Auditing QB Solution

23rd Mid 1
Answer to the Question no:1

Audit is a social phenomenon. It has no purpose or value except in its practical usefulness. It is wholly
utilitarian. The function has evolved in response to a perceived need of individuals or groups in society
who seek information or reassurance about the conduct or performance of others in which they have an
acknowledged or legitimate interest≓ (Flint, 1988, p. 14).

According to Flint (1988), the audit function should embrace information beyond the accounting
dimension, involving aspects related with value for money, that is to say, the economy, the efficiency
and the effectiveness of organizations. Audit is based on a social need, involving an interaction among
auditors, audit organisms and other social groups, so that audit function should adapt to society values.
The audit value inside the accountability process transcends the compliance audit, embracing the
analysis of how management handles the resources with efficient and effectiveness (Lee, 1996; Sherer &
Kent, 1983; Tincker, 1982). This audit role is criticized by Mills and Bettner (1992) who argue that the
audit process, and the supporting standards that support it, are destined to mask the existent social
conflicts, even suggesting that audit is a mere ritual to maintain the social order and to legitimate the
auditor's action (Mills & Bettner, 1992) being so stigmatized by supporting the ideology of the capitalism
(Portwood & Fielding, 1981). Together with these general investigations that discuss the paper of audit
in today's society, more specific analyses are being developed centered on more partial aspects of the
global problem that is the relationships between audit and society, such as: the size of the audit
companies and their independence, the perception that the society has of the audit report, the
enlargement of the audit function for the evaluation of the going concern assumption and the
continuous pressing and present search of illegal acts, frauds and corruption and, finally, the
understanding, for the society, of the proper characteristics and attributes of an audit.

Answer to the Question no:2

Agency theory:
Insurance theory:

we defined auditing as an activity that reduces information risk. This definition follows from the
information hypothesis that is used to explain the demand for external audits. Under the information
hypothesis, audit services are demanded to reduce the information risk to users of financial statements.
Information risk is the risk that user decisions may be based on incorrect information. Thus, using
information risk reduction, auditors must reduce losses due to faulty decisions resulting from errors or
irregularities in the financial statements. Losses to investors may also arise because of failure by
company management to disclose all the facts about a firm. Auditors help assess whether this
information asymmetry is alleviated through proper disclosure. Less-accurate information may also
deter investment, so auditing may also alleviate underinvestment in the capital markets and result in
better resource allocation in the economy.

Another hypothesis has been proposed to explain the sources of demand for audits. The monitoring
hypothesis is based on the principal-agent framework of economic theory. Agency theory predicts that

utility-maximizing agents (the managers), if unchecked, will consume more resources than optimal.
However, investors with rational expectations will take such behaviour into account in pricing a firm’s
securities. As a result, the agents have the incentive to contract for mechanisms to monitor their
opportunistic behaviour. The hiring of an external auditor is one such mechanism. This theory predicts
that management will demand audits whenever the cost of monitoring their activities is less than the
wage loss that management suffers without the monitoring. The presumption here is that the owners of
the firm will pay managers more with monitoring of their activities than without monitoring.

The insurance hypothesis predicts that auditors are demanded so that they may be sued in case
there is a business failure or investors incur losses from inaccuracies in the financial statements.
Auditing thus provides investors a form of insurance. If an investor purchases securities on the basis of
audited financial statements and subsequently sustains losses, the law provides some degree of
recourse against the auditor. In this way, the auditor can, depending on how the court’s reasoning
works, function as an indemnifier against investment losses.

The degree of recourse depends on the legal system in force. Under a negligence-based concept,
some form of audit failure needs to be proved. Moreover, for registration statements under U.S.
Securities and Exchange Commission (SEC) laws (covered in Chapter 20, available on Connect), the
burden of proof is on the auditor to demonstrate that due care was observed in the audit task. Recent
court cases in the United States seem to abandon the negligence concept in favour of an implied
warranty concept. Under the implied warranty concept, the issue of whether the auditor is negligent is
irrelevant. The auditor is responsible once it can be proved that the audited financial statement is
wrong. This concept is concerned with accident (audit failure) prevention, compensating the injured,
and a better distribution of losses. Under implied warranty, the audit fee may be little more than a fee
for insurance against otherwise uninsurable business risk (e.g., due to management incompetence). We
say “may” because it all depends on how courts interpret “wrong” financial statements. If wrong
financial statements mean failure to anticipate any adverse business event, then auditors are
responsible for insuring business losses. If, on the other hand, wrong financial statements mean failure
to disclose only those adverse events for which there is information at the time of the audit, then
auditors are effectively liable only for information risk. So, much depends on court interpretation and
the amount of damages awarded to the plaintiffs. The punitive damage award system in the United
States—with its high multiples of actual damages—is close to the kind of system that would make
auditors insurers of business risk. It is assumed that any auditor-insured business risk is then passed on
in the form of fee increases to all clients. Clients, in turn, pass these costs on to society via increased
prices for their products. In this way, risks faced by investors are passed on to society—that is, business
risk is socialized.

Each of these theories helps explain some aspect of the audit environment and some of the reasons
audits are demanded. These theories are best viewed as complementary rather than mutually exclusive.
They also appear to apply to varying degrees in different countries and different legal systems. For
example, in the United States the risk of an auditor being sued has traditionally been about 10 times
that in Canada. This suggests that the insurance hypothesis may be a more important explanation of the
demand for audits in the U.S. business environment than in the Canadian business environment.

insurance hypothesis:
predicts that auditors are demanded so that they may be sued if there is a business failure or investor
losses due to inaccuracies in the financial statements
negligence-based concept:
holds that auditor negligence needs to be proved in court to support claims against auditors
implied warranty concept:
holds that the auditor is responsible once it can be proved that the audited financial statement is wrong,
so the issue of whether the auditor is negligent is irrelevant.

Answer to the Question no:3

An auditor reviewing a company's financial statement is responsible and legally liable for any
misstatements or instances of fraud, even if errors were not made by them. Managers of a company
may try to manipulate their company's financial statements without the accountant knowing as it might
be best serve their interests. This is why external auditors must audit the financial statements, and
accountability forces them to be careful and knowledgeable in their review. Public companies are also
required to have an audit committee as a part of their board of directors who are external personnel
with accounting knowledge. Their job is to oversee the audit. This is achieved by graph explanation

Reza sir’s graph will be there

Company’s accountability is checked by the auditors through the help of the subject matter (5 financial
statements papers) those are primarily considered as evidence and auditor asks the preparer
(management) to make ready the statements in time to inspect that whether the presented information
is fair or unfair and the management is legitimately liable to represent all the information to the
auditors. Here company’s and management’s accountability is ensured.

Auditor’s accountabilities are checked by the regulatory body and responsible to the users as the
auditing reports are observed by the users. Moreover, all the criteria are made by the regulatory body
through which the auditor cross checks the assertions presented by the company in the financial
statements.

So through this process audit ensures the accountability of company and the auditor as well in a better
way.

Answer to the Question no:4

Objectivity- undue advantage over him,

Professional Behavior- Personality to practice formal attire……. , enjoys the profession from his heart.

Professional Competence and due care- highly sincere and dedicated…… , continuously tries to improve
knowledge and experience,

Integrity- spade a spade, disseminate true and fair information,

Confidentiality- keep certain information secret

Answer to the Question no:5

a)

i)say to analysis the company maintaining professional behavior and competence

ii)maintain the confidentiality

iii)show integrity through talks

iv)Being unbiasness giving information

b) SRC can be accepted. This is because an audit firm can’t provide non auditing services to the listed
companies.

But it can provide non audited services to the non-listed companies.

23rd Mid 2
Answer to the Question no:1

The first auditor of Green Phone Ltd was appointed by the board of directors 45 days later of the date of
registration of the company, which violates section 210(6). It is stated that the first auditor is to be
appointed within 1 month of the date of registration.

The subsequent auditor which was appointed at the first AGM had only one partner. This violates the
fact that a CA firm must have at least 2 partners and 7 years of experience in practice.

The subsequent auditor confirmed his appointment after 36 days of the receipt from the company of
the intimation of his appointment, which violates section 210(2). It stats that every auditor appointed
shall within 30 days of the receipt from the company of the intimation of his appointment, inform the
registrar in writing of his acceptance or refusal.

Answer to the Question no:2

i) Due to competitive environment and complex product there exists inherent risk because inherent risk
arises from the nature of the company. Moreover there can be detection risk as well because of more
external financing.

ii) Predominantly audit approach will be Substantive test due to complex nature. Under substantive test
there will be test of details for acquisition and ratio analysis under analytical test for external financing.

Use of experts:

There will be need for experts for the valuation of assets and liabilities and legal opinion as well.

Audit team:

Hierarchy of Audit team

Experience
⬥
Competence
⬥
Specialized knowledge
⬥
Team hierarchy
⬥
Reviewer
⬥
Ensure that the work is done at right level

Answer to the Question no:3

Assets Tk. Tolerable Actual Material/immaterial

Misstatement Misstatement

Cash 50000 500 0 Immaterial

Receivables 250,000 5000 6000 Material
inventory 100,000 2000 500 Immaterial
PPE 500,000 2000 5000 Material
Intangibles 100,000 500 0 Immaterial
Total 1000000 10000 11500 Material

Receivables and PPE items are material because the actual misstatement exceeds the tolerable
misstatement. As the actual misstatement does not exceed tolerable misstatement of cash, inventory
and intangibles, these items are not material. Total misstatement of the assets (11500) is higher than
the amount which is set by the company (10000). So, the misstatement of the assets is material in total.

23rd Semester Final

Answer to the Question no 1 (a)

Information Theory:

The information hypothesis

Financial reporting was earlier seen to be central to the monitoring purposes, but since the 1960’s the
focus moved to needs and the provision of information to enable users to take economic decisions
(Higson 2003). Therefore, an alternative or complement to the monitoring hypothesis is the information
hypothesis. One argument regarding the demand for audited financial statements is that they provide
information that is useful in investors’ decision-making. Investment decision models in the finance
literature value a company by calculating the net present value of future cash flows. For example, future
cash flows have been observed to be highly correlated with financial statement information. Therefore,
the audit is valued by investors as a means of improving the quality of financial information. (Wallace
1980, 1987 and 2004) Some of the same information that is used in monitoring contracts is also useful in
making investment decisions. The difference from monitoring purposes, however, is that installing
means of monitoring usually requires explicit contracting, as is the case when the agent commits to
providing audited financial statements. However, the information hypothesis emphasizes that financial
information is needed by investors to determine market values, which are means of making rational
investment decisions, even in the absence of an explicit contract with the agent. (Wallace 1980) Fama
and Laffer (1971) discuss three major benefits of information: reduction of risk, improvement of
decision-making and earnings of trading profits. Audited financial statements can be related to each
benefit. Investors tend to be risk adverse, so they will demand a higher return for higher levels of risk or
they will pay a higher price in the form of a risk premium to reduce the level of uncertainty or risk (Fama
et al. 1971). For a simple example let us assume that the risk premium represents an individual
assessment of how much an audit will reduce uncertainty concerning reported financial information.
The audit can be regardedas cost-effective if the risk premium of each individual investor exceeds the
cost of the audit to the company. (Wallace 1980, 1987, 2004) An audit is also valued as a means of
improving the financial data used by managers in decision-making. An auditor can improve the quality of
the input data by finding errors and by making employees more careful in preparing records. More
accurate data will improve internal decision-making. External use of more accurate data for credit and
investment analysis, labor negotiations or regulation decisions will also improve managers’
performance. (Wallace 1980, 1987, 2004) The third use of information refers to gains from trade by
investors with private information. According to the efficient market hypothesis asset prices reflect all
publicly available information. Hence, no abnormal returns can be gained by using publicly available
information. The information benefit of profits from trading is only realized by investors with private
access to new information. The Securities Act require that audited financial statements are made
publicly available. At the public announcement of the audit results, the price of the securities will adjust
to the information (e.g. Chen et al. 2000; Taffler et al. 2004) if the information is relevant and not
already known or expected. It may also be that no price adjustment will result from the announcement
of audit results, the same conclusions could have been reached by outsiders at an earlier date or the
audit results could be replaced by available surrogate information. Therefore, the audit function can be
evaluated with respect to the benefit of trading gains. In other words the announced audit findings may
only confirm investors’ expectations and existing market valuations. However, the absence of gains from
trade on audit results does not imply lack of value for audited information. (Wallace 1980, 1987) The
role of the audited data is confirmed by research results (Beaver et al. 1970) which demonstrate an
improvement in the estimation of risk through the use of accounting information. The improved
estimation of risk does not mean that abnormal earnings could be gained, but suggests that investors
have more accurate information for evaluating investments (Wallace 1980 and 2004). The perceived
credibility of accounting information has been observed to have an effect on interest costs (Wallace
2002), underpricing of initial public offerings (Menon and Williams 1991; Hogan 1997; Willenborg 1999)
and bankruptcy (Menon and Williams 1994).

Insurance theory:

See 23rd Mid 1

Answer to the Question no: 1(b)

Auditor is Watchdog, not a Blood Hound

Case: Kingston cotton mills company (1986)

“An auditor is not bound to be detective and to work with their suspicion, that there is something
wrong. He is a watchdog not a blood hound. He is justified in believing tried servant of the company and
is entitled to rely upon their representation provides he takes reasonable care”

Auditor is Watchdog, not a Blood Hound it means as the dog always think about the owner as it the
same way an auditor always think about the owner of the company. It is the responsibility to find true
and fair value of the business and gives all the details (errors and frauds) of all the business. But this task
is so difficult because people tried who arise fraud in the company gives wrong information to the
company.

Duty of the auditor is not harm to the other person. He is always sincere, systematic, honest, truthful,
and tactful. An auditor has a professional knowledge and expert in own field. In case of any unwanted
situation. The remedial action has to come from the owner of the entity. He has to discharge his
responsibility by informing about the irregularity found in the audit.
The perception of auditor’s duty with regards to detection and prevention of frauds and errors was

initially based on the decision given in Kingston Cotton Mills Co. (1896) case. The learned fudge Lopes

summed up auditor’s duty by stating, “Auditor is a watchdog, not a bloodhound.”

The statement implies:

An auditor is appointed by the shareholders in case of a limited company. He is expected to play the role

of a watchdog on their behalf and should look after their interests.

Unlike a bloodhound the duty of the auditor is verification and not detection. If he discovers something

suspicious, during the course of audit, he should probe the matter thoroughly and appraise the

shareholders about it. In the absence of such suspicious circumstance, he is fully justified in believing

and relying on representations made by the ‘tried servants’ of the company. In short, in case of frauds

and errors, the auditor has a duty of ‘reasonable care only.

Answer to the Question no: 1(c)

1. Enhances the credibility of financial statements which will help them to get bank overdraft
easily.

2.Financing of the company will be done at lower cost of capital.

3. higher quality information will be circulated in the market.

4. enhances the reputation of the company

5. Detect the frauds and errors in the financial statements.

6. identify the deficiency in the internal control system.

Answer to the Question no 2 (a)

See ICAB book page 67. Or ACCA

Answer to the Question no 2 (b)

 i) Self review threat
Safeguards: see sir note or Acca

ii)Statutory audit report- reasonable assurance

report on interim financial information- limited assurance

Difference- ACCA book

Answer to the Question no 2 (c)

Audit Strategy is about implementing a strategy for tackling the audit considering the
audit risks and internal control systems. Audit strategy focuses on tests of controls or
substantive or both. If there is any strong internal control system, then don’t need to go
for Test of control rather go for test of details under substantive test.

Whereas Audit Planning means how you are going to do the test to get sufficient
appropriate audit evidence.

Answer to the Question no 3 (a)

Arens page 251

Answer to the Question no 3 (b)

i)High means it is very likely that event will occur. if acceptable audit risk is high then auditor will collect
fewer evidence as a result detection risk increases.

Low refers to possibility of event occurring is very small . if acceptable audit risk is low then auditor will
collect more evidence as a result detection risk will fall.

Medium means possibility of event occurring and not occurring is pretty much same. . if acceptable
audit risk is medium then auditor will collect fewer evidence in comparison to low acceptable audit risk
situation and it can cause medium level detection risk.

ii)
Detection High Medium low low High Medium
Risk
Planned low Medium High High low Medium
evidence

Iii)
1. increase

2. decrease

3. decrease

4. increase

5. No effect

Answer to the Question no 3(c)

ICAB Page 205

22nd Mid 1
Answer to the Question no:1

“Without audit no accountability, without accountability no control, and if there is no control, where is
the seat of power?”

This statement is related to the benefits of audit. Auditing is the main branch of accounting that ensures
accountability. Here accountability implies two terms. i) responsibility ii) control

Responsibility means the audit is morally obliged to assign the task to the managers for making
prepared the all requisite evidences or information. And control means the
Answer to the Question no:2

Arens page 8

Answer to the Question no:3

See 23rd Final

Answer to the Question no:4

 (i) Self interest- due to business relationship- remove the individual from the audit team

-independent review

(ii) Self review- taxation services- Advice to be obtained from external tax professional

-work should be reviewed by senior expert person having no

Involvement

(iii) Intimidation- threatening the auditor with removal- take legal actions

-must decline or resign from engagement

(iv) Familiarity- Long association of audit team- rotate personnel

-independent partner control reviews.

Answer to the Question no:5

Area of minimum concern Area of most concern

High
5 Foreign exchange risk 1 Technological change
8 Inventory misappropriation 3 Environmental regulation

Likelihood Area of least concern Area of moderate concern

7 Human error 2 Poor customer service
4 Loss of key employee
6 Financial risk
Low
Low Impact High

1. Technological change: Invest in R&D projects to keep updated on the radical changes in
technology, know the market situation of the industry
2. Poor customer service: employee training, ensuring customer feedback, providing incentives
to employees for best services to customer
3. Environmental regulation: forming regulation committee, ensuring compliance with
international regulation standards
4. Loss of key employees: monetary incentives, insurance policy, job security, individual skill
development policy
5. Foreign Exchange risk: keeping foreign currency deposits, can be mitigated with currency
forward or future contracts
6. Financial risk: keep less leverage in the capital ratio, portfolio investment, keeping enough
insurance, proper cash flow management
 7. Human error: install automation system, train individual, following a double check
procedure
8. Inventory misappropriation: install automation system, train individual, following a double
check procedure, review inventory on a regular basis, simplify the process for easy
understanding, improving receiving and stocking process.

22nd Mid 2:
Answer to the Question no:1

See 23rd Mid 2

Answer to the Question no:2

See 23rd Mid 2

Answer to the Question no:3

An in control risk and a decrease in inherent risk of the same amount will result in no effect on planned
detection risk. Don’t agree because it will affect the detection risk with higher percentage. An example is
given below:

Say for example: AR= 10%, IR= 50%, CR=50%, then

DR = AR / (IR*CR)

= 10% / (50%*50%)

= 40%

Now CR is =70% after increasing 20% and CR is =30% after decreasing 20%.

DR= 10% / (70%*30%)

= 47.62 ….

Here description: ………………………………….

Answer to the Question no:4

 Tracing is an audit procedure of inspecting source documents to the accounting records in order to
ensure that the accounting records are complete. Likewise, auditors usually perform the tracing
procedure when they need to test the completeness assertion.

Similar to vouching, tracing is also an act of examination of documents. However, tracing goes the
opposite way of vouching in the audit. While vouching goes from accounting records to source
documents, tracing process starts from source documents to accounting records.

By tracing from source documents to the accounting records, auditors can verify whether transactions
or balances that should have been recorded have actually been recorded. Hence, auditors may detect
any misstatement that could occur due to the omission of transactions or items from the financial
statements.

Tracing Example Audit

For example, in an audit of revenue, auditors usually test completeness assertion by using tracing
procedure as below:
Select a sample of shipping documents
Trace the selected shipping documents to sales invoice and sales journal in order to ensure that they
have been recorded as sales revenue
Of course, other procedures such as scanning the sequential number of sales invoices for missing
numbers and ensuring that they are not unrecorded sales are usually also performed together with
trancing to ensure the completeness of sales revenue.

Answer to the Question no: 5

(i)

Tolerable misstatement Actual misstatement Material / immaterial Audit opinion

Total Assets 10,00,000*1% = 10,000 15,0000= 1.5% material Adverse: Material and
pervasive

Inventory 10,00,000*60% = 15,0000= 2.5% material

6,00,000
6,00,000*1%= 6,000

(ii)
 Tolerable misstatement Actual misstatement Material / immaterial Audit opinion

Total Assets 10,00,000*1% = 10,000 1,000= 0.1% immaterial Unqualified: No material

misstatement is found

Cash 10,00,000- 6,00,000= 1,000= 0.25% immaterial

4,00,000
4,00,000*1%= 4,000

22nd Semester Final

Answer to the Question no:1(a)

..\Downloads\Telegram Desktop\Auditing definition lobeck.pdf

..\Downloads\Telegram Desktop\Auditing definition 2.pdf

Answer to the Question no:1(b)

See 22nd mid 1

Answer to the Question no:1(c)

Differentiation among assurance, non-assurance and attestation service

An assurance service is an independent professional service to improve the quality of information for
decision makers.

There are many possible forms of assurance services, including services related to business performance
measurement, health care performance, and information system reliability.

Non-assurance services include other management consulting, accounting and book keeping, tax
services, and certain management consulting, which can also be defined under assurance services. “The
primary purpose of a management consulting engagement is to generate a recommendation to
management,”. The goals of non-assurance services are different in that they are using the CPA as a
subject matter expert in areas such as installing a new information technology system that will help to
improve the company.
An attestation service is a form of assurance service in which the CPA firm issues a report about the
reliability of an assertion that is the responsibility of another party.

An example of an attestation service is a report on the effectiveness of an entity’s internal control over
financial reporting.

Answer to the Question no:3(a)

Materiality is a relative concept rather than a relative concept

Answer: The three main factors that affect an auditor's judgment about materiality are:
• Materiality is a relative rather than an absolute concept. A misstatement of a given size might be
material for a small company, whereas the same dollar misstatement could be immaterial for a larger
one.
• Bases are needed for evaluating materiality. Since materiality is relative, it is necessary to have bases
for establishing whether misstatements are material. Net income before taxes is normally the most
commonly used base, but other possible bases include current assets, total assets, current liabilities, and
owners' equity.
• Qualitative factors also affect materiality. Certain types of misstatements are likely to be more
important to users than others, even if the dollar amounts are the same, such as misstatements
involving frauds

Materiality threshold is dependent specifically on the client situation

·Uses of benchmarks are common

·Qualitative factors affect materiality decisions

See Arens page 252

Answer to the Question no:3(b)

See 23rd Mid 2

Answer to the Question no:3(c)

Inherent and control risk are independent of each other and they have no indirect relationship.

The audit risk model shows the close relationship between inherent and control risks.
For example, an inherent risk oft 40 percent and a control risk of 60 percent affect planned detection
risk and planned evidence the same as an inherent risk of 60 percent and a control risk of 40 percent. In
both cases, multiplying IR by CR results in a denominator in the audit risk model, if we assume
everything else remain constant then IR And CR has indirect relation. Increasing the IR causes CR to
reduce by the same amount.
The combination of inherent risk and control risk can be thought of as the expectation of misstatements
after considering the effect of internal control.
Answer to the Question no:3(d)

Audit Evidence is persuasive rather than Conclusive

Audit evidence is evidence obtained during a financial audit and recorded in the audit working papers. In
the audit engagement acceptance or reappointment stage, audit evidence is the information that the
auditor is to consider for the appointment.

Audit evidence is usually influential rather than decisive because of the method that it is collected and
the results that it gives. This evidence is the information that the auditor uses in arriving at termination
on the foundation of which he forms his estimation. Rather than be complete, auditors desire to be
rational in their assertion. The auditor should attain adequate and suitable verification which enables
the auditor to turn up at termination and supports his judgment. This means that they will gather
confirmation from a number of dissimilar sources to maintain a similar contention.

In the words of AICPA-

“Audit evidence is evidence obtained during a financial audit and recorded in the audit working papers.”

Audit evidence is different in different stages of auditing.

(a) Audit engagement acceptance or reappointment stage: Audit evidence is the information that the
auditor is to consider for the appointment. Audit evidence forms the foundation for forming estimation
whether the financial statements of an entity state true and fair view or not. For examples, change in
the entity control environment, inherent risk and nature of the entity business, and scope of audit work.

(b) Audit planning stage: Audit evidence is the information that the auditor is to consider for the most
effective and efficient audit approach. In assessment to decisive proof, auditors will not observe all of
the information obtainable to them when collecting their influential evidence. For examples, reliability
of internal control procedures, and analytical review systems.

(c) Control testing stage: Audit evidence is the information that the auditor is to consider for the mix of
audit test of control and audit substantive tests. Evidence collected by the auditor should maintain the
contents of its audit report.

(d) Substantive testing stage: Audit evidence is the information that the auditor is to make sure the
appropriation of financial statement assertions. For examples, existence, rights, and obligations,
occurrence, completeness, valuation, measurement, presentation, and disclosure of a particular
transaction or account balance. They are able to represent realistic conclusions and arguments about a
financial statement allegation by using a diversity of means of collecting data.
(e) Opinion formulation stage: Audit evidence is in that the auditor is to consider whether the financial
statements as a whole presents with completeness, validity, accuracy, and consistency with the
auditor’s understanding of the entity. Audit evidence includes information provided in books of
accounts as well as information from other sources.

The persuasive evidence is composed using an amalgamation of adequacy and suitability. Competence
of audit evidence is the determination of the measure of audit evidence. The two are consistent and
apply to audit evidence that is collected either throughout substantive procedures or tests of control.
Appropriateness of evidence is the excellence of the evidence, i.e., its significance and dependability to
support the auditor’s estimation.

For the above reasons, it is said that Audit evidence is persuasive rather than conclusive.

Answer to the Question no:6(a)

Overstatement testing will be tested for the account receivable. It will give comfort on testing other
assets, liabilities, income and expenses by the following way:

By testing overstatement of accounts receivable, the automatic test will be done of the followings:

Test automatically done:

1.Revenue is not overstated

2.Expense is not understated

3.Other asset is not understated

4.Liability is not overstated

The first basic principle of bookkeeping is that every debit entry has a credit entry. If the trial
balance (ie the list of balances extracted from the general ('nominal') ledger) balances, but a debit
or a credit entry is misstated, it automatically follows that there must be a second misstatement to
balance the first one.

If trade receivables ('debtors') are overstated by $1,900 then either:

* another asset is understated by $1,900 (eg if cash received has not been recorded) or
* liabilities are overstated by $1,900 (eg if the bank is in overdraft and cash is unrecorded) or
* income (eg sales revenue) is overstated by $1,900 (eg due to incorrect 'cut-off' or invalid
invoices being processed) or
* expenditure is understated by $1,900 (eg discounts given) or
* some combination, amounting to $1,900.

By testing debits directly for overstatement (O), the matching credits will be tested indirectly for
overstatement. By testing credits directly for understatement (U), the matching debits will be
tested indirectly for understatement. Thus, IF:

* all asset balances and expenses for the year (i.e. debits) are tested directly for overstatement
and
* all credit balances and income for the year are tested directly for understatement

THEN, misstatement in the opposite directions will be tested indirectly.

Direct and indirect tests are also called primary and corollary tests, respectively.

Answer to the Question no:6(b)

When examining documents. When taking the tracing direction, the auditor selects a basic source
document and follows its processing path forward to find its final recording in a summary journal or
ledger and ultimately the financial statements. Using tracing, an auditor can decide whether all
significant transactions and events that should have been recorded actually were recorded. In doing so,
the auditor complements the evidence obtained by vouching. Scanning is the way auditors exercise their
general alertness to unusual items and events in clients’ documentation. A typical scanning directive in an
audit plan is: “Scan the expense accounts for credit entries; vouch any to source documents.” The
scanning When testing the completeness assertion, the auditor will take the tracing direction process is
an “eyes-open” approach of looking for anything unusual. The scanning procedure usually does not
produce direct evidence itself, but it can raise questions related to other evidence that must be
obtained. The difference between vouching and tracing is that vouching is used to test the existence
assertion and would answer the question did all recorded sales occur and tracing is used to test the
completeness assertion and would answer the question were all shipments made to customers actually
recorded as sales.

Answer to the Question no:6(c)

Difference between qualified, adverse and disclaimer of opinion:

A qualified opinion states that there has been either a limitation on the

scope of the audit or a departure from GAAP in the financial statements, but that

the auditor believes that the overall financial statements are fairly presented. This

type of opinion may not be used if the auditor believes the exceptions being

reported upon are extremely material, in which case a disclaimer or adverse

opinion would be used.

When the financial statements as a whole are not free from material misstatement but
It is not pervasive, auditor give this type of opinion.
An adverse opinion states that the auditor believes the overall financial

statements are so materially misstated or misleading that they do not present

fairly in accordance with GAAP the financial position, results of operations, or

cash flows.

When the financial statements has material misstatement and which is

Pervasive and auditor can collect sufficient evidence and estimate the amount,
auditor give this type of opinion.

A disclaimer of opinion states that the auditor has been unable to satisfy

him or herself as to whether or not the overall financial statements are fairly

presented because of a significant limitation of the scope of the audit, or a

non independent relationship under the Code of Professional Conduct between

the auditor and the client.

When the financial statements has material misstatement and which is

Pervasive but auditor can not collect sufficient evidence and can not
estimate the amount,
auditor give this type of opinion.

In the audit report auditor will express his opinion in this manner-
Qualified Opinion
In our opinion, except for the possible effects of the matter described in the Basis for
Qualified Opinion paragraph, the financial statements present fairly (or give a true and
fair view of) the financial position............view of) the financial position............

Adverse Opinion
In our opinion, because of the significance of the matter discussed in the Basis
for Adverse Opinion paragraph, the financial statements do not present fairly (or
give a true and fair view of) the financial position.......

Disclaimer of opinion
Because of the significance of the matter described in the Basis of Disclaimer of Opinion
paragraph, we have not been able to obtain sufficient appropriate evidence to provide a
basis for an audit opinion.
Accordingly, we do not express an opinion on the financial statements.

Examples of situations that are appropriate for each type of opinion are as

follows:
OPINION TYPE EXAMPLE SITUATION

Disclaimer Material physical inventories not observed

and the inventory cannot be verified
through other procedures.
Lack of independence by the auditor.

Adverse A highly material departure from GAAP.

Qualified Inability to confirm the existence of an

asset which is material but not extremely
material in value.

21st Semester Final

Answer to the Question no:1(a)

See 23rd Mid 1

Answer to the Question no:1(b)

Flint (1988) stated that there is a matter of public accountability demanding an independent audit for its
demonstration with clear definition and intention, based on evidence that only skilled auditors gather,
measure it, and compare it against the standards, which generates economic or social benefit (as cited
in Moizer, 1989). Following are the seven postulates or assumptions stated by Flint (1988):
*There is a relationship of accountability or a situation of public accountability.

*Accountability cannot be demonstrated without an audit.

*An audit requires independence and freedom.

*The subject matter of audit is susceptible to verification by evidence.

*Auditors are skilled judges who are able to measure and compare actual performance against
standards of accountability.

*The meaning, significance, and intention of statements to be audited must be clear.

*An audit produces an economic or social benefit.

(Flink, 1989)

Whenever an economic relationship exists one of the parties owe a duty of an acceptable accountability,
consequently audits are voluntary, imposed for the health of the relationship. There are also audit
related to the interest of the public in matters of the society institutions.

C:\Users\Md.Rakibur Rahman\Downloads\Telegram Desktop\An audit is a social phenomenon .....pdf

Answer to the Question no:1(c)

See 23rd Final

Answer to the Question no:1(d)

According to International Standards on Auditing ISAs, auditor is required to obtain reasonable

assurance whether financial statements give true and fair view or in others words he must be
reasonably sure that financial statements are free from material misstatements.

Again, I must emphasize he needs to be reasonably sure and NOT absolutely sure. There is a big
difference if you are absolutely sure about something or reasonably sure.

Making the two level of assurances easy to understand in context of financial statements and audit
engagements or other assurance engagements, absolute assurance means that there is absolutely no
misstatement in the financial statement and thus financial statements are absolutely reliable and
relevant for the user of financial statements. On the other hand, reasonable assurance is also a high
level of assurance but it means that auditor has conducted the engagement in a way that he is
reasonably i.e. to the best possible extent provided the situation circumstances he is reasonable sure
that financial statements are free from material misstatement but there might be some misstatements
that go undetected.

The reason why auditor is unable to obtain absolute assurance is not because auditor’s do not conduct
audit engagements with enough care rather there are limitations and these limitations restricts the
auditor to obtain only reasonable assurance and even with such limitations and restrictions auditor tries
his best to provide some level of assurance to the users to reinforce their confidence in the financial
statements.

Such limitations that restricts the auditor to gain absolute assurance are known as Inherent limitations
of an Audit.

Inherent Limitations of an audit

Inherent limitations of an audit arise due to the following reasons:

 Persuasive evidence instead of conclusive evidence

 Inherent limitations of an accounting system:
o Use of judgement in establishing estimates for reporting purposes

o Human error

o Absence of clear instructions on accounting treatment

o Room for more than one possible interpretations of the requirements

o Degree of uncertainty and complexity of the transactions involved

o Negative effects of subjective decisions or bias on part of the management or

employee of the entity

 Existence of fraud committed by entity’s management or employees and thus concealing

important financial information leading towards fraud
 Use of sampling techniques by the auditor in conducting different audit procedures. In
sampling auditor applies audit procedures only to a small portion of the whole population
instead of checking each and every element of the population.
 Practical and/or legal limitations to obtain sufficient appropriate audit evidence
 Limitations applied or forced by the management
 Limitations as agreed upon in engagement letter
 Auditor does not have investigative rights and cannot demand certain information or
evidence from management if refused by the management
 Existence of situations at present or in future that may cause an entity to stop being a going
concern
 Cost-benefit limitations i.e. conducting audit engagement requires resources which auditor
might not have or in auditor’s judgment cost of gaining additional assurance will be higher
than the benefit gained and thus not obtained.
Answer to the Question no:4(a)

An Account with immaterial balance may contain material misstatement

Under IFRS, a transaction is considered material if omitting or misstating it can influence decisions that
users make based on financial information about the reporting entity.

Stated otherwise, materiality refers to the potential impact of the information on the user’s decision-
making relating to the entity’s financial statements or reports.

Auditors refer to financial statement information that’s not 100 percent correct as a misstatement. A set
of financial statements can never be completely accurate. But misstatements aren’t the issue in an audit
— whether they’re material is what matters

Here are some factors you consider when deciding if a misstatement is material:

 The comparative size of the misstatement: An expense difference of $10,000 is material if the
total expense amount is $40,000, but it’s immaterial if the total expense amount is $400,000.
 The nature of the misstatement: The type of misstatement may make it material even if the
comparative size is immaterial. For example, $10,000 incorrectly excluded from income may be
material even though it’s a small percentage of overall income, if the omission was deceptive in
nature.
 The relationship to other misstatements: An immaterial misstatement in one financial
statement account may relate to a material misstatement in another. For example, there could
be an immaterial difference in interest expense but a material difference in the dollar amount of
the note payable on the balance sheet.
 The inherent character of the mistake: The amount of the item may be small, but the type of
the item is significant. For example, you may find expenses that you don’t normally associate
with the type of business. You should be concerned if you find aircraft and boat expenses in the
financial statements of a company whose clients are all in the same geographic landlocked area.

Answer to the Question no:4(b)

i) Difference between Materiality and Performance Materiality?

 Materiality vs Performance Materiality
Materiality refers to the state where financial Performance materiality is the amount of
information has the ability to affect economic variation that can exist in individual financial
decisions of users or the discharge of accountability accounts due to errors and omissions without
by management or those charged with governance if affecting the auditor’s opinion regarding the
some information is misstated, omitted or not objectivity of financial statements.
disclosed.

Scope

Level of materiality is based on the needs and Level of performance materiality is based on
expectations of the users of financial information. the assessment of audit risk.

Nature

Materiality is a standalone concept. Performance materiality depends on the level

of materiality.

1.1 Summary- Materiality vs Performance Materiality

The difference between materiality and performance materiality depends on allowing a fair
and objective representation of financial statements free of material misstatements
(materiality) and the level of materiality acceptable for individual accounts (performance
materiality). Both materiality and performance materiality may be subjected to change over
time; for example, if the auditor determines that a lower materiality for the financial
statements than what was initially determined is appropriate, performance materiality can
also be changed accordingly.

ii)
Answer to the Question no: 4(C)

There is a direct relationship between acceptable audit risk and planned detection risk

Detection risk is the risk that the auditors’ procedures are unable to detect any material misstatements
in a company’s financial statements. There are two key points about planned detection risk. First it
depends on three factors of audit risk model. Second on the amount of substantive evidence auditor
plans to accumulate.

Using audit risk model, there is a direct relationship between acceptable audit risk and planned
detection risk and an inverse relationship between acceptable audit risk and planned evidence. For
example if the auditor decides to reduce acceptable audit risk, planned detection risk is there by reduce
and planned evidence must be increased. Auditor also assign more experienced staff or review the
working papers more extensively for a client with lower acceptable audit risk

Answer to the Question no:4(d)

inherent risk: (i and ii)

Control risk: - does not have an internal audit department and its audit committee does include member
according to corporate governance guidelines

Detection risk: does have not financially literate person

For example: AR=10%, IR & IR= 60%,

DR= AR / ( IR*CR)

= 10% / ( 60% * 60% )

= 27.77%

Now AR= 8%

DR= 8% / ( 60% * 60% )

= 22.22%

Detection risk Should be less than 27.77%.

Answer to the Question no:5(a)

Auditor gathers sufficient appropriate audit evidence to reduce audit to an acceptably low level and also
the same audit evidence enables the auditor to reach reasonable conclusions which form the basis of
auditor’s opinion.

Now to gather sufficient appropriate audit evidence, auditor has to select the appropriate audit
approach or audit methodology that promises the achievement of audit objective within the given
constraints and circumstances. One of the audit approach is directional testing.

Although it has been replaced by advanced auditing techniques now but this methodology is still worth
mentioning that how it stands out from other audit approaches.
Directional testing has its roots connected directly in the financial accounting basics. We can understand
how much double entry system is essential in financial accounting. Directional testing is an auditing
technique that has based the same principle to audit the financial statements. As we understand for
every debit “effect” in books of account there must be a credit effect with the equal amount. Thus if trial
balance is agreeing and the debits are correctly done, then more chances are that credits are also done
correctly. So, if auditor confirms the debit amounts then corresponding credit amount will be checked
also. And thus we may have the chance to kill two birds with one stone.

Example
Mr. A bought some goods worth 14,000.

This will be recorded in his books as:

Purchases a/c 14,000

to Cash a/c 14,000

Now, lets assume for a second that its the only entry in his books then his trial balance will be debit
14,000 and credit 14,000. In this situation if auditor checks for understatement or overstatement in
Purchases and finds that Purchases account is OK then even if he has not checked Cash account, he has
automatically confirmed that Cash account is also correct. And if Purchases account is overstated or
understated then as trial balance are equal then Cash account will also be overstated or understated
respectively.

As we will be examining only one side or one direction of the transaction at a time i.e. either debit or
credit hence we get the name directional testing. And after selecting the direction we look for either
overstatement or understatement in the account balances.

When we look for overstatements, we are basically checking whether the transaction actually occurred
at first point or not because if transaction has not occurred and still has been recorded then it will surely
cause overstatement in one account and understatement or overstatement in other account or
accounts depending on the types of accounts getting affected by the transaction.

When we look for understatements, we are basically checking whether all the transactions have been
recorded or not because of the transaction has occurred and has not been recorded then it will cause an
understatement in one account and understatement or overstatement in another account or accounts
depending on the types of accounts getting affected by the transaction.

One thing more on how overstatement and understatement tests are carried out. When auditor wants
to check for overstatement then basically he wants to check occurrence so he will have to work back
from the ledger to the very source document that evidences the transaction’s occurrence. Whereas,
while checking for understatements, he basically wanted to confirm that all the transactions have been
recorded. For this he will start from the source document and will work forward until he reaches the
ledger in which the transaction should be recorded. This might be just another reason why this
technique has the name directional testing.

Have a look at the following figures to best understand how the procedures take place. Remember,
following figures are neither a universal way of maintaining records nor every audit is conducted in this
fashion but most often this is the case.
 Directional Testing -
Simplified

Dire
ctional Testing - Detailed
Vouching vs Tracing
Tracing

Tracing refers to first selecting an accounting transaction (a source document) and then following it into
the journal or ledger. The direction of testing in this case is from the source documents to the journals
or ledgers and tests whether transactions that occurred are recorded (completeness) in the accounting
records.

Vouching

Vouching refers to first selecting an item for testing from the accounting journals or ledgers and then
examining the underlying source document. Thus, the direction of testing is from the journals or ledgers
back to the source documents. Vouching provides evidence that items included in the accounting
journals or ledgers have occurred (are valid).

Answer to the Question no:5(b)

See 22nd Final

Answer to the Question no:5(c)

 i) right
ii) valuation
iii) classification
iv) completeness

Answer to the Question no:5(d)

The appropriate analytical procedure is compare the client data with the client’s prior period data. Now,
we will test the data with the ratio analysis.

2015(Taka) 2016(Taka) 2015 2016

Revenue 10,00,000 15,00,000
COGS 6,00,000 9,00,000 60% 60%
Gross Profit 4,00,000 6,00,000 40% 40%
Operating 2,00,000 1,90,000 20% 12.67%
expense
Operating 2,00,000 4,10,000 20% 27.33%
income
Most concerned areas are Revenue and operating expenses. Revenue has increase 50% from the prior
period. Revenue may be manipulated by recording sales which have not occurred ( by creating fake
vouchers). Operating expenses also may be manipulated by not recording expenses to increase income.
There is risk of material misstatements in the revenue, operating expenses which are automatically
manipulate operating income.