UBAF2144&UKAF2124 AUDITING & ASSURANCE SERVICES II

Tutorial 4 & 5 -Completing audit and review

Questions
Review questions
MCQ

1. Which of the following situations would require adjustment or disclosure in the

financial statements?

A. A merger discussion.
B. The application for a patent on a new production process.
C. Discussions with a customer that would lead to 40% increase in the client’s sales.
D. The bankruptcy of a customer who regularly purchased 30% of the company’s
output.

2. Which of the following document is obtained from the management at the completion
of an audit?

A. Internal control questionnaire.

B. An engagement letter.
C. Audit planning memorandum.
D. Client representation letter (Written representation)-ISA 580.

3. Which of the following statement is correct concerning an auditor’s required

communication with those charged with governance (ISA 260)?

A. This communication is required to occur before the auditor’s report on the

financial statements is issued.
B. This communication should include management’s changes in the application of
significant accounting policies.
C. Any significant matter communicated to those charged with the governance
should also be communicated to management.
D. Significant audit adjustments proposed by the auditor and corrected by
management need not be communicated to those charged with governance.

4. The representation letter (ISA 580) is used to

A. Allow management to corroborate oral representations to the auditor.

B. Confirm the term in audit engagement.
C. List material weaknesses with respect to internal control noted by the auditor.
D. Make recommendations to the client based on the observations made during the
audit

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5. If the auditor discovers that management intends to liquidate the entity:

A. the going concern basis is inappropriate.
B. it is irrelevant if they did not intend to liquidate the entity at reporting date.
C. it requires inclusion as a disclaimer of opinion.
D. it requires inclusion as an ‘except for’.

Short Questions

Q1. Discuss when does a company make accounting estimates and the required
considerations and approach to audit of accounting estimates

Q2. Are analytical procedures required as part of the overall review of the financial
statements? What is the purpose of performing such analytical procedures?

Q3. What are “events after the date of financial statements” as set out in MFRS 110
and how are they accounted for in the financial statements? Give 2 examples

Q4. Define what is meant by contingent liability. What is the accounting treatment for
contingent liability according to MFRS 137? Give 2 common examples of
contingent liability

Q5. Provide 2 examples of commitments that are often disclosed in the notes to the
financial statements

Q6. What procedures should the auditor apply to examine identified related party
transactions?

Q7. Why does the auditor obtain are representation letter from management?

Q8. What information does the auditor ask the solicitor to provide pending or
threatened litigation?

Scenario Questions

Question 1 (This question will be discussed in the lecture)

The following items of subsequent events are unrelated. For each of the following items,
you are to indicate the required accounting treatment of the event. Assume that the
external auditor has completed the field work and is preparing the auditor’s report on the
client’s financial statements for the year end 31 October 2006.

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a) A large account receivable from a customer, ABC company (material to the

financial statement) was considered fully collectable at 31st October 2006. ABC
suffered a plant explosion on 28 November, 2006. Because ABC was not insured, it
was unlikely that the account will be collected.

b) The court ruled in favour of the client company on 26 December, 2006 for the
lawsuit from a customer that involved in the alleged breach of contract in 2005. The
client had been provided for the full amount of the potential liability from the
claim. The customer will not appeal the court’s ruling.

c) On 15 December 2006, the client applied to the Securities of Commission for the
issuance of 20 million new ordinary shares of RM1.00 each. The proposed new
issuance represents 10% of the issued and paid up capital of the company as at 31
October 2006.

d) On 22 December 2006, P. Sam a major investment advisor, issued an unfavourable

report on the client’s long term prospects. The share prices of the company
subsequently declined by 30%.

e) As at 5 November 2006 meeting, the board of directors decided to increase

substantially the advertising budget for the coming year and authorized a change in
advertising agencies.

f) On 30 November 2006, the company entered into a conditional sales and purchases
agreement to acquire 30% of equity interest in ASP Designs SDN BHD at a
consideration of RM1.9 million to be satisfied by cash payment.

Question 2

You are the auditor of Q-Best Sdn Bhd, whose principal activities are manufacturing and
retailing. The audit for the year ended 30 June, 2000 was completed on 15 August, 2000.
The profit for the year ended 30 June, 2000 was RM50 million. The board of directors
approved the accounts on 20 October, 2000.

Required

(a) Describe the extent of your responsibilities in respect of subsequent events and
the procedures that you need to perform.

(b) Your audit report includes an emphasis of matter in respect of uncertainty on the
outcome of a major lawsuit alleging infringement of certain patent rights by a
third party. On 15 October, 2000, the financial controller informed you that
judgment on the lawsuit has recently been delivered and that Q-Best Sdn Bhd has
to pay RM20 million to the third party. He further informed you that the accounts

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are due to be issued to the shareholders on 25 October, 2000. You checked your
records and noted that you have signed the auditors’ report on 28 September,
2000.

Discuss the course of action that you should undertake.

(Adapted from the Malaysian Association of Certified Public Accountants)

Question 3

APEX Sdn Bhd is a private company manufacturing wooden frames, doors and staircases
for domestic houses. It has prepared draft financial statements for the year ended 30
September, 2013. As the external auditor, you are concerned that the company may have
serious going concern problems. Excerpts of the Income Statements and Balance Sheets
for the last three years are as follows:
2011 2012 2013
Income Statements (RM ‘000) (RM ‘000) (RM ‘000)
Sales 2,242 3,322 3,762
Cost of sales (1,924) (2,652) (3,020)
Gross Profit 318 670 742
Other expenses (322) (480) (576)
Finance costs (116) (180) (234)
Net profit/(loss) (120) 10 (66)
2011 2012 2013
Balance Sheets (RM ‘000) (RM ‘000) (RM ‘000)
Fixed Assets 1,088 1,200 1,174
Current Assets
Inventory 362 614 898
Receivables 606 626 728
968 1,240 1,626
Less: Current Liabilities:
Payables 710 880 1282
Bank overdraft 422 538 730
Hire purchase payable 196 184 118
1,328 1,702 2,130
Total net assets 728 738 670
Represented by:
Share capital 34 34 34
Reserves 94 104 36
128 138 70
Long term loan 600 600 600
728 738 670

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The company has been in business for about fifteen years. In 2011, it decided to build a
new factory on a site leased from the local authority which would facilitate a major
increase in sales. This new factory was completed a year later. The factory was financed
by a bank overdraft and a long term loan of RM600,000.

Banking facilities are secured by a fixed and floating charge on the leasehold factory and
other assets of the company.

The company purchases its main raw material (i.e. wood) from timber wholesalers. It sells
about 80% of its production to local and national builders of new domestic houses.

Required:

(a) Based on the excerpts of the financial statements provided, what are the relevant
factors you would consider in determining whether the company is facing a going
concern issue?

(b) What are the audit procedures that should be conducted in reviewing the going
concern problem?

(Adapted from the Malaysian Association of Certified Public Accountants)

Question 4

EastVale Co manufactures a range of dairy products (for example, milk, yoghurt and
cheese) in one factory. Products are stored in a nearby warehouse (which is rented by
EastVale) before being sold to 350 supermarkets located within 200 kilometres of
EastVale’s factory. The products are perishable with an average shelf life of eight days.
EastVale’s financial statements year-end is 31 July.

It is four months since the year-end at your audit client of EastVale and the annual audit
of EastVale is almost complete, but the auditor’s report has not been signed.

The following events have just come to your attention. Both events occurred in late
November.

(a) A fire in the warehouse rented by the company has destroyed 60% of the inventory
held for resale.

(b) A batch of cheese produced by EastVale was found to contain some chemical
impurities. Over 300 consumers have complained about food poisoning after eating the
cheese. 115 supermarkets have stopped purchasing EastVale’s products and another 85
are considering whether to stop purchasing from EastVale. Lawyers acting on behalf of
the consumers are now presenting a substantial claim for damages against EastVale.
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Required:
In respect of EACH of the events at EastVale Co mentioned above:

State, with reasons, whether or not the financial statements for the year-end require
amendment

Question 5

During the audit of Sutera Bhd, the auditor has satisfactorily completed the examination
of the accounts payable and other liabilities and now plans to determine whether there are
any contingent liability arising from litigation and claims.

Required:

What audit procedures should the auditor follow to determine whether there is any
contingent liability arising from litigation and claims?

(Q 17.27 of Margaret Boh- 3rd edition page 581)

Question 6

Your firm is the auditors for excel Sdn Bhd, a large construction company. During the
audit for the year ended 31 December 2016, you were informed by the managing director
that the company has recently lost a major government contract. You know that Excel’s
projections include a major share of the work from this contract. The company has been
experiencing some cash flow difficulties, although this is not unusual in the industry.
Management has recently fully extended their bank credit facility in order to pay day to
day expenses. The audit partner is concerned that the company may be facing going
concern problem, but the managing director maintains that they intend to cut back future
capital expenditure to alleviate the going concern issue.

Required:

a. Identify five indicators of a financial nature that may arise doubt on an entity’s
ability to continue as a going concern.
b. In addition to the plan of action mentioned by the managing director, what are other
possible mitigating factors that may help a company to alleviate its going concern
problem?
c. What evidence should the auditor obtain with respect to management’s plan about
the various mitigating factors identified in part (b)?

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(Q 17.31 of Margaret Boh- 3rd edition page 584)

Question 7

Zeta Software Bhd (ZSB) was incorporated in 1987 as a pioneer specialized in software
applications in the IT industry. The company develops both off-the-shelf packages
software and tailored software to order, mainly for business applications. The off-the-
shelf packages require substantial investment in R&D and intellectual capital before they
are ready to be marketed. To fund these needs, ZSB went public with an initial public
offering in 2004. The public offering was successful and ZSB’s ambitions management is
convinced that they must report a good profit this year (2006) to maintain the current
market price of the shares. ZSB’s chairman recently stressed this point when he told his
chief accountant, Alladin, “If we don’t make RM1.25 million pre tax this year, our shares
will fall significantly.”

Alladin was pleased that even after adjustments for accrued vacation pay, 2006 pre tax
profit was RM1.35 million. However, ZSB’s auditors, Haris & Co., also insisted that
RM450,000 in the capitalized software development account should be expensed, an
additional adjustment that would reduce the profit to RM900,000. This RM450,000 is
related to a project not yet completed but in relation to which the nearest competitor had
just launched an advertising campaign and begun marketing and off-the-shelf application.
The auditor argued that recovery of this expenditure was no longer assured beyond any
reasonable doubt and that the amount should be expensed.

The issue of accrued executive vacation pay arose in 2004 and 2005. At that time the
auditors did not insist on the adjustment because the amount was not material to the
years. The cumulative accrued executive vacation pay amounts to RM300,000 and has
been accrued at the end of 2006.

The audit partner, Haris, insisted that ZSB should make the adjustment for the softwares,
but the auditors was adamant. Alladin knew that the development cost of the software
was now worthless, but he reminded the auditor of the importance of this year’s reported
profit. Alladin continued his argument, “You can’t take both the write-off and the
vacation accrual in one year; it doesn’t fairly present our performance this year. If you
insist on taking that write-down, I am taking back the accrual. Actually, that’s a good
idea because the executives are such workaholics, they don’t take their vacations
anyway.”
As Alladin calmed down, he said, “Haris, let’s be reasonable; we like you – and we want
to continue our good working relationship with our firm into the future. But we won’t
have a future unless we put off this accrual for another year.”

Required:

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Identify the relevant audit issues in this case and suggest the course of action the auditor
of ZSB should take.

(Q 17.32 of Margaret Boh- 3rd edition page 584)

Question 8

Grains Sdn Bhd (Grains) manufactures breakfast cereals and has three factories, four
warehouses and three distribution depots spread across North America. The audit for the
year ended 31 December 2019 is almost complete and the financial statements and audit
report are due to be signed shortly. Profit before taxation is RM7·9 million. The
following events have occurred subsequent to the year end and no amendments or
disclosures have been made in the financial statements.

Event 1 – Fire

On 15 February 2020, a fire occurred at the largest of the distribution depots. The fire
resulted in extensive damage to 40% of the company’s vehicles used for dispatching
goods to customers; however, there have been no significant delays to customer
deliveries. The company estimates the level of damage to the vehicles to be in excess of
RM 650,000. Only a minimal level of inventory, approximately RM25,000, was
damaged. Grain’s insurance company has started to investigate the fire to assess the
likelihood and level of payment, however, there are concerns the fire was started
deliberately, and if true, would invalidate any insurance cover.

Event 2 – Inventory

On 18 February 2020, it was discovered that a large batch of Grain’s new cereal brand
‘Loopy Green Loops’ held in inventory at the year end was defective, as the cereal
contained too much green food colouring. To date no sales of this new cereal have been
made. The cost of the defective batch of inventory is RM915,000 and the defects cannot
be corrected. However, the scrapped cereal can be utilised as a raw material for an
alternative cereal brand at a value of RM50,000.

Required:
For each of the two subsequent events described above:
(i) Based on the information provided, explain whether the financial statements require
amendment; and
(ii) Describe audit procedures which should now be performed in order to form a
conclusion on any required amendment.

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Question 9

Leslie Morgan, CPA, has prepared a letter of representation for the president and
controller to sign. It contains references to the following items:
1. Inventory is fairly stated at the lower of cost or market and includes no obsolete
items.
2. All actual and contingent liabilities are properly included in the financial
statements.
3. All subsequent events of relevance to the financial statements have been disclosed.

Required:

a. Why is it desirable to have a letter of representation from the client concerning

these matters when the evidence accumulated during the course of the audit is
meant to verify the same information?
b. To what extent is the letter of representation useful as audit evidence? Explain.

Question 10

In analyzing legal expense for the Boastman Bottle Company, Mary Little, CPA,
observes that the company has paid legal fees to three different law firms during the
current year. In accordance with her CPA firm’s normal operating practice, Little
requests standard attorney letters as of the balance sheet date from each of the three law
firms.

On the last day of field work, Little notes that one of the attorney letters has not yet been
received. The second letter contains a statement to the effect that the firm deals
exclusively in registering patents and refuses to comment on any lawsuits or other legal
affairs of the client. The third attorney’s letter states that there is an outstanding unpaid
bill due from the client and recognizes the existence of a potentially material lawsuit
against the client but refuses to comment further to protect the legal rights of the client.

Required:

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a. Evaluate Little’s approach to sending the attorney letters and her follow-up on the
responses.
b. What should Little do about each of the letters.

(Question 24-28 of Arens page 746)

Question 11
Ben and Alex Bradley have a sister, Jo, who runs an interior design company, Lantern
Sdn Bhd. During a review of board minutes, performed as part of the planning of Bill
Bhd’s audit, it was discovered that Bill Bhd has paid RM 225,000 to Lantern Sdn Bhd
during the year, in respect of refurbishment of development properties. On further
enquiry, it was also found that Lantern Sdn Bhd leases an office space from Bill Bhd,
under an informal arrangement between the two companies.

Required:

(i) Explain the inherent limitations which mean that auditors may not identify related
parties and related party transactions; and

(ii) Recommend the audit procedures to be performed in relation to Bill Bhd’s

transactions with Lantern Sdn Bhd.

Question 12(FA May 2020)

The following are independent situations for which you will recommend an appropriate
audit report:

I. You are the auditor of Star Bhd., and you learnt that a recent fire caused
heavy damage to one of the client’s two plants and the loss will not be
reimbursed by insurance. The client did not disclose the loss caused by
fire in the financial statements.

II. During the course of the audit of the financial statements of Gemilang
Bhd., the auditor was refused permission to inspect the minute books
containing the significant decisions from the board of directors’
meetings.

III. An auditor is engaged in the audit of the financial statements of Laju

Bhd., a large manufacturing company with branch offices in many
widely separated cities. The auditor was not able to count the
substantial undeposited cash receipts at the close of business on the last

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day of the fiscal year at all branch offices. The management refused to
provide any evidence related to the undeposited cash receipts to the
auditor. The auditor was not able to satisfy himself as to the cash
receipts by alternative procedures.

IV. Salt Technology Bhd., has prepared financial statements but has
decided to exclude the statement of cash flows. The management
explained to you that the users of the financial statements find that the
statement of cash flows are rather confusing to understand and prefer
not to have it included.

V. During your audit of Danga Bhd., you concluded that there is a

possibility that inventory is materially overstated. The client refused to
allow you to expand the scope of your audit sufficiently to
verify whether the balance is actually misstated.

Question13 (Self Practice) FA MAY 2020

Colorful Designs Bhd. is a kitchen manufacturing company and the

company’s year end is 30 April. You are the audit manager of Terence & Co
and have been provided with the information as follows:

Recently, Colorful Designs Bhd. has been experiencing trading difficulties, as

its major customer who owes them RM850,000, ceased trading. However, the
balance is included in the financial statements. The sales director has left
Colorful Designs Bhd. and yet to be replaced.

The monthly cash flow has shown a net cash outflow for the last two months
of the financial year and is forecast as negative for the forthcoming financial
year. As a result of this, the company has been slow in paying its suppliers
and some are threatening legal action to recover the sums owing.

Due to its financial difficulties, Colorful Designs Bhd. missed a few months
of instalment for loan repayment. As a result of this breach in the loan
covenants, the bank has asked that the loan of RM5 million to be repaid in
full within four months. The directors have decided to maintain the liquidity
level, as such no final dividend will be paid in 2019.

Required:

(i) Briefly explain SIX (6) potential indicators that Colorful Designs Bhd.
may face any going concern issues.

(ii) Describe EIGHT (8) audit procedures that Terence & Co should
perform in assessing going concern issues.

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Question 14-Self Practice

You are the auditor of Shukri Bhd, a company which manufactures and sells
chemical pesticides and related products. The audit of Shukri Bhd for the year
ended 31 December 2018 revealed the following events:

Date Event
15 February One of the major customers, representing 25% of the
2019 trade receivables in the statement of financial position,
went into receivership.

21 March 2019 Financial statements approved by directors.

22 March 2019 Audit work completed and auditor’s report signed.

1 May 2019 Toxic pesticide chemicals were accidentally released
into the air from the company’s factory resulting in
health hazards to the community of residents living
within the radius of 10 km.
23 May 2019 Financial statements issued to members of Shukri Bhd.

Required:

(i) Explain the auditor’s responsibilities for identifying subsequent events

in the following periods:
- 31 December 2018 to 21 March 2019
- 22 March 2019 to 23 May 2019

(ii) Explain whether or not the financial statements need to be amended in

respect of the events occurring on the following two dates:
- 15 February 2019
- 1 May 2019

Question 15 (Self practice)

The IAASB has published the Exposure Draft, Proposed ISA 540 (Revised) Auditing
Accounting Estimates and Related Disclosures (ED-540) stating ‘The objective of ED-
540 is for the auditor to obtain sufficient appropriate audit evidence to evaluate whether
accounting estimates and related disclosures are reasonable in the context of the
applicable financial reporting framework, or are misstated. ED-540 includes enhanced
requirements for risk assessment procedures and the auditor’s work effort in responding
to the assessed risks of material misstatement to support this evaluation.’

Required:
Explain why accounting estimates are considered to be a source of high audit risk

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and discuss the reasons for the development of ED-540 commenting on its proposals
for an enhanced risk assessment in relation to the audit of accounting estimates.

Question 16-Self Practice (FA May 2021)

Canvas Bhd (Canvas) is a well-established company that has generated
revenue through the sale of exclusive camping tents for those who love
outdoor activities. Canvas has recently experienced a real growth in the
market competition and demand for its products has decreased quite
significantly. To make matters worse, in the past, the company did not
invest enough in the development of new products and as a result, the
management tried to remedy this situation by recruiting properly trained
personnel to join the product development department, but this has proved
more difficult than expected. Apart from the recruitment of personnel, the
company also had to invest RM2 million in the plant and machinery. The
company wanted to borrow this amount but was unable to accept the
appropriate terms with the bank. Consequently, it used its overdraft
facility which had a higher interest rate. As a result, some suppliers of
Canvas were paid much later than usual and some of them therefore
withdrew credit terms, which means that the company has to pay in cash
upon delivery. This has led to a significant increase in the company's
overdraft balance. Furthermore, the directors have produced a cash flow
forecast, indicating that the situation will deteriorate significantly over the
next twelve months. The directors have informed you that the Bank
Overdraft Facility is due for renewal next month, but they are confident it
will be renewed. They also firmly believe that new products that are being
developed will be ready to be put on the market which soon will improve
the sales tremendously. Therefore, they do not intend to make any
disclosures in the accounts regarding going concern.

Required:

(i) Identify any potential indicators that the company is not a going
concern and describe the possible impact upon the ability of the
company to continue trading on a going concern basis. (8 marks)

(ii) Explain the audit procedures that the auditor of Canvas Bhd should
perform in assessing whether or not the company is a going
concern.
(4 marks)

(iii) The auditors have been informed that Canvas Bhd’s bankers will
not make a decision on the overdraft facility until after the audit
report has been completed. Hence, the directors have now agreed
to include going concern disclosures.

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Required:

Describe the impact on the audit report of Canvas Bhd if the

auditor believes the company is a going concern but a material
uncertainty exists.

Question 17 (May 2022 FA)(Self Practice)

Glotier Bhd. (Glotier) operates a chain of food wholesalers across the
country and its financial year end is 31 December 2021. The company is
financed solely from equity including internally generated fund of the
company since incorporation.

The final audit is nearly complete and it is proposed that the financial
statements and audit report will be signed on 31 January 2022. Revenue
for the year is RM 200 million and profit before taxation is RM 30
million. Total assets amounted to RM 100 million.
The following events have occurred subsequent to the year end.

Event 1-Warehouse flooded

Glotier has three warehouses and following a heavy rain on 8 January
2022, the warehouse located in Shah Alam was flooded. All the inventory
was damaged and has been written-off. The insurance company has
already been contacted. No amendments or disclosures have been made in
the financial statements.

Event 2-Lawsuit
A key supplier of Glotier is suing them for breach of contract. The lawsuit
was filed prior to the year end, and the sum claimed by them is RM 4
million. This has been disclosed as a contingent liability in the notes to the
financial statements. However, a correspondence has just arrived from the
supplier indicating that they are willing to settle the case for a payment by
Glotier of RM 1.8 million. It is likely that the company will agree to this.

Required:
For each of the two events above:
(i) Discuss the accounting treatment in financial statements of Glotier
for the financial year ended 31 December 2021.
(ii) Describe TWO (2) audit procedures that should be performed in
order to form a conclusion on the accounting treatment.
(iii) Explain the impact on the audit report should the issues remain
unresolved.

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