DRC-ICAB Mock Test March – April 2021

Audit & Assurance

Time allowed – 3 hours Total marks – 100

[N.B. –Question must be answered in English. Examiner will take account of the quality of language
and of the manner in which the answers are presented. Different parts, if any, of the same question
must be answered in one place in order of sequence.]

1. You work as senior at Khan Sabur & Co., a Chartered accountant firm. Khan Sabur & Co. (KSC) is
relatively a new firm. Although it gained popularity by performing different advisory and consultancy
works in last few years, but it started its audit practice very recently. Mr. Khan, partner of the firm,
has sent you following email.

To : You
From : Khan
Subject : New Client – Masum Pharma Limited

Hi, Recently I had a meeting with Masum Pharma Limited (MPL) to conduct the audit the financial
statements for the year ended 30 June 2020. MPL is also a relatively new company like us and is
currently engaged in manufacturing and distribution of animal health products. It started its operation
in 1st July of 2019 and just completed its second year of operation.

I had an initial meeting with the management last week. I have attached the meeting memo with the
mail (See Exhibit C). In the meeting I have requested management of MPL to share the previous
audited financial statements as part of initial assessment for accepting client. They have sent the
Extracts of the audited financial statements which has been attached (Exhibit B). They also have
shared a brief background of the Company (Exhibit A).

I have concerns regarding our resources, most of our personnel are engaged in consultancy works or
other audit engagements. We only have few junior staffs who does not have experience in the
pharmaceutical industry. I guess you have to take charge of this engagement. Addition of MPL audit
engagement will increase our client portfolio.

I have a meeting with the client management next week to confirm our acceptance of the audit
engagement. I need you to go through each of the attachments and prepare for the engagement. Come
back to me if you face any issue.

Khan
Partner, Khan Sabur & Co.,

Exhibit A (Background of MPL)

Masum Pharma Limited (MPL) was incorporated in 01 July 2019 with a vision to manufacture and
distribute good quality animal health product throughout the country. MPL is jointly owned by Mr.
Masud Monir & his wife Mrs. Shaila Monir. Prior to starting own business, Mr. Masud worked as head
of marketing for a very long time in a multinational animal health product company. Mrs. Shaila Monir
has vast experience in production management. Both of them used their experience in forming the
company.

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Audit & Assurance
MPL is operating from its head office at Dhaka. At present MPL does not own any plant or distribution
centres. It is currently manufacturing its product in a third-party plant and using their distribution
network. However, MPL has plan to setup its own plant. It has already purchased land for a small
factory and manufacturing licence for some products from a foreign company.

At present MPL has 4 different products which are sold mostly at the small locality of Gazipur.
Although the company is yet to reach the breakeven point, sales are increasing and shows good
prospect.

Exhibit B (Extract from audited financial statements of Year End 2020)

Masum Pharma Limited (MPL)

Statement of the Financial Position
As at 30 June 2020

Particulars Amounts Particulars Amounts

(‘000) (‘000)
Assets Equity & liabilities

Non-current assets Equity

Property, plant & equipment 7,800 Share capital 4,000
Intangible assets 2400 Retained earnings (1,320)
10,200 2,680
Current Assets Current Liabilities
Inventory 1,500 Short term loan 8,300
Advance, deposits & prepayments 3,770 Accruals 2,200
Receivables 5,330 Provisions 1,000
Cash & cash equivalents 200 Payables 6,820
10,800 18,320

Total assets 21,000 Equity & liabilities 21,000

Masum Pharma Limited (MPL)

Statement of the Financial Position
As at 30 June 2020
Particulars Amount
(‘000)
Revenue 6,120
Less: cost of revenue (3,672)
Gross profit 2,448
Less: Operating profit (3,586)
Loss before tax (1,138)
Less: finance cost (182)
Loss for the year (1,320)

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Audit & Assurance
Exhibit - C (Memo of the meeting with MPL management prepared by Mr. Khan)
Mr. Masud Monir, Chairman of MPL Board of Directors, requested for an official meeting when we met
in a business conference. In our initial meeting, Mr. Masud expressed his intention to change the
current auditor of MPL. I informed him that KSC has started auditing very recently and very much
interested to take the audit engagements.

Today I had a formal meeting with Mr. Masud Monir & his wife Mrs. Shaila Monir at MPL’s office. Both
of them are co-founder of MPL and each owns 50% shares of MPL. After we introduced our firm and
its services, Mr. Masud presented a brief background of the company (Exhibit A). He informed me
that MPL is in its start-up phase and just completed its second year of operation. Mrs. Shaila indicated
that the board has large business plans at hand which will be implemented once the company becomes
stable. Although the company is yet to reach at breakeven point, board is confident about its success.

However, at present company is facing some problem which must be addressed immediately. MPL is
currently going through a liquidity crisis as it required to provide extended credit terms to the
distributors and pharmacies. Furthermore, MPL had to incur huge promotional expenditure which
was not considered at the initial stage. At present MPL is meeting is requirement of working capital
through short term financing at a higher finance cost. Management of the company is thinking of
taking a long-term loan at a reduced interest rate in order to refinance the short-term loan obligations.
Bank has expressed its interest to provide loan based on the prospective financial statements but with
some strong covenants.

When asked about the previous auditor, Mrs. Shaila have informed me that financial statement of YE
2016 was audited by Mannan Nahid & Co (MNC), Chartered Accounts. Their fees appeared bit high to
MPL considering MPL was first year of operation and a loss-making concern. Furthermore, MNC has
requested MPL to increase audit fee in respect of financial statement for YE 2017. MPL management
is interested to reduce its current expenditure. So, board has decided to change the auditor and now
looking for auditors who will charge lower fees or at least similar to 2016 audit fee. Mr. Masud
presented me the last year audited report which included limitation of scope regarding inventory and
receivable confirmation. I requested for a copy of the financial statements which Mr. Masud agreed to
send through email. I also asked Mr. & Mrs. Masud regarding the current year financial statements.
They have informed me that current year financial statements are not prepared yet. Some of the
documents related to inventory purchase are missing. They might need our help in preparation and
fair presentation of the financial statements.
Requirements:
1. What factors should be considered and what procedures should be performed by KSC before
accepting the MPL audit engagements? (6 marks)
2. Identify and explain any ethical or professional issues that might arise from accepting the audit
engagements. Suggest appropriate safeguards which should be taken to address the ethical or
professional issues (8 marks)
3. List the elements of Quality Control as per BSQC 1 that KSC should consider (6 Marks)
4. Consider that KSC has decided to accept MPL audit engagement. Draft an engagement letter for
MPL audit. (8 marks)
5. Define is business risk and audit risks. What are the components of audit risks? (7 marks)

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Audit & Assurance
2. a) You are currently developing audit plans for your client Smitha Engineering Limited (SEL) for the
year ending 30 June 2020. SEL was founded 3 year earlier but still not reached to breakeven.
Company has completed setting up its production plant which was financed by taking bank loan.
Shareholders of the company is now focusing to increase its market share and revenue. As a result,
they are incurring significant administrative and selling expenses. Your firm has audited the
financial statements of SEL in prior period and identified significant non-compliance of reporting
standards and required several adjustments in the financial statements to achieve fair
presentation. In its financial statements for the year ended 30 June 2020, SEL has reported
following financial information:

Total Asset 9,000,000 Revenue 15,000,000

Total Equity 5,000,000 Gross Profit 10,500,000
Total Liabilities 4,000,000 Profit before interested & tax 2,250,000
Net loss for the year (875,000)

According to the industry standard following materiality levels are suggested:

1% to 2% of total assets; 2% to 5% of shareholders' equity; 0.5% to 1% of revenue; 1% to 2% of
gross profit; 5% to 10% of net profit.

Requirements:
i. Determine and explain what basis should be appropriate to calculate overall materiality.
(8 Marks)
ii. Explain what percentage of materiality range should be applied in calculating overall
materiality. (5 Marks)

b) Radiance System Limited (RSL) is a lighting company producing indoor and outdoor lighting
products like CFL and LED lightbulbs for residential and industrial downlighting purpose; It
also produces lighting products to Healthcare use, decoration, Commercial use lighting,
billboard lighting, Landscape lighting, Roadway, Floodlights etc.
Management of RSL are operation focused and keen to increase the market size for RSL. For
this purpose, Accounting, Payroll and taxation service has been outsourced to 2 Service
organizations, Olive Consulting Group (Olive) and HR Solutions (HRS). Under this
arrangement Olive is responsible for initiating, recording, processing and reporting day to day
transactions and preparing the Financial Statements. Olive also provides taxation service like
calculating salary tax for RSL employees, Annual Income tax for RSL, Submission of corporate
tax returns. In other part, HRS is responsible for processing payroll data like attendance,
increment, overtime etc and finalizing gross & net salaries. HRS shares the monthly salary
statements to Olive which then pass the appropriate accounting entry.

RSL has also appointed an audit firm for internal audit which is responsible for testing the
operating and design effectiveness of existing controls and suggest for improvements where
necessary. Internal auditor also reviews the accounting records and related supporting
documents.

RSL runs a defined benefit plan to provide post-employment benefit for its employees. At the
year-end, RSL has appointed an actuary to determine the present obligation for post-
employment defined benefit plan. Actuary has submitted his report and the amount determined

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Audit & Assurance
by the actuary has been reported in the financial statements of RSL for the year ended 30
September 2019. Your firm has appointed as auditor of RSL for the year ended 30 September
2019 and you have been assigned as engagement manager.
Requirements:
i. How use of service organizations by RSL will impact your audit planning? What procedures
you will perform related to service organizations? (8 Marks)
ii. As external auditor, what factors you need to evaluate to determine whether the internal audit
function can be used for your audit? (6 Marks)
iii. What should be included in your audit documentation if you decide to use the work of internal
auditor of RSL? (6 Marks)
iv. What procedures you will need to perform when the post-employment benefit obligation
determined by the actuary will be considered as audit evidence? (7 Marks)

3. a) You are auditing Banana Limited. Planning Materiality for Banana has been set at BDT 800,000
and performance materiality has been considered at 50% of the planning materiality due to the
apparent inherent risks of the company. Audit procedures has identified that:

 Revenue has been overstated by 220,000 as goods remained undelivered.

 For the above reason, Cost of revenue has been overstated by BDT 185,000.
 BDT 255,000 exchange gain has not been recognized as foreign currency denominated
monetary items were not revalued at the year end.
 FDR interest income of BDT 190,000 has been netted of with Salary expenses.

Management has adjusted first 2 items by reversing the overstated revenue and cost of revenue.
However, they are unwilling to adjust remaining 2 items.

Requirements:
i. Identify and conclude on the effect the uncorrected misstatements. How it will affect your
audit opinion. (8 Marks)
ii. What items should be documents in support to audit opinion formed. (4 Marks)

b) Your firm has been appointed as the auditor for Nova Group Limited (Nova). Group consists of
two other subsidiaries both are material to Nova. Subsidiaries of Nova are being audited by two
other auditors. You have sent group instruction to both of the component auditors. Component
auditors have followed your instruction and issued qualified opinion on revenue recognition,
allocation of overheads to inventories and capitalization of non-current assets.
Requirements:
i. What procedures you will follow for using works of component auditors? (5 marks)
ii. What matters should be documented by group auditors while relaying on the works
of component auditors? (5 marks)
iii. How component auditors’ report will impact your audit opinion? (3 marks)

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