restructure arises only when an entity has a detailed formal
plan for the restructuring identifying at least the principal locations affected.
❑ In this case it is unlikely that a constructive obligation exists in respect of third
factory because the factory which is to be closed is not identified.
❑ The auditor shall determine whether provision of Rs. 30 million pertains to two factories
which are identified or it pertains to three factories (including one which is not identified).
❑ If the provision relates to three factories, auditor will ask the management to adjust the
amount of provision to reflect the provision for two factories
Moreover, the plan for closure of the third factory should be disclosed.
❑ If the management refuses to do so, a qualified or adverse opinion may be issued
depending upon the materiality and pervasiveness.
ANSWER # 63 - PAIDAR TAMEERAT LIMITED
Discrepancies in the estimates provided by the project managers:
(i) The auditor would need to determine whether he can rely on the reports of the
engineer hired by the management.
(ii) In determining the extent of reliance on the work of the engineer, the auditor would:
▪ Evaluate the competence, capabilities and objectivity of the engineer,
▪ obtain an understanding of the procedure followed by the engineer and
▪ evidence for verification of stage of completion and the estimated cost of completion.
(iii) Subsequent receipts/costs/completion status would be reviewed to assist the
reasonableness of the engineer’s estimate.
(iv) The auditor will determine the extent of substantive procedure for verification of estimated cost
of completion if he can place reliance on the reports of the engineers.
(v) If the auditor cannot place reliance on the work performed by the engineer, he will reassess the
initial risk assessment and consider the need of involvement of independent external engineer.

ANSWER # 64 - HBBL
Significant improvements in profits reflects the risk that the revenue and profit in the 2014 financial
statements may be significantly overstated.
The following point are needed to be considered in relation to the given situation:
▪ HBBL’s arrangement with JDS is such that JDS facilitated sales to customers but does not purchase
the inventory itself and HBBL retains title to the product until it is sold to the final customer.
▪ HBBL may have knowingly or erroneously, recognize the Sales Revenue on dispatch of goods to JDS.
▪ Subsequent recovery of 65% up to 31 May 2014, is also not sufficient appropriate audit evidence of
receivable balance from JDS, because as per the agreement JDS is required to make the payments
within 30 days of sale to customers.
▪ It is also indicative of the risk that sales/receivable balance is overstated.
▪ Although, the differences between stock sheets and balances were corrected subsequently, but it is
indicative of a risk that during the year there is a possibility of wrong posting in the system of JDS,
which consequently will result in overstatement/ understatement of sales and stock in trade
In response to the above we would need to carry out the following procedures:
(i) Obtain an understanding of when the sales are recorded in the system.
(ii) Enquire the reasons of 65% of subsequent recovery from JDS, and ask for confirmation from JDS.
(iii) Review global reconciliation of Sales, Receivable and stock at JDS.
(iv) Assess what type of mistakes were made in the stock posting system at JDS and review the
reconciliations prepared before making the corrections.
Implications on the Audit Report:

▪ After performing the above procedures if the auditor finds any error in the recording of sales or
receivables, he should ask the client to make appropriate adjustments, failing which the report may
be modified i.e. qualified or adverse depending upon the materiality of the amounts involved.
▪ If we are unable to obtain sufficient appropriate audit evidence, as regards the recording of sales or
in relation to receivable from JDS, it will be scope limitation and based on the materiality and
pervasiveness of the matter, the auditor may issue a qualified or disclaimer of opinion.
ANSWER # 65 - FIVE STAR
i. Change in Accounting Policy

Steps need to be taken by the auditor:
Review change in accounting policy for biases and evaluate whether the circumstances producing the
bias, if any, represent a risk of material misstatement due to fraud.
▪ Whether the change in accounting policy will result in reliable and more relevant information about
entity’s financial position, its performance and cashflows.
▪ Whether the requirements of IAS 16 in relation to change in accounting policy, has been complied
with.
▪ Evaluate the competence, capabilities and objectivity of the professional valuers;
▪ Obtain an understanding of the work of that valuer; and
▪ Evaluate the appropriateness of that valuer’s work as audit evidence for the relevant assertion
▪ Consider the need for appointment of an auditor’s expert.
▪ Ensure that all the assets in the entire class of plant and machinery has been revalued.
▪ Checking appropriateness of disclosures related to the requirements of Companies Ordinance, 1984
and IAS 16.

ii. Deferred tax asset:
Steps needs to be taken by the auditor:
▪ Whether the recognition criteria for deferred tax asset as specified in IFRS has been met.
▪ Whether the methods estimating the amount of deferred tax are appropriate and have been applied
consistently, and whether changes, if any, in accounting estimates are appropriate in the
circumstances.
▪ Determining whether events occurring up to the date of the auditor’s report provide evidence
regarding the deferred tax asset.
▪ Review the company’s restructuring plan (assumptions) to assess its reasonableness and viability.
▪ Review the future projections provided by the client and their viability vis a vis restructuring plan.
▪ Checking appropriateness of disclosures related to the requirements of IAS 12.
▪ Written representations from the management.
ANSWER # 66 - AKHTAR AUTOS

(a) Audit procedures in case of litigation and claims:
▪ Inquiring the management and, where applicable, others within the entity, including in- house
legal counsel;
▪ Reviewing minutes of meetings of those charged with governance and correspondence
between the entity and its external legal counsel; and
▪ Reviewing legal expense accounts.
▪ Review the legal confirmations to assess whether all liabilities have been appropriately
disclosed.
▪ If the legal advisor confirms the existence of liability or contingent liability which have not
been disclosed in the financial statements then the auditor will ask the management to make
appropriate adjustment/ disclosure in the financial statements.
(b) The tough competition faced by the company, negative equity, dispute with customers and
bankruptcy of major supplier clearly depicts that the company is facing going concern issues.
In order to evaluate the management’s plan for future action in relation to its going concern
assessment, including consideration of mitigating factors, following information/ documents
would be required from management:
▪ Management assessments of entity’s ability to continue as a going concern:
▪ Status of negotiation with the foreign customers.
▪ Reason for offering discounts to suppliers above market rates.
▪ Status of legal proceedings of the allegations levied by the customers.
▪ Availability of alternate suppliers to deal with the unfulfilled orders
▪ Cash flow, profit and other relevant forecast
▪ Latest available interim financial statements
▪ Minutes of shareholders’ meeting and those charged with governance.
(c) If the matter related to previous years modification is still unresolved, the auditor shall modify
the auditor’s opinion on the current period financial statements, and in the basis for modification
paragraph, the auditor shall refer to both the current period’s figures and the corresponding
figures in the description of the matter giving rise to the modification when the effects or possible
effects of the matter on the current period’s figures are material.
If the previous years’ matter is resolved and properly accounted for or disclosed in accordance
with the applicable financial reporting framework, the auditor’s opinion on the current period
need not refer to the previous modification.
If the previous years’ matter is not relevant to the current period figures, it may still be
appropriate for the auditor to qualify the opinion on current period financial statements
because of the effects or possible effects of the unresolved matter on the comparability of the
current and corresponding figures.
(d) The suggestion for improving compliance with the Code of Corporate Governance would be as
follows:
The board of directors is required to be recomposed on the following guidelines:
▪ The executive directors that is the paid directors of the company shall not be more than one
third of the elected director, presently there are four executive directors which is more than
one third of the elected directors.
▪ The board of director is required to include at least one independent director and preferably
one third of the total members of the board should be independent directors.
▪ Presently there are three non-executive director but they are not independent as they are on
the board for the fourth time.
▪ The audit committee is required to be recomposed by inclusion of:
▪ An independent director from the board of directors.
▪ The chairman of the audit committee should preferably be the independent director,
although the audit committee is presently chaired by a non-executive director,
➢ but he is not independent as he is elected for the fourth time on the Board;
➢ further although real uncle does not come under the definition of close relatives,
but it can be perceived as a close personal relationship and proof of independence
would be very difficult.
▪ It is required to be ensured that at least one member of the audit committee has relevant
financial skills/ expertise and experience;
▪ In addition to the audit committee, the Board should form a Human Resource and
Remuneration (HR&R) Committee;
▪ Appointment of a full time Head of Internal Audit. The company can either form an in
house internal audit department by hiring suitably qualified people or can outsourced to
a professional services firm but it should be ensured that they are suitably qualified and
experience people and are conversant with the company’s policies and procedures.
(e) As per the requirements of Code of Corporate Governance, the 2nd quarter accounts are to be
placed for review by audit committee and are to be approved by the board of directors.
▪ If the matter is appropriately disclosed in the Statement of Compliance with the
requirements of Code of Corporate Governance the auditor will highlight this non-
compliance in the review report drawing attention to the note where the matter has been
appropriately disclosed by the management.
▪ If the management has not disclosed this matter in the Statement of Compliance or the
disclosure is not factually accurate, the auditor will need to qualify his report on the
Statement of Compliance with the Code of Corporate Governance.

(f) Apart from suggestions given in part (d), the other suggestions for improvement in control
environment are as follows:
▪ The warehouse should not be under supervision of sales department;
▪ The management of the company should be independent of those charged with governance
and there should be minimum interference of those charged with governance in the
management of the company.
▪ The internal audit department or some other department independent of sales should be
assign the responsibility for ascertaining discount of distributors before any payment / credit
is processed;
▪ Historical trend analysis of sales made to distributor should be done in order to assess if any
unethical practice is being going on in the company.
▪ Appointment of qualified personnel in internal audit department.
ANSWER # 67 - NATIONAL
(a) Procedure for verification of working of impairment review:

• Interview management to evaluate whether or not the assumptions on which the value
measurements are based, are reasonable and consistent with:
– the general economic environment, the economic environment of the specific industry,
existing market information and the entity’s economic circumstances;
– assumptions made in prior periods; and
– the risk associated with cash flows, including the potential variability in the amount and
timing of the cash flows and the related effect on the discount rate.
• Check whether the forecast have been approved at the appropriate level of management.
• Compare prior year forecasts with current year actual result and identify and assess the
variances.
• Check the cash flow projections with the most recent financial budgets/forecasts approved by
management.
• Check the projections covered the maximum period of five years as prescribed by IAS 36. If the
period is greater than five years, understand how the entity has justified it.
• Ensure that projections do not include any cashflows arising from future restructuring.
• Evaluating the competence, capabilities and objectivity of personnel preparing the projections.
• Check the appropriateness of discount rate used by the management
• Test the underlying data to confirm that it is accurate, complete, relevant and provides
objective support for the assumptions used in the valuation analysis.
• Consider involving internal expert to review the working.
• Check subsequent period performance as far as possible.
(b) Procedures to deal with the situation:

▪ Discuss the matter with management and inquire the reason for keeping the projections on lower
side for computing the impairment on patents.
▪ Convince the management that prudence does not allow deliberate understatement of assets
of the company, therefore the management argument that they have kept the projections on
lower side to avoid any overstatement of patent is not correct.
▪ However, as the different projection provided in the directors’ report creates doubt as to
reliability of projections provided earlier, therefore the auditor is required to verify the
correctness of both the projections.
▪ Determine whether revision is required in the financial statements (impairment) or in the

directors’ report.
▪ If impact on the financial statements is material then discuss the matter with the
management to adjust the financial statements.
▪ If the management refuses to amend the financial statements, the auditor shall modify the
opinion in the auditor’s report.
▪ If the impact on financial statements is not material, the matter may be reported in the
management letter.
▪ If revision of directors’ report is necessary and management refuses to make the revision, the
auditor shall communicate this matter to those charged with governance and include in the audit
report an Other Matter paragraph describing the material inconsistency.
ANSWER # 68 - BHIT GAS
(i) The decision given by the court confirms the existence of mark-up due from SEL, therefore the
qualified report issued on account of recognition of mark-up amounting to Rs. 2.7 billion does not
hold good and therefore the auditor needs to amend the report.
In view of the above, the auditor needs to take the following steps in each of the two situations i.e.
situation given in para (i) as well as the situation given in para (ii).
▪ Assess whether Salim Limited is in a position to repay the amount as per court’s decision.
▪ If the auditor and the management agree on the amount of provision to be made, (Whether
25% or as may be agreed) or if the amount of dispute is not material to the financial
statements, the auditor will issue an unqualified opinion on the amended financial statements.
Otherwise, the auditor would issue a qualified opinion after duly changing the amounts in the
audit report.
▪ Carryout the audit procedures (as may be necessary under the circumstances) on the
amendment.
▪ Review the steps taken by management to ensure that anyone in receipt of the previously issued
financial statements together with the auditor’s report thereon is informed of the situation.
▪ If the management does not take the necessary steps to ensure that anyone in receipt of the
previously issued financial statements is informed of the situation, the auditor shall notify
management and where appropriate, those charged with governance, that the auditor will seek
to prevent reliance on the auditor’s report. If despite such notification, management or those
charged with governance do not take necessary steps, the auditor shall take appropriate action to
seek to prevent reliance on the auditor’s report.
When Law and Regulation prohibit management from restricting the amendment of the financial
statements to the effects of subsequent events causing that amendment the auditor will take the
following steps:
▪ Extend the audit procedures on (all) subsequent events to the date of the new auditor’s report.
▪ The new auditor’s report shall not be dated earlier than the date of the approval of the
amended financial statements.
▪ The auditor shall include in the new auditor’s report an emphasis of matter paragraph or other
matter paragraph referring to a note to the financial statements that more extensively
discusses the reason for the amendment of the previously issued financial statements and to
the earlier report provided.

When Law and Regulation does not prohibit management from restricting the amendment of the
financial statements to the effects of subsequent events causing that amendment, the auditor will
take the following steps:
▪ Restrict the audit procedures on subsequent events to the decision given by the court.
▪ Amend the auditor’s report to include an additional date restricted to that amendment that
thereby indicates that the auditor’s procedures on subsequent events are restricted to the
adjustment of an amount of mark-up due from SEL as a result of decision given by the Court; or
▪ Provide a new or amended auditor’s report that includes a statement in an Emphasis of matter
paragraph or Other matter paragraph that conveys that the audit procedures on subsequent
events are restricted solely to the amendment of the financial statements as described in the
relevant note to the financial statements. The emphasis of matter paragraph or other matter
paragraph will also include reference to a note to the financial statements that more
extensively discusses the reason for the amendment of the previously issued financial
statements and to the earlier report provided.
(ii)
• The emphasis of matter paragraph should indicate that auditor’s opinion is not qualified in respect
of the matter referred.
• The audit report should refer to all relevant notes including the note where material
uncertainty has been described. If there is no such note than the opinion should be qualified.
• The phrase “that the company may be unable to continue as a going concern” is to be replaced
with the phrase “which may cast significant doubt on the company’s ability to continue as a
going concern”.
ANSWER # 69 - KARIM LIMITED
(a) Since the confirmation has been received via email and that too, indirectly through the client’s CFO,
the situation involves the following risks:
(i) Confirmation may not have been received from the intended party as email do not contain
the signature nor the letterheads of the intended party.
(ii) Since the confirmation has been received through the client, there is a risk that it may have
been tampered before being forwarded to the auditor.
(iii) The possibility that the integrity of the transmission may have been compromised during
electronic transmission.
In view of the above risks, the auditor may consider the following:
(i) See whether the identity of sender of email and authenticity of the message be validated
using appropriate techniques such as digital signatures etc. If this is not possible, the
auditor may:
— Verify the source and contents of the response by contacting the confirming
party and may request the confirming party to respond in writing directly to
the auditor.
— Carry out other audit procedures such as checking of subsequent receipts or
checking appropriate documents such as invoices, shipping documents etc.
(ii) If the auditor concludes that the response was forged or otherwise tampered with, the
auditor may need to revise the assessment of the risks of material misstatements and
modify planned audit procedures or take other necessary steps.

(b) A refusal by management to allow the auditor to send a confirmation request is a limitation on the
audit evidence to be obtained by the auditor.
In such situation, the auditor shall proceed as under:
(i) Inquire and assess whether the reason provided by the management for not sending
confirmation request to ML is correct i.e. the dispute as mentioned in the question is the only
reason.
(ii) If the management’s refusal to send confirmation request seem appropriate, the auditor may
perform alternative audit procedures, such as examining subsequent cash receipts,
shipping documents etc.
(iii) Since the management refusal is on account of a dispute with the customer, the auditor
should:
▪ Check correspondence etc to the nature of dispute.
▪ Obtain lawyer opinion.
▪ Assess whether provision has been made, as may be appropriate under the
circumstances.
(iv) Evaluate the implications of management’s refusal on the auditor’s assessment of the
relevant risks of material misstatement, including the risk of fraud and on the nature, timing
and extent of other audit procedures.
(v) If the auditor concludes that the management request for not sending confirmation is
reasonable but alternative audit procedures do not provide appropriate audit evidence,
then the management representation can be used as audit evidence.
However in above situation the following factors should be kept in perspective:
— The written representation provided by management is less reliable.
— The existence of any other audit evidence that may support the written
representation.
— If controls are operating effectively then the representation provided by management
may be considered as reliable.
(vi) If the auditor concludes that:
— Management’s refusal to allow the auditor to send a confirmation request is
unreasonable, it may indicate the existence of a fraud risk factor or;
— If the auditor is unable to obtain relevant and reliable audit evidence from alternative
audit procedures, the auditor shall:
▪ communicate the matter to those charged with governance.
▪ consider the impact on the audit and audit opinion.
ANSWER # 70 - XYZ AND COMPANY
(a) (i) New Auditor’s (ABC and Company) responsibility before acceptance of audit:
▪ ABC and Company should consider whether the acceptance of new client would create
any threats to compliance with fundamental principles.
▪ Evaluate significance of threats before accepting the audit engagement . If the threats
are other than clearly insignificant, safeguards should be considered and applied as
necessary, to eliminate them or reduce them to an acceptable level.
▪ Communicate with the retiring auditor to establish the facts and circumstances behind
the proposed change, however, before communicating it shall seek permission of the
client for such communication.
▪ Comply with relevant legal and other regulations in communicating with retiring auditor.

(ii) Retiring Auditor’s responsibility:
Retiring auditor is responsible to respond to any communication by the incoming auditor.
However, before giving any information about the client, he should seek client’s permission.
While communicating with the auditor, the retiring auditor need to meet the legal and ethical
requirements related to such communication and disclosure.
The retiring auditor should promptly transfer to the new auditor all books and papers related
to SL, which may be held after the appointment has been effected and should also advise SL
accordingly.
Incoming Auditor’s Course of action if SL and retiring auditor do not fulfill their
responsibility:
In case ABC and Company is unable to communicate with the retiring auditor due to any
reason, it should try to obtain information about any possible threats by other means such as
inquiries from third parties or background investigation of senior management or those
charged with governance.
If unable to reduce threats through alternative procedures, it may decline the engagement.
(b) The matters that would be considered in the above situation are as follows:
• Whether auditors are in a position to obtain sufficient appropriate audit evidence with
respect to quantities of inventory at the beginning of the year by means of other operating
procedures.
▪ If auditors are unable to obtain sufficient appropriate audit evidence with respect to
quantities of last year through other audit procedures, it will imply that the matter giving
rise to modification is still unresolved, and the auditor shall modify the auditor’s opinion
on the current period’s financial statements.
Impact on the audit report would be as follows:
▪ Auditor shall explain in the audit report that the audit opinion has been modified
because of the effects or possible effects of the unresolved matter on the comparability
of the current period’s figures and the corresponding figures, although the matter is not
relevant to the current period figures.
• Even if the above matters are resolved auditor shall be required to include in the audit report,
an other matter paragraph stating that:
▪ The financial statements of the prior period were audited by the predecessor auditor,
who has issued a qualified opinion due to non-observance of inventory count and date
of prior year’s audit report.
• The qualification related to non-verification of building of last year is not relevant as the
auditor is able to physically verify the building.

ANSWER # 71 - FARLEY LIMITED
(a) Potential bad debt from Spade

(1)
- Amount is not material to Farley
- At it only represents 1.9% of profit for year / 0.3% of total assets
- Represents an adjusting post balance sheet event
- As it provides evidence of conditions at balance sheet date
- As not material no further work required
£350,000 invested in inventory for new contract

£1.5M invested in specialist plant and machinery
- Inventory may need writing down if now obsolete
- Material as represents:
- 27% of profit/4% of total assets
- Plant and machinery may be impaired by cancellation of contract/Need writing down
- Plant cost is 115% of profit for the year/18% of total assets
- So impairment likely to be material
- Required to amend values for both as material adjusting post balance sheet events
- Loss of contract could have going concern implications because of substantial loans
- If clear that company is not a going concern
o note in financial statement disclosing that it is not a going concern/break up basis
- Material uncertainty about going concern
o going concern basis used
o with a note in the financial statements
(2) Claim for breach of patent
- The outcome of the legal action is at least one year away
- Case has not yet come to court
- The matter constitutes an inherent uncertainty
- Provision does not need to be made
- But full disclosure should be given in the accounts
Subsequent events review

- Review correspondence from Farley's solicitor re claim
- Review correspondence from competitor
- Review amended cash flow/P&L forecast to see if debts can be paid as they fall due
- Particularly loan repayments can be made on time
- Ensure bank covenants not breached in forecasts
- Discuss with directors progress with current contract holder
- Discuss alternative uses for plant/inventory with directors
- Review board minutes for discussion of issue
- Obtain management representation on going concern
- Review bank correspondence /progress of meetings with bank
- Review post year end management information
- Assess recoverable amount of plant and machine/inventory

(b) Claim for breach of patent
- If auditor satisfied that directors' disclosures are sufficiently detailed
- No qualification will be required
- But consider an emphasis of matter paragraph drawing attention to the uncertainty
- Audit report will state report not qualified
- If disclosure unclear or inadequate
- Qualify report
- Except for
- Disagreement
- As to extent of disclosure of material fact
ANSWER # 72 - PETRIE LTD

(i) Revaluation of properties
In accordance with IAS 16 Property, plant and equipment, if a policy of revaluation is to be
adopted, it must be applied to all the non-current assets in that class. Therefore Petrie’s
management should have revalued all the properties, not just three of them.
The valuation of nine of the properties after the end of the reporting period represents an
adjusting event in accordance with IAS 10 Events after the reporting period. Hence these should
be adjusted for as well as the three properties valued by the end of the reporting period. The
increase in revaluation of 12 of the 15 properties amounts to $7.1 million, which represents
23.1% of total assets and is therefore very material to the statement of financial position.
If the management does not revalue all the properties for the year ended 31 March 2008 then
the financial statements would be qualified on the basis of a disagreement with management
(except for opinion), as tangible non-current assets would be materially understated in the
accounts.
The management should therefore either revalue all the properties for the year or one of them,
in order to avoid a qualification in the year ended 31 March 2008.
(ii) Warranty
The sales of stainless steel cookware represent $18.2m of revenue for the year which is 43% of
total revenue and therefore are material to the accounts. The warranty however was introduced
three months into the year so would apply to approximately $13.6m which represents 32% of
total revenue.
The conditions for recognising a provision in the financial statements in accordance with IAS 37
Provisions, contingent liabilities and contingent assets are that there is a present obligation as a
result of a past event, it is probable that a transfer of economic benefits will be required to settle
the obligation, and a reliable estimate can be made of the amount of the obligation.
Petrie’s management should recognise a provision in the financial statements for the year ended
31 March 2008 if the conditions are met. However, the disclosure in the accounts is as a
contingent liability – but it is very unlikely that the company cannot make a reliable estimate of
the obligation.

If a provision is not made for the warranty then the audit opinion would be qualified on the basis
of disagreement (except for) in respect of non-compliance with the requirements of IAS 37.
ANSWER # 73 - JOHNSTON AND TITMAN
(i) Inventory should be valued at the lower of cost and net realisable value in accordance with IAS 2
Inventories. The overvaluation of 2.7 million was identified in the year ended 30 September 2007
and should have been written off then. It should not be written off over three years.
Inventory is therefore overvalued by $0.9 million in the year ended 30 September 2008. This
represents 5.6% of Titman’s total assets and 129% of the profit before tax and is therefore clearly
material. In the prior year, inventory would have been overvalued by $1.8 million, so the
reported profit then should actually have been a loss.
The prior period’s audit report was unqualified, implying that the previous auditor either agreed
with the accounting treatment or issued an inappropriate opinion on the financial statements for
the year ended 30 September 2007. A prior period adjustment is required in accordance with IAS
8 Accounting policies, changes in accounting estimates and errors, so the comparative figures for
the preceding period should be restated in the financial statements and notes and an adjustment
made to the opening balances of reserves for the cumulative effect, as well as being disclosed
appropriately.
(ii) A provision for $2.3 million has been made in Titman’s accounts for the redundancies and non-
cancellable lease payments that would result from the restructuring. This represents 14% of the
total assets for the year and is very material.
According to IAS 37 Provisions, contingent liabilities and contingent assets, a provision should
only be recognised if an entity has a present obligation (legal or constructive) as a result of a past
event, it is probable that a transfer of economic benefits will be required to settle the obligation
and a reliable estimate can be made of the amount of the obligation.
In this case, it is likely that there was a recent obligation at the date of the statement of financial
position, given that Titman was acquired sometime in September 2008 and therefore very close
to the end of the reporting period. Furthermore the provision for restructuring costs should only
be recognised if a formal plan had been prepared and a public announcement made of the plan.
If this had not happened, the provision should not have been recognised in the accounts for the
year ended 30 September 2008. The restructuring should, however, be disclosed in the accounts
for the year ended 30 September 2008 as a non-adjusting event in accordance with IAS 10 Event
after the reporting period.

Effect on the audit report of Titman
If the adjustments required in respect of the two issues discussed above are made to the
accounts, then the audit report for Titman should be unqualified. However if the amendments
are not made, the audit report will be qualified on the grounds of a disagreement with
management. This would be an ‘except for’ qualification as the matters are not pervasive to the
accounts.
Effect on the audit report of Johnston

If the adjustments required to the accounts of Titman are made then the audit report of
Johnston will also not be qualified. If the adjustments are not made, they could be made on
consolidation of Titman to avoid a qualification of the accounts of Johnston. However, an
‘except for’ qualification would result on the financial position if these adjustments were not
made upon consolidation, but the results of operations would be unqualified.
ANSWER # 74 - QASMI STEELS
(a) Although QSL’s accumulated losses are only Rs. 17 million i.e. about 5% of the share capital yet the
following circumstances indicate that QSL is facing going concern issues:
▪ QSL has incurred huge loss during the past year which is almost equal to its share capital.
▪ QSL has defaulted on its loan repayments.
▪ The management has certain plans to revive the business however these are subject to major
uncertainties as discussed below:
— The company plans to convert the plant to make it possible to run it on gas. However, it
would require significant costs whereas QSL is in financial crisis.
— It is not certain whether the company’s banker would agree on the restructuring of loan.
— The above conversion would require a year’s time and the company may be required to bear
the fixed costs for that period.
— Due to current energy crisis prevailing in the country it seems doubtful that the company
would be able to secure a gas connection in the first place and whether sufficient gas would
be available to it or not.
— The company is negotiating to lease its plant temporarily to reduce losses during the period
of its planned inactivity. However this plan does not seem very convincing as the prospective
lessee would also be subject to the same circumstances.
The auditor would need to evaluate the company’s detailed plan by carrying out the following
procedures:
(i) Review the cash flow projections provided by QSL and assess their reasonableness
(ii) Discuss with the management about the uncertainties described above and assess whether
the management would be in a position to overcome them.
(iii) Consider subsequent events and discuss the impact thereof, with the management, if
necessary.
(iv) Seek written representation from management regarding its plans for future actions.
(v) After performing the above procedures, if there is a doubt about the appropriateness of
the going concern assumption, auditor will need to carryout additional audit procedures
depending upon the circumstances.
▪ Besides the going concern issues, the discontinuance of operations of company and
reduction in production of steel may result in impairment of plant and machinery, as
the company may not be able to recover the carrying amount of the plant. The auditor
needs to review the value in use of the plant and machinery provided by the client.
(b) Implications on the Audit Report:

(i) If it is concluded that going concern assumption is appropriate and no material uncertainty
exists, the auditor shall express an unmodified opinion.
(ii) If it is concluded that going concern assumptions is appropriate but a material uncertainty
exists which is adequately disclosed in the financial statements, the auditor shall express:
▪ an unqualified opinion
▪ include an emphasis of matter paragraph in the auditor’s report to:
— highlight the existence of material uncertainty relating to the event or condition that
may cast significant doubt on the entity’s ability to continue as a going concern; and
— draw attention to the note in the financial statement which contains the disclosure.
However, If material uncertainty exists and is not adequately disclosed in the financial
statements. The auditor shall express a qualified opinion or adverse opinion as
appropriate.
(iii) If it is concluded that the going concern assumption is not appropriate, in the preparation of
the financial statements the auditor should advise the company to revise the accounts
appropriately. In case of disagreement, the auditor shall express an adverse opinion.
(iv) If the company revises its financial statements, the auditor shall include an emphasis of matter
paragraph referring to the note in the financial statements and explaining that the financial
statements are prepared on estimated realizable settlement values of assets and liabilities
respectively as the company is no longer a going concern for the reason stated in the aforesaid
note.
(v) If management is unwilling to make or extend its Assessment, the auditor will issue a qualified
opinion or a disclaimer of opinion, as appropriate.
ANSWER # 75 - DILAWAR PAINTS
(i) Chemical leakage- Evaluation of the situation: Matters to be considered

▪ Fine of Rs. 500,000 has been correctly expensed out but is immaterial.
▪ The cost of clean-up represents 0.25% of the total assets and 3% of the profit before tax and is
therefore not material. However this expense does not improve the future operating capacity
of the property and hence it should not be capitalized. If management does not agree to
reverse the capitalized amount it will not affect the audit opinion, however, this amount could
be included in the aggregate of uncorrected misstatements.
▪ Rs. 10 million spent on modernizing the storage tanks represents a major overhaul of the asset.
It constitute 10% of profit before tax and is therefore material to the financial statements. The
Company has rightly capitalized the said cost.
▪ The substantial cost of modernization of tanks when included in the present carrying value,
may result in carrying value being in excess of the recoverable amount. In this case auditor
would need to carryout impairment testing of the storage tanks and if said testing concludes
any impairment loss, the auditor would need to check whether such losses have been
recognized appropriately.

How audit evidence would be obtained
▪ The management would be asked as to whether any other fine has been levied by any
regulatory agency, due to this leakage; and the matter would be documented.
▪ Review legal confirmations obtained by you and see whether they contain any information in
this regard.
▪ Physical verification of storage tanks should be carried out.
▪ Major payments should be vouched.
▪ Obtain management representation that the matter is now closed and no further proceeding
are in progress against the company.
(ii) Outsourced storage facility- Evaluation of the situation: Matters to be considered

▪ Inventory at the end of the reporting period (31 March 2013) represents 16.67% of the total
asset value and is therefore a material item in the statement of financial position.
▪ The inability of the auditor to carry out a stock check may result in a limitation of scope.
▪ It can be seen that inventory has increased by 67%, although the revenue has increased by
6.4% only. Moreover, there is a decline in the inventory turnover from 9.79 times in 2012 to
6.25 times in 2013. This situation when viewed in the light of auditor’s inability to carry out a
stock check may indicate the possibility of material misstatement.
How audit evidence would be obtained

▪ The management should be asked to provide written representation regarding the value of
inventory as at 31 March 2013, although it does not provide sufficient evidence regarding its
condition or obsolescence.
▪ Test of control established by the management in respect of quantity, quality and access to the
inventory stored at nearby factory.
▪ Confirmation from the nearby factory needs to be obtained, relating to the quantity of the
stock held by them.
▪ Monthly returns / stock details submitted by neighboring factory should be analysed and
significant movements in inventory should be traced to the material consumption reports and
purchase invoices.
▪ The auditor may refer to the inventory aging analysis to determine the possibility of
obsolescence of stock.
▪ Subsequent transfers of chemicals from the neighboring factory to DPL’s premises should be
reviewed.

ANSWER # 76 - HAALI LIMITED
(a) As per IAS 16, if an item of property, plant and equipment is revalued, the entire class of property,
plant and equipment to which that asset belongs shall be revalued.
It is not appropriate to incorporate the revised value of only three properties out of eight as the
effect of revaluation of entire class of properties has not been incorporated in the financial
statements.
Impact on audit report

(i) The auditor would need to mention that the recording of impairment restricted to only 3
properties instead of entire class of assets is not in accordance with the IAS. Moreover, since
the valuation of the other properties has not been completed it represents scope limitation
and therefore the auditor would be required to give a qualified opinion or a disclaimer,
depending upon the materiality of the issue.
(ii) The auditor will need to report that the value of three properties at the valuation date is
impaired and to report the amount of impairment. Moreover, since the valuation of the other
properties has not been completed it represents scope limitation and therefore the auditor
would be required to give a qualified opinion or a disclaimer, depending upon the materiality
of the issue.
(b) Auditor will ask the management for justification for change in accounting policy from fair value to
cost method.
The auditor shall mention the exception to the consistent application of accounting policy and a
statement that whether they concur with the change in accounting policy or not.
Moreover, the auditor would need to evaluate whether all the accounting treatment/ disclosures
related to the change have been appropriately recorded in accordance with IAS -8.
If the management is unable to provide reasonable justification for change in accounting policy
than the auditor will issue a qualified or adverse opinion, depending upon the materiality and
pervasiveness of the matter.
ANSWER # 77 HELSINKI LIMITED
(i) Evaluation
Irrespective of the amount of the related party balance, Fourth Schedule of the Companies Act
2017 requires to disclose all balances with related parties. Not disclosing the related party
balance would be a non-compliance of the Companies Act 2017 and will be a material
misstatement.
Course of action
Since the non-disclosure would lead to a material misstatement of the financial statements, we
shall discuss the non-disclosure with those charged with governance.
Implications on the audit report

• If the disagreement persists, we shall qualify our audit report;
• Describe in the Basis for Opinion section the nature of the omitted information; and
• Unless prohibited by law or regulation, include the omitted disclosures, provided it is
practicable to do so provided we are able to obtain sufficient appropriate audit evidence
about the omitted information.

(ii) Evaluation
Since it has been agreed that the audit report will be issued on or before 20 December, there is a
possibility that all other information may not be provided if the audit report is to be issued before
20 December.
Course of action
• Determine through discussion, which document(s) comprises the annual report and when
they would be available.
• Communicate with the management regarding:
- our expectations in relation to obtaining the final version of the annual report in a timely
manner prior to the date of auditor’s report; or
- if that is not possible, as soon as practicable and in any case prior to the entity’s issuance of
such information.
• Request management to provide the written representation regarding the following:
- Management has informed the auditor of all the documents that it expect to issue that
may comprise other information.
- With regard to other information that has not been obtained by the auditor prior to the
date of the auditor’s report, that management intends to prepare and issue such other
information and the expected timing of such issuance.
• Read the other information which have been timely received and evaluate that whether it is
consistent with the financial statements and the auditor’s knowledge obtained during the
audit.
• If any inconsistency is identified the auditor shall discuss the matter with the management
and if they refuse to make the adjustment, it would be communicated to those charged with
governance and they will be requested to make the correction.
Implications on the audit report

• It also needs to be communicated to the management that in case the other information is
not provided before the date of audit report then it would be impacted in the following
manner:
- It would be mentioned in the other information section of the auditor’s report, the
information which is expected to be made available to us after that date.
- When we read the pending other information and if we conclude that there is a material
misstatement therein, we are required to communicate to those charged with governance.
• If it is concluded that there is uncorrected material misstatement in other information, then a

statement would be added which describes such misstatement in the other information
section of the audit report.
(iii) Evaluation
The prior year financial statements are audited by another auditor who expressed unmodified
opinion. Further, management of HL has accounted for the rectification of error in the financial
statements of the current year, whereas it should have been made in the previous year. Hence
the current year’s profit is understated by the same amount and corresponding figures/opening
balances also contain a material misstatement.
Course of action
• The auditor should ask the management and those charged with governance to restate the
comparative figures and take the effect of the rectification of error retrospectively.
• Request the management that the predecessor auditor be informed about the prior year
error.

• If the management agrees to make the adjustment retrospectively, an unqualified opinion will
be expressed with an emphasis of matter paragraph giving reasons for restatement of figures
and a reference to the notes to the financial statements.
• If the management does not agree then the auditor’s report will be qualified due to the
misstatement in current year as well as the corresponding figures/opening balances.
• If the prior period financial statements are amended, and the predecessor auditor agrees to
issue a new auditor’s report on the amended financial statements of the prior period, the
auditor shall report only on the current period.
• After correction of prior year error, if the predecessor auditor is unable or unwilling to reissue
the auditor’s report on the prior period financial statements, an Other Matter paragraph of
the auditor’s report may indicate that the predecessor auditor reported on the financial
statements of the prior period before amendment.
(iv) First year of audit

• Since the financial statements of the prior period were audited by a predecessor auditor, in
addition to expressing an opinion on the current period’s financial statements, we will state
in an Other Matter paragraph:
- that the financial statements of the prior period were audited by a predecessor auditor;
- the type of opinion expressed by the predecessor; and
- the date of that report
ANSWER # 78 - DIVERSIFIED
The auditor needs to ascertain whether transactions with the related party have been appropriately
accounted for and disclosed in accordance with the IFRS and Companies Ordinance, 1984.
Management’s assertion that the transactions were conducted on terms equivalent to those prevailing
in an arm’s length transaction may be materially misstated due to practical difficulties that limit the
auditor’s ability to obtain audit evidence that all aspects of the audit evidence are equivalent to those
of the arm’s length transaction.
▪ In order to address the above factors, the auditor shall:
— Inspect the underlying contracts or agreement.
— Determine the business rationale behind the transaction.
— Determine whether the terms of the transactions are consistent with management’s
explanations.
— Obtain audit evidence that the transactions have been appropriately authorized and
approved.
▪ The auditor will evaluate management’s support for the assertion of arm’s length
transaction, which may involve one or more of the following:
— Considering the appropriateness of management’s process for supporting the assertion.
— Verifying the source of the internal or external data supporting the assertion, and
testing the data to determine their accuracy, completeness and relevance.
— Evaluating the reasonableness of any significant assumptions on which the assertion is
based.
▪ In addition to the above, we shall seek representation that management has disclosed all
the facts and documents related to the above transaction.

ANSWER # 79 - DREAMS LIMITED
The detailed steps needed to be performed in the above situation are as follows:
1. Gain an understanding of the controls applied by DL for assessing the reliability of the pricing
service’s valuation.
2. Gain an understanding about pricing service. This includes:
▪ The reputation and experience of the third party and its experience in providing similar type
of valuation.
▪ Auditor’s past experience with the third party (if any).
▪ Objectivity of the pricing service. The objectivity may be impaired if Pricing service Company
has a close relationship with DL or where has a financial or other interest in such valuation.
▪ The processes and controls established by Pricing Services while conducting such type of
valuations.
3. Gain an understanding about Pricing Service’s valuation method. It includes:
▪ Evaluating Pricing Service’s controls and processes, valuation techniques, inputs and
assumptions used by Pricing Services.
▪ Testing the controls at DL to assess the reliability of the information provided by Pricing
Service Company.
▪ Test the controls and processes, valuation techniques, inputs and assumptions used by Pricing
Service Company.
▪ Obtain pricing from other sources and/or carry out own calculations of the valuation and
compare it with valuation provided by Pricing Service.
4. In addition to the above or if the auditor is unable to carry out the above procedures or if the
results thereof do not seem satisfactory, the auditor may consider hiring an expert.
5. Obtain an understanding of information/ input provided by management of DL to pricing services
and verify its reliability and reasonableness.
6. In case the auditor is unable to obtain sufficient and appropriate audit evidence, he should
consider the implications thereof on the audit report.
ANSWER # 80 - ALPHA
(a) While planning the audit of currency swap contracts, the auditor is required to obtain the
understanding of the following in order to provide a basis of the identification and assessment of
the risks of material misstatement for estimates used in the valuation of currency swap as per the
requirement of ISAs:
(i) The requirements of the applicable financial reporting framework relevant to accounting
estimates, including related disclosures.
(ii) Management means / procedures for identification of transactions, events and conditions that may
give rise to new, or the need to revise existing, accounting estimates.
(iii) How management makes the accounting estimates, and an understanding of the data on which
they are based, including:
▪ The method used in making the accounting estimate.
▪ The assumption underlying the accounting estimates.
▪ Relevant controls.
▪ Whether management has used an expert.
▪ Consider the use of auditor’s expert
▪ Whether there has been or ought to have been a change from the prior period in the
methods for making the accounting estimates, and if so, why.
▪ Whether and, if so, how management has assessed the effect of estimation uncertainty.
(b) Audit procedures to be performed for valuation of currency swap contract:

(i) Obtain the details of the foreign currency swap contracts;
(ii) Assess the reasonableness of assumptions used in the foreign currency swap contracts;
(iii)Verify the valuation rates used, if available from authentic websites (e.g. Bloomberg);
(iv) Check subsequent settlement of contracts, if any, for verification of the valuation rates.
(v) In case valuation methodologies have been used in valuation of derivative contracts then
apart from assessing the reasonableness of the assumptions, get the valuation re-performed
for the contract by the auditor.
(vi) Evaluate whether the auditor’s expert has the necessary competence, capabilities and
objectivity for the auditor’s purposes.
Audit procedures to be performed for actuarial liability:

(i) Assess that the management expert should have relevant competence and capable enough of doing
the tasks assigned.
(ii) Evaluate whether the auditor’s expert has the necessary competence, capabilities and
objectivity for the auditor’s purposes.
(iii) Obtain and ensure the completeness and accuracy of the data in respect of staff retirement benefits
provided by the management to the management and auditor’s expert.
(iv) Independently assess the accuracy of the assumptions pertaining to salary increase rate, discount
rate, retirement age, pension indexation, if any on the basis of historical trend and current status of
the things.
(v) Discuss and resolve the differences, if significant, between the report of the expert and report of
auditor’s expert.
(vi) Ensure that proper disclosure is given in the financial statements in respect of defined benefit plan
liability.
ANSWER # 81 - GMP
(i) Kamran Limited:

Measurement of goodwill on acquisition
▪ Agree the purchase consideration to the legal documentation pertaining to the acquisition and review
the documents to ensure that the figures included in the goodwill calculation are complete.
▪ Review due diligence report relevant to the acquisition, for confirmation of acquired assets and
liabilities and their fair values.
▪ Verify and assess the reasonableness of the discount rate used for discounting the purchase
consideration received on 1 October 2017.
▪ Evaluate the methods / assumptions used to determine the fair value of acquired assets, including
the property and liabilities, to confirm compliance with IFRS 3 and IFRS 13.
▪ Review of board minutes for discussions relating to the acquisition and for the relevant minutes of
board approval.
▪ Verify and assess the reasonableness of the fair value of NCI.
Impairment of goodwill:
▪ Discussion with management regarding potential impairment of Group assets and confirmation as
to whether an impairment review has been performed.
▪ A copy of any impairment review performed by management, with scrutiny of the assumptions
used, and re performance of calculations.
▪ Assess the reliability of cash flow forecasts through a review of actual past performance and
comparison to previous forecast
▪ Involve our valuation specialist for evaluating the appropriateness of the fair value of the building,
leasehold land and also for the impairment testing of goodwill.
Intercompany transactions:
▪ Ensure the elimination of intercompany balances.
▪ Ensure that profit included in inventory purchased from HL has been reversed.
▪ Ensure that appropriate adjustments have been made for consistent application of accounting
policies across the group as required by IFRS 3.
(ii) Waris Limited:

▪ We need to assess, why the accounting policy was changed and the impact of the change on
the financial statements. We should also consider whether the change in accounting policy is
free from bias.
▪ Evaluate whether the change in accounting policy has been properly accounted for and
adequately presented and disclosed.
▪ The change of policy will be required to be reported to those charged with governance and
change in policy would also require board approval.
▪ The opinion paragraph of our report will be altered to mention the fact about change in
accounting policy and whether we concur with it or not.
ANSWER # 82 - TOFIND LTD
Procedures in relation to cyber attack

Discuss with the directors / review board minutes for:
- reasons for/extent/nature of data lost
- plans to rectify situation / recover data
Review media for adverse commentary / reputational damage Inspect correspondence with:
- regulators re: fines
- customers re: legal action
- lawyers re: outcome of legal action
Post year-end management accounts and revised cash flow forecasts:
- to ascertain impact on business performance and risk to going concern status Inspect financial
statements to ascertain if provisions/contingent liabilities are adequately provided/disclosed
Inspect after date payments for evidence of damages/fines
ANSWER # 83 - FRAUD
Journals that:
• relate to unusual or seldom used accounts
• are processed by individuals who do not normally make journal entries
• are recorded at the end of the period
• have no explanation or have a vague description
• are in round numbers
• are made outside of office hours
• are made to suspense accounts
• involve contra entries
• involve directors or related parties
• lack commercial rationale
• involve accounts prone to misstatement.
ANSWER # 84 - SNOWBALL LTD
Additional audit procedures

Inspect the contract with Pets to confirm credit terms are 60 days Inspect other contracts to confirm
credit terms are 30 days Check date of contract with Pets
Inspect records of goods dispatched to Pets prior to year end Ascertain if amount was paid after year
end
Direct confirmation of balance with Pets
Reperform trade receivables days’ calculation excluding Pets and ascertain if:
- days are in line with 30-day credit policy for other customers
- days are in line with prior year
ANSWER # 85 - SOPRANO & CO

Audit procedures – impairment of goodwill
The auditor should perform the following procedures:
- The assumptions used in the impairment test should be confirmed as agreeing with the auditor’s
understanding of the business based on the current year’s risk assessment procedures, e.g. assess
the reasonableness of assumptions on cash flow projections.
- Confirm that the impairment review includes the goodwill relating to all business combinations.
- Consider the impact of the auditor’s assessment of going concern on the impairment review, e.g.
the impact on the assumption relating to growth rates which have been used as part of the
impairment calculations.
- Obtain an understanding of the controls over the management’s process of performing the
impairment test including tests of the operating effectiveness of any controls in place, for example,
over the review and approval of assumptions or inputs by appropriate levels of management and,
where appropriate, those charged with governance.
- Confirm whether management has performed the impairment test or has used an expert.
- The methodology applied to the impairment review should be checked by the auditor, with inputs
to calculations, e.g. discount rates, agreed to auditor-obtained information.
- Develop an independent estimate of the impairment loss and compare it to that prepared by
management.
- Confirm that the impairment calculations exclude cash flows relating to tax and finance items.
- Perform sensitivity analysis to consider whether, and if so how, management has considered
alternative assumptions and the impact of any alternative assumptions on the impairment
calculations.
- Check the arithmetic accuracy of the calculations used in the impairment calculations.
Tutorial note: Credit will be awarded for other relevant audit procedures recommended.
ANSWER # 86 - VENTNOR ESTATES LTD
(a) Purpose of sustentative analytical Procedures

Substantive analytical procedures assist the external auditor in forming an overall conclusion on the
financial statements. The procedures are used to obtain relevant and reliable audit evidence by
identifying expected relationships or detecting material misstatements and can be used as a ‘proof in
total’. The procedures assist audit efficiency as they can reduce the need for tests of details, reduce
sample sizes and identify areas where further work is required.
(b)
(i) Expected rental income £’000
Rental income: based on prior year rental income and 2% increase 16,001
(£15,687 x 1.02)
Tenant in administration: lost rental income (300)
(£100,000 x 3 quarters)
Vacant property: six months lost rental income on vacant property (150)
(£75,000 x 2 quarters)
Sold property: lost rental income (800)
(£400 x 2 quarters)
Total expected rental income 14,751

(ii) Evidence to test reliability of data used
• Agree prior year rental income to prior year working papers/audited financial statements
• Agree rent increase to board minutes/correspondence/invoices
• Tenant in administration: Agree details to correspondence with the administrator
• Vacated property: Correspondence confirming dates of vacation
• Sale of property: Disposal/completion statement
• Agree current year rental income to the nominal ledger
• Agree amounts due to rental agreements
• Agree amounts received to bank statements
(iii) Enquiries based on the result of analytical procedures £’000
Rental income recorded by Ventnor Estates 15,151

Expected rental income based on analytical procedures 14,751
Difference 400
The difference represents 2.64% of recorded rental income and is not acceptable as it exceeds the
materiality threshold (ie greater than 1%). Rental income therefore appears to be overstated.
Enquire of management as to what factors have affected rental income this year. For example;
• other sources of income or new properties that the auditor was not aware of
• change in revenue recognition leading to early rental income recognition or cut-off issues.
The auditor should request and review post year-end management accounts to see if rental income is
lower than expected. A breakdown of rental income by property and month may help to identify why
rental income is higher than expected.

(c)
Asset verification
Assets may be overvalued because: • Annual or more frequent reconciliations
o assets recorded in the register may not exist or to be performed by a named person who
have been stolen
is independent of the custodian of the
o assets may be impaired or no longer in use.
assets
Assets may be undervalued because:
• Physical assets should be checked to the
o acquisitions may not be recorded
o assets may still in use but fully written down.
register to ensure completeness of
Assets may not be available when required for use records
resulting in business disruption. • Entries in the register should be checked
to the physical asset to ensure existence
Additionally, incorrect capital allowances may be Inspections should include consideration
claimed and depreciation charges/useful life may be of condition and appropriateness of useful
inappropriate. life of the assets
• Differences to be reported to a
Compliance with covenants may be affected by responsible official who should investigate
misstated assets/profits. and resolve the differences
• Communication of policy to staff
• Monitoring to ensure that procedures are
followed.
• Disciplinary action if procedures are not
followed
Content of management accounting information
There may be cash flow issues and the business may • The agenda of directors’ meetings should
be unable to pay its debts as they fall due. include a review of cash flow forecasts
and compliance with bank covenants
The business could breach loan covenants resulting
in the withdrawal of loans. • Information presented at directors’
meetings should include cash flow
Extra costs may be incurred as a result of penalties forecasts for at least the next 12 months
imposed by the bank. (or the period of the bank loans), key
assumptions used in their preparation, a
Ultimately the going concern status could be at risk. sensitivity analysis and a commentary on
The directors may be unable to take corrective compliance/non-compliance with
action or may make poor decisions because of the covenants.
lack of information.
The business may be trading illegally and the

directors may be failing in their responsibility for
maintaining solvency of the business.

ANSWER # 87 - BUDGIE LTD
• Implications for the auditor’s report

o Misstatement
o £5.8m impairment Which is 12.4% of PBT Material
o Audit report/opinion should be modified
• Not pervasive
- 0.7% of gross assets
- not a substantial proportion / isolated to individual item in FS
Qualified opinion/’except for’

Explanation included in ‘basis for qualified opinion’ section
ANSWER # 88 – BROWN LTD
(a):
Brown
The receipt of a letter from the administrator of Duffel provides evidence of conditions existing at the
year end and is therefore an adjusting subsequent event. The amount due from Duffel should be
written off.
The amount is 19.7% of profit before tax and 2.5% of total assets and is therefore material.
A modified audit report/opinion should be issued due to material misstatement. The matter is not
pervasive as it only affects specific items in the financial statements and therefore a qualified (‘except
for’) opinion should be issued. The audit report should include an explanation of the issue in the basis
for modified/qualified opinion paragraph.
Bear
The Chairman’s Statement is not part of the financial statements and the auditor is not required to
express an opinion on the Chairman’s Statement. However, the information relating to fair trade status
in the Chairman’s Statement is misleading and represents a material misstatement of fact. Whilst this
does not undermine information contained in the financial statements the auditor is required to take
further action under ISA 720A The Auditor’s Responsibility Relating to Other Information in Documents
Containing Audited Financial Statements.
The audit report should be modified to include a description of the issue in an Other Matter paragraph.
The audit opinion on the financial statements is not modified.
Windsor
ISA 710 Comparative Information requires the auditor to state, in an Other Matter paragraph, that
comparative financial statements are unaudited.
The audit opinion on the financial statements is not modified.
Peru
The assumptions over revenue do not provide a reasonable basis for the preparation of the prospective
financial information. An adverse opinion should be issued in relation to the reasonableness of the basis
for the assumptions. The report should describe the matters leading to this conclusion.
As the prospective financial information is properly prepared on the basis of the assumptions, the firm
should express an unmodified opinion that the forecast is properly prepared.
(b):
The report should state that “Actual results are likely to be different from the forecast since anticipated
events frequently do not occur as expected and the variation may be material.”
Reasons for inclusion

The caveat is included to meet the requirements of ISAE 3400 The Examination of Prospective Financial
Information. It warns users that prospective financial information may not be reliable because:
- assumptions made may not come to fruition
- unforeseen events may occur after completion of the prospective financial information / after the
report is issued
The caveat aims to prevent over reliance on the firm’s conclusion and seeks to narrow any
expectations gap. It may protect the firm from legal action in the event that users of the prospective
financial information incur losses as a result of relying on the information.
(c):
Firms can reduce their exposure to claims from unforeseen third parties by including the following in
their audit and assurance reports:
- specific addressee(s) / intended users of the report
- a clear statement of management’s and the assurance provider’s responsibilities
- reference to the intended purpose(s) of the report
- in the case of external audits, a Bannerman paragraph which explicitly states the firm does not
accept responsibility to anyone other than the company/members
Where possible the firm should seek to restrict the distribution of its report.
The engagement letter should state that the client must seek the firm’s written consent before
disclosing
the firm’s report to a third party. The firm should then refuse any requests to disclose to a third party
where the risk of inappropriate reliance is considered too high.
ANSWER # 89 - KRISTOFF LTD
Kristoff
The audit opinion should be modified. Related party transactions are material by nature and the failure
to disclose such transactions results in a material misstatement. The misstatement is not pervasive as it
is isolated to one aspect of the financial statements therefore a qualified/except for opinion should be
issued. A basis for qualified opinion paragraph should include the reasons and amounts relating to the
qualification.
Reindeer
An unmodified opinion should be issued. The claim is 4.9% of total assets and 122% of profit before tax
and represents a significant uncertainty. The auditor agrees with management’s treatment and there is
no limitation on scope. As a successful claim would turn Reindeer’s profit into a loss the existence of the
claim is fundamental to the users' understanding of the financial statements. Therefore, the audit
report should be modified using an emphasis of matter paragraph which should draw the users’
attention to the relevant disclosure note. This is included immediately after the opinion paragraph and
should indicate that the auditor’s opinion is not modified in respect of this matter.
Pabbie
The audit opinion should be modified. The firm is unable to obtain sufficient appropriate audit evidence
over Queen’s financial statements. Queen affects a large number of areas of Pabbie’s group financial
statements and therefore appears to be pervasive to the group financial statements. A disclaimer of
opinion should be issued stating that the firm does not express an audit opinion. A basis for disclaimer
of opinion paragraph should include the reasons for the disclaimer of opinion. The firm should also
report by exception under the Companies Act 2006 that it has not received all information and
explanations required for the audit.

ANSWER # 90 - REDTAIL LTD
(a):
Redtail is currently renegotiating its contract with Hawk and is reliant on Hawk for some components.
Redtail may fail to renegotiate contract terms with Hawk which means it will be unable to continue with
the assembly of turbines. It seems unlikely that Hawk will agree to further discounts as it is in a strong
bargaining position.
Redtail is currently purchasing components from Hawk at full list price leading to an erosion of its gross
profit margin from 23% to 18%. If this continues it may lead to an inability to generate cash from
operations.
Redtail has fixed-price contracts with its customers and an adverse movement in sterling has made
components more expensive. As Redtail invoices its customers in sterling, increases in import prices are
not offset by changes in export prices. Contracts are likely to become unprofitable and any continued
falls in sterling will exacerbate this issue.
Customer contracts are negotiated years in advance. It is unlikely that Redtail will be able to renegotiate
non-profitable contracts without suffering significant penalties.
There have been significant delays on the Tiberius contract. This contract may be terminated and any
work in progress may have a value below cost. Contract termination will impact adversely on Redtail's
reputation and may result in the loss of future business.
Tiberius may invoke penalty clauses. There is likely to be a cash outflow to settle the penalty and to
meet legal fees and expenses.
Stock outs have occurred for some components. This may result in delays on other contracts.
Redtail is likely to exceed its overdraft limit by November 2017 and the bank has requested to review
the audited financial statements before approving an extension to the facility. An overdraft is an
expensive form of finance and can be withdrawn at any time.
The above factors have an adverse impact on Redtail’s profitability and cash flows increasing the
likelihood that the company will be unable to pay its debts as they fall due.
(b):
(i) make appropriate disclosures
SLP should issue an unmodified audit opinion. There is no misstatement as appropriate disclosures
have been made and no limitation on scope as sufficient evidence is available.
The uncertainty is fundamental to the users’ understanding of the financial statements and
therefore SLP should issue a modified audit report with a ‘Material uncertainty related to going
concern’ paragraph. This should be positioned after the basis for opinion section. It will draw users’
attention to the matter disclosed in the financial statements and state that conditions indicate that
a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a
going concern. it should also state that the opinion is not modified in respect of this matter.
(ii) do not make any disclosures

There is a misstatement due to the lack of appropriate disclosure. SLP should issue a modified audit
report with a modified opinion.
If the matter is not considered to be pervasive a qualified opinion should be issued. If the matter is
considered pervasive an adverse opinion should be issued.
A paragraph describing the matter giving rise to the modification should be included and headed
“basis for qualified/adverse opinion”.

ANSWER # 91 - THURMAN CO
(a) Assets held for sale

(i) Audit evidence obtained
The evidence does not appear to be sufficient to draw a conclusion on the appropriateness of
classifying the property and any other related assets and liabilities as held for sale. A discussion with
management regarding the accounting treatment is relevant, as the audit team will need to understand
management’s rationale. However, management’s explanation should not be accepted at face value
and should be corroborated through further audit procedures. It is not sufficient to simply put
management’s justification for the accounting treatment on the audit file and conclude that it is
correct. For example, the factory can only be classified as held for sale if it is available for immediate
sale in its current condition, which may not be the case.
In terms of the manual journal, checking that it is arithmetically correct, while relevant, is not sufficient
evidence. Further evidence should be obtained in order to conclude that the basis of the calculation is
in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations and there
should be consideration as to whether other requirements of the standard other than those related to
the reclassification and measurement of the asset have been complied with. For example, the results
specific to the factory may need to be disclosed as a discontinued operation in the statement of profit
or loss and the statement of cash flows. No audit evidence appears to have been obtained in respect of
these issues.

- Review board minutes to confirm that the sale of the factory has been approved and to agree
the date of the approval to the board minutes and relevant staff announcements.
- Obtain correspondence with estate agents to confirm that the factory is being actively
marketed.
- Obtain confirmation, for example, by a review of production schedules, inventory movement
records and payroll records, that production at the factory has stopped and thus it is available
for immediate sale.
- Use an auditor’s expert to confirm the fair value of the property and agree that this figure has
been used in the impairment calculation.
- Using management accounts, determine whether the factory is a separate major line of business
in which case its results should be disclosed as a discontinued operation.
(iii) Report to those charged with governance

ISA 265 Communicating Deficiencies in Internal Controls to Those Charged with Governance and
Management requires the auditor to communicate significant deficiencies in internal control to those
charged with governance and management. In deciding whether a control deficiency is significant, one
of the matters which should be considered is the importance of the control to the financial reporting
process. Controls over the period-end financial reporting process such as controls over non-recurring
journal entries can be important as they often deal with one-off material matters which are being
accounted for outside the normal accounting system.
Therefore the journal posted by the finance director should be subject to some form of internal control,
for example, approval by the board or the audit committee. The report to those charged with
governance should recommend that controls are established over period-end journals posted to
ensure their accuracy and validity.
In addition, the finance director should not be asking the audit team to check his figures; this could be
perceived as a self-review threat to independence. This should potentially be flagged to the audit
committee.
The fact that there is, according to the finance director, no one else at the company with relevant
knowledge is concerning. The audit committee should be made aware of this and appropriate steps
taken to ensure that sufficiently knowledgeable personnel are hired or appropriate training is
provided to existing staff.
(b) Capital expenditure

(i) Audit work performed
The audit work has revealed that internal controls have not been operating and this should have led to
more extensive testing of capital expenditure, rather than the audit programme being completed as
planned. Generally, the audit team should extend audit testing on capital expenditure, for example, by
extending sample testing and reducing the level of materiality applied in audit tests.
The audit team should also investigate why the controls are not operating, considering whether they
are being deliberately ignored or overridden, whether time pressure or lack of resources is making the
controls difficult to operate, or if there is a suspicion of collusion and possible fraud.
The procedures on the purchase of the vehicles do not appear to cover all relevant assertions, for
example, there is nothing to confirm that Thurman Co has correctly depreciated the vehicles or that
they are actually owned and being used by the company, or even that they exist.

- Obtain the insurance documents to confirm that Thurman Co is paying the relevant insurance for
the vehicles.
- Physically verify the vehicles and confirm that they are being used by employees on company
business.
- Obtain the log book/vehicle registration document and other relevant ownership documents
such as those issued by the vehicle licensing body, to confirm the right of Thurman Co to
recognise the vehicles.
- Trace the vehicles to the company’s non-current asset register.
- Recalculate the depreciation which should have been charged on the vehicles and agree to the
statement of profit or loss for the year.

The auditor should report to those charged with governance that there appears to be a deficiency in
internal controls. While the audit team’s findings do not indicate that a fraud is taking place, the lack of
segregation of duties and the failure to obtain appropriate authorization makes it easy for assets to be
misappropriated and creates a significant fraud risk.
The audit firm should explain the implications of the control deficiencies to management and
recommend improvements. For example, authorization should be a pre-requisite for any order over a
certain monetary amount. Thurman Co should also be encouraged to improve the control environment,
for example, by training staff on the importance of controls and setting an appropriate tone at the top
so that there is no tolerance of controls being ignored or deliberately circumvented.

(c) Payroll
(i) Audit work
The audit work in respect of the payroll needs to be much more thorough; simply agreeing the amounts
to the reports issued by Jackson Co provides no evidence on the completeness, accuracy or validity of
the payroll figures recognised in the financial statements. The audit team seems to have relied on
Jackson Co’s year-end reports as being accurate and the requirements of ISA 402 Audit Considerations
Relating to an Entity Using a Service Organisation do not appear to have been followed.
The audit team needs to obtain assurance on the controls which Jackson Co has implemented in order
to assess the risk of material misstatement in the payroll figures and to respond to the risk with
appropriate audit procedures. The controls which Thurman Co uses to verify the information received
from Jackson Co also need to be understood. With the permission of Thurman Co, the audit team
should contact Jackson Co with the objective of obtaining more information which can be used to
assess how the payroll has been processed, and the controls which are in place. The controls in place at
Thurman Co should be documented and tested.
It is recommended that further substantive procedures should be carried out to provide a wider range
of evidence on the payroll expense recognized in the financial statements.
In relation to the casual employees, the fact that the amount involved is immaterial means that the
audit team does not need to perform any further detailed audit procedures as there is no risk of
material misstatement. However, as there is a risk over the completeness of these costs, the controls in
place to ensure this process is effectively managed should be discussed with management and
documented.

- Review the service agreement between Thurman Co and Jackson Co to understand the exact
work which is conducted by Jackson Co as a service organisation.
- Read all reports made by Jackson Co during the year to identify any risks of misstatement in the
payroll figure.
- Discuss and document relevant controls in place at Thurman Co over the information received
from Jackson Co and the management of casual employees, and perform tests of controls on a
sample basis.
- The amount of unpaid taxes in respect of the casual workers should be quantified by
recalculations of the amounts due.
- Read any user manuals or systems overviews to assess the efficacy of controls in place over the
processing of payroll.
- If necessary, obtain a type 1 or type 2 report from Jackson Co to obtain further assurance on the
controls which the service organisation has in place.
- Perform a substantive analytical review on payroll, preparing an auditor’s expectation of the
payroll figures and comparing it to that recognised in the financial statements and discussing any
variance with management.
- Perform test of detail by selecting a sample from the payroll records and agreeing the amounts
to payslips and HR records.

The fact that casual employees are being paid from petty cash without being put onto the company’s
payroll indicates that Thurman Co may not be complying with relevant regulations, for example, that
appropriate payroll taxes are not being paid. Despite the amounts involved being immaterial, the
potential non-compliance should be reported to those charged with governance, along with a
recommendation that all employees, whether casual or not, should be processed through the
company’s payroll system. There may be implications for the financial statements if fines or penalties
are imposed by the tax authorities in respect of the non-compliance.

ANSWER # 92 - BOSTON CO
(a) Matters to discuss at meeting

During the completion stage of the audit, the effect of uncorrected misstatements must be evaluated by
the auditor, as required by ISA 450 Evaluation of Misstatements Identified during the Audit. This requires
that the auditor obtains an understanding of management’s reasons for not making recommended
adjustments to the financial statements and that they take this into account when evaluating whether
the financial statements as a whole are free from material misstatement.
In order to maintain accurate accounting records, management should be encouraged to record all
misstatements to ensure that the risk of material misstatements in future periods is reduced due to the
cumulative effect of immaterial uncorrected misstatements.
ISA 450 also requires that the auditor communicates with those charged with governance about
uncorrected misstatements and the effect that they, individually or in aggregate, may have on the
opinion in the auditor’s report. Each of the matters included in the summary of uncorrected
misstatements will be discussed below and the impact on the audit report considered individually and
in aggregate.
(i) Impairment
When performing an impairment test, in accordance with IAS 36 Impairment of Assets, the carrying
value of the asset (or cash generating unit) in question is compared to the recoverable amount of the
asset. If the recoverable amount is lower than the carrying value an impairment loss should be
recognized, reducing the asset down from its carrying value to the recoverable amount.
The recoverable amount is calculated as the higher of the fair value less costs to sell and value in
use. In relation to the cash generating unit, Boston Co estimated that the greater of these two
figures was the value in use at $3·5 million. This was compared to the carrying value of $3·6
million and the asset has been impaired by $100,000 accordingly.
The findings of audit procedures carried out suggest that an inappropriate estimate was used in the
calculation of value in use. Boston Co applied the company’s annual growth rates when estimating the
cash flows attributable to the cash generating unit. A more relevant estimate for the growth rates,
specific to the cash generating unit, was available and should have been used.
This would have generated a value in use of $3·1 million which is still higher than fair value less cost to
sell of $3 million, and should be used as the recoverable amount. As management already impaired the
asset to $3·5 million, a further impairment of $400,000 is required to value it appropriately at $3·1
million.
At the meeting management should be asked why they used the company’s forecast growth rates,
rather than the factory’s growth rates and whether any matters have arisen since the audit to suggest
that the growth rates used by the audit team are now inappropriate.
The adjustment represents 6·25% of profit and 0·4% of total assets. While not material to the statement
of financial position, it is material to profit. If management does not adjust for this or provide
justifications as to why their valuation is more appropriate, then this will lead to a material
misstatement of the financial statements.

(ii) Borrowing costs
Interest charges are borrowing costs. The borrowing costs relating to the construction of qualifying
assets, such as property and plant, should be capitalized during the construction period, in accordance
with IAS 23 Borrowing Costs.
As the manufacturing plant is not due for completion until November 2016, it is still a qualifying asset
and the interest should have been capitalized. Boston Co has incorrectly expensed the interest as part
of the finance charges for the year.
The correcting adjustment is therefore to reduce finance charges and to add the interest to the cost of
the asset on the statement of financial position.
The charges of $75,000 represent 1·2% of profit and 0·07% of assets so are not material to either profit
or the statement of financial position.
(iii) Cleveland Co
At the year-end Boston Co would have recognized a net receivable of $95,000 as being due from their
customer Cleveland Co. Although $30,000 has been received after the year end, the request to have the
company liquidated indicates that any further payment is unlikely to be received. In accordance with
IAS 10 Events After the Reporting Period, this is an adjusting event indicating that management’s
assessment of the recoverability of the balance is inaccurate and that the remainder of the
outstanding balance should be written off as an irrecoverable debt.
As Boston Co has previously provided for $5,000 management should provide for the remaining
$65,000 in the financial statements for the year ended 31 December 2015. This will reduce trade
receivables in the statement of financial position and profit before tax by $65,000.
At the meeting enquiries should be made as to whether any further correspondence has been received
from either the management of Cleveland Co or the liquidators offering any form of reimbursement to
Boston Co. If not, then the proposed adjustment should be encouraged.
The adjustment represents 1·0% of profit and 0·06% of total assets so is not material individually to
either profit or the statement of financial position.
(iv) Investment in Nebraska

The investment in Nebraska has been designated as fair value through profit or loss. As such, the value
at the year-end must be adjusted to reflect the fair value of the investment and any gain or loss
recognized in the statement of profit or loss.
The fair value of the investment at the year end is $643,500 (150,000 shares x $4·29). This represents an
increase in the fair value of $43,500, which should be taken to the statement of profit or loss as a gain.
The carrying value of the investment should also be increased by this amount.
$43,500 represents 0·7% of profit and 0·04% of total assets. It is therefore not material individually to
either profit or the statement of financial position.

(b) Impact on the audit opinion and auditor’s report
When considering their opinion, the auditor must conclude whether the financial statements as a whole
are free from material misstatement. In order to do this, they must consider whether any remaining
uncorrected misstatements are material, either on an individual basis or in aggregate.
The aggregate effect of the misstatements would be to overstate Boston Co’s profit by $346,500
($465,000 – $118,500). Total assets on the statement of financial position would also be overstated
by this amount.
This represents 5·4% of profit and 0·3% of total assets. The overstatement would therefore be material
to the statement of profit or loss on an aggregate basis but not to the statement of financial position.
However, as the necessary adjustment regarding the impairment of the factory building is individually
material, management should be informed that if the valuation calculated by the audit team is more
appropriate then failure to incorporate this adjustment will result in the auditor concluding that the
financial statements are materially misstated. Based upon this, a modification to the audit opinion in
accordance with ISA 705 Modifications to the Opinion in the Independent Auditor’s Report will be
required.
The type of modification depends on the significance of the material misstatement. In this case, the
misstatement regarding the impairment is material to the financial statements, but is unlikely to be
considered pervasive. This is supported by the fact that the adjustment is not material to the
statement of financial position and it is therefore unlikely that the auditor will conclude that the
financial statements as a whole are misleading.
Therefore a qualified opinion should be expressed, with the auditor stating in the opinion that the
financial statements show a true and fair view ‘except for’ the effects of the matters described in the
basis for qualified opinion paragraph.
A basis for qualified opinion paragraph should be placed immediately before the opinion paragraph.
This should include a description of the matter giving rise to the qualification, including quantification of
the financial effects of the misstatement.
The remaining uncorrected misstatements are, individually and in aggregate, immaterial to the financial
statements and it will be at the discretion of management to amend and will have no impact on the
audit report. Although as previously mentioned because of the impact on future periods, management
should be encouraged to amend for all misstatements. If management intends to leave these as
uncorrected misstatements, written confirmation of their immaterial nature should be obtained via a
written representation.
ANSWER # 93 - MALEVICH & CO
(i) Going concern matters

Revenue and profitability
The extract financial statements show that revenue has fallen by 38·2%. Based on the information
provided, operating profit was $1,150,000 in 2014 but is only $340,000 in 2015. Operating margins
have fallen from 29·1% to 13·9% during the year and the fall in revenue and margin has caused the
company to become loss-making this year.

These changes are highly significant and most likely due to the economic recession which will impact
particularly on the sale of luxury, non-essential products such as those sold by Kandinsky Co. The loss-
making position does not in itself mean that the company is not a going concern, however, the trend is
extremely worrying and if the company does not return to profit in the 2016 financial year, then this
would be a major concern. Few companies can sustain many consecutive loss-making periods.
Bank loan
The bank loan is significant, amounting to 33·7% of total assets this year end, and it has increased by
$500,000 during the year. The company appears to be supporting operations using long-term finance,
which may be strategically unsound. The loan is secured on the company’s properties, so if the
company defaults on the payment due in June 2016, the bank has the right to seize the assets in order
to recoup their funds. If this were to happen, Kandinsky Co would be left without operational facilities
and it is difficult to see how the company could survive. There is also a risk that there is insufficient
cash to meet interest payments due on the loan.
Trade payables
The trade payables balance has increased by 38·5%, probably due in part to the change in terms of
trade with its major supplier of raw materials. An extension to the payable payment period indicates
that the company is struggling to manage its operating cycle, with the cash being generated from sales
being insufficient to meet working capital requirements. Relations with suppliers could be damaged if
Kandinsky Co cannot make payments to them within agreed credit terms, with the result that suppliers
could stop supplying the company or withdraw credit which would severely damage the company’s
operations. There is also a risk that suppliers could bring legal action against the company in an attempt
to recover the amounts owed.
Borrowing facility
Kandinsky Co has $500,000 available in an undrawn borrowing facility, which does provide a buffer as
there is a source of cash which is available, somewhat easing the going concern pressures which the
company is facing. However, the availability of the borrowing facility depends on certain covenants
being maintained. The calculations below show that the covenants have now been breached, so the
bank is within its right to withdraw the facility, leaving Kandinsky Co exposed to cash shortages and
possibly unable to make payments as they fall due.
Covenant 2015 2014
Interest cover 2 340/520 = 0·65 1150/500 = 2·3

Borrowings to operating profit 4:1 3,500/340 = 10·3:1 3,000/1,150 = 2·6:1
Contingent liability
The letter of support offered to a supplier of raw materials exposes Kandinsky Co to a possible cash
outflow of $120,000, the timing of which cannot be predicted. Given the company’s precarious trading
position and lack of cash, satisfying the terms of the letter would result in the company utilizing 80% of
their current cash reserve. Providing such support seems unwise, though it may have been done for a
strategic reason, i.e. to secure the supply of a particular ingredient. If the financial support is called
upon, it is not certain that Kandinsky Co would have the means to make the cash available to its
supplier, which may create going concern issues for that company and would affect the supply of cane
sugar to Kandinsky Co. There may also be legal implications for Kandinsky Co if the cash could not be
made available if or when requested by the supplier.
(i) Audit procedures in relation to going concern matters identified
o Obtain and review management accounts for the period after the reporting date and any
interim financial accounts which have been prepared. Perform analytical review to ascertain
the trends in profitability and cash flows since the year end.
o Read the minutes of the meetings of shareholders, those charged with governance and
relevant committees for reference to trading and financing difficulties.
o Discuss with management the strategy which is being developed to halt the trend in declining
sales and evaluate the reasonableness of the strategy in light of the economic recession
and auditor’s knowledge of the business.
o Review the company’s current order book and assess the level of future turnover required to
breakeven/make a profit.
o Analyse and discuss the cash flow, profit and other relevant forecasts with management and
review assumptions to ensure they are in line with management’s strategy and auditor’s
knowledge of the business.
o Perform sensitivity analysis on the forecast financial information to evaluate the impact of
changes in key variables such as interest rates, predictions of sales patterns and the timing
of cash receipts from customers.
o Calculate the average payment period for trade payables and consider whether any increase is
due to lack of cash or changes in the terms of trade.
o Obtain the contract in relation to the borrowing facility to confirm the covenant measures and
to see if any further covenants are included in the agreement.
o Review correspondence with the bank in relation to the loan and the borrowing facility to
gauge the bank’s level of support for Kandinsky Co and for evidence of deteriorating
relationships between the bank and the company’s management.
o Obtain the bank loan agreement to confirm the amount of the loan, the interest rate and
repayment dates and whether the charge over assets is specific or general in nature.
o Review the bank loan agreement for any clauses or covenants to determine whether there
are any breaches.
o Obtain the letter of support in relation to the supplier to confirm the conditions under which
Kandinsky Co would become liable for payment of the $120,000.
o Discuss with management the reason for the letter of support being given to the supplier to
understand the business rationale and its implications, including why the supplier
approached Kandinsky Co for the letter of support.
o Inspect minutes of management meetings where those charged with governance discussed
the letter of support and authorised its issuance.
o Obtain any further documentation available in relation to the letter of support, for example,
legal documentation and correspondence with the supplier, to confirm the extent of Kandinsky
Co’s involvement with the supplier and that no further amounts could become payable.

ANSWER # 94 - RAPHAEL & CO
(a) The purpose of due diligence

Information gathering
Due diligence is the process of fact finding to help reduce the risk involved in investment decisions. It is
used when gathering information about a target company, for the purpose of ensuring that the
acquirer has full knowledge of the operations, financial performance and position, legal and tax
situation, as well as the general commercial background of the target. In particular, due diligence
helps to uncover potential problems before a decision regarding the acquisition is made.
Verification of management representations

During a sale, the vendor may make representations to the potential acquirer which it is essential to
verify. As an example, the vendor may state that the company has recently had a health and safety
or fire safety investigation or that since their last year end they have replaced ageing property, plant
and equipment. Due diligence can be used to substantiate such claims.
Identification of assets and liabilities

One of the key reasons for performing due diligence is to identify the assets and liabilities of the target
company, which is vital when trying to value the target company. It is particularly important to attempt
to identify and value the intangible assets of the target company, including their brands, customer
databases and development costs. Internally generated intangibles will not be included on the
statement of financial position and are particularly difficult to assess.
The valuation of liabilities is also critical because the acquirer will have to settle these in the future.
This must be appropriately planned for and considered during the negotiation of the acquisition price.
Contingent liabilities are particularly significant because, by their nature, the amount required to settle
them and the likelihood of settlement are uncertain.
Operational issues
As well as the risk associated with the valuation of a business, the acquirer must also consider
operational implications which could jeopardize a proposed acquisition, such as high staff turnover, the
need to renegotiate supplier or customer contracts or contracts with lenders, and future changes in
the product mix of the target company. Any of these could lead to operational problems in the future
and could be considered potential ‘deal breakers’ or, at the very least, be used to negotiate the
acquisition price.
Acquisition planning
Due diligence will also assess the potential commercial benefits and drawbacks of the acquisition. For
example, it could be used to calculate the potential economies of scale from aligning the supply
chains of the buyer and the target company. On the other hand, there are post-acquisition costs to
consider, such as the costs of reorganization and the potential staff turnover which may be
experienced.
Scope of a due diligence assignment compared to an audit

With due diligence, the scope is focused primarily on fact finding, which means that the investigation
will draw on a much wider range of sources than those connected with the current financial
statements. These include:
– Several years’ worth of historical financial statements
– Management accounts
– Profit and cash flow forecasts
– Recent business plans and internal strategies/objectives
– Employee contracts, particularly those of management
– All binding contracts, such as supply contracts, lease agreements and loan agreement
– Discussions with management, employees and third parties.
While many of these items may be reviewed during an audit of historical financial statements, it is
likely that due diligence will require a much wider range of information. The objective of an audit is
to provide reasonable assurance that the financial statements are free from material misstatement. In
contrast, the aim of due diligence is to provide the acquirer with a set of information which has been
collated and, most likely, reviewed by the practitioner. Unless requested by the client, the practitioner
will not express any opinion with regard to the accuracy of the information provided. In this case,
due diligence is performed as an ‘agreed upon procedures’ assignment.
If the practitioner is requested to provide assurance regarding the accuracy of the information
provided, the due diligence service would be performed as a limited assurance review engagement.
This is a lower level of assurance than that provided in an audit due to the reduced procedures
performed during due diligence.
The type of work performed during due diligence is quite different to an audit, as a due diligence
investigation uses, primarily, analytical procedures and enquiry as a means of gathering information.
Very few, if any, substantive procedures are carried out, unless they are specifically requested by the
client or there are specific issues which cause concern and therefore need more detailed
investigation. This is in contrast to an audit, where a comprehensive range of tests of control and
substantive tests are performed.
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. This is in contrast to an audit, where
procedures only tend to consider future events if they are directly relevant to the year-end 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.
(b) (i) Intangible assets

Customer database
o A copy of the financial statements for the year ended 30 June 2015 to identify the current
carrying value of any purchased intangibles relating to the database, such as computer
software.
o A copy of the original purchase agreement for the software to identify the age of the software
and when any product licences expire.
o A copy of the original purchase/ongoing maintenance contracts for the software to identify the
continuing costs of maintaining the system at its current level of efficiency.
o Historic records of sales by customer to verify management’s statement that repeat customers
make up over 60% of annual sales.
o Copies of a sample of recent automated customer communications; these can be traced to
customer bookings/sales records to confirm the current efficacy of the system.
o Sales forecasts for the foreseeable future to assess the potential future cash flows attributable
to the customer database system to assess its value when determining the potential purchase
price.
o Confirmation of the current price of similar database software to assess the market value/fair
value of the asset.
License
o A copy of the original purchase agreement for the licence to confirm the $5 million cost and the
exclusivity of the agreement.
o The original purchase agreement can also be used to identify whether any further
incremental/contingent considerations or royalties are due in the future.
o A copy of the licence agreement to confirm whether the licence is for a fixed period of time or
not and to confirm the exclusivity of the licence.
o A breakdown of the sales figures relating to the new tyres; these can be used to compare the
performance of the new tyres to existing brands.
o Forecasts showing the expected future sales attributable to the new tyres to confirm the
continued inflow of economic benefit from the asset.
(ii) Contingent liabilities

The following enquiries should be made of the management of Titian Tyres Co:
o Enquire of management and ascertain if any legal advice has been sought to determine who is
liable to pay compensation in these cases, Titian Tyres Co or the supplier of the parts.
o Enquire whether management has sought any legal advice with regard to the likelihood of
having to settle the claims or not.
o Enquire if management has records showing how many vehicles have been fitted with the
faulty parts and whether these have been used in any estimates of the likely settlement costs.
o Discuss with management the level of claims which have been settled since the year end.
Compare this with the original estimation to establish how effective management has been in
making these estimates
o Enquire of management for how long the company used the faulty parts and for what portion
of this time period the known claims relate to.
o Discuss with management the details of any new claims which have been made since the year
end which were not included in any estimations of the cost of settlement included in the
contingent liability disclosure in the financial statements.
o Discuss with management their assessment of any risk that further claims will be made which
they are currently unaware of.
o Enquire of management if other quality problems have been experienced with other parts from
the same supplier.
ANSWER # 95 - REGULATORY BODY
(i) Dear Sir,

If there is a conflict between the new requirements introduced by the regulatory body and the
existing financial reporting framework, we will have to assess the situation and proceed in the
following manner:
(a) If the compliance with additional requirements can be met through additional disclosures,
you shall be required to incorporate the additional disclosures in the financial statements.
(b) as the external auditor we shall ensure the adequacy of the disclosures.
(c) If the additional requirements cannot be met with the additional disclosures, you will need to
amend the description of applicable financial reporting framework mentioned in the Statement
of Compliance in Policy notes of the financial statements

(d) In case you don’t agree with incorporating additional disclosures or the amendment of the
description of the applicable financial reporting framework, then in this case we may require
modifying our opinion in accordance with the applicable International Standard on Auditing.
We hope that the above points will clarify your concerns relating to the compliance with the
additional requirements, introduced by the regulatory body and the possible reasons due to
which we may need to modify our opinion.
Yours faithfully,
XYZ and Company, Chartered Accountants
(ii) BASIS FOR MODIFICATION PARAGRAPH

In accordance with the requirement of the XYZ Act 2012, the company is required to disclose the
amount of all the Contingent Assets that existed at the balance sheet date. The Company has not
disclosed the amount of Contingent assets as required under clause XX of the XYZ Act, 2012,
because the inflow of economic benefits was not probable and hence such disclosure would not
be in compliance with the requirements of the International Financial Reporting Framework.
ANSWER # 96 - BLUE SKY LIMITED
On September 30, 2007, the inventory of a subsidiary was overvalued by Rs. 5.7 million. The
overvaluation was adjusted to the extent of Rs. 1.9 million during each of the years ended September
30, 2008 and 2009. Consequently the inventory as appearing in the consolidated financial statements
for the year ended September 30, 2009 has been overstated by Rs. 1.9 million. In our opinion, the
above adjustment is not in accordance with the International Accounting Standards which requires that
the overstatement should be rectified retrospectively. Accordingly, the inventory should be reduced by
Rs. 1.9 million in the year 2009 and by Rs. 3.8 million in the year 2008, profit for the year should be
increased by Rs. 1.9 million in the year 2009 and by Rs. 0.475 million in 2008, accumulated retained
earnings should be increased by Rs. 2.1375 million in the year 2009 and by Rs. 0.4275 million in the year
2008, goodwill should be increased by Rs. 3.8475 million in both the years i.e. 2009 and 2008 and
minority interest should be reduced by Rs. 0.19 million in the year 2009 and by Rs. 0.38 million in the
year 2008.
In our opinion, except for the effect on the consolidated financial statements of the matter referred to
in the preceding paragraph, the consolidated financial statements present fairly the financial position of
Blue Sky Limited and its subsidiary as at September 30, 2009 and the result of their operation for the
year then ended.
ANSWER # 97 - NAVEED LIMITED

Evaluation of the situation:
The debts should have been shown as current debts in accordance with the terms of the loan
agreements.
▪ The verbal confirmation from the banks cannot be a replacement to avoid showing loans as
current liabilities as nothing is in writing.
Furthermore, even if the bank confirms it even then it is a subsequent non-adjusting event as
this has been done subsequent to year-end, and on the balance sheet there was a breach of loan
covenants.
▪ In addition to this the period of grace should be at least of twelve months after the reporting date
within which the Naveed Limited can rectify the breach.
Basis for qualified opinion

As more fully explained in note xx to the financial statements, the debt covenants of the loans as at 30
June 20XX have been breached by the company. Accordingly, the long term loans reflected in the
statement of financial position of the company amounting to Rs. XXX million should have been
classified as “current liabilities” as the terms of the loan require immediate repayment of loan in case
of breach of debt covenants.
ANSWER # 98 - MARS LIMITED

(a) The inclusion of emphasis matter paragraph in the audit report for explaining the irrecoverability
of amount due from UL is not appropriate.
▪ As the amount is outstanding since last September, it needs to be provided in the financial
statements of September 2013.
▪ The auditor will ask the management to restate the prior period figures in the current financial
statements and make appropriate disclosures thereof.
▪ If the management agrees to restate the figures and make appropriate disclosures in the
financial statements, the auditor report may include an emphasis of matter paragraph
describing the circumstances and referring to the note in the financial statements.
▪ If the management refuses to restate the financial statements or make appropriate
disclosures, the auditor shall express a qualified opinion or an adverse opinion on the current
period financial statements, modified with respect to the corresponding figures included
therein.
▪ Furthermore, UL is a major customer of ML as 40% of its revenue is earned from it, as the
company has incurred a loss of Rs. 22.4 million in the absence of sales to UL. The appointment
of a liquidator at UL is an event which (alone or aggregated with other events) may cast
significant doubt on ML’s ability to continue as going concern.
▪ If the management has not yet performed an assessment of the entity’s ability to continue as a
going concern, requesting management to make its assessment.
▪ Evaluating management’s plans for future actions in relation to its going concern assessment,
whether the outcome is likely to improve the situation and whether management’s plans are
feasible in the circumstances.
▪ If after reviewing management’s plan and performing procedures, it is concluded that material
uncertainty exists as regards the going concern assumption, a note should be given in financial
statements describing the liquidation of UL, which may cast significant doubt on the
company’s ability to continue as a going concern and management’s plan to deal with the
situation and therefore, that it may be unable to realize its assets and discharge its liabilities in
the normal course of business.
▪ The audit report will be modified in the form of inclusion of an emphasis of matter paragraph
which will explain the uncertainty and draw the shareholders’ attention to the note in the
▪ If the management donot agree to disclose a note, a qualified or adverse opinion should be
considered.
▪ It shall also be stated in the audit report that there is a material uncertainty that may cast
significant doubt about the company’s ability to continue as a going concern.
▪ If the financial statements have been prepared on a going concern basis but, in the auditor’s
judgment, management use of going concern assumption is inappropriate, the auditor shall
express an adverse opinion.
▪ If the use of going concern assumption is not appropriate, and the management prepares the
financial statements on alternative basis, the auditor will express an unmodified opinion,
provided adequate disclosure is made in the financial statements, but may consider it
appropriate or necessary to include an Emphasis of matter paragraph in the auditor’s report,
to draw user’s attention to that alternate basis and the reasons for its use.
▪ If management is unwilling to make or extend its assessment, a qualified or disclaimer of
opinion may be appropriate, because it may not be possible for the auditor to obtain sufficient
appropriate audit evidence regarding the use of the going concern assumption in the
preparation of financial statements.
(b) As described in note X to the financial statements, the company has recognized the provision of
Rs. 70 million against amount due from Utopia Limited in the current year. We consider that the
said provision should have been recognized in the year 2013. Had a provision been made of the
amount receivable from Utopia Limited, the profit after taxation of year 2013 would have been
reduced by Rs. 70 million and loss after taxation of year 2014 would have been reduced by Rs. 70
million.
In our opinion, except for the effect on the financial statements of the matter referred to in the
preceding paragraph, the financial statements present fairly the financial position of Mars Limited
as at 30 September 2013 and the results of their operation for the year then ended.
ANSWER # 99 - ROSE LIMITED
Key audit matter How the matter was addressed in our audit
Tax Contingency
Refer note x to the financial statements
The company has significant tax We have obtained and assessed the management’s contention
contingencies which can have a against the demands made by the taxation authorities.
significant impact if materialized. We also had a discussion with the tax advisor of the Company and
Due to the high level of judgment his rationale and justifications against the demands made by the
required to assess the outcome of taxation authorities.
tax litigations, we consider it to be We used our own tax specialist to consider the level of provision
a key audit matter. required in light of the nature of the company’s exposure,
applicable regulation and the company’s correspondence with
the tax authorities.
We have considered any legal precedent or case law by assessing
relevant historical and recent judgments passed by the courts and
other authorities in similar situation.
We evaluated the adequacy of the disclosure in the financial
statement.
Related Party Transactions


The company has significant We assessed the management controls over identification and
purchases from related parties. capturing and recording of related party transactions.
Further, significant amount of We also assessed how frequently the related party listing is
advertising expenses are also paid updated by the management and whether there are any time lags
to related parties. or not.
Due to the large number of Reviewed filings with the regulatory authorities for the names of
transactions with the related related party in which officers and directors occupy directorship
parties, we consider it as an area of or management position.
significant risk, and hence this was
identified as a key audit matter. Reviewed contract with related party for providing advertising
and other services.
Reviewed minutes of meeting of board of directors for the

discussion and authorization of related party transaction.
Reviewed accounting record for large, unusual and non- recurring
transactions.
We circulated confirmation request to the related parties regarding

the transactions carried out with them and their balances as at
year end.
We evaluated the adequacy of the related party disclosures in the

Non-Current Assets Held For Sale

The company is committed to a We assessed the company’s commitment to the sale plan through
plan to sell part of a understanding the status of the sales process and reviewing
manufacturing facility. correspondence from purchasers and prospective purchasers.
This part of the manufacturing We involved our own valuation specialist to assist in evaluating
facility has been classified as non- the fair value of the plant.
current assets held for sale and
written down to its fair value less We evaluated the adequacy of the financial statement disclosures,
costs to sell. including disclosures of key assumptions, judgment and
sensitivities.
Due to the high level of judgment
involved in estimating the fair
value and the significant carrying
amounts of the assets and
liabilities associated with it, we
considered it to be a key audit
matter.

ANSWER # 100 - KEY AUDIT MATTERS
(a) If one or more matters other than the matter(s) giving rise to an adverse opinion are
determined to be key audit matters, it is particularly important that the descriptions of such
other key audit matters do not imply that the financial statements as a whole are more credible
in relation to those matters than would be appropriate in the circumstances, in view of the
adverse opinion.
(b) A matter giving rise to a qualification by their nature is a key audit matter. In such
circumstances, these matters shall not be described in the Key Audit Matters section of the
auditor’s report, rather the matter is to be reported in accordance with the requirements of
related ISA. Reference to the basis for qualified opinion is to be included in the Key Audit
Matter section.
(c) The non inclusion of Key Audit Matters of prior period is appropriate as the auditor’s
determination of key audit matters is limited to those matters of most significance in the
audit of the financial statements of the current period, even when comparative financial
statements are presented (i.e., even when the auditor’s opinion refers to each period for which
financial statements are presented).
(d) The auditor can only accept the management request if:
▪ law or regulation precludes public disclosure about the matter; or
▪ the auditor determines that the matter should not be communicated in the auditor’s report
because the adverse consequences of doing so would reasonably be expected to outweigh
the public interest benefits of such communication. This shall not apply if the entity has
publicly disclosed information about the matter.
ANSWER # 101 – PIXEL LIMITED
Contingent liabilities
Refer note x to the financial statements.
Key audit matter How our audit addressed the key audit matter
The assessment of the existence of the present Our audit procedures included the following:
legal obligation, analysis of the probability of We had discussions with the Company’s legal
the related payment and determining a reliable advisors in respect of the outcome of the case
estimate, requires significant management’s and reasonableness of the disclosure.
judgment to assess whether it should be
recognized as provisions or disclosing it as a We inquired the management and those
contingent liability. charged with governance and also reviewed the
subsequent correspondence with the
Due to the level of judgement relating to competitor.
valuation and presentation of contingent
liabilities, this is considered to be a key audit We also involved our legal expert to assess the
matter. outcome of the case.
We have also assessed it as an area of higher We evaluated the adequacy of the disclosure in
assessed risk of material misstatement as it the financial statements, in particular the
could not be measured reliably. disclosure of the uncertainty in estimation and
its quantification.

ANSWER # 102 – Voltage Limited
Acquisition of Pyrus Limited

See note x to the consolidated financial statements
On 01 March 2019, CGL acquired 65% shares in Our audit procedures in this area included, among
Pyrus Limited for consideration of Rs. xxx million. others:
The accounting for this transaction is complex due We challenged, with the support of our own
to the significant judgements and estimates that valuation specialists, the key assumptions used by
are required to determine the values of the the Group to determine fair values of assets and
consideration transferred and the identification liabilities acquired;
and measurement of the fair value of the assets
acquired and liabilities assumed. We discussed these assumptions with the
Directors and corroborated the explanations
Due to the size and complexity of the acquisition, provided by comparing them to market data, our
we considered this to be a key audit matter. past experience of similar transactions, and the
Group’s business plan supporting the acquisition;
Where available, we compared the amounts

recognized to supporting external documentation;
We assessed the appropriateness of the

accounting for significant fair value adjustments,
with reference to the IFRS.
We evaluated the adequacy of the disclosure of

acquisitions in the annual report and financial
statements.
Development of electricity transmission infrastructure

See note x to the financial statements
The Company has undertaken major project in Our audit procedures in this area included, among
relation to the development and maintenance of others:
electricity transmission infrastructure and is
installing various grid lines and transmission lines Assessed, on a sample basis, costs capitalised
throughout the country in different phases. during the year by comparing the costs capitalised
with the relevant underlying documentation,
This project contains a combination of capital which included purchase agreements and invoices.
expenditure and maintenance activity which are
not distinct and therefore the allocation of costs Assessed whether the costs capitalised met the
between capital and operating expenditure is relevant criteria for capitalisation as per the
inherently judgmental. applicable accounting and reporting framework.
There are a number of areas where significant Evaluated management’s estimation of economic
management judgement is involved in connection useful lives and residual values by considering our
with the above expansion. These include: knowledge of the business and practices adopted
• Determining which costs are related to in the local industries.
development of electricity transmission
infrastructure and thus meet the criteria for Reviewed the date of transferring capital work-in-
capitalisation and the costs which are related progress to operating fixed assets by examining
to maintenance and needs to be expensed out; the completion certificates and/or project
• Determining the transmission lines which are progress reports, on a sample basis.

completed and the date on which assets under
construction are transferred to operating fixed Assessed whether the disclosures are made in
assets and the respective dates from which accordance with the financial reporting
their depreciation should commence; and framework.
• The estimation of economic useful lives and
residual values assigned to property, plant and
equipment.
We consider the above as a key audit matter being

significant transactions and events for the
Company during the year having significant impact
on the financial position of the Company.
ANSWER # 103 - CINNABER GROUP
Suitability of the audit report

Unqualified report
From the information in the disclosure notes it is apparent that the company is not a going concern.
However it is not clear on which basis the financial statements have been prepared. They have been
prepared:
• On the going concern basis or
• On an alternative basis
An unqualified audit report means that:

• The accounts give a true and fair view
• They have been prepared in accordance with statute
If the accounts have been prepared on a going concern basis an unqualified opinion would not be
appropriate as this does not reflect the true position of the company. The results would be misleading
as the readers would made assumptions about the company’s ability to continue which are clearly not
the case. In addition to the inappropriate basis of preparation, disclosure is inadequate as the notes to
the accounts do not highlight the significant problems the company is facing. In this respect they are
not properly prepared.
If the accounts have been prepared on an alternative basis an unqualified opinion would still not be
valid. This is due to the inadequacy of disclosure. The going concern assumption is a fundamental
principle.
Readers of accounts assume the company is viable unless it is clearly stated otherwise. In this case
even through the basis of preparation is correct the lack of disclosure means that they are not properly
prepared.
Alternative opinions
The ‘except for’ or disclaimer of opinion would not be appropriate irrespective of the basis of
preparation as the issue is not one of uncertainty. The company has liquidated assets and we are told
that the company has ceased to trade in October.
If the financial statements have been prepared on a going concern basis an adverse opinion should be
expressed. This would be due to a disagreement with the basis of preparation. For example, assets and
liabilities are likely to be misclassified as non-current when they should be classified as current. The
opinion would be adverse as the disagreement is pervasive to the overall true and fair view.

If the accounts have been prepared on an alternative basis reflecting that the company is not a going
concern, for example the break-up basis, provide that this has been applied correctly the auditor would
agree with this treatment.
However a qualified ‘except for’ audit report should be issued on the grounds of disagreement with the
adequacy of the disclosure regarding the basis of preparation.
ANSWER # 104 - BEIGE INTERIORS
(a) Audit report for Beige Interiors

Draft audit report extracts
• Jade has drafted a disclaimer of opinion paragraph, which is correct only if the effect of the
limitation is pervasive.
• However, records stolen in August are unlikely to result in a lack of evidence about balances
(for example receivables confirmations and inventory count can be obtained) in the
statement of financial position at the end of September so it is unlikely that the effect is
pervasive to the whole financial statements in this way.
• It is possible it would be more appropriate to give an ‘except for’ opinion restricted to the
statement of comprehensive income for the first four months of the year.
Principal matters to consider

• Whether the auditor has been able to obtain sufficient appropriate audit evidence. If not,
then the auditor must qualify the opinion, as Jade has correctly suggested.
• What judgements and estimates have been made by management in reconstructing the
information stolen by the former chief executive. Evidence may not be sufficient to give an
unqualified opinion.
• What disclosure has been made in the financial statements about the loss of the financial
records and the reconstruction. This should cover what information is missing, what period it
related to, why it is missing and what has been reconstructed. This information should be
cross-referenced from the audit report or included in the audit report. The fact that Jade has
made no cross reference suggests that this information is not given in the notes to the
accounts. If this is the case, the information should be given in the audit report.
• Whether the former chief executive’s actions give rise to a suspicion of fraud. This should not
be referred to in the audit report because it is unproven, but it will affect the auditor’s
judgement and audit work. Because of this suspicion, the auditors are very likely to qualify, in
case there has been an undiscovered fraud.
• The effect these actions have on the appropriateness of the prior year audit report. The
auditors should consider the extent of reliance on representations from the chief executive
the previous year in obtaining audit evidence. It might be necessary to qualify the current
audit report with regard to the comparatives.

ANSWER # 105 - ASIASPORT
Audit report format

The audit senior has wrongfully suggested that the audit firm includes an emphasis of matter paragraph
in the audit report. An emphasis of matter paragraph is only used when the auditor needs to highlight
a particular mater in the financial statements, for example, a fundamental uncertainly affecting the
Auditors would not draw attention to an accounting policy they agreed with in an emphasis of matter
paragraph if there was sufficient disclosure of the policy, which is implied by the reference to a note. If
there was insufficient disclosure, the auditor would be qualifying his report on grounds of
disagreement.
The accountant of Worldsport wishes to treat AsiaSport as a subsidiary or, more accurately, believes
that it is a quasi-subsidiary. Quasi subsidiaries are those investments which, while not falling into the
mainstream definition of a subsidiary undertaking, are in fact controlled by the parent entity to such an
extent that the parent enjoys the same benefits from the relationships with the investments as it would
do if the investments were subsidiary undertakings. The important point is control, which in this
situation means the ability to determine the financial and operating policies of the investment with a
view to gaining future economic benefit. The converse is also true: control means being able to deprive
others of the same rights.
Dominant party
In the situation with AsiaSport it might at first appear that there is no dominant party in the joint
venture. It is very rare for this to be the case, however, and it is more likely that, once the commercial
reality of the situation is revealed, a dominant party will emerge. The accountant of Worldsport
obviously believes that Worldsport is the dominant partner, presumably on the grounds that it provides
finance, equipment and expertise as well as because it has a casting vote.
As auditor, however, I take the opposite view, namely that the government in Worldsport’s home
country is the dominant party, and this view tends to be supported by the following facts:
(i) The casting vote rotates between the two parties, it cannot therefore by seen as an indication of
permanent control. It is not correct accounting to treat the investment differently in alternative
years.
(ii) Profits are not split 50:50 because the government rakes in extra ‘taxes’ levied in effect only on
Worldsport, plus an extra ‘repatriation tax’.
(iii) Worldsport’s rights are restricted on liquidation/termination to its original capital. The majority of
the benefits accrue to the government.
(iv) Worldsport cannot appointment a majority of the Board.
(v) The future plans of AsiaSport are determined by the terms of the local government’s foreign
investment rules and regeneration scheme.
(vi) Most of the agreement has been imposed upon Worldsport with little choice on policy or
direction.
Worldsport, while not exerting a dominant influence may be also to exercise significant influence over
the financial and operating policies of AsiaSport. Further, its interest is more that 20% and is for the
long term (at least five years). Therefore the investment is an associated undertaking. The appropriate
way of accounting for the investment in AsiaSport is to use equity accounting.

Correct audit report format
If the accountant does not agree to change his treatment of AsiaSport in line with the above, the
auditors will disagree with the accounting treatment used and, if it is material, which is implied by the
auditor drawing attention to it in the original report, qualify the accounts on these grounds.
This would be a material qualification, not an adverse opinion, as the matter is not pervasive to the
accounts. No explanatory paragraph would be needed, as an explanation of the disagreement would be
given in the opinion paragraph (which would be headed ‘Qualified opinion arising from disagreement
about accounting treatment’). The opinion would end ‘except for the incorrect treatment of
investments, in our opinion the financial statements give a true and fair view...’
ANSWER # 106 – CLEEVES
(i) The title of the opinion section does not clarify whether the report is unqualified or qualified, and
it qualified on what basis (disagreement or limitation on scope).
The quantitative effects of the failure to recognise the impairment losses have not been set out in
the report and they should be – it simply states that they would increase the loss and reduce the
value of non-current assets if they had been recognised.
The wording of the opinion indicates that it is an adverse opinion but it is unlikely that this would
be the case – it is more likely to be a qualified opinion rather than an adverse opinion if the
reason for it is that impairment losses on non-current assets have not been recognised. Without
any quantifications of the amount involved it is not clearly why the auditors consider the matter
to be ‘pervasive’.
The title of IAS 36 Impairment of assets should be given in full in the report.
It is not clear from the working of the report whether the qualification is on the grounds of
disagreement with the directors or a limitation on scope. The first sentence suggests
disagreement with the directors but later in the report, it states that the directors have not been
able to quantify the amounts and this seems to indicate a limitation on scope.
The prior year report was qualified on the same basis so the current year report should also be
qualified for the comparatives. This prior year qualification should be referred to in the current
year audit report.
(ii) Howard Co is material to Cleeves. Therefore a modified audit opinion on the financial statements
of Howard Co may also affect the consolidated financial statements of Cleeves if the adjustments
required in Howard Co’s accounts are material to the group accounts. If they were immaterial,
there would be no impact on the group audit opinion.
If the adjustments required in Howard Co’s accounts are made, then there would be no
implication for the audit report on the consolidated financial statements. However, if the
adjustments are not made, then it is likely that the audit opinion for the consolidated financial
statement of Cleeves would be ‘except for’.

ANSWER # 107 - ZIA YAQOOB & COMPANY
Adverse opinion:
▪ When the auditor expresses an adverse opinion, due to the significance of the matter the auditor
states, that financial statements do not present fairly or give a true and fair view. The “except for”
phrase is used when the auditor expresses a qualified opinion due to material misstatement.
▪ The auditor also needs to mention the applicable framework, which have not been complied with.
▪ Apparently it seems that in this situation a qualified opinion would have been more appropriate,
since the value of capital spare parts and their depreciation may never represent a substantial
portion of the financial statements.
Basis of adverse opinion:

▪ Reference of the notes to the financial statements where the relevant information is
disclosed/discussed is missing.
▪ Aslam has stated that the auditors have conclusively assessed the value of stores at Rs. 100 million
which is inappropriate. Audit procedures provide reasonable assurance, which is less than the
absolute assurance implied by the word “conclusively”.
▪ Instead of mentioning the audit procedure performed, only mentioning the value of capital stores
would have been sufficient. The description of audit procedures is only provided in the key audit
matter section.
▪ It is not appropriate to give the argument offered by the CFO and use his designation in the audit
report.
▪ Mentioning the CFO may lead to litigations against the firm for defamation. The word management
or company may have been used instead of CFO.
▪ The financial effect of the misstatement has also not been completely discussed. If the capital stores
and spares would have been reclassified as per IAS – 16 then they may have been subject to
depreciation resulting in impact on profit after tax and equity. Reference to International
Accounting Standards has been made in an inappropriate manner which is against the best practices
being followed almost universally. It should have been ensured that full name of those standards are
given rather than their acronyms.
Emphasis of matter paragraph:

▪ As per ISA 706 early application (where permitted) of a new accounting standard that has a material
effect on the financial statements may be considered as emphasis of matter paragraph. However,
information related to non-disclosure of information which results in material misstatement in the
financial statements shall not be included in emphasis of matter paragraph.
▪ A qualified opinion on the basis of inability to obtain sufficient appropriate audit evidence should be
expressed and in the ‘Basis for opinion section’ the nature of the omitted information should have
been described if practicable.
ANSWER # 108 - JAVED LIMITED
The emphasis of matter paragraph should indicate that auditor’s opinion is not qualified in respect of the
matter referred.
▪ The audit report should refer to all relevant notes including the note where material uncertainty has
been described. If there is no such note than the opinion should be qualified.
▪ The phrase “that the company may be unable to continue as a going concern” is to be replaced with
the phrase “which may cast significant doubt on the company’s ability to continue as a going
concern”.

ANSWER # 109 - ROCKWELL & CO
Critical appraisal of the draft audit report

Type of opinion
When an auditor issues an opinion expressing that the financial statements ‘do not give a true and fair
view’, this represents an adverse opinion. The paragraph explaining the modification should,
therefore, be titled ‘Basis of Adverse Opinion’ rather than simply ‘Basis of Modified Opinion’.
An adverse opinion means that the auditor considers the misstatement to be material and pervasive to
the financial statements of the Hopper Group. According to ISA 705 Modifications to Opinions in the
Independent Auditor’s Report, pervasive matters are those which affect a substantial proportion of the
financial statements or fundamentally affect the users’ understanding of the financial statements. It is
unlikely that the failure to recognize contingent consideration is pervasive; the main effect would be to
understate goodwill and liabilities. This would not be considered a substantial proportion of the
financial statements, neither would it be fundamental to understanding the Hopper Group’s
performance and position.
However, there is also some uncertainty as to whether the matter is even material. If the matter is
determined to be material but not pervasive, then a qualified opinion would be appropriate on the
basis of a material misstatement. If the matter is not material, then no modification would be necessary
to the audit opinion.
Wording of opinion/report
The auditor’s reference to ‘the acquisition of the new subsidiary’ is too vague; the Hopper Group may
have purchased a number of subsidiaries which this phrase could relate to. It is important that the
auditor provides adequate description of the event and in these circumstances, it would be
appropriate to name the subsidiary referred to.
The auditor has not quantified the amount of the contingent element of the consideration. For the
users to understand the potential implications of any necessary adjustments, they need to know how
much the contingent consideration will be if it becomes payable. It is a requirement of ISA 705 that the
auditor quantifies the financial effects of any misstatements, unless it is impracticable to do so.
In addition to the above point, the auditor should provide more description of the financial effects of
the misstatement, including full quantification of the effect of the required adjustment to the assets,
liabilities, incomes, revenues and equity of the Hopper Group.
The auditor should identify the note to the financial statements relevant to the contingent liability
disclosure rather than just stating ‘in the note’. This will improve the understandability and usefulness
of the contents of the audit report.
The use of the term ‘we do not feel that the treatment is correct’ is too vague and not professional.
While there may be some interpretation necessary when trying to apply financial reporting standards to
unique circumstances, the expression used is ambiguous and may be interpreted as some form of
disclaimer by the auditor with regard to the correct accounting treatment. The auditor should clearly
explain how the treatment applied in the financial statements has departed from the requirements of
the relevant standard.
Tutorial note: As an illustration to the above point, an appropriate wording would be: ‘Management
has not recognised the acquisition-date fair value of contingent consideration as part of the
consideration transferred in exchange for the acquiree, which constitutes a departure from
International Financial Reporting Standards.’

The ambiguity is compounded by the use of the phrase ‘if this is the case, it would be appropriate to
adjust the goodwill’. This once again suggests that the correct treatment is uncertain and perhaps
open to interpretation.
If the auditor wishes to refer to a specific accounting standard, they should refer to its full title.
Therefore, instead of referring to ‘the relevant standard’ they should refer to International Financial
Reporting Standard 3 Business Combinations.
The opinion paragraph requires an appropriate heading. In this case the auditors have issued an
adverse opinion and the paragraph should be headed ‘Adverse Opinion’.
As with the basis paragraph, the opinion paragraph lacks authority; suggesting that the required
adjustments ‘may’ materially affect the financial statements implies that there is a degree of
uncertainty. This is not the case; the amount of the contingent consideration will be disclosed in the
relevant purchase agreement, so the auditor should be able to determine whether the required
adjustments are material or not. Regardless, the sentence discussing whether the balance is material or
not is not required in the audit report as to warrant inclusion in the report the matter must be
considered material. The disclosure of the nature and financial effect of the misstatement in the basis
paragraph is sufficient.
Finally, the emphasis of matter paragraph should not be included in the audit report. An emphasis of
matter paragraph is only used to draw attention to an uncertainty/matter of fundamental importance
which is correctly accounted for and disclosed in the financial statements. An emphasis of matter is not
required in this case for the following reasons:
- Emphasis of matter is only required to highlight matters which the auditor believes are fundamental
to the users’ understanding of the business. An example may be where a contingent liability exists
which is so significant it could lead to the closure of the reporting entity. That is not the case with
the Hopper Group; the contingent liability does not appear to be fundamental.
- Emphasis of matter is only used for matters where the auditor has obtained sufficient appropriate
evidence that the matter is not materially misstated in the financial statements. If the financial
statements are materially misstated, in this regard the matter would be fully disclosed by the
auditor in the basis of qualified/adverse opinion paragraph and no emphasis of matter is necessary.

ABOUT THE TEACHER:

Hasnain R. Badami is a qualified Chartered Accountant with
cumulative experience of 11+ years in the profession. He also
holds a master’s degree in Philosophy - with critical thinking as
his area of research interest. His particularly versatile academic
background from humanities and business is what makes his
classrooms a thoroughly intriguing experience.
Hasnain believes in learning through experience and

stories. His real life stories come from his equally diverse
experience working in large local and multinational
organisations, as well as from training professionals,
teachers, and students. More specifically, he has worked
with Ernst & Young (Karachi, Dubai and Jeddah offices)
and also with Internal Audit function at Engro Polymer
before he finally quit Engro to pursue his passion for
learning and development work. Presently, he is the co-
founder and Director of Ingenium Business solutions that
is working in leadership, finance, and digital learning
space.
Hasnain is a senior faculty member at KnS Institute of Business Studies with 7+ years teaching
experience of Advanced Auditing to CA final students. He has taught more than 2400 students with
proud 1000+ CA qualified alumni. He uses Socratic style of teaching and inquiry by not only focusing on
the “what’s” and “how’s” of the subject matter but, more importantly, on the ‘whys’ of it. He also
served as an MBA visiting faculty member at a business school in Karachi.
At corporate level, his core areas of training expertise are Thinking Skills (critical, creative, and
collaborative thinking), Corporate Ethics, Leadership skills, Business Acumen, and Internal Auditing.
Notably, he has trained professionals from Engro Corporation, Engro Fertilizer, Engro Foods, Bayer Crop
Science, Bank Al Falah, NIB Bank, Bank Al Habib Limited, Khaadi, Bayer Pakistan, Soneri Bank, Byco,
Jubilee Insurance, Linde Pakistan, EFU General Insurance, HUBCO, PPL, Aisha Steel, IBA, Aisha Steel
Limited, KPMG, FINCA Microfinance Bank, NIFT, Telenor Bank, K-Electric, SSGC, Ernst & Young, United
Bank Limited, Habib Bank Limited, Getz Pharma, Fauji Fertilizer, Atlas Honda, Lucky Cement, TCS Pvt.
Limited etc.
Besides working with corporates and students, Hasnain devotes a substantial portion of his time
volunteering for empowerment of teachers. He is also on board of EDLAB Pakistan, a non-profit that
works on equipping teachers with 21st century pedagogical skills. Hasnain is also an elected member of
the prestigious Southern Regional Committee of Institute of Chartered Accountants of Pakistan (ICAP)
that is responsible to oversee CA members’ Continued Professional Development (CPD) and Student’s
affairs.

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Audit, Assurance & Related Services

Audit Execution and Conclusion – Practice Kit

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However, they expressed their inability to undertake the investigation work.

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Sponsorship arrangements are agreed up to 18 months in advance. Some corporate sponsors,

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Following IT related controls are being employed at Vision Limited:

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During yesterday's tour of Indigo's premises you saw that:

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Pembroke Ltd (Pembroke)

Snowdonia Ltd (Snowdonia)

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(1) Mckessie plc

(2) Danfurth Ltd

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Buzzwell Ltd (Buzzwell)

Pollen plc (Pollen)

Bloome pIc (Bloome)

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(1) Airedale Ltd (Airedale)

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(3) Patterdale Ltd (Patterdale)

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Extracts from the statement of financial position as at 31 July

Net current liabilities 2,750 153

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Basis of modified opinion (extract)

Emphasis of Matter Paragraph

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The following situations were noted regarding recent clients:

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