KnS School of Business Studies

ACCA F8 & CA CAF 9 (Audit & Assurance)

ISA 210 Precondition for an Audit

Index of
Practice Questions

S No Question Attempt Marks Page No

1 Q.17 (a) ACCA September/December 2017 (3 marks) 1–2

2 Q.4 (a) ACCA December 2013 (8 marks) 3–5

Compiled By M. Sajid Kapadia (ACA, FCCA, APFA)

ACCA September/December 2017 (3 marks)
Question 17 (a)
You are an audit supervisor of Cupid & Co, planning the final audit of a new client, Prancer
Construction Co, for the year ending 30 September 20X7. The company specializes in property
construction and providing ongoing annual maintenance services for properties previously
constructed. Forecast profit before tax is $13.8m and total assets are expected to be $22.3m, both
of which are higher than for the year ended 30 September 20X6.
You are required to produce the audit strategy document. The audit manager has met with Prancer
Construction Co’s finance director and has provided you with the following notes, a copy of the
August management accounts and the prior year financial statements.

Meeting notes
The prior year financial statements recognize work in progress of $1.8m, which was comprised
of property construction in progress as well as ongoing maintenance services for finished
properties. The August 20X7 management accounts recognize $2.1m inventory of completed
properties compared to a balance of $1.4m in September 20X6. A full year-end inventory count
will be undertaken on 30 September at all of the 11 building sites where construction is in progress.
There is not sufficient audit team resource to attend all inventory counts.
In line with industry practice, Prancer Construction Co offers its customer a five-year building
warranty, which covers any construction defects. Costumers are not required to pay any additional
fees to obtain the warranty. The finance director anticipates the provision will be lower than last
year as the company has improved its building practices and therefore the quality of the finished
property.
Customers who wish to purchase a property are required to place an order and pay a 5% non-
refundable deposit prior to the completion of the building. When the building is complete,
customers pay a further 92.5%, with the final 2.5% due to be paid six months later. The finance
director has informed you that although an allowance for receivables has historically been
maintained, it is anticipated that this can be significantly reduced.
Information from management accounts
Prancer Construction Co’s prior year financial statements and August 20X7 management
accounts contain a material overdraft balance. The finance director has confirmed that there are
minimum profit and net assets covenants attached to the overdraft.
A review of the management accounts shows the payables period was 56 days for August 20X7,
compared to 87 days for September 20X6. The finance director anticipates that the September
20X7 payables days will be even lower than those in August 20X7.

Required:
a) Describe the process Cupid & Co should have undertaken to assess whether the
PRECONDITIONS for an audit were present when accepting the audit of Prancer
Construction Co.
(3 marks)

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Answer 17:
a) Preconditions for the audit
ISA 210 Agreeing the Terms of Audit Engagements states that auditors should only accept a
new audit engagement when it has been confirmed that the preconditions for an audit are
present.

To assess whether the preconditions for an audit are present, Cupid & Co should have
determined whether the financial reporting frame work to be applied in the preparation of
Prancer Construction Co’s financial statements is acceptable. In considering this, the auditor
should have assessed the nature of the entity, the nature and purpose of the financial statements
and whether law or regulation prescribed the applicable reporting framework.

In addition, the firm should have obtained the agreement of Prancer Constructions Co’s
management that it acknowledges and understands its responsibilities for the following:
- Preparation of the financial statements in accordance with the applicable financial
reporting framework, including where relevant their fair presentation;
- For such internal control as management determines is necessary to enable the preparation
of financial statements which are free from material misstatement, whether due to fraud or
error; and
- To provide Cupid & Co with access to all relevant information for the preparation of the
financial statements, any additional information which the auditor may request from
management and unrestricted access to personal within Prancer Construction Co from
whom the auditor determines it necessary to obtain audit evidence.

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ACCA December 2013 (8 marks)
Question 4 (a)
Salt & Pepper & Co (Salt & Pepper) is a firm of Chartered Certified Accountants which has seen
its revenue decline steadily over the past few years. The firm is looking to increase its revenue and
client base and so has developed a new advertising strategy where it has guaranteed that its audit
will minimize disruption to companies as they will not last longer than two weeks.in addition, Salt
& Pepper has offered all new audit client a free accounts preparation service for the first year of
the engagement, as it is believed that time spent on the audit will be reduced if the firm has
produced the financial statements.

The firm is seeking to reduce audit costs and has therefore decided not to update the engagement
letter of existing clients, on the basis that these letters do not tend to change much on a yearly
basis. One of Salt & Pepper’s existing clients has proposed that this year’s audit fee should be
based on a percentage of their final pre-tax profit. The partners are excited about this option as
they believe it will increase the overall audit fee.

Salt & Pepper has recently obtained a new audit client, Cinnamon Brothers Co (Cinnamon),
whose year end is 31 December. Cinnamon requires their audit to be completed by the end of
February; however, this is a very busy time for Salt & Pepper and so it is intended to use more
junior staff as they are available. Additionally, in order to save time and cost, Salt & Pepper have
not contacted Cinnamon’s previous auditors.

Required:
a) Describe the steps that Salt & Pepper should take in relation to Cinnamon:
i. Prior to accepting the audit; and ( Part of Ethics)
(5 marks)
ii. To confirm whether the preconditions for the audit in place. (3 marks)

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 Answer 4 (a):
i. Steps prior to accepting the audit of Cinnamon Brothers Co (Cinnamon)
ISA 210 Agreeing the Terms of Audit Engagements provides guidance to Salt & Pepper & Co
(Salt & Pepper) on the steps they should take in accepting the new audit client, Cinnamon. It
sets out a number of processes that the auditor should perform prior to accepting a new
engagement, in addition to considering whether preconditions for the audit are in place.
Salt & Pepper should consider any issues which might arise which could threaten compliance
with ACCA’s Code of Ethics and Conduct or any local legislation, including conflict of interest
with existing clients. If issues arise, then their significance must be considered.
In addition, they should consider whether they are competent to perform the work and whether
they would have appropriate resources available, as well as any specialist skills or knowledge
required for the audit of Cinnamon.
Salt & Pepper should consider what they already know about the directors of Cinnamon; they
need to consider the reputation and integrity of the directors. If necessary, the firm may want
to obtain references if they do not formally know the directors.
Additionally, Salt & Pepper should consider the level of risk attached to the audit of Cinnamon
and whether this is acceptable to the firm. As part of this, they should consider whether the
expected audit fee is adequate in relation to the risk of auditing Cinnamon.
Salt & Pepper should communicate with the outgoing auditor of Cinnamon to assess if there
are any ethical or professional reasons why they should not accept appointment. They should
obtain permission from Cinnamon’s management to contact the existing auditor; if this is not
given, then the engagement should be refused.
If given permission to respond, the auditors should reply to Salt & Pepper, who should
carefully review the response for any issues that could affect acceptance.
ii. Preconditions for the audit
ISA 210 Agreeing the Terms of Audit Engagements requires auditors to only accept a new
audit engagement when it has been confirmed that the preconditions for an audit are present.
To assess whether the preconditions for an audit are present, Salt & Pepper must determine
whether the financial reporting framework to be applied in the preparation of Cinnamon’s
financial statements is acceptable. In considering this, the auditor should assess the nature of
the entity, the nature of purpose of the financial statements and whether law or regulations
prescribed the applicable reporting framework.
In addition, they must obtain the agreement of Cinnamon’s management that it acknowledges
and understands its responsibility for the following:

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- Preparation of the financial statements in accordance with the applicable financial reporting
framework, including where relevant their fair presentation;
- For such internal control as management determine is necessary to enable the preparation of
financial statements which are free from material misstatements, whether due to fraud or error;
and
- To provide Salt & Pepper with access to all relevant information for the preparation of the
financial statements, any additional information that the auditor may request from
management and unrestricted access to persons within Cinnamon from whom the auditor
determines it necessary to obtain audit evidence.
If the preconditions for an audit are not present, Salt & Pepper shall discuss the matter with
Cinnamon’s management. Unless required by law or regulation to do so, the auditor shall not
accept the proposed audit engagement:
- If the auditor has determined that the financial reporting framework to be applied in the
preparation of the financial statements is unacceptable; or
- If management agreement of their responsibilities has not been obtained.

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