ADVANCED AUDIT & ASSURANCE

Time allowed – 3 hours

Total marks – 100

[N.B. – Figures in the margin indicate full marks. Questions must be answered in English. Examiner will take
account of the quality of language and of the way in which the answer are presented. Different parts
if any, of the same question must be answered in one place in order of sequence.]
Marks
1. (a) What is Accounting Red Flags? How does it affect investors to take economic investments
decision? What would be the role of the auditor in dealing with accounting red flags? 6
(b) You are the auditor of BFS Ltd. for the year ended 31 December 2011. The company provides
information to the financial services sector and is run by the Managing Director, Joy
Chowdhury. It has a venture capital investment of which part is in the form of a loan. The
investment agreement details a covenant designed to protect the loan. This states an interest
cover of 2 is required as a minimum i.e. the company must be able to cover interest and loan
principal repayment with profits at least twice.
70 per cent of the revenue of the business is subscription based and contracts are typically
three years in duration. 30 percent of the revenue is for consultancy work which is billed on
completion of the work. Consultancy projects are for a maximum of two months.
During the previous year the management performed a review of the subscription revenue
concluded that 40 percent of this represented consultancy work and should therefore be
recognized in the first year of the contract rather than recognized over the duration of the
contract as had previously been the case. The audit for the year 2010 indicates that this
treatment had been questioned vigorously by the audit manager but had been agreed with
the audit partner, James Cowell. James Cowell subsequently left the firm abruptly.
You have received a copy of the 2011 draft accounts which show an interest cover of 2.02 for
2010 and 2.01 for 2011. You have also been told that a similar review of subscription income
has been made for 2011 with 40 percent beng re3classified as consultancy work as in the
previous year.

Required:
What are the issues that you as auditor would need to consider in this situation? 6
(c) On the audit of Megna Gardens Ltd. the audit partner on the engagement set the preliminary
level of audit materiality at Tk.10,00,000. After the partner reviewed the audit senior’s
assessment of inherent risk, he decided that the materiality level should be increased to
Tk.15,00,000.
Required:
1) What is the relationship between materiality and audit risk?
2) How will this new level of materiality affect the nature and extent of auditing procedures? 6

2. (a) You are the audit manager of Parker, a limited liability company which sells books, CDs, DVDs
and similar items via two divisions – mail order and on-line ordering in the internet. Parker is a
new audit client. You are commencing the planning of the audit for the year ended 31 Dec.
2011. An initial meeting with the directors has provided the information below.
The company’s sales revenue is an excess of Tk.85 million with net profits of Tk.4 million. All
profits are currently earned in the mail order division, although the internet division is
expected to return a small net profit next year. Sale revenue is growing @20% p.a. net profit
has remained almost the same for the last four years.
In the next year, the directors plan to expand the range of goods sold through the internet
division to include toys, garden furniture and fashion cloth. The directors believe that when
one product has been sold on the internet than any other product can be as well.

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The accounting system to record sales by the mail order division is relatively old. It relies on
extensive manual input to transfer orders received in the post onto Parker’s computer
systems. Recently errors have been known to occur, in the input of orders and in the invoicing
of goods following dispatch. The directors maintain that the accounting systems produces
materially correct figures and they cannot waste time in identifying relatively minor errors.
The company accountant, which not qualified and who was appointed because he is a
personal friend of directors, agrees with the view.
The directors estimate that their expansion plans will require a bank loan of approximately Tk.30
million, partly to finance the enhanced websites but also has been scheduled for three months after
the year end. The directors expect an unmodified auditor’s report to be signed to this time.
Required:
Identify and describe the matters that give rise to audit risks associated with Parker? 8
(b) You are the audit senior responsible for the audit of BFC, accompany that runs a chain of fast
food restaurants. You are always that a major risk of their sector is that poor food quality
might result in damage claims by customers. You had satisfied yourself at the interim audit
that the company’s control risk as regards purchase of food and its preparation in the kitchen
was low. However, during your final audit it comes to your attention that one month before
the year-end, a customer has sued the company for personal injury caused by food poisoning,
claiming an amount of Tk.200,000 in compensation. This amount is material to the stated
profit of the company, but management believes that it has good defences against the claim.
Required:
1. State two controls that the company should have in place to reduce the risk associated
with purchase of food and its preparation in the kitchen; and 8
2. State two audit procedures you should carry out during controls testing to satisfy yourself
that control risk in this area is low.
(c) ABC Bank Ltd. has a balance of Tk.250,000 in respect of assets classified as held for sale (AFS)
in line with the provisions of BAS – 39 in the financial statements for the year ended 31
December 2011. This is in respect of two assets as follows:
1. Tk.70,000,000 relates to production machinery used for a product which is to be
withdrawn. Production will be run down until the end of January 2012 so that outstanding
orders can be completed. The plant will then be serviced and uninstalled in early February.
2. Tk.180,000,000 relates to a piece of land which was classified as held for sale on 01
October. This classification is made in line with IFRS 5 criteria. On this date the land’s fair
value was estimated to be Tk.210,000,000 with costs to advertise the asset as being
available for sale estimated at Tk.6,000,000. The Tk.180,000,000 represents the carrying
value of the land on the basis that it is lower than fair value less costs to sell. ABC Bank has
adopted a revaluation policy for land.

Required:
Identify the key audit issue for each of the above assets and state audit procedures which
would be performed to address these issues. 8

3. (a) You are the audit manager responsible for the audit of Nuvista Ltd. the company offers
information, proprietary foods and medical innovations designed to improve the quality of
life. (Proprietary foods are marketed and protected by registered names). The draft
consolidated financial statements for the year ended 30 June 2010 show revenue of Tk.74.4
million (2009 – Tk.69.2 million), profit before taxation of Tk.13.2 million (2009 – Tk.15.8
million) and total assets of Tk.53.3 million (2009 – 40.5 million). 10
The following issue arising during the financial audit has been noted on a schedule of points
for your attention.

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In 2001, Nuvista Ltd. had been awarded a 20 year patent on a new drug, Tournose, that is also
approved for food use. The drug had been developed at a cost of Tk.4 million which is being
amortized over the life of the patent. The patent cost Tk.11,600. In June 2010 a competitor
announced the successful completion of preliminary trials on an alternative drug with the same
beneficial properties as Tournose. The alternative drug is expected to be readily available in two
years time.
Required:
1. Comment on the matter that you should considered.
2. State the audit evidence that you should expect to find, in undertaking your review of the audit
working papers and financial statements for the year ended 30 June 2010.
(b) During an audit of a Banking company, the auditor discovered that the recipients of a loan with a
principal balance of Tk.2,100,000 had received only Tk.2,000,000 when the loan was written. The
auditor read the loan agreement and noted that it called for Tk.2,000,000 cheque and Tk.100,000 in
cash to be given to the customer who borrowed the money.
The auditor read other loan agreements and found similar working in each of them. When the
Controller was asked about this practice, she replied that the “service” was given to the customers so
they could have immediately access to cash. She thought that the Tk.100,000 inconsistency was an
error and could be corrected easily. The auditor decided to drop the matter.
Early the following year, a class-action lawsuit was brought against the bank by several customers
who discovered that they had received less than the principal amount of the loans. It was discovered
that the controller had kept the cash. The company’s board of directors notified the auditor that they
would take legal action against him because of his failure to inform them of what he had learned
about this matter.
Required:
1. Could the auditor be held liable for either ordinary negligence or gross negligence in this case? 10
2. Assume that the auditor choose to include this loan agreement practice in a letter of reportable
conditions to the audit committee. Draft the relevant portion of such letter. Include a
recommendation of the controls that can be implemented to prevent such occurrence.
(c) During the course of an audit, Mr. Robin, Audit Manager of MM Ahmed, Chartered Accountants
observed that one of the clerks in the small toy department consistently was taking money from the
customers in areas other than at the cash register. At the time, he gave little thought to this practice,
because most items were priced in “whole BDT” and the customer did not need any change. He did
mention to the controller, who had the same reaction. The audit was completed, and the report was
issued. 8
The following year it was discovered that the clerk had been keeping the money from these “Whole
BDT purchases” rather than putting it in the cash register.
Required:
1. Could the auditor be held liable for failure to detect this fraud? Should his comment to the
controller make any difference?
2. Assume that the auditor choose to include his observation in a letter of reportable
conditions, along with his recommendation on how to eliminate this weakness and
provide reasonable assurance that cash receipts are placed in the cash register drawer.
Draft the relevant part of such a letter.

4. You have been asked to carry out an investigation by the management of Asha Ltd. One of the
company’s subsidiaries, Lata Engineering Ltd., has been making losses for the past year. Asha’s
management is concerned about the accuracy of Lata Engineering’s most recent quarter’s
management accounts. The summarisd income statements for the last three quarters are as
follows:

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Amount in millions
Details 31st March 2012 31st Dec 2011 30th Sept. 2011
Turnover 429 334 343
Opening stock 180 163 203
Materials 318 251 200
Direct wages 62 54 74
560 468 477
Less: Closing stock (162) (180) (163)
Cost of goods sold 398 288 314
Gross profit 31 46 29
Less: Overheads (63) (75) (82)
Net loss (32) (29) (53)
Gross profit (%) 7.2% 13.8% 8.5%
Materials (% of revenue) 78.3% 70.0% 70.0%
Labor (% of revenue) 14.5% 16.2% 21.5%
Asha Ltd.’ management board believes that the high material consumption as a percentage of
turnovers for the quarters to 31st March 2012 is due to one or more of the following factors:
(1) under-counting or under-valuation of closing stock;
(2) excessive consumption or wastage materials;
(3) materials being misappropriated by employees or other individuals.
Lata Engineering has a small number of large customers and manufactures its products to each
customer’s specification.
The selling price of the product is determined by:
(1) Estimating the cost of materials;
(2) Estimating the labor cost;
(3) Adding a mark-up to cover overheads and provide a normal profit.
The estimated costs are not compared with actual costs. Although it is possible to analyze
purchase invoices for materials between customers’ orders but this analysis has not been done. A
physical stock count is carried out at the end of each quarter. Stock items are entered on stock
sheets and valued manually. The company does not maintain perpetual stock records and a full
physical count is to be carried out at the financial year end, 30th June 2012. The direct labor cost
included in the stock valuation is small and should be assumed to be constant at the end of each
quarter. Historically, the cost of materials consumed has been about 70% of turnover. The
management accounts to 31 December 2011 are to be assumed to be correct.

Required:
(a) Define `Forensic auditing’ and describe its application to fraud investigations. 5
(b) Identify and describe the matters that you should consider and the procedures you should
carry out in order to plan an investigation of Lata Engineering’s losses. 9
(c) (i) Explain the matters you should consider to determine whether closing stock at 31st March
2012 is undervalued; 4
(ii) Describe the tests you should plan to perform to quantify the amount of any
undervaluation. 4
(d) (i) Identify and explain the possible reasons for the apparent high materials consumption in
the quarter ended 31st March 2012; and 4
(ii) Describe the tests you should plan to perform to determine whether materials
consumption, as shown in the management accounts, is correct. 4

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