COMSATS University Islamabad Lahore Campus

Mid Term – FA 21
Course Title: Auditing Course Code: MGT-370 Credit Hours: 3(3,0)
Course Instructor/s: Rashid Waheed Qureshi Programme BS AF & BBA
Semester: Batch: Section: Name:
A Date: 20-Nov-2021
Time Allowed: 90 minutes Maximum Marks: 25
Student’s Name: Reg. No.

Important Instructions / Guidelines:

 Read all the questions carefully before solving the paper.

 Mobile phones are strictly prohibited in the examination room.
 Attempt all the Questions.

Question # 1. (10)
The growing recognition by management of the benefits of good internal control and the
complexities of an adequate system of internal control have led to the development of internal
auditing as a form of control over all other internal controls. The emergence of internal auditors
as experts in internal control is the result of an evolutionary process similar in many ways to the
evolution of external auditing.

Required:
(a) Explain why the internal and independent external auditors' review of internal control
procedures differ in purpose.
(b) Explain the reasons why internal auditors should or should not report their findings on
internal control to the following company officials:
(i) The board of directors
(ii) The chief accountant

Question # 2. (5)
The responsibilities of external auditors are not always well understood. When external auditors
provide non-audit services to their audit clients, it is essential that the auditors make a clear
distinction between their audit and non-audit responsibilities.

Required:
Explain why it is essential for external auditors to be independent of their clients.

Continued…..
Question # 3. (10)

Mohsin has to audit the sales transactions of Arham Ltd. Arham Ltd supplies tools to the
mining industry and carries a large number of different makes and models of standard mining
tools. Arham Ltd also designs and manufactures tools for special purposes and for miners
operating in difficult conditions. The custom designed tools are made only on the signing of a
contract and receipt of a deposit, whereas standard tools are supplied to regular customers on
receipt of a telephone order. Arham Ltd’s sales transactions vary from a few dollars to millions
of dollars depending on the number of items sold and whether the individual items are large or
small tools, and whether the tools are standard items or custom designed. Mohsin is instructed to
gather evidence about the sales transactions using sampling and vouching. This is explained in
detail in the audit program.

Required:
What would you expect to see in the audit program given to Mohsin about (1) the sample
selection and (2) the vouching procedures? Explain
Question 2
External auditor independence
(i) External auditors are unable to fulfil their duties to shareholders if they are not independent of
the entity on which they are reporting.
(ii) If external auditors have an interest in the financial statements on which they are reporting,
they may not be objective. For example, if, in the case of a listed company, they have prepared
the financial statements on which they are reporting, their view may not be considered objective.
(iii) If they have financial or employment connections with the company on which they are
reporting they will not be objective.
(iv) If they provide a significant level of additional services to the entity, some argue that they
cannot report objectively as auditors to shareholders.

Question 1
(a) Internal auditors review and test the system of internal control and report to management in
order to improve the information received by managers and to help in their task of running the
company.
They will recommend changes to the system to ensure that management receives objective
information which is efficiently produced. They also have a duty to search for and discover
fraud.
The external auditors review the system of internal control in order to determine the extent of the
substantive work required on the year-end accounts.
The external auditors report to the shareholders rather than the managers or directors. They
report on the truth and fairness of the financial statements, not directly on the system of internal
control.
External auditors usually however issue a report to management, laying out any areas of
weakness and recommendations for improvement in the system of internal control. They do not
have a specific duty to detect fraud, although they should plan their audit procedures so as to
detect any material misstatements in the accounts on which they give an opinion.
(b) (i) Board of directors
A high level of independence is achieved by the internal auditors if they report directly to the
board. There may be problems with this approach.
(1) The members of the board may not understand all the implications of the internal audit
reports when accounting or technical information is required.
(2) The board may not have enough time to spend considering the reports in sufficient depth.
Important recommendations might therefore remain unimplemented.
A way around these problems might be to delegate the review of internal audit reports to an
audit committee, which would act as a sub-committee to the main board. The audit committee
should be made up largely of non-executive directors who have more time and independence
from the day-to-day running of the company.
(ii) Chief accountant
It would be inappropriate for internal audit to report to the chief accountant, who is in
charge of running the system of internal control. It may be feasible for him or her to receive
the report as well as the board. Otherwise, the internal audit function cannot be effectively
independent as the chief accountant may suppress unfavourable reports or may just not act
on the recommendations of such reports.