STRICTLY CONFIDENTIAL

THE PUBLIC ACCOUNTANTS EXAMINATION

COUNCIL OF MALAWI

2009EXAMINATIONS

ACCOUNTING TECHNICIAN PROGRAMME

PAPER TC 7: AUDITING

TUESDAY 16 JUNE 2009 TIME ALLOWED : 3 HOURS

2.00 PM - 5.00 PM

SUGGESTED SOLUTIONS
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1. (a) Letter of representation

(i) Purpose
(1) During the course of the audit many representations are made
by management to the auditors. Some of these are in response
to direct enquiries by the auditors, others are implicit in the
preparation of the financial statements that give a true and fair
view. Most of these representations will be confirmed during
the course of the audit by more reliable evidence such that
reliance no longer need be placed on management
representations. For other representations, however, there will
be no independent corroboratory evidence available. The letter
of presentation, therefore, provides formal confirmation as to
the representations made. In so doing management may be
encouraged to reflect fully on the completeness of the
representations made and provide further information that may
earlier have been overlooked.

(2) Reliability
Failure by the auditors to confirm such representations in
writing would constitute negligence. However, it is important
that auditors do not place reliance on representations where
more reliable evidence would be expected. The absence of
corroboratory evidence would, in itself, be suspicious and
should lead to further audit enquiry. Moreover, written
representations do not necessarily constitute sufficient
evidence. The auditor must consider all available evidence and
its reliability in forming an opinion.

(ii) Matters included

Matters that may be included in the letter of representation specifically
relate to:

- disclosures as to contingencies;
- identification of related parties;
- assumptions underlying accounting estimates such as the
collection of overdue debts, outcome of long-term contracts,
successful outcome of development projects etc;

- unusual contract terms such as purchases with reservation of

title;

- Plans that may significantly alter the carrying value of any of

the entity’s assets;
- Occurrence of specific subsequent events.
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(iii) Refusal

If management refuses to provide written representations as requested,

reasons would need to be enquired and the effect on the overall
sufficiency of evidence considered. Generally, if a matter was
sufficiently important to warrant a request for its inclusion in the letter,
failure to obtain written representation would normally constitute a
scope limitation. This would result in the issue of an audit opinion
which is either qualified or for which a disclaimer of opinion is given.

(b) Procedures

(i) Timeliness

Communication of control weaknesses is normally made shortly after

completion of the audit. On larger engagements where control risk was
assessed during an interim visit a letter should normally be sent after
that visit, as well as, on completion of the audit. Occasionally, the
matter may be sufficiently serious to warrant more timely
communication, such as where the exposure to risk is high or where
there is reason to suspect that fraud or failure to comply with laws or
regulations may already have occurred, as a result of a weakness.

(ii) Method

As is implied in the title commonly given, the communication is

normally made in the form of a letter. Usually, a preliminary meeting
is held with management directly responsible, in order to confirm the
understanding and to discuss the most appropriate form of changes to
the system. The letter is, therefore, more likely to be accepted and its
recommendations acted upon. Oral communication may also be
appropriate for weaknesses that are in urgent need of correction
followed by a written communication.

(iii) Level of management

As mentioned above it is common to discuss the detailed

recommendations with line management before issuing the letter. The
letter would normally be addressed to the finance director. The letter
may refer to minor matters in brief with more detailed
recommendations being sent to the finance officers of divisions or
subsidiaries. More serious matters may be communicated directly to the
board of directors or the audit committee, if there is one. These would
include such matters as previous recommendations that have not been
implemented where the auditors believe the risks to the entity are
material.
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Auditors’ responsibility

The auditors are not primarily responsible for evaluating the

effectiveness of all internal controls and reporting all weaknesses. In
the letter of weakness and in the engagement letter the auditors should
make it clear that the assessment of control effectiveness is restricted to
those controls on which reliance is intended to be placed for audit
purposes. If auditors intend to place reliance for particular financial
statement assertions wholly on substantive procedures, they have no
responsibility for controls over those assertions.

Where the auditors do become aware of internal control weaknesses,

however, there is an expectation that they will warn management where
the risk of loss or misstatement is considered material. Awareness of
control weaknesses may come about from procedures other than those
directed specifically at testing controls. For example, in obtaining an
understanding of the system the auditor may become aware of major
control weaknesses. Also, in performing substantive procedures,
investigation of errors may alert the auditor to the presence of control
weaknesses.

The auditor’s duty to report on effectiveness of internal controls, under

auditing standards, is confined to the management of the entity. They
have no responsibility to report to other parties. The letter of
weaknesses normally carries a disclaimer of responsibility to any other
persons to whom the letter might be shown.

Auditors may accept engagements to report on control weaknesses,

either to managements, or regulators or to third parties. However, such
engagements are not part of the audit on financial statements.

2. (a) Vouching is a method of obtaining audit evidence which involves the

examination of the relevant documents (vouchers) and the processes includes:

(i) Checking the origin and the authenticity of the entry. This includes
checking all vouchers, correspondence, etc which may possibly refer to
the entry and establishing whether all requirements for a sound voucher
have been satisfied.

(ii) Checking the amount of the entry. This point includes not only
checking whether the amount shown on the vouchers has been entered
correctly in the books, but also whether the calculation of the amount is
correct.

(iii) Checking the method of entry and its correctness. This embraces
checking of the entry itself i.e. whether the correct amounts have been
debited and credited.
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(b) Verification requires verification of the existence, ownership and value of the
assets and liabilities and an intelligent viewing of the items on the balance
sheet. The following are the main aspects of the items to be verified:

(i) Leasehold premises

The auditor will have to see the leasehold contract to determine the
period for which the site is leased, the period for which the lease has
been operational and whether the lease is renewable. One provision
should be made for writing off a non renewable lease on the terms of
the lease. The auditor must also ascertain whether rent is paid regularly
and promptly. The amount should be shown in the balance sheet at
cost less amounts written off.

(ii) Motor vehicles

It will first be necessary to obtain evidence of the existence and
ownership of all vehicles by inspection of the vehicles where possible,
licenses, registration books and insurance policies. The current renewal
receipts of licenses and insurance premiums should also be seen.

Concerning the value, the auditor must check the cost from the
invoices. Review depreciation rates applied in relation to:

(i) Asset lives

(ii) Replacement policy
(iii) Past experience of gains and losses on disposal
(iv) Consistence with prior years and with accounting policy.
(v) Ensure that no further depreciation is provided on fully
depreciated assets.

(iii) Cash and Bank Balances

Cash at the bank should be verified by obtaining a bank certificate
direct from the bank and ask for a reconciliation of the bank account.

Cash on hand should be verified by actual count, or by tracing all

receipts up to the actual deposit.

Special consideration should be given to cash in transit particularly the

system of internal checking on this cash, and to ensure that all cash is
accounted for.

The auditor should also obtain certificates of cash in hand from

responsible officials.
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(iv) Creditors

Substantive procedures that would be carried out are:

(1) Reviewing of the trade creditor figure included in the
accounts and consider its reasonableness against comparative
information and knowledge of the business.

(2) Extract the trade creditor balance from the nominal ledger
and check reconciliation to the purchases ledger control
account. Enquire into any differences that arise.

(3) Investigate any debit balances on any individual purchase

ledger account, and if correct and recoverable ensure that these
debit balances are not categorized as trade creditors.

(4) Ensure that any bona fide credit balance on the company’s
sales ledger account is categorized as a trade creditor.

(5) Test a sample of purchase ledger account balances by

checking reconciliations to supplier statements.

(6) Test completeness of trade creditors figure by checking

against company cut off procedures. In particular check to
unmatched goods received, goods returned notes and invoices
received after the year end.

(7) Review payments made to trade creditors in the period after

the year end date to verify value and existence of trade
creditors.

3. (a) Fundamental accounting concepts are the broad basic assumptions which
underlie the periodic financial accounts of business enterprises. At the present
time the following four fundamental concepts are regarded as having general
acceptability:

(i) The going concept – the enterprise will continue in operational

existence for the foreseeable future. This means in particular that the
profit and loss account and the balance sheet assume no intention or
necessity to liquidate or curtail significantly the scale of operation.

(ii) The accruals concept – revenue and costs are accrued (that is,
recognized as they are earned or incurred, not as money is received or
paid), matched with one another so far as their relationship can be
established or justifiably assumed and dealt with in the profit and loss
account of the period to which they relate; provided that where the
accruals concept is inconsistent with the prudence concept, the latter
prevails. The accruals concept implies that the profit and loss account
reflects changes in the amount of net assets that arise out of the
transactions of the relevant period (other than distribution or
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subscriptions of capital and unrealized surpluses arising on revaluation

of fixed assets). Revenues and profits dealt with in the profit and loss
account are matched with associated costs and expenses by including in
the same account the costs incurred in earning them (so far as these are
material and identifiable).

(iii) The consistency concept – there is consistency of accounting

treatment of like items within each accounting period and from one
period to the next.

(iv) The concept of prudence – revenue and profits are not anticipated, but
are recognized by inclusion in the profit and loss account only when
realized in the form either of cash or of other assets the ultimate cash
realization of which can be assessed with reasonable certainty;
provision is made for all known liabilities (expenses and losses)
whether the amount of these is known with certainty or is a best
estimate in the light of the information available.

(b) Accounting bases are methods developed for applying fundamental

accounting concepts to the financial transactions and items for the purpose of
financial accounts, and in particular (1) for determining the accounting periods
in which revenue and costs should be recognized in the profit and loss account
and (2) for determining the amounts at which material items should be stated in
the balance sheet.

(c) Professional independence is a concept fundamental to the accountancy

profession. It is essentially an attitude of mind characterized by integrity and
an objective approach to professional work. A member in public practice
should be and be seen to be free in each professional assignment he undertakes
of any interest which might detract his objectivity.

Four reasons in support of auditors independence are:

(i) Unaudited, the accounting information prepared for the annual financial
statements presented to the company shareholders lacks sufficient
credibility.

(ii) The auditor acts as a bridging point, helping to make management

accountable to the shareholders through the annual financial statements.
It is vital to the strength of this bridging point that the auditor is not
only independent in mind but is also seen to be independent.

(iii) Shareholders and other users need an objective and honest assessment
and evaluation of the accounting information presented to them by
management if they are to treat the information with confidence.

(iv) Because of these factors, user confidence in the information is closely

related to the degree of independence of the auditor. The more
independent he is the greater is the probability that shareholders and
others will have confidence in his work and opinion.
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(d) Problems are:

(i) Negotiation of the audit fee – The remuneration of auditors appointed
by the company in general meeting shall be fixed by the company in
general or in such manner as the company in general meeting shall
determine. In practice companies pass a resolution at the meeting
which empowers the directors to fix the auditors’ remuneration.
Although there are obvious practical reasons for this it is hardly
compatible with the goal of audit independence. However in case of
listed companies this situation has been improved by the involvement
of audit committees.

(ii) Provision of other services – These vary considerably dependent upon

the size of the client and the audit practice and include:

Accountancy – Assistance with the preparation of the company’s

financial statements and accounting records. The threat here is
principally that of self-review and audit firms often guard against this
by employing different staff to prepare the accounts and audit them
(although this is not specifically required by the rules professional
conduct).

Taxation – This will normally involve the preparation of the corporate

tax computation.

Consultancy – This can include a range of services such as assistance

with raising finance, management consultancy, design and
implementation of new accounting and computer based systems,
employees’ recruitment and training.

Expert services – This work comprises reports, opinions, valuations or

statements which directly affects amounts for disclosures in the
financial statements. An expert for this purpose possesses skill,
knowledge experience in a particular field other than auditing such as
specialist valuations, litigation such as arbitration.

(iii) Long stay of audit firm – Independence becomes questionable where

the audit firm has been involved with the client’s business for many
years due to the development of a relationship that may jeopardize the
objectivity of the assignment.

(iv) Long stay of the partner on the job – same as above as the partner
will be viewed to have established a relationship that might affect the
objectivity of the reports being produced by him.

4. (a) Four benefits that the auditor will obtain from working papers that meet the
requirements stated in the question are:

(i) The reporting partner needs to be able to satisfy himself that the work
delegated by him has been properly performed. The reporting partner
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can only do this by having available to him detailed working papers

prepared by the auditing staff who performed the work.

(ii) Working papers will provide, future reference for details of audit
problems encountered, together with evidence of work performed and
conclusions drawn there from in arriving at the audit opinion. This can
be invaluable if, at some future date, the adequacy of the auditor’s work
is called into question, in the event of a litigation against him by either
the client or some third party.

(iii) Good working papers will not only assist in the control of the current
audit, but will also be invaluable in the planning and control of future
audits

(iv) The preparation of working papers encourages the auditor to adopt a

methodical approach to his audit, which in turn is likely to improve
quality of the work.

(b) Specific matters that should be recorded in the current file are:

(i) Details of the claim such as : who made the claim and on what grounds,
the amount of the claim, the date when the grounds arose and the
possible effect of the claim on other possible claimants;

(ii) Full details of management’s estimates, with reasons, of the probable

outcome of the claim;

(iii) Full details of the specific audit work carried out in relation to the claim
together with the conclusions reached as a result of such work.

The inclusion of the above specific matters in a current file is desirable

especially where the auditor’s judgement is questioned by a third party who
has the benefit of hindsight. It then becomes important to tell what facts were
known at the time the auditor reached his conclusion and to be able to
demonstrate that based on those facts the conclusion was reasonable.

(c) Three types of information typically retained in the audit permanent file and
the reasons for retaining them are:

(i) A brief history of the organisation which assists the auditor in

understanding how the organisation came to be what it is today.

(ii) An organisation chart which shows who is who within the organisation
thus helping the auditor to appreciate the division of duties and
responsibilities within the organisation.

(iii) Copies of all important documents relating to the organisation, such as,
a copy of its constitution (e.g. memorandum and articles of association
or partnership agreement, etc). These are used as reference point for
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the various authorities in relation to the client to which the auditor will
have to give regard during the course of his audit work.

(iv) The use of standardized audit working papers may improve the
efficiency with which they are prepared and reviewed. If used
properly, they help to instruct audit staff and facilitate the delegation of
work, while providing a means to quality control. However, despite the
advantages of standardizing the routine documentation of the audit (e.g.
checklists for compliance of the financial statements with statutory
disclosure requirements), it is never appropriate to follow mechanically
a ‘standard’ approach to the conduct and documentation of the audit,
without regard to the need for exercising professional judgement.

5. (a) Appointment of an auditor of a public company

Section 191 of the Malawi Companies Act, 1984 states that every company
shall within three months after its incorporation and at each annual general
meeting appoint an auditor or auditors to hold office until the next annual
meeting. No person shall be appointed or act as auditor of a company unless
he shall prior to such appointment have consented in writing to be appointed
and he is duly qualified in accordance with the provision of section 192.
Notwithstanding any contrary provision in the company’s articles auditors
shall be appointed by an ordinary resolution of the company and not otherwise.

The subscribers to the memorandum, or if the subscribers have made no

appointment within one month of incorporation, the directors may appoint the
first auditors of a company.

The directors may fill any casual vacancy in the office of auditor and if a
company has no auditor for a continuous period of three months the registrar
may appoint auditors.

(b) The main provisions in relation to the statutory period of the appointment of
the auditor of a limited company are:

(i) At each annual general meeting of the company at which the directors
lay before the company a copy of every document required to be
comprised in the accounts of the company in respect of each accounting
period, shall appoint auditors to hold office from the conclusion of that
meeting until the conclusion of the next general meeting of the
company.

(ii) In case of the first auditors of the company who may have been
appointed by the directors of the company, the period of office will be
from the date of appointment to the conclusion of the first annual
general meeting at which directors will lay accounts before it.

(c) (1) An auditor’s rights regarding his removal from office include the
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following:

(i) The removal requires the passing of an ordinary resolution of

which special notice should be given. The auditor is entitled to
receive a copy of this special notice.

(ii) If the resolution is passed, the company must then notify the
registrar of companies within 14 days of the date of the
meeting.

(iii) Where an attempt is being made to remove an auditor during his

term of office or where the notice of a resolution to appoint
another in his place has been received by the company, the
auditor may make representations and he may require the
company to:

- state in any notice of the resolution given to the

members that representations have been made;

- the company should send a copy of the representations

to the members provided that it is not received late and it
must be of reasonable length;

If the representations were not sent out either because they were
received late or because of the company’s default, the auditor
may require that they be read at the meeting. This will not
prejudice his normal right to speak at the meeting. As regards
statements made on resignation, representations need neither to
be sent out nor read out at the meeting if on application, either
of the company or any other person who claims to be aggrieved,
the court is satisfied that the auditor’s right is being abused to
obtain needless publicity for defamatory matter.

The auditor is entitled to receive all notices relating to the

general meeting at which his term of office would have expired
and any general meeting at which it is proposed to fill a casual
vacancy caused by his removal.

He is entitled to attend such meetings and to speak at them on

any part of the business which concerns him as the former
auditor.

(2) An auditor’s rights regarding access to information include the

following:

(i) Access to books and records of the company at all times;

(ii) Right to require information and explanations from the
company’s officers; 1
(iii) Right as auditor of a holding company to require information
from the auditors of its subsidiaries.
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6. (a) The following matters should be considered when planning the audit of Spur
Limited’s financial statements for the year ending December 2008:

(i) Specific issues arising from the previous year’s audit. A review of
the previous working papers should indicate any audit matters arising
that are likely to impact on this year’s audit. For example, high
inherent tick areas from the previous year are likely to present similar
risk profiles this year.

(ii) Major changes in the company’s operations. The significant growth

experienced by Spur Limited together with the change in the internal
control system will have a major impact on audit planning. As a
consequence, my firm will need to consider the additional audit
resources required to carry out an efficient audit on a company with a
larger scale of operations. The requirement to ascertain, record and
evaluate the company’s new internal control system will also need to be
considered.

(iii) Timing requirements. We will need to liaise with the company’s

management to prepare a time table for the completion of our audit.
The time table should set out the agreed dates for stock count
attendance, the date draft financial statements will be available for audit
and the date by which the company requires us to issue our audit
report. Our planning procedures should include the issue of a timetable
for our work, agreed by Spur Limited management.

(iv) A review of interim or management accounts prepared by the

company. Our firm should review a copy of any accounts already
prepared during the year to date, in order to gain an insight into Spur
Limited’s performance and any matters arising which could have audit
significance. For example, a build up of longstanding trade debtors
balances could indicate the existence of bad debts not recognized by
Spur Limited.

(v) Problems encountered during the year. We should meet senior

management of Spur Limited to identify and discuss any problems
encountered by the company during the year to date which could
impact on our audit. For example, discussions may reveal significant
repairs and maintenance expenditure was incurred following the
continual breakdown of plant and machinery. Similarly management
may update us with the outcome of discussions they may have recently
had to renew the company’s overdraft facility.

(vi) Changes in legislation or accountancy practice. Spur Limited’s

retailing activities are likely to be subject to stringent legislative
requirements such as health regulations. Similarly the financial
complexities involved in the day to day operations of the company are
likely to require careful monitoring, to ensure that the company’s
financial reporting function accords with the relevant contemporary
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accounting standards. My firm should consider any recent changes in

legislation or accounting practice relevant to Spur Limited.

(vii) Work to be carried out by the client’s staff. Involvement of Spur

Limited staff in preparing/supplying reconciliation analysis schedules
should facilitate a more efficient audit. Whilst we will still need to
carry our specific procedures to verify information on such schedules,
the provision of them should save time freeing audit resources to
concentrate on more complex tasks.

(viii) Audit staffing. My firm should give careful consideration to make up

of the audit team, ensuring there is an adequate balance between the
number of employees to be assigned to the audit, their experience and
the fee chargeable to Spur Limited for carrying out the audit work.
When assigning audit staff, due consideration should be given to other
commitments within the firm, staff available and work experience
training issues.

(b) My firm may record the internal control system of Spur Limited by employing
any of the following methods:

(i) Narrative notes;

(ii) Flow charts;
(iii) Internal control questionnaires or check lists;
(iv) Organisational charts.

(c) Benefits of audit planning:

(i) It helps to ensure that the work is completed efficiently and effectively;
(ii) It establishes the intended means of achieving the objectives of the
audit.
(iii) Assists in the direction and control of the work.
(iv) It helps to ensure that attention is devoted to critical aspects of the
audit.

(d) Audit program is essentially a record of the audit testing. It specifies the
nature and extent of the checking, and the members of staff who have carried
out the work. It also contains evidence of review of work. The audit program
serves as:

(i) A set of instructions to the audit team.

(ii) A means to control and record the proper execution of the work.
(iii) A record of the audit procedures to be adopted, the audit objectives,
timing, sample size and basis of selection for each area.

7. (a) (i) Audit software – These are computer programs used for audit purposes
to examine the contents of the clients computer files. They may be
used during many audit testing of transactions and balances as it may
scrutinize large volumes of data and extract information leaving skilled
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manual resources to concentrate upon the investigation of the results.

Typical uses of such programs include:

(1) Calculation checks, for example the program adds the value of
open items on a file to ensure that they agree with control
records that are maintained.

(2) Detecting violation of system rules, for example the program

checks all accounts on the sales ledger to ensure that no
customer has a balance above a specified credit limit.

(3) Detecting unreasonable items, for example a check that no

customer is allowed trade discount of more than 50% or that no
sales ledger balance is more than the total sales made to that
customer.

(4) Conducting new calculation and analysis, for example

obtaining a statistical analysis of stock movements to identify
slow moving items.

(5) Selection of items for audit testing, e.g. obtaining a stratified

sample of sales larger balances to be used as a basis for a
debtors’ circularization.

(6) Completeness checks, e.g. checking continuity of sales

invoices to ensure they are all accounted for.

(ii) Test data – This is the data used by the auditor for computer
processing to test the operation of the client’s computer programs. The
data may be processed during a normal production run referred to as
running test data live or during a special run at a point in time outside
the normal cycle (running the test data dead).

Approaches:
(1) Using live data – At its simplest level the auditor could use real data
that has been processed which involves the control he wants to test. He
should then predetermine the results which he would expect from the
processing of the data. He later checks that the actual processing has
been carried out in the expected way and investigates any differences.
This method is not usually feasible. The auditor will usually want to
use a collection of normal, exceptional and even absurd data to test
controls.

(2) Dummy data in a normal production run – The auditor constructs a

series of dummy transactions which contain the required condition.
These are processed along with normal data. Actual results are then
compared with predetermined results. This method has the advantage
of producing a realistic test environment. The client’s actual programs
and data files are used in the test.
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(3) Dummy data in a special run – In this method the auditor creates
special data and uses it against copies of the client’s data files. The
dangers associated with live testing are therefore largely eliminated
although the interaction of one file with another must still be carefully
considered.

(b) Advantages of computer assisted auditing techniques (CAATs) to the auditor:

(i) In a computer based system the large volume of transactions is likely to
force the auditor to rely upon programmed controls. CAATs are likely
to be the only effective way of testing programmed controls.

(ii) The use of CAATs will enable the auditor to test a much larger number
of items quickly and accurately and therefore increase the confidence
he has in his opinion.
(iii) CAATs enable the auditor to test the accounting system and its records
rather than relying upon testing printouts of what he believes to be a
copy of those records.

(iv) Once set up CAATs are likely to be a cost effective way of obtaining
audit evidence provided that the enterprise does not regularly change its
systems.

(v) Careful planning by the auditor should enable the results of his work
using CAATs to be compared with results from the traditional clerical
audit work to increase confidence.

(c) Disadvantages in using computer audit programs are:

(i) Costs – There will be substantial set up costs even in using a

generalized package. This is because the client’s procedures and files
need to be investigated thoroughly prior to identifying audit tests. The
use of specially written programs will be even more expensive.

(ii) Changes to client’s systems – These can mean costly alterations to the
programs or at least require the programs to be run regularly during the
year to test the system at different dates.

(iii) Small installations – There may be no suitable audit software package

for use on mini-computer or micro-computer installations. Software
documentation may be incomplete so that it is very difficult to identify
all procedures. It may be impossible to justify and hence recover the
cost of specially written audit software.

(iv) Over-elaboration – There may be a tendency to produce over

elaborate enquiry programs which are expensive to develop, take up
considerable computer running time and extensive reviewing time. The
auditor should be able to justify the costs of using program to the
benefit in audit terms of its use.
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(v) Version of files used in the test – The audit software only tests the
files against which it is run. It is therefore preferable to use the
software on the actual files of the client. The permission of the client is
needed and the software must be carefully tested prior to its use on live
data.
(vi) Quantities of output – An enquiry program may produce huge
quantities of output. This may be because the system is wrong or the
enquiry program was badly designed. To avoid this problem some
packages can be set to terminate after a given number of items have
been included in the count. The auditor must distinguish between cases
when he has merely misjudged the parameters and obtained too large a
sample and cases where the print out is long because lots of items are
wrong. In the latter case he must follow the audit work through and
consider the implication of the problems encountered.

END