Solutions manual

to accompany

AUDIT AND ASSURANCE

Leung, P., Coram, P., Cooper, B.J., Richardson, P. (2019). Audit and Assurance
(1st Ed), John Wiley & Sons Australia (ISBN:9780730363477)

The following questions and answers are from John Wiley & Sons
and reproduced with permission of the publisher

© John Wiley & Sons Australia, Ltd 2019

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Chapter 9: Materiality and audit evidence

Review questions
9.15 Describe the two main alternative audit strategies that may be adopted in
performing an audit.
ASA 330 describes requirements for auditors to follow in addressing risks identified.
The two main alternative audit strategies are a predominantly substantive approach
and a lower assessed level of control risk approach. A predominantly substantive
approach is one where the majority of audit evidence is obtained by substantive audit
procedures that provide direct evidence as to the fairness of management’s financial
statement assertions. A lower assessed level of control risk approach is one that relies
on internal controls to support the use of a reduced level of substantive procedures.
This approach requires that the auditor tests internal controls to verify that control
procedures are actually operating as laid down.

9.18 What is the difference between a test of control and a substantive test?
A test of control tests the effectiveness of the internal controls in preventing,
detecting and correcting errors. The auditor must test internal controls before placing
reliance on them in support of the audit opinion. Effective internal controls can reduce
the amount of substantive testing that the auditor needs to perform.
Substantive tests aim to obtain direct evidence about transactions and balances in the
financial report by testing the financial statement assertions. Tests include tests of
detail of transactions and balances and analytical procedures.

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Professional application questions

9.23 Substantive procedures and audit evidence 
An auditor may perform the following three types of substantive procedures: (a)
tests of details of transactions; (b) tests of details of balances; and (c) analytical
procedures. Below are specific audit procedures that fall within one of these
categories:
1. Reconcile supplier statements at the year-end with balances in the purchase
ledger.
2. Validate a sample of sales invoices to goods despatch records held in the
inventory system.
3. Review post year-end receipts from customers to establish the extent of unpaid
debts.
4. Calculate gross profit ratios for each branch of a chain of supermarkets and
compare month-by-month and prior year.
5. Obtain schedule of asset disposals in the period and validate against supporting
sale documents.
6. Attend the factory on the final day of the year to review work in progress.
7. Validate payment to equipment hire company to a copy of the lease.
8. Calculate expected payroll costs from last year’s amount adjusted for staff
changes and pay rise in the year.
Required
For each procedure, explain which of the three types of substantive procedures it
belongs to.
1. (b)
2. (a)
3. (b)
4. (c)
5. (a)
6. (b)
7. (a)
8. (c)

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9.27 Audit objectives, procedures and evidence 

You are an audit senior and your firm audits Miningwell Ltd, a large mining company
that operates all over Australia. Consider the following situations that have arisen
during the audit.
1. Miningwell owns some highly-specialised mining tools and equipment held at
various remote regions across the country. Your firm has engaged an expert to
carry out a physical audit check of the equipment and tools at each location, and
to perform an independent valuation of each material asset.
2. In reviewing the account receivables of Miningwell, you realise that the majority
of Miningwell’s customers are in Indonesia and other parts of remote South-East
Asia. Because of communication difficulties, direct confirmation of the accounts
receivables’ balances is unlikely to give satisfactory results.
3. During the audit, you also notice that Miningwell owns the majority of shares in
related, unlisted companies in Australia.
Required
a. Identify the key assertion(s) at risk in relation to the balances described in each
of these three situations.
b. Describe the audit procedures you would perform to gather sufficient
appropriate audit evidence on each of these assertions.

1. a. Existence / Accuracy, valuation and allocation

b. In this case an independent expert has performed the work on the key risk
areas. The auditor would need to consider ASA 620, Using the Work of an
Expert:
• The auditor should assess the appropriateness of the expert’s work.
• The auditor should review the source data used by the expert and ensure
that it is sufficient, relevant and reliable. The auditor should also test the
data used by the expert.
• If the results of the expert’s work do not provide sufficient appropriate
audit evidence, or if the results are not consistent with other audit
evidence, the auditor should resolve the matter (e.g. more work or audit
qualification etc.)
Other Work
Select a sample of fixed asset additions and disposals and vouch to supporting
documentation.

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2. a. Existence / Accuracy, valuation and allocation

b. The main problem here is existence. The following alternatives are possible
when direct confirmation with debtors is unlikely to provide satisfactory
results:
• Review for subsequent payments by the debtors – payment of the amount
owing is good evidence to suggest that the amount exists and is fairly
stated.
• Review for evidence of delivery of goods to customer.
• Review invoices (very weak evidence)
• When the auditor does not carry out a debtor’s confirmation, the reasons
for doing so should be documented in the audit work papers.
Valuation
•Select a sample of long outstanding and doubtful accounts and review
collectability by reference to correspondence files and discussions with client
staff.
3. a. Accuracy, valuation and allocation
b. Obtain copies of the latest accounts of the investee companies (audited if
possible). Compare the percentage shareholding with the percentage
value of net assets to ascertain reasonableness.

9.28 Audit evidence 

You are about to complete the planning stage of the audit of Stack Print Ltd and you
are considering your approach to several events that have occurred during the year.
Stack Print Ltd’s revenue for the year is $25 million and profits are $3 million.
A customer has made a claim against Stack Print Ltd for breach of contract. The
customer claims that products were not delivered in accordance with the contract
and this led to them having to engage other contractors to carry out the work at
great expense. The customer is suing the company for damages of $1 million.
A major customer has not paid Stack Print Ltd for three months and the receivable
balance at the year-end for this customer is $120 000. The customer is rumoured to
be having significant cash flow difficulties; however, Stack Print Ltd’s directors
believe they will be paid as the customer is one of long standing and has always paid
in the past.
Stack Print Ltd recently purchased new equipment for the factory. This replaced old
machinery, which is no longer being used, included in the balance sheet at a net
written down value of $2 250 000. The old equipment has not reached the end of its
originally-expected useful life, remains on the balance sheet and is being
depreciated in line with previous years.

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Required
Describe substantive procedures that would provide sufficient appropriate evidence
in relation to the issues outlined above.
Customer claim
The amount claimed constitutes ⅓rd of the profit for the year and is therefore
material.
There should be included in the financial report some information with regard to the
contingent liability. If it is probable that an amount will be paid, then a liability
should be included in the balance sheet.
Correspondence from the customer and between Stack Print and its solicitors would
confirm the existence and the nature of the claim made as well as the progress of
any discussion to resolve the issue.
The best source of evidence to establish the value to be placed on any liability would
be a settlement being made after the year end. If a payment has been made this
would confirm the liability that should be included in the balance sheet.
In the absence of a settlement being made a solicitor’s letter would give
confirmation of the claim being made and might also give a progress report on the
case indicating the likely outcome.
If it is possible but not probable that an amount will be paid, then disclosures will be
required but not provided for.
Management representations may need to be sought to confirm the views in
relation to the likely outcome of the case.

Customer with cash flow difficulties

The amount outstanding at the year-end is 4% of the profit for the year which is less
than ½% of the revenue. It is likely that this amount would therefore not be
considered material. The amount of the error should be recorded and if together
with other errors the adjustment required to the financial report becomes material,
then the directors will be asked to correct all the errors.
In order to understand the likely error, it will be necessary to obtain whatever
information is available that gives rise to the rumours of cash flow difficulties. Is this
just the non-payment of the receivable balance or are there other indications? The
auditor may be able to rely on their own industry knowledge to support any view of
the customers’ financial position.

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History of the relationship with the customer may support the fact that amounts
have remained outstanding but ultimately been paid.
A review for cash received after the year end will be necessary to establish if the
debt has been paid after the year end, this review can be done right up to the
finalization of the financial report and the signing of the audit report.
Management representations may be sought in relation to the recoverability of the
debt.

Old equipment
The value of the old machine is material and appears to be obsolete and should be
written down to its recoverable amount. Whether the write down to recoverable
amount is material will need to be established.
The auditor should obtain details of management intention with regard to the
machinery. If the machine is expected to be sold, then details of any negotiations or
contacts with potential buyers should be reviewed. If the machine has been sold
after the year end a copy of the contract of sale should be sighted. An expert
valuation of the value of the machine might be sought to confirm the valuation.
If the company does not intend to sell the machine or no second-hand market is
available, then it is likely a write down of the full amount or down to a scrap value is
necessary. Details of this valuation will be required.

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