Audit Risk Seminar 5 - Questions Risk & Materiality

Question 1

At the audit planning meeting for the year ended 28 February 20X4 with the finance
director of Malbec Ltd, you ascertained that payroll processing, which had been outsourced
for a number of years, was brought back in-house in December 20X3.

Management was not satisfied with the performance of the service provider and repudiated (might get
fine)
the contract. The service provider had been responsible (Inexperience) for making payments to the
employees and the monthly remittances to HMRC (might pay wrong). Two of Malbec Ltd's accounts
clerks
have been trained in payroll processing.

Identify the audit risks in respect of the above matter for the year ended 28 February 20X4
and state how you would address these risks.
(4 marks)
Question 2

Your firm is the external auditor of GreenEat, a charity established to promote the
protection of the environment. GreenEat raises income from the sale of food and drink in
cafés located in city centres and from donations made by individuals. The cafés are
managed and staffed by unpaid volunteers (not expertise enough). Donations are made to GreenEat
through
collection boxes (Cash) located in each café and by post to GreenEat's headquarters.
Donations are Unpredictable you may run out of business.
Identify and explain three key audit risks associated with your firm's audit of GreenEat's
income.
(3 marks)

Question 3

You are planning the audit of Scorpio plc (Scorpio) for the year ending 31 December
20X0. Scorpio's principal activity is the manufacture of a range of electrical appliances. In
today's newspapers, there are headlines about Scorpio recalling one of its most popular
products due to electrical faults which, in a number of cases, have caused fires.

Explain why this matter should be considered when planning the audit of Scorpio for the
year ending 31 December 20X0.
(2 marks)
Question 4

During the year ended 31 May 20X6, Federa Ltd (Federa) outsourced its payroll
processing to a service organisation which provides Federa with monthly payroll
information relating to its employees. Federa uses this information to pay the wages and
salaries directly into its employees' bank accounts and the relevant payroll taxes to the tax
authorities.

Identify the business risks arising out of Federa outsourcing its payroll processing and
explain the implications for the financial statements.
(4 marks)

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Audit Risk Seminar 5 - Questions Risk & Materiality

Question 5
State what is meant by 'performance materiality' and outline why this is set by external
auditors.
(2 marks)
Question 6

During the course of the audit of your client Sloth plc you notice a balance within
receivables entitled 'advances against directors' expenses'. The company's managing
director, who is familiar with the concept of materiality, has questioned your need to audit
this balance, which at the year end stands at £12,500. The company's retained profit for the
year is £1.3 million.

Prepare brief notes to the managing director explaining your audit approach in respect of
this item.
(2 marks)
= Qualitative material, need to disclose directors’ remuneration

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Audit Risk Seminar 5 - Questions Risk & Materiality

Question 7
In accordance with ISA 500 Audit Evidence an auditor should obtain “sufficient appropriate audit
evidence to be able to draw reasonable conclusions on which to base the audit opinion”

The following are items of audit evidence obtained during the course of the audit of Southbank Plc.:

1. Correspondence from the lawyers of Southbank Plc. regarding a claim for damages against
the company
2. A trade journal article stating that Southbank Plc. faced a decrease in profits during the
current year of some 35% from the previous year
3. Attendance at the year-end inventory count and making test counts
4. A reconciliation of Southbank’s payables statements by a member of the company’s accounts
staff
5. A bank confirmation letter received from the company’s bankers

REQUIRED

i. Explain what is meant by ‘sufficient’ and ‘appropriate’ audit evidence giving suitable and
relevant examples (5 marks)

ii. For each of the above (in 1-4), state the reliability of the audit evidence and describe an
additional item of audit evidence that you would seek to support your audit opinion
(10 marks)

iii. Describe and explain the procedures for obtaining audit evidence
(5 marks)

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Audit Risk Seminar 5 - Questions Risk & Materiality

Question 8
Materiality is a concept that is fundamental to both auditing and accounting. Materiality has to
be considered at all stages of an audit not only in terms of amount but also using non
quantifiable criteria.

REQUIRED

a. Explain in your own words, your understanding of materiality.

(2 marks)

b. Why are audit risk and materiality closely connected? (3 marks)

= Risk and materiality have inverse rel, one high other low.

c. Explain using suitable and relevant examples how and why the auditor uses
performance materiality during the audit
(5 marks)

d. Why is materiality important at both the planning and review stages of the audit?
(10 marks)

Total: 20 marks

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Audit Risk Seminar 5 - Questions Risk & Materiality

Question 9

You have been approached by Delta Film Productions Limited to act as their external auditor.
The management have told you that their current auditors are resigning because they do not
have the expertise to continue acting. The company is involved in film production and has its
own distribution division. The draft accounts for the year ended 30 June 2015 show a turnover
of £16 million with a net profit of £4 million.

The company has recently been floated on the Alternative Investment Market (AIM) and a
large venture capital company is now a major shareholder. The venture capital company has
insisted that the four directors have a basic salary of £30,000 each with a bonus payment
based on profitability.

The managing director of the company, Ivor Oscar, is a former film producer and is a very
charismatic person that told you in a recent meeting that “his way was always the best way
and if anyone disagreed, then they would be dismissed, including the auditor!!!”

During the year, the following occurred:

1. The company opened satellite offices in Los Angeles, Paris and Berlin
2. The excess cash of the company were invested in listed investments through their
merchant bank Lehman Brothers and these investments have lost some 80% of their
value since the demise of Lehman Brothers
3. You have read in the film press that Delta Films Production Limited was being sued
by a screen writer for breach of contract. The damages claimed are in the region of £2
million
4. The Finance Director is currently under suspension for alleged accounting
irregularities. The matter is currently in litigation.
==== Credibility of the report

REQUIRED

a. Explain the difference between the modern risk based approach to auditing as
opposed to the more traditional system based approach.
(5 marks)
b. Outline the audit risk model, defining each of its components.
(5 marks)

IA CA DA Risk define
c. Write a memo to the audit engagement partner outlining FIVE risk areas that
you have identified with Delta Film Productions Limited. Conclude your
memo with your view as to whether your firm should accept or reject this
new potential client. (10 marks)
Total: 20 marks
= Identify Why
Nature of Business
Profit Driven
Dominating Management