Professional Documents
Culture Documents
2021
TULIP
2 of 26
AUDIT AND ASSURANCE – SFQs
1.1 Firm's response to a request to revalue assets and reasons
Refuse the request
Prohibited by Ethical Standard
No adequate safeguards
To protect independence/objectivity
Assets are material to FS
greater than 1-2% of total assets
Self-review threat, firm may:
over rely on valuation during audit
be reluctant to identify a misstatement
Management threat:
may involve making decisions/subjective judgement
firm's views may be too closely aligned with management.
1.2 Purposes of a cold audit file review
A continuing part of quality control process designed to:
assess effectiveness of firm's procedures
assess compliance with:
– ISAs
– Ethical Standard
– Legal requirements
– UK Audit Regulations
assess if appropriate auditor's report was issued
identify where:
– changes to procedures are needed
– additional training is required
prevent problems in future audits
minimise damage to the firm.
3 of 26
1.3 Steps taken by the UK government and regulators since January 2018 to
address criticisms of external auditors
Kingman review
government commissioned review of role of FRC/replacement of FRC
Competitions and Market Authority review
review of the audit market
proposal for joint audits
Brydon review
review the existing model for auditing/reduce expectations gap
BEIS report
future of Audit
break up of Big 4/separation of audit and non-audit services
FRC increasing number of audit reviews.
1.4 Why and how a group auditor evaluates evidence obtained by component
auditors
Why evaluate
Required by ISA (UK) 600
Group auditor is responsible for the audit opinion on the group FS
Reduces the risk of:
material misstatement in the group financial statements
inappropriate opinion
Determine whether:
the work undertaken by component auditors supports firm's opinion
additional procedures are needed
How to evaluate
Questionnaires
Review of component auditors' working papers/plans
Inspect summary of component auditors' conclusions
Evaluate uncorrected misstatements.
1.5 Ethical issues of an ICAEW Chartered Accountant exaggerating his
experience
Self-interest threat
to objectivity
influenced by the financial reward
putting his own interests first
Threat to integrity
statements that are materially false or misleading
4 of 26
Threat to professional behaviour
exaggerating his experience
bringing profession into disrepute
Threat to professional competence and due care
lacks experience in bank audits
audit quality compromised.
1.6 Implications for the audit report of management's refusal to provide written
representations
Auditor is unable to obtain sufficient appropriate evidence/limitation on scope
Written representations required by ISA (UK) 580
Matter is pervasive
impacts FS as a whole
Modified opinion
Disclaimer of opinion
do not express an opinion
Basis for disclaimer of opinion paragraph
explaining the matter
after opinion section
Report by exception
not received all information and explanations/inadequate accounting records.
5 of 26
AUDIT AND ASSURANCE – LFQs
2
Marking guide
Marks
2.1 Familiarity threat and safeguards
Threat 3½
Safeguards 8
Marks available 11½
Maximum 7
2.2 Risks and procedures
Going concern:
Justification 18½
Procedures 17½
Bonus accrual:
Justification 10½
Procedures 9½
General:
Justification 2
Total marks available 58
Maximum 23
2.3 Auditor's report implications 6½
Total marks available 6½
Maximum 4
2.4 Consequences 8
QC procedures 5½
Total marks available 13½
Maximum 8
Total marks available 42
2.1 Threat
A familiarity threat arises when the auditor is predisposed to accept or is
insufficiently questioning of Mallard's point of view, thereby impairing the objectivity
of the auditor.
This may occur where there are close personal relationships between the external
audit team and client personnel.
This threat arises in the case of Mallard because:
Lorna Linnet has been the engagement partner for 5 years and will have
developed a relationship with the management of Mallard
6 of 26
the chair of the audit committee was a former partner in the firm and may have
developed a close relationship with Lorna
Jack Bird, the former audit manager, was appointed as financial controller of
Mallard in March 2021 and members of the audit team may be too trusting of
their former colleague.
Safeguards
In respect of the engagement partner, the ES requires compulsory rotation after
five years but allows the engagement partner to continue in that role for two more
years to maintain audit quality in the event of Mallard's reorganisation.
The firm should consider whether a reasonable and informed third party would
consider independence and objectivity to be impaired if Lorna remains as the
engagement partner.
Where it is decided that Lorna is not rotated after 5 years, the ES requires the
following safeguards:
an expanded review of audit work undertaken by an engagement quality
control reviewer or an independent partner
documentation of the reasons as to why Lorna continues to participate in the
audit
communication of the facts to shareholders and those charged with
governance at Mallard.
The ES requires the firm to consider the composition of the engagement team to
ensure that objectivity and independence are not impaired as a result of
relationships between Jack and members of the audit team.
However, the new manager may reduce the need to change members of the
engagement team.
The ethics partner should be consulted on each of these issues.
2.2 Going concern
Justification
Mallard may experience cash flow issues and may not be able to pay debts as
they fall due because:
– gross margin declining from 22.7% to 15.8%
– gross margin per job declines over the second half of the 2020/21 year
(per the visualisation), resulting in lower cash receipts
– profit before tax declining by 95.2%
– revenue increased rapidly by 26.2% which may indicate overtrading
– net current liabilities increasing by 1043%
– trade payables rising throughout the year (per the visualisation), which is
suggestive of payment difficulties resulting from cash constraints
7 of 26
– prices lowered to obtain contracts resulting in tight margins (declining
gross margin per job)
– the company operates:
(a) short- term contracts leading to uncertainty over future income
(b) fixed-price contracts which are susceptible to losses if there are cost
overruns
– if customers refuse to pay the balance, Mallard is exposed to 70% of the
contract value. The rising proportion of credit notes being issued (per the
visualisation) suggests that this is increasingly common.
Mallard is reliant on a bank overdraft:
– significant increase of 4650%
– close to overdraft limit – according to the current trend (per the
visualisation), Mallard will run out of cash within 2 months unless the
situation changes
– an expensive form of finance
– due for review and could be recalled at any time
– Mallard may not be able to secure other finance
Bank loan is due for repayment within the next three months:
– there is insufficient headroom in the overdraft to repay the bank loan
– bank loan covenants may be breached which could lead to foreclosure
Revenue rises in the second half of 2020/21 (per the visualisation), which may
signal overtrading or possible manipulation in relation to contract liabilities
Mallard operates in a competitive market where competitors have invested in
the latest equipment
Adverse media comment, causing reputational damage and possible loss of
future work
Sub-standard work leading to possible damages and rectification costs. Credit
notes have risen as a proportion of revenue (per the visualisation), which
suggests that work quality is falling.
Additional costs may be incurred, such as redundancy payments associated
with the reorganisation
Procedures
Obtain profit and cash flow forecasts for a minimum of 12-month period after
the date of approval of the financial statements:
– ascertain if Mallard can meet its debts as they fall due and stay within the
overdraft facility limit
– consider the reasonableness of the assumptions, such as whether:
(a) they are consistent with the reorganisation plan
8 of 26
(b) loan repayments are included
(c) new equipment costs are included
– perform sensitivity analysis on key variables, such as revenue, contract
margins and interest rates
Discuss and review the reorganisation plan
– obtain a written representation from management regarding the feasibility
of Mallard's plans.
Review board minutes for evidence of discussions of alternative sources of
finance
Review post year-end management accounts to assess Mallard's performance
and ascertain whether:
– revenue has been affected by the adverse publicity
– quarterly loan repayments were made on their due dates
Inspect correspondence with customers/lawyers to ascertain the likelihood of
incurring damages/rectification costs
Review the loan agreement to ascertain the loan terms and the consequences
of a breach of covenants
Inspect correspondence with the bank to ascertain the quality of Mallard's
relationship with its bank.
Accrual for directors' bonuses
Justification
The accrual is material and there is a risk of understatement because:
Bonuses as a percentage of revenue are 0.23%, down from 0.93% in prior
year - this is a decrease of 68.8% and the accrual is not in line with the
increase in revenue
The expected current year bonus would be in the range of £54.1m to £108.2m
(10825 0.5%-1.0%) - the accrual is outside this range
The expected prior year bonus would be in the range of £42.8m to £85.7m
(8577 0.5%-1.0%) - the accrual was in this range
Prior year bonus was payable in May, but if unpaid, the understatement will be
greater
Directors' bonus rates vary according to contract terms - incorrect rates may
be applied
Risk of incorrect formulae used in the spreadsheet
Procedures
Inspect the spreadsheet and reperform the calculations
Discuss with the directors the reason for the reduction in bonus accrual,
specifically whether new terms negotiated or lower rates agreed
9 of 26
For each director's bonus, inspect:
– contract of employment
– bank statements for payments
– notification to each director of the bonus payable in August, December
and May
Compare the current year payment to the prior year bonus accrual to ascertain
management's track record in accurately accruing bonuses
Obtain a management representation regarding the completeness of the
accrual.
General
Justification
Reliance by the bank on the financial statements may lead to window dressing
The bonus scheme encourages revenue maximisation at the expense of profit
There is limited time for review of subsequent events which may provide additional
evidence on items reflected in the financial statements.
2.3 The strategic report is not part of the financial statements so the opinion on the fin-
ancial statements is not modified in respect of this matter.
However, Companies Act 2006 requires the auditor to make a specific statement
on whether the strategic report is consistent with the financial statements and has
been prepared in accordance with applicable legal requirements.
The audit report should be modified to include a description of the issue in the sec-
tion headed "Opinion on other matters prescribed by the Companies Act 2006" and
state "except for this matter, the information given in the Strategic Report is con-
sistent with the financial statements".
The matter should also be reported in the section of the audit report headed
''Matters on which we are required to report by exception''.
10 of 26
The firm may be investigated by regulatory bodies (such as ICAEW), which
may result in disciplinary action and penalties including fines or withdrawal of
registered auditor status.
The adverse publicity associated with legal claims and disciplinary procedures
may result in a loss of reputation, clients and key employees.
There will be increased costs for the firm as a result of greater scrutiny
adversely impacting profits and cash flow of the firm.
In extreme cases this could lead to the financial collapse of the firm.
(b) Quality control procedures
The firm should have robust procedures to ensure competent employees are
recruited and subsequently trained.
The firm should allocate competent and experienced staff to each engagement
team.
Junior members of the team should be adequately briefed, prior to starting
their work, and supervised throughout the audit.
All team members' work should be subject to a review by a more senior
member of the team.
Consultation should take place on contentious issues and all such matters,
including their resolution, should be documented.
An engagement quality control review should be performed on the audit of
Mallard as it is a listed company and audit risk is considered higher than
normal because of going concern issues.
The firm should undertake annual due diligence procedures, including the
assessment of management's integrity when deciding whether to continue as
auditor of Mallard.
11 of 26
3
Marking guide
Marks
3.1 Taking the year as a whole, there is a 9% increase in Cost of Sales compared with
the prior year (2018: £881,464; 2017: £809,659). This gives a potential risk of
overstatement of Cost of Sales.
It is useful to drill down to individual accounts within Cost of Sales.
Tutorial note
Use the 'Account View' in the audit software to review Cost of Sales at the
individual account level for the range of account codes given in the question. This
enables highlighting of risks and investigation where there have been significant
changes from 2017.
12 of 26
There is a potential risk of overstatement of COS from significant increases (% and
absolute) in a number of accounts:
61017 Deliveries: 23% up (£5,244)
61050 Mock-Ups: 49% up (£24,681)
61085 Travel and subs on jobs: 19% up (£13,840)
61097 New Media - External: 39% up (£25,997)
62405 Equipment Rental: 29% up (£6,491)
The increases require explanations from management given that income
increased by 14%. There may be appropriate business factors that management
can highlight to explain the changes (eg changes in the type of contracts in 2018
compared with 2017 which may for example require more Mock-Ups). Such
business explanations would require further investigation to corroborate them. To
the extent that business factors cannot fully explain the changes, then there is a
risk that accounting factors may cause the increases (eg invalid transactions,
overvalued transactions or transactions recognised in the incorrect period).
Use the 'Account view' in the audit software to review COS accounts where there
has been a significant decrease:
61060 Photography: down 17% (£12,380). This may suggest a potential risk of
understatement. Enquire of management if there are valid business reasons for
the decline in photography costs. In the absence of valid business reasons fully
explaining the 17% decrease, there may be accounting reasons, for example
through omission, cut-off errors or misclassification of photography costs to other
accounts. All these risks would require further investigation.
Elevated risk transactions in Heat Map in COS ‘Account view’:
There is one transaction in the red area which represents the second highest level
of elevated risk, which is the capitalisation of website development costs at
£95,000.
This requires explanation from management of the transactions comprising these
costs. Also, there are risks regarding the methodology used to identify costs which
are appropriate for website capitalisation. These should be discussed with
management.
The Stacked Bar Chart for COS in 'Account View' indicates a number of
transactions which are outside (or significantly outside) normal working hours of
9am to 5pm. These are a control risk if the application of normal internal controls
differs when outside normal working hours (eg supervision). Explanations for the
unusual working hours should be required of management using specific
examples from the Stacked Bar Charts of periods of a high incidence of out of
hours working.
Cost of Sales comprises two elements in the Financial Statement View: 'Cost of
Goods Sold' and 'Other Cost of Sales'. Other Cost of Sales is small at only £5,368.
However, it appears to comprise Entertaining accounts 63010 and 63015. Enquire
of management why these have been separately identified within Cost of Sales.
Identify these accounts as high risk as they may comprise private expenditure
elements, including by directors.
13 of 26
Cost of Sales excludes payroll costs which are normally classified as part of Cost
of Sales and are direct costs. There is also a risk that other costs, appropriately
belonging to Cost of Sales, have been misclassified into inappropriate classes of
transactions or balances.
3.2 (a)
Tutorial note
There is a wide variety of observations that could be made regarding trends
and relationships. The points below are illustrative of the range of issues that
could be identified. Alternative issues and approaches are acceptable where
they are consistent with the data and are valid observations on the data.
Using the ‘Financial Statement View’.
Tutorial note
Whilst it is necessary to look at the monthly data for Income and Costs of
Sales separately, it may also be useful to net them off and look at the net
monthly amount (ie Gross Profit). To do this, use the Financial Statement
View, tick the boxes for both Income and Cost of Sales. Select the Stacked
Bar Chart and use the Effective Period for both Primary and Secondary
Variables. This shows Gross Profit, which is the difference in the two Stacked
Bar Chart visualisations given in the question.
14 of 26
There appear to be some common monthly movements. For example,
Income and Costs of Sales are both high in June and, to a lesser extent, in
September. However, these matches may be random, as the matching for
other months is less clear.
Looking beyond comparisons of individual months, to a wider view of clusters
of months, it can be seen that, at the beginning of the year, January to April
have low Income figures and fairly low Cost of Sales figures. Later in the year,
most of the monthly figures are higher than in the January to April period. This
could be caused by, for example, growth or seasonality.
Towards the end of the year (October to December) the relationship between
Income and Cost of Sales appears to break down. In October, monthly Cost
of Sales is highest, but October Income is below the average at £236k.
COS/Income is 58.5%, which is more than double the annual average. This
could suggest a potential risk of overstatement of Cost of Sales or
understatement of Income.
The converse is the situation in December where Income is high and Cost
of Sales is low. COS/Income is 10.3%, which is less than half the annual
average. There is a potential risk of overstatement of income. This could be
creative accounting in attempting to recognise all possible income in December
2018 to improve profit in the financial year ending 31 December 2018. Cut-off
and late adjusting journal entries would be key risks in this respect.
Using the Stacked Bar Chart with ‘Effective Period’ as the Primary Variable
and ‘Document Type’ as the Secondary Variable shows a £100,000 sales
receipt which overstates sales in December 2020. This is a cash deposit which
should not be recognised as Income of the year and requires further
investigation.
The gross profit chart noted above, shows December 2018 has by far the
highest gross profit. This indicates risks of cut-off and closing journal entries.
3.2 (b) Elephant typically has three-month contracts where revenue is recognised
at end of the three months when customers sign off. In contrast, costs are
recognised monthly as incurred over the three months. There is no WiP
account which would defer recognition of contract costs, so they are treated
as expenses as incurred. On a monthly basis, there is therefore a mismatch
of the timing of recognition of Income and Cost of Sales. There may
therefore be some broad links between monthly Income and monthly Cost
of Sales (eg if there is a busy season or there are a lot of contracts of less
than three months), but a close match should not be expected and it was
not observed.
Labour costs are not included in Cost of Sales and have therefore been
ignored in the above analysis. However, some contracts may be very labour
intensive and drive sales, which weakens the link between Income and Cost
of Sales.
Substantial knowledge and understanding of the business is required to
interpret the results of analytical procedures - this knowledge may be lacking
in a trainee chartered accountant with limited experience.
15 of 26
The use of analytical procedures relies upon good quality information, but
Elephant’s data may not be reliable as final adjustments have not been made
and, as yet, it is unaudited.
Overall, a degree of professional scepticism should be applied to the
relationships identified as they appear weak. There should be a questioning
mind relating to the data and a self-questioning mind applied to any
relationships or trends we appear to have derived from the data. For example,
there is a risk of confirmation bias in seeking to look for and favour evidence
that supports the prior expectation of a link between Income and Cost of Sales.
16 of 26
APPENDIX TO Q3 ANSWER
The following section explains the audit software screens used and the navigation
methods but is not itself part of the answer. (Note: the audit software screens
cannot be cut and pasted from the software into your answer in the Audit and
Assurance exam).
3.1 Using the Explore module; Financial Statement View, click Expense to show the
breakdown of Expenses. Then click on Cost of Sales to show the breakdown of
Cost of Sales. The following screen shows % changes:
Now using the Explore module; Financial Statement View, select Expenses.
In the audit software, the accounts identified in the question comprising Cost of
Sales (account codes from 61010 to 63015, except salaries, NI and signage) can
then be identified and the % changes observed.
Tutorial note:
It is not necessary to select the accounts to observe the % changes and to do so
may waste time in the exam. However, if the accounts are selected, it proves the
total Cost of Sales figures provided in the question.
17 of 26
If you do wish to select the relevant accounts, remove all green ticks (use top click
box) then tick the account codes provided. The screen appears as below:
18 of 26
Salaries accounts and 7000 accounts have been omitted from the above
screenshot as they are not relevant to the question.
Heat map
Keeping the selection of the Cost of Sales accounts from Financial Statement
View as above, select the Heat Map. It can be seen from the diagram below that
there is one dot (circled) in the second highest grouping of elevated risk. Click on
this dot to make it go green.
Then click on the transaction icon in the top right corner of the above diagram
to show the transactions relating to the green dot, as below.
19 of 26
Then click on the blue Transaction Id to reveal the double entry as follows:
3.2 To obtain further information and analysis, the visualisations provided in the
question can be reproduced, and then interrogated further, using the Financial
Statement View. Tick the box for Income. Select the Stacked Bar Chart and use
the Effective Period for both Primary and Secondary Variables. Repeat this for
Cost of Sales to obtain the second visualisation.
To obtain some further analysis of, for example, the Income visualisation, change
the secondary variable to Document Type. This shows an unusual December cash
transaction as follows (discussed in the mark plan):
Line Count Net Primary Variable: Secondary Variable:
Stacked Bar Charts Effective Period Effective Period
350K
300K
Dec 2018
Nov 2018
250K
Oct 2018
Sep 2018
Net
200K 402K
Aug 2018
340K Jul 2018
150K 313K
Jun 2018
237K 239K 249K
235K 236K
214K 220K May 2018
100K 205K
186K Apr 2018
Mar 2018
50.0K
Feb 2018
Jan 2018
0.00
Jan 2018 Feb 2018 Mar 2018 Apr 2018 May 2018 Jun 2018 Jul 2018 Aug 2018 Sep 2018 Oct 2018 Nov 2018 Dec 2018
Clicking on the December cash transaction shows the following details (discussed
in mark plan):
20 of 26
To net off the Income and Cost of Sales (ie gross profit) use the Financial
Statement View. Tick the boxes for both Income and Cost of Sales. Select the
Stacked Bar Chart and use the Effective Period for both Primary and Secondary
Variables. This shows monthly Gross Profit which is the difference in the two
Stacked Bar Charts given in the question. This is shown in the following
visualisation:
Income less cost of sales (gross profit)
10.0K
70.0K
Aug 2018
80.0K Jul 2018
90.0K Jun 2018
Jan 2018 Feb 2018 Mar 2018 Apr 2018 May 2018 Jun 2018 Jul 2018 Aug 2018 Sep 2018 Oct 2018 Nov 2018 Dec 2018
21 of 26
4
Marking guide
Marks
4.1 Communicating re internal control deficiencies 9½
Marks available 9½
Maximum 4
22 of 26
The order might be incomplete leading to supplier disputes
Goods might be ordered for private use
Resulting in an adverse impact on profit and cash flow.
Recommendations
Goods should be checked for quality and quantity
Deliveries should be confirmed to copies of authorised order
Delivery notes should be signed and details passed to accounts payable for
subsequent checking to invoice
Storage issues
Consequences
Precious metals
Possible theft of precious metals leaving the company unable to manufacture
if metals run out unexpectedly
Chemicals
Risk of breach of health and safety regulations, resulting in:
– fines by health and safety regulators
– closure or suspension of activities
Accidents could happen, resulting in the company being sued
Adverse publicity and reputational damage
Resulting in an adverse impact on profit and cash flow
Recommendations
Precious metals
Locks on stores
– keys stored securely/security code changed on regular basis
– CCTV
A record of metals in/out maintained
– regular inventory checks and comparison of physical inventory to inventory
records
– investigation of differences
Chemicals
Store chemicals in closed tanks
Warning signage
Staff to be given protective clothing
Implement a health and safety policy
Designated person responsible for health and safety
23 of 26
General
Training/communication of requirements to staff
Staff to sign to confirm they will comply
Disciplinary procedures for non-compliance
Monitoring of compliance by management.
4.3 The audit opinion should be modified with a qualified ("except for") opinion due to
an inability to obtain sufficient appropriate audit evidence because the auditors did
not observe the counting of inventories at 31 May 2020 and no alternative
procedures were available regarding the opening inventory balance.
The amount of inventory is material because it represents 9.8% of profit before
tax. It is not pervasive as it is confined to a specific element of the financial
statements.
Reference to the inability to obtain sufficient appropriate evidence should be made
in the "basis for qualified opinion'' section of the auditor's report, positioned after
the opinion section and should state the reasons and the amounts involved.
The auditor should also report by exception under the Companies Act 2006 that
adequate accounting records were not maintained and that all information required
for the audit was not obtained.
The firm should include an "other matter" paragraph stating that the corresponding
figures for the year ended 31 May 2020 were audited by another firm.
The opinion of the other firm should be stated along with the reasons for any
modification and the date of their auditor's report.
24 of 26
BLANK PAGE
25 of 26
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any
form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written
permission of BPP Learning Media Ltd.
The contents of this book are intended as a guide and not professional advice. Although every effort has been made
to ensure that the contents of this book are correct at the time of going to press, BPP Learning Media makes no
warranty that the information in this book is accurate or complete and accept no liability for any loss or damage
suffered by any person acting or refraining from acting as a result of the material in this book.
ICAEW
Metropolitan House
321 Avebury Boulevard
Milton Keynes
MK9 2FZ
www.icaew.com