PROFESSIONAL LEVEL EXAMINATION

2021
ORCHID

AUDIT AND ASSURANCE

ANSWERS

Copyright  ICAEW 2021. All rights reserved.

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AUDIT AND ASSURANCE – SFQs
1.1 Whether explanations for an improvement in the current ratio are plausible
(a) Refinancing
 plausible explanation
– restructuring the loan would result in a reduction in current liabilities
(denominator in the current ratio)
(b) Sale of freehold store
 plausible explanation
– disposal of the non-current asset for cash would result in an increase
in current assets (numerator in the current ratio). (2 marks)
1.2 Why the matter should be considered
 damages could be payable
– may be material
– may not be reflected in the financial statements
– if probable
 provision required
– if possible
 disclosure as a contingent liability
 implications for management integrity/control environment
 may affect going concern status
 modified report may be required. (4 marks)
1.3 Differences between the conclusion expressed following an examination of
prospective financial information and the opinion expressed in an audit
report
Conclusion
 expressed negatively/'nothing has come to our attention………..'
 assumptions do not provide a reasonable basis for the forecast
 opinion that the forecast is properly prepared on the basis of the assumptions
Opinion
 expressed positively/true and fair view
 properly prepared in accordance with CA06
 opinion on consistency of information in directors'/strategic report with the
financial statements
 matters to report by exception

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 Reasons for the differences
 examination provides limited/moderate assurance
 audit provides reasonable assurance
 examination defined by management/ISAE 3400
 audit defined by law/CA06/ISAs
 examination is on assumptions about the future
– which are subject to uncertainty
 audit is on historical information
– which can be verified to a greater degree
 examination reduces risk to a level that is acceptable
 audit reduces risk to an acceptably low level. (4 marks)
1.4 Implications for the auditor's report on financial statements
 material
– 15.0% of profit before tax
– 2.6% of total assets
 modify opinion
 qualified/except for opinion
 limitation on scope/unable to obtain sufficient appropriate evidence
 not pervasive
– confined to specific element of the financial statements
 basis of qualified opinion paragraph
– reasons for modification/qualification
– immediately after the opinion section
 report by exception
– not able to obtain all information necessary for the audit. (4 marks)
1.5 Responsibilities of the ethics partner
 firm's policies and procedures regarding integrity, objectivity and
independence
 firm's compliance with the FRC Ethical Standard (ES)
 communication of ethical matters to partners and employees
 ethical guidance to partners and employees
– where difficult and objective judgement needs to be made
 ensuring policies and procedures are properly covered in training
 assessing implications of any breach of ES
 determining whether any safeguards can be put in place
– or whether there is a need to resign from an engagement. (3 marks)

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1.6 Actions to take, with reasons
 report to money laundering reporting officer (MLRO) within the firm
 MLRO to report to National Crime Agency
– represents proceeds of crime
– no de minimis limit with money laundering
– revenue 0.095 of 1%, profit 1.17%, not material by size
 do not tip off
– as this might prejudice legal proceedings
 tipping off and failure to report money laundering are criminal offences
 consider impact on other areas of the financial statements
 reconsider assessment of management's integrity. (3 marks)
Total: 20 marks

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2
Marking guide
Marks
2.1 Reason for auditor resignation 1
Availability of resources/expertise 1
Can opinion be reached in time 1
Ethical issues 2
Ability to implement safeguards 1
Are risks of engagement acceptable 2
Management integrity 2
Commercial viability 1
11
Max 7 marks

2.2 Income cut-off

Justification 7
Procedures 6
Cost of sales
Justification 7
Procedures 6
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Max 17 marks

2.3 Related party transaction 1

Reporting implications 1
Market rate not relevant 1
Identify value & compare materiality 2
Disagreement due to non-disclosure 1
Qualified 'except for' 1
Include qualified opinion/basis of qualified opinion paras 1
8
Max 6 marks

Total marks 45
Maximum 30

2.1 Reasons why Elephant's previous auditors resigned and whether

management gave permission to approach previous auditors
 may indicate disagreements with management, unpaid fees, illegal acts or
a limitation on scope of the audit

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 Availability of staff resources, in particular
 sufficient personnel and geographic coverage, given Elephant's three
locations, to perform the external audit competently
Availability of expertise, in particular
 access to personnel with sufficient understanding of digital marketing
Whether an appropriate audit opinion can be reached in the time available
 the audit requires sign off by 31 March 2019 to meet the bank's deadline
Ethical issues
 any threats to objectivity and independence
 potential conflicts of interest or confidentiality issues as the firm already
acts as auditor for one of Elephant's main competitors
Ability to implement safeguards
 information barriers to protect against confidentiality breaches if acting for
competing clients
Whether the overall level of risk associated with the external audit is
acceptable
 as a new client, the firm lacks cumulative audit knowledge of Elephant and
its directors
 possible duty of care to the bank
 possible going concern risk
Management's integrity
 bank reliance on 2018 financial statement increases the risk of
management bias/fraudulent reporting
 the results of background checks on management and the risk of money
laundering
Whether the engagement is commercially viable.
2.2 Revenue cut-off
Revenue may be overstated through premature recognition of contract
revenue.
The impending bank loan approval may incentivise management to overstate
income.
The audit software shows that income has increased by a material amount
(£369,360) over the prior year.
The fact that contracts are only invoiced on completion and client sign-off
necessitates establishing a value for accrued income at the year end.

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Increased risk related to revenue cut-off arising from the fact that Elephant
signs sales contracts for 2-4 months resulting in significant numbers of
contracts that straddle the year end.
Judgment may be required to apportion the sales value of such contracts
between accounting periods – time apportionment may not reflect the
provision of services. Management estimates may be required to determine
the percentage of completion.
Amounts accrued in the current year may be overstated if no allowance is
made for the fact that a proportion of contracts billed will be subject to a
discount.
Using the audit software, it can be identified that £300,000 was credited to
54800 Other Income in respect of accrued sales. This is significantly more
than the amount of £170,294 of income accrued in 2017 that can be seen
being reversed through 54800 Other Income in 2018.
This increase of 76% in accrued sales significantly exceeds the overall 14%
increase in income.
In addition, the amount accrued for 2018 is a round number suggesting it may
be a broad estimate, rather than a result of a more detailed calculation.
Procedures:
 Enquire of management as to the methodology for apportioning revenue
on contracts straddling the year end.
 Enquire of management how the figure of £300,000 for accrued income
was arrived at and seek explanation for the large increase over the prior
year.
 Obtain a listing of sales contracts straddling the year end and identify
percentage complete.
 For a sample of contracts invoiced after the year end assess whether the
amount recognised as income in 2018 is consistent with degree of
completion.
 Calculate own estimate for accrued income and compare to management
figure of £300,000.
 For a sample of contracts invoiced after the year end establish whether
amount invoiced was lower than contract amount - identify percentage of
contracts where this occurs and average discount percentage.
Cost of sales
Cost of sales may be understated.
Cost of sales has increased 9% to £881,464.
This increase is less than the 14% increase in income resulting in increased
profitability.
Project managers are rewarded based on contract profitability, this creates an
incentive for project managers to understate cost of sales.

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Cost of sales are invoiced by suppliers after the services/goods have been
supplied and used in performance of a contract and are only passed to
accounts once authorised.
Therefore, at year end a significant amount of cost of sales will require
identification and accrual, including for those not invoiced and those invoiced
but not yet passed to accounts for payment.
There appears to be no system to record uninvoiced costs other than the 'job
card' spreadsheets maintained by project managers.
For contracts that straddle the year end, judgement may be required to
estimate the proportion of direct costs that have been incurred in the current
year.
Accruals related to Cost of Sales cannot be identified. Using the audit
software, we can identify that 34030 Accruals Control A/C does not contain an
explicit accrual for costs related to 2018.
Entries to the account include two entries described as reversal of 2017
accrued expenses one of which was itself reversed. By comparing the entries
underlying the two accrual reversal transactions, the difference between the
two amounts can be identified as relating to the reversal of the 2017 accrual
reversal for rent of £112,050.
The closing balance of £106,153 on Other Income is thus composed of the net
of the unreversed 2017 rent accrual of £112,050 and two other small entries. It
is hard to see how this represents an attempt to arrive at a value for 2018
accruals including those in respect of cost of sales. The omission of accruals
would be likely to lead to a material understatement of cost of sales.
The entries in 34030 Accruals Control A/C may indicate a lack of competence
in the accounts department in relation to accruals.
Costs are recorded in the accounting system only once invoices authorised for
payment by project managers.
Procedures:
 Compare profitability on incomplete contracts at the year end to average
for the year.
 Compare contract profitability by project manager and seek explanation for
large differences.
 Examine a sample of 'job card' spreadsheets for contracts ongoing at the
year end and trace costs incurred to cost of sales.
 For a sample of direct cost invoices posted after the year end confirm that
they are included in cost of sales for appropriate accounting period.
 Seek explanation from management for apparent absence of 2018
expense accrual.
 Seek explanation for entries in 34030 Accruals Control A/C.

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2.3 Fox is controlled by a director's wife.
Family of a director, such as a spouse, is a related party
Related party transactions necessitate disclosure under IFRS/FRS102 of the
details of the transaction in the notes to the financial statements
This disclosure is required even if the terms of the transaction are at market
rate
From the audit software it can be determined that the amount spent on
photography in the year to 31 December 2018 was £60,302
This is marginally over twice audit materiality, however related party transac-
tions are material by nature.
This material misstatement will lead to a modified audit opinion.
The opinion section of the auditor's report should be headed up 'Qualified
Opinion' and the opinion contained therein should be qualified 'except for'
The reasons for the qualified opinion including details of the related party and
the value of the transactions will be provided in a 'Basis for qualified opinion'
paragraph in the auditor's report.

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APPENDIX TO Q2 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 A&A exam).
2.2 Income cut-off
Using the Explore module a material increase in income can be identified.

Other Income can be selected from Account View

Clicking on reveals the transactions in Other Income

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Clicking on the Transaction Id for sales accrued shows the underlying entries

Cost of sales
In Account View select Cost of Sales

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Click Confirm to reveal accounts

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In Account View select 34030 Accruals Control A/C within Liabilities

Clicking on reveals all the transactions in Accruals Control A/C

Clicking on the Transaction IDs for the two transactions NOM059643 and
NOM059643, both described as '2017 accruals revers – Accruals'. A
comparison of the entries identifies that the difference in value is accounted for
by the reversal of the rent accrual to account number 72000.

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2.3 The value of photography costs for 2018 can be identified in Account View.

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3
Marking guide
Marks
3.1 Explanation of issue 1 and matters to discuss with audit team
Why identified 3
Matters that should have been discussed 7
Marks available 10
Maximum 5
3.2 Explanation of issues 2 and 3, and additional procedures
Issue 2 - Direct confirmation of trade receivables
Why identified 9
Additional procedures 6
Issue 3 - EQCR
Why identified 2
Additional procedures 3½
Marks available 20½
Maximum 7
3.3 Issue 4 - procedures to address going concern risk
Procedures 12
Marks available 12
Maximum 6
3.4 Audit opinion
On a break-up basis without disclosure 4½
On a going concern basis 4
Marks available 8½
Maximum 6
3.5 Consequences of inappropriate audit opinion
Professional negligence claims 2½
Regulatory body investigation 2
Commercial effects on firm 4
Marks available 8½
Maximum 4
Total marks 28

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3.1 Explain why issue (1) above was identified by the independent partner
and outline the matters that should have been discussed with the audit
team at a briefing meeting.
Issue 1 - Audit briefing meeting not held
Why identified
It is a requirement of ISA 220 that a briefing meeting is held prior to starting
audit fieldwork. The meeting reduces the risk of issuing an inappropriate
opinion as it allows juniors the opportunity to raise questions and understand
their role in the audit. The issues discussed at the meeting should be
documented.
Matters that should have been discussed
 background information about the client and its industry, including any
applicable laws and regulations
 relevant ethical requirements including the importance of independence
and objectivity
 the importance of professional scepticism
 areas of key audit risk, including any:
– susceptibility to misstatement due to fraud and how fraud might occur
– going concern considerations
– points forward from the prior year
 business risks and how they impact on the financial statements
 objectives of the work to be performed
 how the audit plan addresses the risks identified
 materiality / performance materiality thresholds
 how the audit work is to be assigned to members of the audit team and
how to raise issues, arising
 changes in financial reporting requirements
 the timetable for completion of audit work.
3.2 Explain why issues (2) and (3) above were identified by the independent
partner and for each item, list the additional procedures that should have
been undertaken by your firm.
Issue 2 - Direct confirmation of trade receivables
Why identified
Insufficient work has been completed and therefore, the firm is not in a
position to form any conclusion on the trade receivable balances. In respect of
non-replies, confirming balances to sales invoices is not a reliable procedure,
as the sales invoices are internally generated. All items in a sample must be
verified, including the balances that individually are not material. Any errors
identified must be followed up and reasons for the error identified. When
relevant the sample size must be increased and the error extrapolated and
transferred to the summary of audit differences. The error of £150,000 when
extrapolated is £2.25m which is material. Finally, the incorrect conclusion
casts doubt on the adequacy of review procedures.

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 Additional procedures
The firm should make further enquiries to understand why the error of
£150,000 occurred and extend the sample if needed. In respect of non-replies
to the confirmations, alternative procedures must be undertaken such as,
agreeing the balance to the billings schedule in the contract or valuations. All
immaterial balances in the sample should be verified.
Issue 3 - Engagement quality control review (EQCR)
Why identified
It is a requirement of ISA 220 that an EQCR must take place on or before date
of the auditor's report for audits of listed clients.
Additional procedures
An EQCR requires:
 discussion of significant matters with the engagement partner
 review of financial statements and proposed auditor's report
 review of judgements
 evaluation of conclusions
 evaluation of the firm's independence
 consideration of whether appropriate consultation has been undertaken on
contentious matters.
3.3 In respect of issue (4), describe the audit procedures that should have
been undertaken to address the going concern risk.
Issue 4 – Audit procedures to address the going concern risk
The work that should have been undertaken by the audit team is as follows:
 obtained profit and cash flow forecasts for at least one year from the date
of the financial statements (per ISA 570) or from the date of approval of
the financial statements (per ISA UK 570)
 assessed the assumptions for reasonableness, in particular, the
assumptions regarding loan repayments
 performed sensitivity analysis on key components of the forecast such as
revenue, exchange rates and interest rates
 reviewed the cash flow forecasts to see if Gremlins
– can pay its debts as they fall due
– will comply with bank covenants
 obtained the reorganisation plan and assessed whether profit and cash
flow forecasts are consistent with the plan
 obtained written representation from management regarding their future
plans and the feasibility of those plans
 ascertained management's contingency plans for alternative sources of
finance should the bank overdraft be withdrawn

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  inspected bank correspondence for evidence of the banking relationship
 inspected bank covenants and assessed Gremlins' ability to comply with
covenants
 reviewed post year-end management accounts and assessed company
performance
 reviewed board minutes for evidence of funding issues
 inspected legal correspondence for evidence of claims against the
company.
3.4 Assuming that your firm should have concluded that Gremlins was not a
going concern, state whether you would have modified the audit opinion
if the financial statements of Gremlins for the year ended 30 June 2021
were prepared:
(a) on a break-up basis with adequate disclosure included in the notes
to the financial statements; or
(b) on a going concern basis.
Give reasons for each conclusion and describe the modifications, if any,
to the auditor's report.
On a break-up basis with adequate disclosure
An unmodified audit opinion should have been issued. There is no
misstatement as appropriate disclosures have been made and no limitation on
scope as sufficient evidence is available. The use of the break-up basis of
accounts preparation is fundamental to the user's understanding of the
financial statements and therefore, the auditor's report should be modified to
include an "emphasis of matter" paragraph after the opinion section. It should
draw users' attention to the disclosures in the notes to the financial statements
and state that the opinion is not modified in respect of this matter.
On a going concern basis
A modified audit opinion should have been issued. There are misstatements
as the financial statements have been incorrectly prepared on a going concern
basis. The matter is material and pervasive as it is not confined to specific
elements of the financial statements. An adverse opinion should be issued. A
paragraph describing the matter giving rise to the modification should be
included, after the opinion section, and headed "basis for adverse opinion".
3.5 List the possible consequences for your firm if an inappropriate auditor's
report had been issued
The firm may be subject to professional negligence claims from the audited
entity and its shareholders and/or third parties (such as the company's bank)
where it can be demonstrated that the auditor owed a duty of care. Although
damages awarded against the firm may be covered by professional indemnity
insurance, the cost of future insurance will increase.

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The firm may be investigated by the regulatory bodies (such as the ICAEW
and the FRC), 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 the loss of reputation, clients and key employees. There will be
an increase in costs for the firm as a result of greater scrutiny. In extreme
cases this could lead to the financial collapse of the firm. Ultimately there
could be criminal prosecutions for the partner or the firm where the auditor's
report is deemed to have been issued in a reckless manner.

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4
Marking guide
Marks
4.1 Report on internal control - consequences and
recommendations
(a) No comparison of actual against budgeted costs
Consequences 5
Recommendations 2
(b) Failure to book airfares and hotels through the website
Consequences 4
Recommendations 2½
General marks 2
Marks available 15½
Maximum 8
4.2 Threats and response
Threats 3½
Response 3½
Marks available 7
Maximum 4
4.3 Threats and how they should be addressed
Recruitment of a new chief executive
Threats 2½
How to address the threats 3
Provision of payroll services
Threats 4½
How to address the threats 1½
Marks available 10½
Maximum 7
4.4 Procedures to address potential conflict of interest 5½
Marks available 5½
Maximum 3
Total marks 22

4.1 For each internal control deficiency listed as (a) and (b) in agenda item
(1), outline what should have been included in the report to those
charged with governance regarding the possible consequence(s) of the
deficiency and the recommendations to address the deficiency.
(a) No comparison of actual against budgeted costs
Consequences
Cost overruns and projects falling behind schedule will not be identified
and result in management remedial action being delayed. There will be
customer dissatisfaction and penalty clauses for late completion could be
triggered. Work in progress may be overvalued if provisions for losses are

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 not recognised resulting in unreliable management information. This
reduces the ability of Yeti to price future contracts on a profitable basis.
There will be an adverse impact on cash flow and profitability.
Recommendations
 comparison of budget against actual to be evidenced by signature
 all significant variances to be investigated
 progress reports to be prepared for senior management
 review of all contracts to identify any additional provisions for losses.
(b) Failure to book airfares and hotels through the website
Consequences
There is increased scope for fraud and Yeti may not get the best rates for
airfares and hotels. Manual expense claims are inefficient and there could
be loss of employee goodwill as the website is not user friendly. Liabilities
for airfares and hotels are not known until an expense claim is made. Non-
use of the website could leave Yeti exposed to breach of contract and be
liable for damages. There will be an adverse impact on cash flow and
profitability.
Recommendations
 investigate why consultants claim that the system is not user friendly
and follow up with Zombie
 commission Zombie to improve the website
 carry out user acceptance testing
 do not process any expense claims that have bypassed the website.
General marks applicable to both scenarios (2 marks, awarded once
only)
The following recommendations apply:
 communication of procedures and training
 employees should acknowledge in writing that they understand and
will comply with the procedures
 disciplinary action if procedures are not followed and
 regular monitoring of procedures by senior management.
4.2 In respect of agenda item (2), identify and explain the threats to Griffin's
objectivity and state, with reasons, how Griffin should respond to the
proposal that Nicola Canvey continues as audit engagement partner.
Threats
Nicola Canvey has worked continuously as the audit partner for Yeti for five
years. The close association of Nicola with Yeti represents a familiarity threat
as she may be too trusting and insufficiently sceptical of Yeti's financial
statements. A reasonable and informed third party may consider the firm's

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 independence and objectivity to be impaired. Additionally, there are self-
interest and self-review threats as Nicola may be reluctant to identify prior-year
misstatements which subsequently come to light.
Response
Nicola may continue as engagement partner, for up to two years, to maintain
audit quality. This is permitted by the ES when there are unexpected changes
in the structure of the client's business such as the retirement of the chief
executive. However, the following safeguards are required:
 an expanded review of the audit work
 the facts and reasons to be disclosed to shareholders and those charged
with governance.
 the ethics partner should be consulted.
4.3 For each invitation to provide non-audit services listed as (a) and (b) in
agenda item (3), draft notes that identify and explain the threats to
Griffin's objectivity. State, with reasons, how Griffin should address
those threats.
Recruitment of a new chief executive
Threats
A familiarity threat arises if the firm plays a significant role in the recruitment of
the chief executive as the firm is less likely to be critical of information
provided by the new chief executive. A management threat also arises as the
firm may become too closely aligned with management and be required to
make decisions about which candidate to select.
How to address the threats
The firm must decline to assist with the recruitment of a new chief executive.
The ES expressly prohibits audit firms from undertaking an engagement to
provide recruitment services in relation to key management positions of a
listed company.
Provision of payroll services
Threats
The self-review threat arises because payroll information will be reflected in
the amounts included or disclosed in the financial statements. External audit
staff may be reluctant to identify shortcomings in their colleagues' work or may
place too much reliance on that work without checking it. A management
threat arises if members of the firm are expected to make decisions on behalf
of management. The firm may become too closely aligned with the views and
interests of management. The regular fee income may give rise to a self-
interest threat and the firm may be reluctant to modify the auditor's report.
How to address the threats
Your firm must refuse to provide the payroll services. The ES expressly
prohibits audit firms undertaking payroll services for listed clients.

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4.4 In respect of agenda item (4), outline the procedures that Griffin should
implement to address the potential conflict of interest.
Obtain consent to act from both clients. Once obtained, separate teams should
be used for each client with information barriers between the teams. There
should be a system of confidential and secure data filing. Teams should be
physically separated and staff from different offices used. The firm should
have clear guidelines for members of each engagement team on issues of
security and confidentiality. Employees and partners of the firm should sign
confidentiality agreements. Procedures should be in place for dealing with any
need to disseminate information beyond the barrier. There should be a regular
review of safeguards by an independent person.

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