PROFESSIONAL LEVEL EXAMINATION

MONDAY 16 MARCH 2015

(2½ hours)

AUDIT AND ASSURANCE

This paper consists of SIX short-form questions (20 marks) and THREE long-form questions
(80 marks).

1. Ensure your candidate details are on the front of your answer booklet. You will be
given time to sign, date and print your name on the answer booklet, and to enter
your candidate number on this question paper. You may not write anything else until
the exam starts.

2. Answer each question in black ballpoint pen only.

Short-form Questions (1 – 6)

3. Answer the short-form questions in note form only. Complete sentences are not
required.

4. Answers to each short-form question must be submitted in numerical order.

Long-form Questions (7 – 9)

5. Answers to each long-form question must begin on a new page and must be
clearly numbered. Use both sides of the paper in your answer booklet.

6. The examiner will take account of the way in which answers are presented.

7. When the assessment is declared closed, you must stop writing immediately. If you
continue to write (even completing your candidate details on a continuation booklet),
it will be classed as misconduct.

You MUST enter your candidate number in this box.

ontain confidential information and must NOT be removed from the examination hall.

DO NOT TURN OVER UNTIL YOU ARE INSTRUCTED TO BEGIN WORK

Copyright © ICAEW 2015. All rights reserved. Page 1 of

BLANK PAGE
1. One of your clients, Frowzen Ltd (Frowzen), is a small company which is not legally required
to have an external audit. Frowzen’s managing director owns 75% of the company’s share
capital.

Explain the benefits to small companies such as Frowzen and their shareholders of
voluntarily undergoing an external audit. (3 marks)

2. Your firm has recently been appointed as external auditor of Flayke Ltd (Flayke). Flayke
owns a number of luxury hotel resorts throughout Europe. Flayke’s finance director has
suggested that the planning meeting for the forthcoming audit is held at one of Flayke’s
resorts. He has also suggested that the members of the audit team and Flayke’s finance
department stay at the resort for four nights, at Flayke’s expense, to get to know each other
better.

Identify and explain the threats to your firm’s independence and objectivity presented by the
finance director’s suggestion and state how your firm should respond. (3 marks)

3. Snoe plc (Snoe) has four factories in the UK and one in Poland. It is required to prepare a
greenhouse gas (GHG) statement, which discloses information about the company’s
GHG emissions, in accordance with specific industry regulations. Your firm, which has
offices in the UK, has been appointed by Snoe to perform a reasonable assurance
engagement, in respect of the GHG statement, and report its findings.

List the factors your firm should consider when planning how to resource this assurance
engagement. (4 marks)

4. Your subsequent events review, performed during the audit of Ice Ltd for the year ended
31 December 2014, included reading the minutes of board meetings held after the year
end. Minutes of the board meeting held on 16 February 2015 identified that the company
failed a routine health and safety inspection performed by industry regulators in January
2015.

Outline the further audit procedures you should perform in respect of this matter. (3 marks)

5. List the key differences between the auditor’s report issued in respect of an audit conducted
under the Companies Act 2006 and an assurance report issued in respect of an engagement
to examine prospective financial information. (4 marks)

6. During the external audit of Whinter Ltd your firm has identified a material inconsistency
between the directors’ report and the financial statements.

State the actions your firm should take and outline any potential implications for the auditor’s
report. (3 marks)

QUESTION 6 COMPLETES THE SHORT-FORM QUESTIONS

LONG-FORM QUESTIONS (7 – 9) FOLLOW

7. Your firm has recently been appointed as the external auditor of Weselton plc (Weselton)
which is your firm’s largest and only listed client. You are the senior responsible for
planning the external audit for the year ended 28 February 2015 and the engagement
partner has asked you to consider the following key areas of audit risk:

(1) Work in progress

(2) Trade receivables

Weselton provides global relocation services to corporate customers. Services include

project management of overseas relocation of offices and employees.

For each relocation project, Weselton estimates the cost of supplying services based on
customer requirements and the locations in which the services will be supplied. An indicative
price is provided to the customer equal to the estimated cost plus a mark-up of 35%. Actual
costs incurred often vary from estimated costs due to changes in customer requirements
during the relocation project or unforeseen issues resulting in higher than expected costs. On
completion of each project, the customer is invoiced, in sterling, for actual costs incurred plus
the 35% mark-up. Credit terms are 30 days.

Weselton employs a small team of project managers who manage multiple projects.
However, the majority of costs billed by Weselton arise from the use of external suppliers and
other third parties. Costs include payments to local employment agencies for temporary
personnel who pack the items to be relocated, fees for overseas legal and HR advice, local
visa and immigration costs, shipping and transport fees and insurance costs.

Temporary personnel submit timesheets to local employment agencies which invoice

Weselton each month for the total hours worked at rates agreed with Weselton. Invoices may
include hours relating to more than one relocation project. Other suppliers invoice Weselton
for services at varying points during the relocation and some overseas suppliers invoice in
their local currency. All costs incurred, including those of Weselton’s own project managers,
are recorded in the job costing system against a unique code for each relocation project. Any
costs recorded for projects not completed at 28 February are included as work in progress in
the year-end financial statements.

Weselton’s financial controller, Olaf Cyro, has provided you with the following information:

 In July 2014, the directors decided that the job costing system was outdated. A
replacement system was implemented on 21 January 2015 and use of the old system
ceased immediately. A delay in training employees on the new system resulted in a
backlog of costs to be recorded and some customers were invoiced before all the costs
relating to their projects were included on the new system. Additional invoices in
respect of the omitted costs, plus the 35% mark-up, were sent to customers in February
or are due to be sent by 31 March 2015.

 Bulda GmbH (Bulda), a customer, is refusing to pay its balance outstanding at

28 February 2015 due to a disagreement over the amount invoiced in respect of its
relocation project. The disagreement has arisen due to a significant variation between the
indicative price and the actual amount invoiced. The balance due from Bulda at
28 February 2015 is £1.8 million. The original indicative price provided was £1.3 million.
Olaf believes all of the additional costs arose due to changes in Bulda’s requirements
during the relocation and that the full amount is recoverable.
  Weselton’s previous auditors did not seek reappointment after completing the
external audit for the year ended 28 February 2014. During that audit, reliance was
placed on the controls over the job costing system. Olaf requested that your firm also
relies on those controls as he believes this will ensure the audit is conducted
efficiently.

Olaf also provided you with the following extracts from the financial statements of
Weselton to use as part of your consideration of the key audit risks:

Statement of profit or loss for the year ended 28 February

2015 (draft) 2014 (audited)
£’000 £’000
Revenue 45,467 41,339
Cost of sales (30,795) (30,622)
Gross profit 14,672 10,717

Statement of financial position as at 28 February

2015 (draft) 2014 (audited)
£’000 £’000
Work in progress 7,171 5,034
Trade receivables 5,481 3,741

Your discussion with Olaf also revealed the following internal control deficiencies:

(i) Customers are not required to provide written confirmation of changes to their
requirements arising during a relocation project.
(ii) Project managers do not monitor actual costs incurred to date compared with
the estimated cost of each project.

Requirements

(a) List the matters your firm should have considered and the procedures it should have
performed before accepting appointment as external auditor of Weselton. (10 marks)
(b) Justify why work in progress and trade receivables have been identified as key areas
of audit risk and, for each one, describe the procedures that should be included in the
audit plan in order to address those risks.
You should present your answer in a two-column format using the headings:
(i) Justification; and
(ii) Procedures to address each risk. (18 marks)

(c) Explain why reliance on controls over the job costing system, requested by Olaf, is
unlikely to be appropriate in respect of the audit for the year ended 28 February
2015.
(5 marks)

(d) For each internal control deficiency listed as (i) and (ii) in the scenario, draft points for
inclusion in your firm's report to those charged with governance and management at
Weselton. For each deficiency, you should outline the possible consequence(s) of the
deficiency and provide recommendations to address it. (7 marks)

Total: 40 marks
8. Your firm has been the external auditor of Arendelle Ltd (Arendelle) for a number of years
and has recently been engaged to perform a review of Arendelle’s interim financial
information for the six months to 31 January 2015. Arendelle’s bank has requested interim
financial information in support of a loan application and requires the information to be
reviewed and reported on by Arendelle’s auditor. Your firm’s review is to be conducted in
accordance with ISRE 2410 and will consist of making enquiries and applying analytical and
other review procedures.

Arendelle supplies boxes of fruit and vegetables to households and businesses in the east of
the UK. Deliveries are spread evenly throughout the year and revenue is collected by direct
debit on the day of delivery. Arendelle’s delivery vehicles are currently fully utilised. The
directors have requested the bank loan to invest in new delivery vehicles so the company can
extend its service to other areas of the UK.

You are the senior responsible for the review engagement and you recently met with
Arendelle’s finance director, Elsa Duke, who provided you with the following information
regarding events in the six months since 31 July 2014:

 Arendelle contracted to supply 22 nursing homes. On average, each contract is worth

£20,000 pa and supplies commenced on 1 August 2014. Arendelle allowed 30-day credit
terms on these specific contracts.

 To meet the increased demand from the nursing home contracts, Arendelle commenced
purchasing fruit and vegetables from two new suppliers. The two new suppliers require
payment on delivery in contrast to the 30-day credit terms allowed by Arendelle’s four
existing suppliers.

 On 1 September 2014, Arendelle rented additional space adjacent to its existing storage
facility for the purpose of fulfilling the new nursing home catering contracts.

 20 of Arendelle’s 40 delivery vehicles became fully depreciated on 1 August 2014 but are
still in use awaiting the outcome of the loan application.

 On 30 October 2014, Arendelle paid Trolls Ltd £100,000 for a marketing campaign due
to be launched in April 2015 in the areas of the UK where Arendelle plans to extend its
delivery service.

Elsa also provided you with draft interim financial information for the six months to
31 January 2015 from which you have extracted the following key information for further
review:
Statement of profit or loss for: Six months to Full year to
31 January 2015 31 July 2014
(draft) (audited)
£’000 £’000

Revenue 4,720 6,500

Cost of sales* (3,446) (5,120)
Gross profit 1,274 1,380
Operating expenses** (650) (638)
Profit from operations 624 742

*Cost of sales includes:

Warehouse rent paid 125 180
Depreciation: delivery vehicles 55 110

**Operating expenses include:

Marketing expenses 196 192

Statement of financial position as at 31 January 2015 31 July 2014

(draft) (audited)
£’000 £’000

Trade receivables 62 -

Trade payables 660 435

Elsa commented she is looking forward to your firm’s guidance on how best to present the
interim financial information to increase the likelihood of Arendelle’s bank agreeing to provide
the loan. She also indicated she anticipated Arendelle would be unwilling to pay your firm’s
fee for this engagement if the loan application was not successful.

You agreed with Elsa to meet with her again on 18 March 2015 to discuss any questions you
have arising from your initial review of the draft interim financial information.

Requirements

(a) Explain the ethical issues arising from Elsa’s comments in respect of:

(i) providing guidance on the presentation of Arendelle’s interim

financial information; and

(ii) your firm’s fee being contingent on Arendelle successfully receiving the loan
from its bank.
(3 marks)

(b) As part of your review of the interim financial information, perform analytical procedures
on the information provided and prepare a list of questions which you wish to ask Elsa
at your meeting on 18 March 2015. (17 marks)

Total: 20 marks
PLEASE TURN OVER
9. 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:

(a) Identify and explain the threats to your firm’s objectivity and state the steps that your
firm should take to address them. (12 marks)

(b) 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)

Total: 20 marks
 PROFESSIONAL LEVEL EXAMINATION

MONDAY 8 JUNE 2015

(2½ hours)

AUDIT AND ASSURANCE

This paper consists of SIX short-form questions (20 marks) and THREE long-form questions
(80 marks).

1. Ensure your candidate details are on the front of your answer booklet. You will be given
time to sign, date and print your name on the answer booklet, and to enter your
candidate number on this question paper. You may not write anything else until the
exam starts.

2. Answer each question in black ball point pen only.

Short-form Questions (1 – 6)

3. Answer the short-form questions in note form only. Complete sentences are not
required.

4. Answers to each short-form question must be submitted in numerical order.

Long-form Questions (7 – 9)

5. Answers to each long-form question must begin on a new page and must be clearly
numbered. Use both sides of the paper in your answer booklet.

6. The examiner will take account of the way in which answers are presented.

7. When the assessment is declared closed, you must stop writing immediately. If you
continue to write (even completing your candidate details on a continuation booklet),
it will be classed as misconduct.

You MUST enter your candidate number in this box.

contain confidential information and must NOT be removed from the examination hall.

DO NOT TURN OVER UNTIL YOU ARE INSTRUCTED TO BEGIN WORK

Copyright © ICAEW 2015. All rights reserved. Page 1 of

BLANK PAGE
1. Your firm, a firm of ICAEW Chartered Accountants with over 100 offices throughout Europe,
is planning to move to a new office in London. It proposes to lease at the market rate an
office block from Run plc (Run), one of the largest property companies in the UK. Your firm is
the external auditor of Run.

State, with reasons, whether or not it is appropriate for your firm to lease the office from Run.
(3 marks)

2. 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)

3. Your firm recently conducted the external audit of the financial statements of Oval Ltd (Oval)
for the year ended 28 February 2015. Oval’s bank requested the audited financial statements
before deciding whether to make a loan to Oval. Oval received the loan from its bank but has
defaulted on its first quarterly loan repayment. Your firm’s audit opinion was unmodified.

In respect of the bank having relied on the audited financial statements, explain the possible
consequences for your firm if it has provided an inappropriate opinion in the auditor’s report
on Oval’s financial statements. (4 marks)

4. Your firm is the external auditor of Googly Ltd (Googly). The directors of Googly have
requested that your firm provides a member of staff to assist in the preparation of its annual
financial statements.

Explain the threats to your firm’s objectivity arising from the above and describe the
safeguards, if any, which should be put in place to mitigate those threats. (4 marks)

5. List the factors, for a recurring external audit, that may make it appropriate for an audit firm to
revise the terms of an audit engagement or remind the audited entity of existing terms.
(3 marks)

6. You are the audit junior working on the external audit of Bouncer Ltd (Bouncer). The sales
ledger clerk informed you that when he requested the payment of an overdue amount from
Mr Wicket, a sole trader, he was told by Mr Wicket that the managing director of Bouncer had
personally collected the overdue amount in cash. The managing director subsequently
instructed the sales ledger clerk to write off the overdue amount as a bad debt. The amount
is not material to the financial statements.

State, with reasons, the actions that should be taken by you and your firm in relation to this
matter. (3 marks)

QUESTION 6 COMPLETES THE SHORT-FORM QUESTIONS

LONG-FORM QUESTIONS (7 – 9) FOLLOW

7. Your firm has recently been appointed as the external auditor of Hutton plc (Hutton), a listed
company, for the year ending 30 June 2015. The previous auditors did not seek
re-appointment following the conclusion of the previous year’s audit.

Hutton sells household products through a chain of retail stores in the UK and its own
website. An extensive range of products is offered including the latest electronic equipment
such as smart phones and soft furnishings such as curtains and carpets. Hutton has
experienced many years of rapid growth but recent trading conditions have been difficult due
to competitors offering comparable products at lower prices. In response to the difficult
trading conditions, Hutton has developed a new website to replace the old website and is
planning a reorganisation involving the closure of 50% of its stores.

You are the senior responsible for planning the external audit for the year ending 30 June
2015 and the engagement partner has asked you to consider the following key areas of
audit risk:

(1) Volume-based supplier rebates

(2) Inventory
(3) Intangible assets – website development costs.

The engagement partner has provided you with the following extracts from the financial
statements, to assist with your analytical procedures:

Statement of profit or loss for the year ending 30 June

2015 2014
(estimated) (audited)
£m £m

Revenue 2,329 2,784

Cost of sales (gross) (1,434) (1,489)

Supplier rebates 185 106

Statement of financial position as at 30 June 2015 2014

(estimated) (audited)
Non-current assets £m £m
Intangible assets – website development costs 31 11

Current assets
Inventories 306 220

The engagement partner has also provided you with the following information:

Hutton has negotiated individual terms for supplier rebates, which range from 1% to 15% of
purchases, with each of its 350 principal suppliers. The terms are set out in signed contracts,
with each supplier, which typically run from one to three years. Rebates are paid in arrears to
Hutton on the conclusion of the contract if Hutton exceeds the volumes of purchases
stipulated in the contract. Hutton’s sales managers prepare revenue forecasts for each
product. The revenue forecasts are used by the accounts department to estimate the volume
of purchases that will be placed with each supplier over the contract period. If the volume of
estimated purchases exceeds that required in the contract to earn a rebate, a rebate is
recognised in the financial statements. Spreadsheets are used to collate the information and
calculate the rebate attributable to the current year.
The company has standard operating procedures in every store including electronic point of
sales (EPOS) systems and maintains a perpetual inventory system, which records the
quantities held and the cost price of inventory. Quantities in the perpetual inventory system
are updated from goods received records, the EPOS systems, the company website and the
results of inventory counts. The cost price of inventory is updated from purchase invoices.
Where there is sufficient certainty that a supplier rebate relating to historical purchases will be
received in the future, an adjustment is made to the cost of inventory. Overseas suppliers
invoice in their local currency.

At each month end, the inventory system generates an inventory valuation listing and an
aged inventory report. The valuation listing includes the cost and quantity on hand for each
inventory item. The valuation listing at 30 June 2015 will be used as the basis for the
inventory value in the financial statements as no count will take place at the year end. Hutton
carries out monthly inventory counts at all of its stores and the next inventory count is
planned for 19 June 2015. Your firm has not attended any inventory counts during the year
but the internal auditors have attended inventory counts at a sample of stores throughout the
year.

Employees from Hutton’s IT department commenced work on the replacement website on

1 October 2014 but were unable to resolve a technical issue arising on the interface between
the new website and the perpetual inventory system. A contract was signed with Sweepweb,
a website development company, to resolve this issue and the IT director has stated that the
interface is now working properly. Internal costs are based on the IT director’s estimate of
time spent by Hutton’s staff. The total costs of developing the replacement website are
included as an intangible asset in the financial statements for the year ending 30 June 2015
and are being amortised over ten years.

Requirements

(a) Set out the benefits and limitations of using analytical procedures at the planning stage
of an external audit. (5 marks)

(b) Justify why the items listed as (1) to (3) in the scenario have been identified as key
areas of audit risk and, for each item, describe the procedures that should be
included in the audit plan in order to address that risk.

Note: You should present your answer in a two-column format using the headings:

(i) Justification; and

(ii) Procedures to address the risk. (30 marks)

Total: 35 marks
8. The Financial Reporting Council (FRC) has recently undertaken reviews of the quality
control procedures at your firm including the inspection of a sample of external audit files. It
has reported the following matters to be addressed by your firm.

(1) External audit partners and staff are set targets for selling non-audit services to their
audit clients and, as an incentive, are given credit in their annual pay review when the
target is met or exceeded.

(2) Shane Smith has been the audit engagement partner for Garfield plc, a listed
company, since 2008. No further documentation relating to this issue was available on
the files reviewed.

(3) One external audit file did not show any evidence that work performed by junior
members of the audit team was reviewed by more senior members.

(4) Kapil LLP (Kapil), a firm of consultants, was verbally instructed to act for your firm as
an auditor’s expert providing valuations of property included in the financial statements
of a number of audited entities. Your firm intends to continue to use Kapil but has not
formalised the arrangement.

Requirements

(a) (i) Describe how the FRC promotes improvements in the quality of auditing.
(3 marks)

(ii) Explain why matters (1) to (4) above have been reported to your firm and
describe the actions that your firm should take in respect of each matter.
(10 marks)

(b) (i) In respect of quality control procedures undertaken by audit firms, outline the
differences between:

 an engagement quality control review (hot review); and

 a review as part of the firm’s monitoring procedures (cold review).
(5 marks)

(ii) Set out the attributes required of an individual who is appointed by an audit firm
to undertake engagement quality control reviews. (2 marks)

Total: 20 marks
9a. You are responsible for the external audit of Yorker plc (Yorker) a firm of management
consultants with offices in London, Cardiff and Edinburgh. All consulting services are
provided under fixed-price contracts which state that customers will be invoiced on the
completion of each contract. Yorker requires that its project managers make a weekly
comparison of costs, on each contract with the budgeted costs. During the external audit for
the year ended 31 May 2015, you identified the following significant internal control
deficiencies:

(1) At the Cardiff office, 25% of the work in progress balance at the year end related to
completed projects which were delivered to customers before the year end but had not
yet been invoiced.

(2) At the Edinburgh office, project managers had not performed the weekly comparison
of actual against budgeted costs in 30% of the contracts examined by the auditors.

Requirement

Draft points for inclusion in your firm’s report to those charged with governance and
management at Yorker. For each of the two internal control deficiencies identified above, you
should outline the possible consequence(s) of the deficiency and provide recommendation(s)
to address the deficiency.

You should present your answer in a two-column format using the headings:

(i) Consequences; and

(ii) Recommendations. (9 marks)

PLEASE TURN OVER

9b. Your firm is the external auditor of Spinball plc (Spinball) for the year ended 31 May 2015.
Spinball distributes pharmaceutical products and 40% of its revenue comes from Turkey
where the government requires Spinball to have a licence to operate. The regulatory situation
in Turkey is undergoing considerable change and Spinball expects its licence to operate in
Turkey to be withdrawn. However, after carrying out an assessment of the entity's ability to
continue as a going concern, the directors have decided that Spinball has sufficient
resources to continue operating for the 18 months ending 30 November 2016. Additional
funding may be required from that date but Spinball does not currently have this in place.

Spinball is a listed company and is required to apply the UK Corporate Governance Code.

Requirements

(i) Briefly state the additional disclosure requirements that should be included in the
auditor’s report on the financial statements of listed companies that are required to
apply the UK Corporate Governance Code. Identify and explain the attributes that are
required to make these disclosures effective. (4 marks)

(ii) State, with reasons, the implications for the auditor’s report on Spinball’s financial
statements for the year ended 31 May 2015 if the directors of Spinball:

(1) adequately disclose; or

(2) do not disclose

the information in respect of the licence to operate in Turkey in the notes to the financial
statements. (7 marks)

(iii) State, with reasons, the implications for the auditor’s report if the directors had based
their assessment of the company’s ability to continue as a going concern on financial
forecasts for the six months ending 30 November 2015, instead of the 18 months
ending 30 November 2016. (5 marks)

Total: 25 marks
 PROFESSIONAL LEVEL EXAMINATION

MONDAY 7 SEPTEMBER 2015

(2½ hours)

AUDIT AND ASSURANCE

This paper consists of SIX short-form questions (20 marks) and THREE long-form questions
(80 marks).
1. Ensure your candidate details are on the front of your answer booklet. You will be
given time to sign, date and print your name on the answer booklet, and to enter your
candidate number on this question paper. You may not write anything else until the
exam starts.

2. Answer each question in black ball point pen only.

Short-form Questions (1 – 6)

3. Answer the short-form questions in note form only. Complete sentences are not
required.

4. Answers to each short-form question must be submitted in numerical order.

Long-form Questions (7 – 9)

5. Answers to each long-form question must begin on a new page and must be
clearly numbered. Use both sides of the paper in your answer booklet.

6. The examiner will take account of the way in which answers are presented.

7. When the assessment is declared closed, you must stop writing immediately. If you
continue to write (even completing your candidate details on a continuation booklet),
it will be classed as misconduct.

You MUST enter your candidate number in this box.

contain confidential information and must NOT be removed from the examination hall.

DO NOT TURN OVER UNTIL YOU ARE INSTRUCTED TO BEGIN WORK

Copyright © ICAEW 2015. All rights reserved. Page 1 of

BLANK PAGE
1. Explain why it is important for an external audit firm to assess the integrity of a prospective
client's management prior to accepting an audit engagement. (4 marks)

2. You are the audit senior responsible for the external audit of Krill Ltd (Krill). The
engagement partner has requested that you undertake a review of the work recently
performed by the audit junior during the audit of Krill’s financial statements.

List the purposes of the review requested by the engagement partner. (3 marks)

3. Your firm has recently accepted appointment as external auditor of Herring Ltd (Herring), a
competitor of Hake Ltd (Hake). Your firm has acted as external auditor of Hake for a number
of years. Both companies have provided your firm with informed consent to act.

Outline the procedures that your firm should implement to address any potential conflicts of
interest arising out of this appointment. (3 marks)

4. You are responsible for planning the external audit of Squid Ltd (Squid) for the year ending
30 September 2015. Today, you read a newspaper article stating that Squid, a manufacturer
of dried food products, has recalled its leading baby milk powder from supermarkets due to
a number of batches being contaminated with substances that may be harmful to babies.

Briefly explain the matters you should consider, as part of your audit planning, as a result of
reading the newspaper article. (4 marks)

5. Your firm is concluding its audit of the financial statements of Turtle Ltd (Turtle) for the year
ended 31 March 2015. The audit work has identified a number of misstatements, which are
individually immaterial, in transactions and account balances recorded in the statement of
profit or loss and statement of financial position.

State the actions your firm should take in relation to the misstatements before reaching its
audit opinion on the financial statements of Turtle. (3 marks)

6. Outline the differences between the conclusion expressed following an engagement to review
financial statements and the opinion expressed in an external audit report on financial
statements. Give reasons for these differences. (3 marks)

QUESTION 6 COMPLETES THE SHORT-FORM QUESTIONS

LONG-FORM QUESTIONS (7 – 9) FOLLOW

7. Your firm has recently been appointed as the external auditor of Haskett Ltd (Haskett), a
wholly-owned subsidiary of McCarthy Travel Group Ltd (MT Group).Your firm has been the
external auditor of MT Group for a number of years. The group audit is performed by an audit
team based in your firm’s London office.

MT Group owns a number of subsidiaries that operate bus services in five regions of the UK.
In July 2014, MT Group was awarded a new contract, by a government body, to provide bus
services in the east of England. On 1 August 2014, MT Group created a new company,
Haskett, to supply the bus services under the new contract. All revenue and costs relating to
fulfilment of the contract are recorded in Haskett’s own accounting records.

You are the audit senior responsible for the audit of Haskett’s financial statements for the
year ended 31 July 2015 and you are based in your firm’s office located in the east of
England. Your responsibilities include preparing the audit plan and communicating with the
group auditor in your firm’s London office. The engagement partner for the Haskett audit,
Mandy Winter, has asked you to consider the following key areas of audit risk:

(1) Revenue
(2) Property, plant and equipment – buses
(3) Legal claim against Haskett

Passengers can pay for journeys taken on Haskett’s buses in the following ways:

 purchase of a ticket using cash when boarding a bus

 electronic contactless card which the customer has pre-loaded with funds.
Customers touch their contactless card on a card reader when boarding a bus and
a single fare is deducted from the funds available on the card
 purchase of a season ticket, through Haskett’s website, which allows unlimited
travel on Haskett’s bus routes for a period of three, six or twelve months

The contactless card system is operated by Dolphin Systems Ltd (Dolphin). Dolphin was
formed in June 2014 by Clay McCarthy who was appointed as managing director of Haskett
in August 2014. Clay owns 100% of the share capital of Dolphin.

Revenue from season ticket sales is recognised evenly over the relevant season ticket
period. All other revenue is recognised on the day of travel. Haskett’s customers load funds
onto a contactless card through Dolphin’s own website, payment is taken and the funds held
by Dolphin until the customer makes a bus journey. Data from the Dolphin card reader on
each bus is electronically transmitted to Dolphin’s central computer at the end of each day.
The central computer software calculates the amount due to Haskett and the funds are
electronically transferred, on a daily basis, to Haskett’s bank account, after deducting a 12%
commission charge. No checks are made by Haskett regarding the amounts calculated and
transferred by Dolphin. This is the first time any MT Group subsidiary has used a contactless
card system on its buses.

Haskett operates a fleet of buses half of which consists of buses purchased at market value
from other MT Group subsidiaries and refurbished by Haskett’s own employees. The rest of
the fleet consists of new buses purchased from EchoBus Ltd (EchoBus), a UK bus
manufacturer. All costs associated with both purchasing and refurbishing the fleet have been
recognised as property, plant and equipment in Haskett’s financial statements. All buses are
being depreciated over ten years.
The east of England bus service contract runs for eight years and required Haskett to
commence bus services on 1 February 2015. However, due to delays in the manufacture of
the new buses by EchoBus, a significantly reduced service commenced on 1 February 2015
and the full service commenced on 1 April 2015. The government body that awarded the
contract has made a claim for damages against Haskett of £250,000 for breach of contract.
The outcome of the claim will not be known until after the audit report on Haskett’s financial
statements is due to be signed. Haskett’s directors do not wish to include a provision or make
any disclosure in respect of the claim as they intend to make their own claim of £250,000
against EchoBus.

Mandy has provided you with the following draft extracts from the financial statements of
Haskett and budget information, prepared by MT Group when tendering for the new contract,
to be used as part of your consideration of the key audit risks. Mandy also informed you that
Haskett’s draft profit before tax for the year ended 31 July 2015 is £538,000.

Statement of profit or loss for the year ended 31 July 2015 (extract)

Actual Budgeted
(draft)
£’000 £’000
Revenue 8,975 7,450
Cost of sales (7,180) (6,183)
Gross profit 1,795 1,267

Statement of financial position as at 31 July 2015 (extract)

Actual Budgeted
(draft)
£’000 £’000
Property, plant and equipment – buses 4,900 3,500

Requirements

(a) Justify why the items listed as (1) to (3) in the scenario have been identified as key
areas of audit risk and, for each item, describe the procedures that should be included
in the audit plan in order to address those risks.

You should present your answer in a two-column format using the headings:

(i) Justification; and

(ii) Procedures to address each risk (25 marks)

(b) Set out the matters you should consider, as part of your audit planning, arising from:

(i) the ownership of Dolphin by Clay McCarthy; and

(ii) Haskett being a component of MT Group.
(10 marks)

Total: 35 marks
8. Your firm is considering whether to accept the following four unrelated
prospective engagements:

Clymene Ltd (Clymene)

Your firm has been the external auditor of Clymene for a number of years. Clymene has
recently reduced the number of employees working in its accounts department to save costs.
The directors have asked your firm to accept reappointment as external auditor for the year
ending 31 December 2015 and have requested that your firm prepares the year-end financial
statements in addition to the audit. Your firm has not prepared the financial statements in
previous years. The engagement partner has estimated that your firm’s current fee from
Clymene, of £600,000, would increase by 25% as a result of providing the additional service.
Your firm’s gross annual fee income, excluding amounts received from Clymene, is
£6.4 million.

Dusky Ltd (Dusky)

Your firm’s report to management and those charged with governance, prepared during the
external audit of Dusky for the year ended 30 September 2014, identified a number of
significant internal control deficiencies in Dusky’s inventory system. In March 2015, the
company modified its inventory system to address the deficiencies identified in your firm’s
report. The directors of Dusky have requested that your firm accept an engagement to
evaluate the design and operation of the system and confirm in an assurance report that the
system is now free from any control deficiencies.

Risso Ltd (Risso)

Risso is a marine biology research and development company. The directors of Risso have
approached your firm to provide a second opinion on the application of an accounting
standard to Risso’s financial statements.The audit opinion on Risso’s financial statements for
the year ended 31 March 2015 was modified by Risso’s external auditors due to a
disagreement over the application of the accounting standard.

Irrawaddy Ltd (Irrawaddy)

The directors of Irrawaddy have requested that your firm accepts an engagement to examine
and report on prospective financial information for the three years ending 30 June 2018,
prepared by the company in support of a loan application. The independent examination and
report has been requested by Irrawaddy’s bank. Irrawaddy’s external auditor is currently
performing audit work on the financial statements for the year ended 30 June 2015 but has
not been offered the engagement to examine the prospective financial information.

Requirement

For each of the four prospective engagements, identify the matters that your firm should
consider, including any professional and ethical issues arising, and any steps it should take
before deciding whether to accept the engagement.
Total: 25 marks
9. Rescue24 is a UK not-for-profit charity whose activities involve the rescue and veterinary
treatment of injured wild animals. The charity is required to undergo an external audit in
accordance with the constitution in its governing document and you are the audit senior
responsible for the audit for the year ended 30 June 2015.

Due to a reduction in government spending, Rescue24 has experienced a decline in the level
of government grants available for its activities. It has also found it increasingly difficult to
obtain financial donations through its traditional fundraising activities of street collections and
telephone campaigns. In December 2014, the trustees decided to meet a shortfall in
Rescue24’s funding using crowdfunding which is the practice of obtaining funding by raising
monetary contributions via the internet. Rescue24 chose to raise funds through the
crowdfunding website, crowdcause.com, and launched a campaign on the website in
January 2015. However, the trustees had no experience of this type of fundraising activity
and failed to put in place any promotional or marketing support for the campaign. The lack of
public awareness meant the campaign failed and no funds were received by Rescue24.

In March 2015, the trustees negotiated an increase in Rescue24’s overdraft facility and
obtained a bank loan, secured on Rescue24’s only premises, to meet the shortfall in funds
and enable Rescue24 to continue its activities. However, the draft statement of financial
activities for the year ended 30 June 2015 shows that expenditure exceeded income for the
year and the draft balance sheet at 30 June 2015 shows a net liability position. As a result of
the financial issues arising in the year, three of Rescue24’s five trustees and its fundraising
manager resigned from their positions.

During the audit, you identified the following internal control deficiencies:

(1) Collection boxes used during street collections were not sealed or numbered
and collectors were responsible for counting and recording proceeds from their
own collection boxes.

(2) Certain veterinary drugs were not stored in a secure lockable container, in
contravention of the requirements of the Veterinary Medicines Directorate.

Requirements

(a) For each internal control deficiency identified in (1) and (2) above, draft points for
inclusion in your firm's report to the trustees. For each deficiency, outline the possible
consequence(s) of the deficiency and provide recommendations to address it.
(7 marks)

(b) Identify and explain the factors which give rise to an uncertainty about the going
concern status of Rescue24. (7 marks)

(c) Assuming your firm concludes there is an uncertainty about the going concern status
of Rescue24, explain the potential implications for the audit opinion on the financial
statements of Rescue24 for the year ended 30 June 2015 if the trustees:

(i) make appropriate disclosures; or

(ii) do not make any disclosures.

Your answer should describe the effects, if any, on your firm’s audit report in each
situation. (6 marks)

Total: 20 marks
 PROFESSIONAL LEVEL EXAMINATION

MONDAY 7 DECEMBER 2015

(2½ hours)

AUDIT AND ASSURANCE

This paper consists of SIX short-form questions (20 marks) and THREE long-form questions
(80 marks).

1. Ensure your candidate details are on the front of your answer booklet. You will be given
time to sign, date and print your name on the answer booklet, and to enter your
candidate number on this question paper. You may not write anything else until the
exam starts.

2. Answer each question in black ballpoint pen only.

Short-form Questions (1 – 6)

3. Answer the short-form questions in note form only. Complete sentences are not
required.

4. Answers to each short-form question must be submitted in numerical order.

Long-form Questions (7 – 9)

5. Answers to each long-form question must begin on a new page and must be
clearly numbered. Use both sides of the paper in your answer booklet.

6. The examiner will take account of the way in which answers are presented.

7. When the assessment is declared closed, you must stop writing immediately. If you
continue to write (even completing your candidate details on a continuation booklet),
it will be classed as misconduct.

You MUST enter your candidate number in this box.

contain confidential information and must NOT be removed from the examination hall.

DO NOT TURN OVER UNTIL YOU ARE INSTRUCTED TO BEGIN WORK

Copyright © ICAEW 2015. All rights reserved. Page 1 of

BLANK PAGE
1. Your firm has decided to resign as external auditor of Tahoe plc (Tahoe), a listed company,
during the firm’s term of office, due to a disagreement with the directors of Tahoe over an
accounting policy.

List your firm’s rights and responsibilities, under the Companies Act 2006, in relation to its
resignation. (2 marks)

2. The ICAEW Code of Ethics identifies circumstances where an auditor is or may be required
to disclose, to third parties, confidential information obtained during the course of an
external audit.

List, with examples, the circumstances in which the disclosure of confidential information,
without the client’s permission, is or may be required. (4 marks)

3. Coniston LLP (Coniston) has tendered for the external audit of Windermere plc. Coniston
has proposed a fee below the market rate in the hope that the firm will subsequently be
awarded more lucrative advisory work.

Identify and explain the ethical issues posed by Coniston’s proposal. (4 marks)

4. Your audit firm, which has several listed clients in its portfolio, has a policy
prohibiting partners and staff from owning shares in client companies.

Outline the procedures that your firm should have in place to ensure that partners and staff
comply with this policy. (3 marks)

5. During the year ending 30 November 2016, the audit committee of Baikal plc (Baikal) is
scheduled to meet three times. One of the terms of reference of the audit committee of
Baikal is to monitor the effectiveness of the outsourced internal audit function.

List the matters that should be considered by the audit committee at its meetings during the
year ending 30 November 2016 that will assist it to meet this term of reference. (3 marks)

6. External auditor’s reports on the financial statements of companies that are required to
apply the UK Corporate Governance Code have to provide additional information about the
audit work performed.

List the additional information required to be included in the auditor's report and state the
benefits to the users of the financial statements of having this information. (4 marks)

QUESTION 6 COMPLETES THE SHORT-FORM QUESTIONS

LONG-FORM QUESTIONS (7 – 9) FOLLOW

7. Your firm is the external auditor of Whistler Consultants Ltd (Whistler). You have succeeded
Tom Turner as audit manager. Tom was the audit manager for the previous three years
until he joined Whistler as finance director in July 2015. You have not previously worked on
the Whistler audit. Lisa Lowry is the engagement partner and has been responsible for the
audit of Whistler since it became a client of your firm ten years ago.

You are planning the external audit for the year ended 30 November 2015 and Lisa has
asked you to consider the following key areas of audit risk:

(1) Fee income

(2) Work in progress
(3) Trade receivables
(4) Provision for claims.

Tom has provided you with the following extracts from the financial statements:

Statement of profit or loss for the year ended 30 November

2015 2014
(draft) (actual)
£’000 £’000

Fee income 501,320 470,903

Cost of sales 240,556 233,014

Statement of financial position as at 30 November

2015 2014
(draft) (actual)
£’000 £’000

Work in progress 84,251 67,425

Trade receivables (net of allowance for bad 71,671 52,335
debts)
Provisions for claims 9,991 15,521

Whistler provides management consultancy services to clients across Europe. All work is
performed under fixed-price contracts and clients are invoiced in either sterling or euro. Total
fee incomes in the industry as a whole have declined by 2% on average over the year ended
30 November 2015. Whistler has submitted a loan application to its bank to finance
expansion in India and China where a number of government consultancy contracts are to be
awarded in 2016 and 2017.

The scope of the work is agreed with each client at the start of the assignment. Fee income
from fixed-price contracts is recognised once the assignment is complete and the final
consultancy report is issued. Customers are required to pay Whistler an initial payment of
30% of the contract value prior to the commencement of any work and the balance on
completion of the work. Whistler’s terms of trade require payment within 30 days of invoice
date for both initial payments and final instalments.

Whistler maintains a project costing system, an earlier version of which was replaced in
September 2015. Costs relating to each assignment are recorded against a unique project
code. At the end of each day, Whistler’s consultants record their time spent on each
assignment, together with any expenses incurred, directly into the project costing system.
Whistler’s consultants have standard charge-out rates dependent on their level of seniority.
These charge-out rates are recorded in the project costing system which is used to value
work in progress in the financial statements. Provision is made for expected losses on
contracts.

Whistler sometimes becomes involved in disputes with clients which could potentially lead to
claims for damages by the client. Insurance cover is maintained against the payment of
damages in respect of such claims. Where management considers that there is a reasonable
basis for a claim against Whistler, a provision is made in the financial statements for the
uninsured costs in respect of that claim. Because of Whistler’s high volume of claims in
previous years, the insurer has reduced the scope of Whistler’s insurance cover for new
claims arising from work completed during the year ended 30 November 2015.

A discussion with Tom has revealed the following internal control deficiencies:

(i) On several occasions throughout the year, consultants ordered IT equipment

directly from suppliers. Company policy requires all IT equipment to be
purchased by the buying department.

(ii) Whistler does not have any bribery prevention policies in place.

Requirements

(a) Explain what is meant by the familiarity threat in the context of the external audit of
Whistler and discuss the safeguards available to your firm in order to mitigate this
threat. (6 marks)

(b) Justify why the items listed as (1) to (4) have been identified as key areas of audit risk
and, for each item, describe the procedures that should be included in the audit plan
in order to address those risks.

You should present your answer in a two-column format using the headings:

 Justification; and
 Procedures to address each risk. (24 marks)

(c) For each internal control deficiency listed as (i) and (ii), draft points for inclusion in
your firm's report to those charged with governance and management at Whistler. For
each deficiency, you should outline the possible consequence(s) of the deficiency
and
provide recommendations to address it. (10 marks)

Total: 40 marks
8. Tasty Sauces Ltd (TSL) was incorporated three years ago. TSL produces a range of branded
sauces which are exceptionally popular, especially in the warmer months when they are
bought for barbeques. The directors are planning to reorganise the business as a result of a
forecast rapid growth in revenue. This will involve outsourcing all manufacturing, relocation of
the business premises and development of new products.

The growth will be funded by equity finance from Denzil Dragon (Denzil), proceeds from the
disposal of TSL's manufacturing unit and an increase in the bank overdraft facility. Denzil is a
wealthy individual who specialises in providing finance for rapidly expanding businesses in
return for a minority shareholding in the business. The directors have prepared profit and
cash flow forecasts for the three years ending 31 December 2018 in support of the request
for the overdraft facility. The company's bank requires the cash flow forecasts to be examined
and reported on by independent accountants and the directors have requested that your firm
performs this examination.

The directors have provided the following additional information:

 The significant growth experienced since incorporation was due to a two-year contract
with Terose, a supermarket with stores across the South of England. The contract
specifies that TSL cannot supply any other supermarket during the period of the
contract. The contract is due to expire in June 2016. Credit terms are 75 days after
delivery. The contract specifies that if Terose purchases a specified volume of sauces
over the period of the contract, TSL has to pay Terose a rebate at the end of the
contract.

 TSL is in negotiations with five other large supermarkets, with stores across the UK
and Europe, which want to purchase TSL’s sauces when the contract with Terose
expires in June 2016. The directors are seeking four-year contracts with each
supermarket with credit terms of 30 days.

 TSL will cease its own production and has agreed with Mixit Ltd (Mixit), a specialist
manufacturer, that Mixit will manufacture TSL’s sauces from July 2016 onwards. Mixit
has requested payment in advance each month, for 12 months, until a trading
relationship is established after which it will give 30 days credit.

 TSL will sell its manufacturing unit, which it owns, as it will then be surplus to
requirements. The manufacturing unit will take six months to decommission and
all equipment will be scrapped. A property developer has expressed interest in the
site and TSL is currently applying for permission to change the use of the site from
industrial to residential.

 TSL proposes to rent a new combined warehouse, office and research facility from
July 2016. Rent is payable quarterly in advance with a rent-free period for the first
six months. TSL plans to develop new products such as soups and curries at this
facility. It is expected that soups will take one year to develop and curries two
years before they can be sold to supermarkets.

 Denzil will provide equity funding in equal tranches in March 2016 and June 2016. Half
of Denzil’s investment will be repurchased by TSL once TSL achieves a specified level
of profit. TSL has a policy of paying cash dividends equivalent to one quarter of its
annual profits.
You are the senior responsible for planning the examination of the cash flow forecasts and
the engagement partner has identified the following items included in the cash flow forecasts
as being significant:

(1) Receipts from and payments to supermarkets for the sale of products
(2) Payments to Mixit
(3) Proceeds from the disposal of the manufacturing unit
(4) Payments for the rented warehouse, office and research facility
(5) Receipts from and payments to Denzil Dragon.

Requirements

(a) (i) Identify the matters to be included in your firm’s engagement letter for the
examination of the cash flow forecasts in respect of:

 management’s responsibilities;
 the purpose and scope of your firm’s work; and
 limiting your firm’s liability.

(ii) Explain why these matters should be included. (8 marks)

(b) For the items listed (1) to (5), identify the specific matters you would consider when
reviewing the reasonableness of the assumptions underlying each receipt or payment.
(10 marks)

(c) State four key differences you would expect to see between the items included in the
profit forecasts and the receipts and payments included in the cash flow forecasts
prepared by the directors of TSL. (4 marks)

Total: 22 marks
9. Described below are three situations that have arisen at unrelated external audit clients of
your firm, a firm of ICAEW chartered accountants. The year end in each case is 31 October
2015.

Mint Ltd (Mint)

Your audit work concluded that the accounting records relating to cash sales were
inadequate. Cash sales comprise 7% of Mint’s recorded revenue.

Coriander Ltd (Coriander)

The financial statements of Coriander include inventory at cost of £1.3 million. The inventory
was purchased on 1 October 2015 in anticipation of fulfilling a large order for a customer.
However, the customer went into liquidation on 5 November 2015 and was unable to
complete any part of the transaction with Coriander. On 30 November 2015 Coriander sold
the inventory for £1 million. The draft financial statements show that Coriander’s profit before
tax is £12.9 million and total assets are £39.1 million.

Basil Ltd (Basil)

The financial statements of Basil show the purchase of a motor vehicle from Saffron Ltd
(Saffron), for £19,000, which has been appropriately included in non-current assets. Whilst
reviewing Basil’s board minutes you discovered that Saffron is owned and managed by the
husband of Basil’s managing director. The directors of Basil refuse to disclose the transaction
in the notes to the financial statements as they claim that the amount is too small to warrant
disclosure. The draft financial statements of Basil show total assets of £7.5 million.

Requirements

(a) For each of the situations outlined above, state whether or not you would modify the
audit opinion. Give reasons for your conclusions and describe the modifications, if any,
to each audit report. (11 marks)

(b) Describe the possible consequences for your firm if an inappropriate audit opinion
on financial statements is issued and outline the quality control procedures your firm
should implement to reduce the risk of issuing an inappropriate audit opinion.
(7 marks)

Total: 18 marks
 PROFESSIONAL LEVEL EXAMINATION

MONDAY 7 MARCH 2016

(2½ hours)

AUDIT AND ASSURANCE

This paper consists of SIX short-form questions (20 marks) and THREE long-form questions
(80 marks).

1. Ensure your candidate details are on the front of your answer booklet. You will be
given time to sign, date and print your name on the answer booklet, and to enter your
candidate number on this question paper. You may not write anything else until the
exam starts.
2. Answer each question in black ballpoint pen only.
Short-form Questions (1 – 6)
3. Answer the short-form questions in note form only. Complete sentences are not
required.
4. Answers to each short-form question must be submitted in numerical order.
Long-form Questions (7 – 9)
5. Answers to each long-form question must begin on a new page and must be
clearly numbered. Use both sides of the paper in your answer booklet.
6. The examiner will take account of the way in which answers are presented.
7. When the assessment is declared closed, you must stop writing immediately. If you
continue to write (even completing your candidate details on a continuation booklet),
it will be classed as misconduct.

contain confidential information and must NOT be removed from

You the
MUSTexamination
enter yourhall.
candidate number in this box.

DO NOT TURN OVER UNTIL YOU ARE INSTRUCTED TO BEGIN WORK

Copyright © ICAEW 2016. All rights reserved. Page 1 of 8

BLANK PAGE
1. During a recent external audit performed by your firm, a trainee ICAEW Chartered
Accountant altered the sample of trade receivable balances initially selected for testing, at the
request of the audited entity’s financial controller, an ICAEW Chartered Accountant. The
financial controller threatened the trainee that he would tell the audit engagement partner that
the trainee was incompetent if he did not comply with the request. Therefore, the trainee
replaced trade receivable balances for which no cash was received after the year end with
balances for which cash had been received.

Identify and explain the ethical issues arising in this situation. (4 marks)

2. The directors of your firm’s external audit client Gruber Ltd (Gruber), an accounting software
company, have approached your firm with a proposal to sell Gruber’s software to your firm’s
other external audit clients. Under the proposal Gruber would supply the software and your
firm would be responsible for its implementation at each client. The directors of Gruber
expect to increase software sales by 50% as a result of this arrangement.

State, with reasons, whether it is appropriate for your firm to accept the directors’ proposal.
(4 marks)

3. Padding LLP (Padding) has tendered for the external audit of Clyde plc. Padding has
proposed a fee which is less than the market rate in the hope that the firm will
subsequently be awarded the more lucrative tax and advisory work for Clyde plc.

Identify and explain the ethical issues posed by Padding’s proposal. (4 marks)

4. State what is meant by ‘performance materiality’ and outline why this is set by external
auditors. (2 marks)

5. During the external audit of Bushat Ltd it was discovered that, on a number of occasions,
adjustments were made, by the payroll clerk, to standing data relating to employees on the
payroll system on the oral authority of the human resources manager.

Outline the possible consequences of this internal control deficiency and provide
recommendations to remedy the deficiency. (3 marks)
6. List the differences between a report prepared by a practitioner for an engagement to
review financial statements and the report prepared by auditors for an external audit
engagement.
(3 marks)

QUESTION 6 COMPLETES THE SHORT-FORM QUESTIONS

LONG-FORM QUESTIONS (7 – 9) FOLLOW

7. Your firm has recently been appointed as the external auditor of Marmalade Ltd
(Marmalade). You are the audit manager responsible for planning the external audit for the
year ended 31 January 2016. The engagement partner for the audit, Lucy Bond, has asked
you to consider the following key areas of audit risk:

(1) Revenue
(2) Property, plant and equipment – freehold factory
(3) Inventory – finished goods

Marmalade designs and manufactures luxury luggage at its UK factory and sells its products
through its website to customers around the world. Customers pay online in their local
currency using a debit or credit card. Demand for Marmalade's luggage has increased
following a recent rise in popularity amongst internet bloggers who like the fact that
Marmalade frequently updates its luggage designs and colours.

To meet the increased demand, Marmalade expanded its production capacity during the
current year by 25%, by converting the warehouse space in its freehold factory into additional
manufacturing space. The conversion, along with repairs to the existing factory, was carried
out by a building contractor, assisted by some of Marmalade's employees. The conversion
was completed at the end of August 2015. Marmalade has included the associated costs in
the cost of the freehold factory in property, plant and equipment.

In February 2015, to compensate for the loss of warehouse space, Marmalade engaged a
fulfilment company Pastuzo Ltd (Pastuzo), to store and operate the despatch of finished
inventory to customers and subsequent returns. Marmalade despatches finished inventory
directly from its factory to Pastuzo’s warehouse and Pastuzo views customers’ orders
through an interface with Marmalade’s website. Pastuzo maintains inventory records for
finished goods on behalf of Marmalade and provides real-time reporting to Marmalade on
inventory movements and quantities on hand. Marmalade has included the inventory
quantities reported by Pastuzo on 31 January 2016 in its draft financial statements at that
date. Marmalade’s employees performed an inventory count at Pastuzo’s premises on
31 May 2015 but no other counts have taken place. Pastuzo’s own auditor is able to provide
an assurance report regarding the adequacy of Pastuzo’s controls over inventory managed
on behalf of third parties.

Historically, Marmalade has recognised a provision for returns in its financial statements
equal to 5% of website sales made in December and January. Since February 2015,
Marmalade has experienced an increase in the volume of returns due to Pastuzo
despatching incorrect products to customers. However, Marmalade’s directors believe this
issue is now resolved and therefore propose to include the provision for returns on the same
basis as in prior years.

In April 2015, Marmalade won a contract to design and supply cabin crew luggage for
TaxiDair Ltd (TaxiDair), a large commercial airline. The contract runs for two years from
1 May 2015 and requires Marmalade to supply 4,500 units of luggage during the contract
period. Under the terms of the contract, TaxiDair is required to make four six-monthly
payments of £281,500 and the first payment was made on 1 May 2015. Marmalade had
completed and despatched 1,200 units by 31 January 2016.

Lucy has provided you with the following draft extracts from the financial statements of
Marmalade to be used as part of your consideration of the key areas of audit risk:
Statement of profit or loss for the year ended 31 January (extract)

2016 2015
(draft) (audited)
£’000 £’000
Revenue
- Website sales (net of provision for returns) 9,617 7,124
- TaxiDair contract 563 -
10,180 7,124
Cost of sales (5,169) (4,277)
Gross profit 5,011 2,847

Statement of financial position as at 31 January (extract)

2016 2015
(draft) (audited)
£’000 £’000
Property, plant and equipment
- Freehold factory (see note below) 6,330 3,240

Inventory – finished goods 1,797 850

Note – freehold factory 2016 2015

(draft) (audited)
£’000 £’000
Cost 7,800 4,500
Accumulated depreciation brought forward (1,260) (1,080)
Depreciation charge for the year (210) (180)
Carrying amount at 31 January 6,330 3,240

Requirements

7.1 State the purposes of performing analytical procedures when planning an external audit
and when undertaking substantive procedures. (4 marks)

7.2 Justify why the items listed as (1) to (3) have been identified as key areas of audit risk
and, for each item, describe the procedures that should be included in the audit plan
to address those risks.

You should present your answer in a two-column format using the headings:

 Justification; and
 Procedures to address each risk (28 marks)

7.3 Outline the key matters that should be discussed with the junior members of any audit
team before performing the planned audit procedures. (5 marks)

Total: 37 marks
8. Your firm has recently been invited to accept appointment as external auditor of
Underground Ltd (Underground) for the year ending 31 March 2016. The audit has been
requested by Underground’s bank. The engagement partner considering the invitation has
asked you to gather information about Underground and its directors to help her reach a
decision on whether to accept the appointment.
You have documented the following relevant information:

Underground makes and supplies fresh sandwiches from its UK factory. The company
was incorporated on 1 April 2015 having previously traded as a partnership owned by
Judy and Jonathan Bird, husband and wife. The trade and assets of the partnership were
sold to Underground by Judy and Jonathan in exchange for shares in Underground. The
value of the shares issued by Underground exceeded the value of the assets by £1.8
million and this has been included as goodwill in the financial statements of Underground.
Judy and Jonathan are the only directors and shareholders of Underground.

Judy and Jonathan previously worked at Hill Snacks Ltd (Hill) where they were customer
service managers. They left Hill and formed their business partnership in June 2014 to
supply sandwiches to the London stores of a large UK supermarket chain, Notting Ltd
(Notting). Notting was previously a customer of Hill. However, Judy spent a number of
months, whilst still working at Hill, persuading Notting’s purchasing director to move
Notting’s business to them by promising to undercut Hill’s prices.

Sandwiches are now supplied by Underground to Notting’s stores throughout the UK

under a three-year contract which commenced on 1 June 2015. The contract specifies
situations in which Notting may terminate the contract early, which include poor quality
and failure to deliver quantities ordered. Underground has also won a few smaller
contracts but supplies to Notting are expected to account for at least 70% of
Underground’s revenue whilst the contract is in force.

The growth in Underground’s business has been funded by a bank loan. The loan
covenant requires Underground to maintain a current ratio of 1.8:1.

Underground makes sandwiches from fresh ingredients which are delivered daily by
its suppliers. The storage and production of fresh food is highly regulated in the UK.
On
1 March 2016 Underground received a warning after a routine inspection by the regulator
identified that, due to a mechanical defect, Underground’s refrigerator temperatures were
too high. Underground has been told to correct the problem before 30 April 2016, when a
further inspection will take place.

At a meeting with Judy on 1 March 2016, she told you that she has used spreadsheets to
maintain Underground’s accounting records. However, she has found that these have
become increasingly inadequate due to the size of the business. She also confided that
the setting up of Underground and the rapid growth in business has been very stressful
for herself and Jonathan. Consequently, they have decided to divorce and Judy is
considering leaving the business and selling her shares to Jonathan.
The directors of Underground have also requested that your firm undertakes a non-audit
engagement to advise on an appropriate valuation of Judy’s shares in Underground.

Requirements

8.1 Explain the relevance of each item of information, as documented in the box above, to
your firm’s decision on whether to accept appointment as Underground’s external
auditor for the year ending 31 March 2016. (18 marks)

8.2 Assuming your firm accepts appointment as external auditor of Underground, explain
the conflict of interest and self-interest threat which may arise if it also accepts the non-
audit engagement requested by the directors. Outline the safeguards, if any, which
should be put in place to mitigate those threats. (7 marks)

Total: 25 marks

PLEASE TURN OVER

9. 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

9.1 For each of the situations described above, outline, with reasons, the implications for
your firm’s audit or assurance reports. (10 marks)

9.2 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)

9.3 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