IPRO EDUCATION

+917742693555

ACCA MOCK
Advanced Audit and Assurance
Jun 21

Advanced Audit and Assurance

Time allowed: 3 hours 15 minutes

Attempt all three questions

IPRO EDUCATION
www.iproeducation.com
 IPRO EDUCATION
+917742693555

Question 1

Email
To: Audit team – AB society and AB trust
From: Senior audit manager – ABC and Co.
Subject: Audit planning – AB group & components
Hi team
As you might be aware, I have been assigned the supervision of the annual audit of
AB group, which comprise of two component audits as well. I have gone through
the draft annual accounts made available to us by AB trust. The purpose of this
email is to help start-up the planning process and define our audit approach.
Following three main areas will be discussed in this email:
(a) Difference between component audits and group audit (and importance of
component audits)
(b) Understanding the environment of AB trust and devising the materiality for
each significant account head
(c) Identified audit risks in investment property and key audit procedures to verify
this balance
(d) Items appearing in fixed asset register
(e) Advantages of having assets tagged

Component and group audit

I have been told that the audit team assigned on these engagements do not have
prior experience of group audits, hence, I am starting this email with a quick
overview of the group audit and component audits.
In this particular scenario, AB society and AB trust are the components of AB
group, AB society is the parent company and AB trust is the subsidiary, as the
governing body of the AB society also controls and governs the trust.
The individual financial statements of these two components will combine to
become the group financial statements. Therefore, the component financial
statements are very important, we have the opportunity here to audit the
components, i.e. AB society and AB trust, which can make our final assignment, i.e.
annual audit of AB group, very easy.
If we are able to verify all the balance with sufficient evidence appearing in the
individual financial statements of the two components, we will be able to form an
opinion on the group financial statements relatively easily.

www.iproeducation.com
 IPRO EDUCATION
+917742693555

We would have to focus especially on the intra-company transactions, to verify that

they are treated properly by the group. Other than those all the other balances will,
more or less, be the same.
We are not yet provided the annual accounts of AB society, but as far as we know
AB trust and AB society are the only two components of the AB group, we can
assume that these two are significant components. Auditing these two components
separately will significantly reduce the associated audit risk of the AB group.
Therefore, as I have explained above the importance of components, the audit of
these two components will reduce the risk and associated cost of the AB group,
hence, the annual audits of the both components are very important for us to
perform the annual audit of the AB group efficiently.

Environment of AB trust and materiality

Let’s move on to the second point on our agenda, the environment of AB trust. As
you all are already aware, this is a new client and we are not familiar with its
environment and operations. Additionally, this is the first year of audit for the client
as well, prior to this year the annual turnover of AB trust was not above the
threshold limit necessary for the trusts to get their annual accounts audited.
The audit manager has also shown concern regarding the significant policies of
trust, the client has not yet shared these policies with us and there is a possibility
that these policies do not exist. This can be a possibility, as this is the first year of
the annual audit of the trust. This issue might not have been communicated to the
management of the AB trust previously. The significant policies include
procurement policy, remuneration policy, accounting policy and HR policy.
Finally, the manager also has reasons to believe that the trust is not yet registered
with the tax authorities, this gives rise to significant compliance risk, the trust might
be subjected to penalties and fines. We will be discussing the associated risks
attached with the investment property in the next section.
The audit risk is a combination of inherent risk, control risk and detection risk. As
we are doubtful that the company lacks significant policies that increase the
inherent risk of the company, we would need to perform control testing to properly
quantify the control risk, but looking at events, like not registering trust with tax
authorities and missing investment property register, leads us to believe that the
controls of the trust are not very efficient and effective.

www.iproeducation.com
 IPRO EDUCATION
+917742693555

The increase in these two risks significantly increase the audit risk (that
inappropriate opinion will be given on the financial statements), the only risk that is
in control of the auditor is the detection risk (risk that any material misstatement or
omission will not be detected by the auditor). This considerably increases the audit
work that needs to be performed to reduce the detection risk to acceptable level.

Based on the assessment of audit risk, now we are in a position to devise

materiality level of the account balances, as this is the first year to audit the annual
accounts, we are not given any comparative figures with the draft accounts. To
assign materiality level, keeping in mind that this is a new client, we first have to
perform a vertical analysis of the financial statements provided:

Statement of financial position vertical analysis

No. Account head % of general

funds
1 Current liabilities 0%
2 Fixed assets 20%
3 Work in progress 14%
4 Investment property 59%
5 Advances, deposits and prepayments 0.04%
6 Cash and bank balances 7%

www.iproeducation.com
 IPRO EDUCATION
+917742693555

Statement of income and expenditure

No. Account head % of income
1 Salaries 1.3%
2 POL 0.6%
3 Utilities 1.1%
4 Repair & Maintenance 3.4%
5 TA/DA 0.4%
6 Bank Charges 0.2%
7 Vehicle Repair 0.2%
8 Audit fee & Professional Charges 2.2%
9 Executive Committee Meeting 1.2%
10 Miscellaneous 1.3%
11 Grants to AB society 20.7%
12 Rent 5.4%
13 Exchange (gain)/loss (0.03%)

As quite apparent, from the balance sheet (or statement of financial position) we
might not have to devise a materiality level, as all the account heads except
current liabilities and advances, deposits and prepayments are above 5%. Though
current liabilities are not material based on value, the nature of this account head
can be considered martial (keeping in mind the amount is $0). The annual
accounts state that trust has no current liability, no accruals or payables. This
appears to be abnormal for any business, therefore, even though this balance is
not appearing material based on its value, due to the nature and uniqueness of
this account we can label it material as well.

Moving on to the account heads appearing in the statement of income and

expenditure, the materiality level of 1% can be selected. This makes salaries,
utilities, repair and maintenance, audit fee and professional charges, executive
committee meetings, miscellaneous expenses, grants to AB society and rent paid
are all material account heads. What is more important is to note that grants to AB
society comprise of about 21% of the total income, as this is an intra-company
balance, this automatically increases the materiality of this account. The nature
and value of this account head make it the most significant account head or
statement of income and expenditure item.

www.iproeducation.com
 IPRO EDUCATION
+917742693555

Investment property – risk and audit procedures

Finally, we move on to the last section of our agenda item, the investment
property, the first thing that I would like to comment on is the classification of
investment property in the statement of financial position. Currently the
management of AB trust has classified this account as the current asset, however,
investment property should be treated as a non-current asset. We might have to
look into the accounting policy of the management and intention of the
management (via inquiry) to evaluate its calcification.
Aside from the classification issues, the management states that they do not
maintain any property-wise break-up of the investment property. This increases
the risk over the assertions of existence, completeness, valuation and rights and
obligations of this account balance. Therefore, the detection risk of this account
balance needs to be lowered to an acceptable level by significantly increasing the
audit work to be performed on this account head. This balance is also about 60%
of the total general funds of the trust, thus the largest account balance of the
trust. All these stated factors considerably increase the associated risk of this
account balance. Following is a list of audit procedure that should be performed
on this account head to reduce the detection risk:

1- Checking the existence of the investment property by physical verification

(visits of the properties).
2- Confirming the rights of the investment property by verifying the legal
documents of the properties (title deeds, etc.).
3- Confirming the completeness of the account head by tracing payments to the
property holders and verifying the payment documents (pay orders, crossed
cheques, etc.)
4- Verifying valuation of the account balance by asking trust to provide break-up
of payment installments and third party payment acknowledgments.
5- Verifying rights by taking third party confirmations of the payments and title
transfers.
6- Verifying disclosures of the investment property, by reviewing stated
management policies of the investment property.
7- Inquire and review the management’s assertions and valuation policies.
8- Verify valuation of the account head by taking third party verification on the
recorded fair value of the investment property.

www.iproeducation.com
 IPRO EDUCATION
+917742693555

9- Inquire from the management, the intention behind the investment in these
properties to confirm sufficiency of disclosers.
10- Inquire from the management, the intention behind divestment in the
investment property to confirm the classification of investment property.

Items appearing in fixed asset register

Date of purchase - Usually, the first field appearing in the fixed asset register is the
date of purchase of the asset.
Reference number - Another important item appearing in the fixed asset register is
the reference to the asset or token number, a unique serial number allocated to
each asset. This reference number is usually tagged on the assets.
Nature of asset - The next item stated for each asset in the fixed asset register is
the nature (e.g. property, plant, machinery, electric equipment, etc.).
Class or sub-category of asset – Some companies segregate the asset into sub-
categories, for example air conditions and photostate machine in main category of
equipment.
Estimated useful life – It is also a good practice to state the estimated useful life of
the asset, so that the management is made aware when the asset is getting old.
Description - Next, companies provide summarised description of each asset in the
register (e.g. conference (wooden) table – 8’x12’).
Purchase price - Next, the purchase price of the asset is recorded.
Freight or transportation cost – These costs are also stated, usually separately from
the purchase price of the asset.
Estimated scrap value or disposal charges – If applicable, companies state the
expected scrap value or disposal charges for the asset as well.
Funding source - Usually, companies state the funding of the asset as well (e.g.
owner contribution, donation, etc.).
Depreciation policy - Companies also state the depreciation policy in front of each
asset as well (the company needs to apply the policy consistently on each class of
asset).
Accumulated depreciation - Companies state the accumulated depreciation
charged for each asset in fixed asset register.
Net book value - Companies also state the net book value of each asset in the fixed
asset register

www.iproeducation.com
 IPRO EDUCATION
+917742693555

Location - The fixed asset register also lists the location of the fixed asset as well
(e.g. regional office Atlanta, head office New York).
Custodian - The fixed asset register also mentions the custodian of the asset if it
has been issued to any employee (e.g. laptop issued to CEO, smart phone issued
to procurement manager).

Advantages of having assets tagged

1- Helps in the physical count of the assets performed by the management. The
assets, if properly tagged, can be easily tracked and identified during the physical
count,
2- Any missing assets can be easily identified.
3- Helps in properly controlling assets by assisting in their identification,
allotment, issuance and prevention from loss or theft.
4- Helps in overall planning and asset management.
5- Helps in tracking old assets for auction or maintenance.

Conclusion
Taking account of all the risks involved in this particular assignment, the related
audit work needs to increase significantly, to reduce the detection risk to
acceptable level. We will be arranging a meeting soon in next week to go over the
audit planning and execution phase of the assignment.
Thank you!

Regards
Senior audit manager
ABC and Co.

www.iproeducation.com
 IPRO EDUCATION
+917742693555
Question 2
Part (a)
Audit Risk
Audit risk is the risk that auditor will give an inappropriate opinion on the
financial statements, although it appears to be the most significant expense of
ZL. It is 24% of the total revenue, this might be the reason why audit supervisor
labeled it as the most risky area.
However, the audit supervisor overlooked the work in progress expense that is
capitalised in the statement of financial position. This is not a revenue expense,
therefore, it does not appear in the profit and loss account, however, it is an
expense incurred by the company that, for the time being, is being capitalised.
The expense that is capitalised as work in progress (construction cost) is 40% of
the total assets of ZL and is $3.6 million higher than the total payroll cost. By
looking at the drafts provided for the annual accounts, the work in progress
appears to be the most risky area for the audit.
Apart from the size of this account head, the nature of this capital expense is
material as well, the process of construction is inherently very risky, the process
involves high procurements, labour cost, transportation costs, etc., the
treatment of which is very risky. The classification of expenses as revenue or
capital is again a subjective and risky area for the audit. Finally, the construction
process involves estimates and subjective measurements, all these factors make
the entire construction process very risk and material for the audit.

Part (b)
Importance of documentation of audit working papers
The international standard on auditing that deals with audit documentation is
ISA 230 – Audit Documentation. The standard requires auditors to properly
document the audit so that:
1- The audit documentation can act as a proof of work performed by the auditor,
on which the audit opinion is based on. The auditors are accountable for the
opinion they issue, the documentation of audit helps auditors confirm their
accountability.
2- The audit documentation can help serve as evidence that the auditors
followed the international standards on auditing and other regulatory and
statuary requirements.
3- The audit documentation can help in the review of the audit work performed,
to ensure correct opinion is issued based on evidence gathered.

www.iproeducation.com
 IPRO EDUCATION
+917742693555

4- The audit documentation can help in the professional development of the

auditors, the supervision and review help the auditors groom and improve.
5- The audit documentation kept as for permanent files of the clients can help in
understanding the entity and planning the next audit for the same client.

Part (c)
Work performed on work in progress
Keeping in mind the materiality and significance of the account head, applying only
two audit procedures to verify a balance of $5.6 million is not sufficient. The audit
work performed on this permanent (balance sheet) account should cover all the
aspects of the account head, taking note of all the relevant assertions, which
include completeness, existence, rights and obligations, valuation and management
assertions relating to disclosures.

The additional work that the auditors should perform is:

1- Inspecting the procurement process of the selection of the construction
company, to ensure that the procurement policy was properly followed.
2- Reviewing the bid analysis, to ensure that the selection of the construction
company was properly justified.
3- Obtain phase completion confirmations from the selected Engineering
consultants to ensure that the amount capitalised is in accordance with the
progress of construction.
4- Review the competency, professional background and profile of the selected
Engineering consultants to ensure that reliance can be placed on the judgment and
work of the selected consultants.
5- Reconcile the total payments made to the construction company with the
amount capitalised.
6- Obtain payment confirmations from the construction company for payment of
invoices issued against phase completions.
7- Review the construction contract between ZL and the construction company to
ensure that phase completions invoiced for are in accordance with the contract.
8- Recomputed the measurements and estimations provided by the construction
company to ensure the accuracy of cost.
9- Obtain the view/opinion of independent experts on the reasonableness of the
estimates and measurements provided by the construction company to ensure
accuracy.
10- Inspect the sufficiency of the disclosures presented in the notes to the financial
statements for the explanation of work in progress.
www.iproeducation.com
 IPRO EDUCATION
+917742693555

Question 3

Part (a)
Events that cast significant doubt over the going concern assumption
The ISA 570 – Going concern segregates the events that cast significant doubt
over the going concern assumption into three main areas:

Financial
The events casting doubt on the going concern, which relates to the financial
performance and the financial position of the company, belong to this area. The
auditors are expected to evaluate the information appearing in the financial
statements (profitability, liquidity, solvency, cash flow, investor relations, etc.) to
evaluate the going concern assumption of the company.

Operating
The events casting doubt on the going concern, which relates to the operations of
the company, belong to this area. The auditors are expected to evaluate
competition, management’s intention, management’s competency, operational
capacity of the business to evaluate the going concern assumption of the
company.

Other
Other issues that cast significant doubt on the going concern are categorised
here, these include changes in regulations, litigations on company or other
natural disasters adversely affecting the ability of the company to function till
foreseeable future.

Part (b)
Going concern assumption of Hike Inc.
Financial
The financial extracts of Hike Inc. are used to calculate the financial ratios of the
company in table 1, to help evaluate the financial performance and position of
the company.
The company has moved from being profitable to loss making, the net profit
margin has reduced from +0.6% to -2.5%. Although, last year the company barely
managed to give a profit, the situation has gravely deteriorated in 2016.

www.iproeducation.com
 IPRO EDUCATION
+917742693555

The current ratio of the company shows an improvement, but this, if is seen in
conjunction with the working capital of the company, can be interpreted
differently. We see a drastic increase in the accounts receivable, inventories and
accounts payable, such an increase is not a good sign. The operating cash flow is
negative depicting that operations and working capital management of the
company is very inefficient. The increase in inventory signals inventory
mismanagement and risk of obsolesce. The increase in receivables signals
ineffective recovery and credit policy, the company is not receiving cash on time
against the sales. Another concern is that the revenue of the company has reduced
in 2016, still accounts receivable and inventory has increased, this is a very
negative sign on the working capital management of the company. An increase in
payables signals Hike’s inability to meet its current obligations on time, as evident
from the negative operating cash flows, the company simply does not have
enough money to meet its current liabilities. This indicates solvency and liquidity
issues for the company.

The quick ratio shows a better picture of the liquid of the company as it shows a
gradual reduction, despite an increase in the current ratio. The quick ratio for 2015
and 2016 both are below 1, this indicates that the operational efficiency of the
company was deteriorating slowly.

The major concern for the company should be solvency, the finance cost has
increased significantly and the PBIT has deteriorated from 2015 to 2016. Hike Inc.
does not seem to be able to meet its current liabilities, the interest coverage has
reduced to a negative 2%, indicating that the finance cost of the company has
increased from the PBIT. The company cannot continue in this state. The operating
cash flows are negative, the company is declaring losses, and the company is not
able to pay its payables or finance cost. At this rate that company will soon
become insolvent and bankrupt.

The problems identified in solvency can be traced to the capital structure of the
company, the debt to equity ratio of Hike Inc. has increased to 115%. This can be
linked with company’s inability to support working capital, to finance the
operations, Hike Inc. has taken out a loan from the bank, the increase in the
gearing has further increased the finance cost.

www.iproeducation.com
 IPRO EDUCATION
+917742693555

Finally, the operating cash flow to sales has also become negative, this indicates
very ineffective operations, all the issues the company is facing can be traced back
to this ratio. If Hike Inc. is not able to generate positive cash flow from its
operations, it cannot pay-off its current liabilities. To maintain solvency the
company had to borrow a loan, which further increased the chances of liquidation.

Operational
The competitive environment of the company is becoming fiercer, the increase is
competition can be the reason of reduced sales of the company. Hike Inc. might
need to diversify its operations to help increase its sales and efficiency of its
operations.
The loss of top management can be the reason of inefficient operations, the cash
flow situation of the company is such that it cannot retain its employees. Loss of
employees to competitors again cast significant doubt on the going concern of
Hike Inc., taking account of the financial conditions of the company.
The inability of Hike Inc. to retain the employees is another problem that Hike Inc.
needs to tackle as soon as possible. If the company shows no improvement in the
operating cash flows, the company will not be able to meet its debts or afford
good employees.

Other
Another problem that (in conjunction with inverse in gearing and reduction in the
solvency of the company) casts significant doubts on the going concern of the
company is the litigation that it is under due to malfunctioning of its products. A
provision of $55,000 is created in the accounts, this provision can be the reason of
making a loss in 2016, but the ability to meet this obligation seems very remote.

Conclusion
Looking at the financial, operating and other events that cast doubt over the going
concern of Hike Inc. it highly probable that company might default in near future,
looking at the increasing gearing and deteriorating operating cash flows, we can
conclude that Hike Inc. should not prepare accounts on going concern assumption.

www.iproeducation.com
 IPRO EDUCATION
+917742693555

Table 1

Ratio Formula 2016 2015

Net profit Net profit / sales x 100 (2.67%) 0.56%

margin
Current ratio Current assets / current 1.70 1.39
liabilities
Quick ratio (Current assets - inventory) / 0.80 0.83
current liabilities
Interest cover PBIT / interest (0.33) 2.00

Debt to equity Debt / equity 115% 20%

Operating cash Operating cash flow / sales x (1.00%) 1.67%

flow to sales 100

www.iproeducation.com