CAF 8: Audit & Assurance

Suggested Solution – Term Test 2

Answer # 1

(a)
There is a risk that there are some payables which are not yet recorded (i.e. completeness of creditors).

1. Review of Goods Received Notes (GRNs):

Inspect all GRNs that are pending as of the balance sheet date. This includes goods received but not yet
invoiced by the suppliers. The objective is to ensure that all such liabilities are accurately recorded in the
financial statements. This procedure helps in assessing the completeness of trade payables.
2. Post-Year-End Payments Analysis:
Select a significant sample of payments made after the year-end and trace these back to the corresponding
liabilities recorded at the year-end. This process will help in verifying whether the liabilities were
appropriately recognized at the balance sheet date, thus addressing the risk of understated liabilities.
3. Supplier Ledger Scrutiny:
Conduct a thorough review of the supplier ledger to identify any potential omissions of major suppliers.
This involves comparing the current year's supplier list with that of the previous year to detect any
significant changes or exclusions.
4. Comparison and Analysis of Individual Trade Payables:
Compare individual trade payable balances with those of the previous year. Special attention should be
given to accounts that have significantly decreased or are absent in the current year. This investigation will
assist in identifying any unusual patterns or discrepancies that might suggest errors or omissions in the
recording of trade payables.
(1.0 marks for each procedure; subject to the maximum of 3.0 marks)

(b)
State four (04) types of account which should receive special attention when picking a sample for a
receivables confirmation.

1) Accounts over performance materiality level

2) Overdue accounts
3) Accounts with negative/credit balance
4) Major customers with small or zero balances
5) Accounts with unusual changes
(0.5 marks for each category; subject to the maximum of 2.0 marks)

Answer # 2

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 CAF 8: Audit & Assurance
Suggested Solution – Term Test 2

(a) Defective Fuel Injectors:

1) A provision for PKR 20 million should be recorded, as it is probable that an outflow of resources will
occur.
2) This represents a misstatement of PKR 20 million.
3) The amount is material, exceeding the materiality threshold of PKR 750,000 (15,000,000 * 5%).
4) The auditor should issue a Qualified opinion if this issue is not resolved.

(b) Rusted Motorcycle Chains:

1) Inventory should be valued at the lower of cost and net realizable value (NRV). The cost is PKR
180,000, while the NRV, after refurbishment costs, is PKR 110,000 (200,000 - 90,000).
2) This leads to a misstatement of PKR 70,000.
3) The amount is not material, as PKR 70,000 is less than the materiality level of PKR 750,000
(15,000,000 * 5%).
4) The auditor should express an unmodified opinion if this issue is not significant to the overall financial
statements. (0.5 marks for each category; subject to the maximum of 2.0 marks)

Answer # 3
(a)
I concur with Sara's observation that Ali committed several errors in his sampling approach:
1. Inappropriate Sample Population:
Ali's sample should have been selected from suppliers as of December 31, 2012, rather than from current
(01 mark)
records. This is crucial to match the financial statement date.

2. Misinterpretation of Sample Misstatement:

The actual misstatement in Ali's sample is a PKR 350 understatement, not an overstatement. This error
(01 mark)
arises from incorrectly summing the differences between recorded and correct values.

3. Failure to Extrapolate Misstatement onto the Entire Population:

Ali neglected to project the discovered misstatement across the entire population of accounts payable. This
(01 mark)
projection is essential to estimate the total potential misstatement in the financial statements.

(b) Examples of Situations/Circumstance when Emphasis of Matter Paragraph is included in

Audit Report:
1. If there is material uncertainty relating to the exceptional litigation or regulatory action.
2. A significant subsequent event occurs between the date of financial statements and the date
of auditor’s report.
3. When a major disaster significantly affects entity’s financial position.
4. Early application (when permitted) of a new accounting standard that has a material effect
on financial statements.

Examples of Situations/Circumstance when Other Matter Paragraph is included in Audit

Report:
1. When financial statements of prior period were not audited or were audited by another
auditor.
2. When auditor reports on more than one sets of financial statements.
3. When auditor restricts distribution of auditor’s report.
(0.5 marks for each example, subject to the maximum of 1.0 marks in each category)

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 CAF 8: Audit & Assurance
Suggested Solution – Term Test 2

Answer # 4
(a)
Beta:
Beta's balance should be selected for testing since it is above the performance materiality threshold of Rs.
60,000. Moreover, there is a significant increase in the balance from the previous year (from Rs. 35,000 to
Rs. 70,000), which warrants further investigation.

Gamma:
Despite being below the performance materiality level, Gamma's balance should be tested because the
company went into liquidation during the year. This raises concerns about the recoverability of the
receivable.

Epsilon:
Epsilon's balance is clearly above the performance materiality threshold and is therefore individually
material. The balance has also seen a notable increase from the previous year (from Rs. 230,000 to Rs.
250,000), which necessitates a closer examination.

Other Customers:
Although each of the “other customers” balances are below the performance materiality threshold, they
are collectively material (totaling Rs. 180,000). Therefore, a representative sample of these balances should
be tested to verify their accuracy and existence.
(1.0 marks in each category, subject to the maximum of 4.0 marks)

(b)

Assessment of Materiality:
The remaining difference of Rs. 8 million should be evaluated against the materiality level for the audit. If
(01
the materiality level was set at Rs. 10 million, the remaining misstatement falls below this threshold.
mark)

Expression of Audit Opinion:

An unmodified opinion could be appropriate if:

1. Qualitative Materiality:
The misstatement of Rs. 8 million does not hold materiality on qualitative grounds. This includes
considerations like the nature of the misstatement, its impact on trends, and its effect on covenants
(0.5 mark)
or regulatory requirements.
2. Aggregate Misstatements:
The Rs. 8 million misstatement, when aggregated with any other immaterial misstatements
(0.5 mark)
identified during the audit, does not exceed the materiality level.

Documentation and Communication:

It's essential for the audit partner to document the rationale behind the decision, including how the
materiality level was determined and why the misstatement is considered immaterial. Furthermore,
(01 mark)
communication with the audit committee and management about this conclusion is crucial.

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 CAF 8: Audit & Assurance
Suggested Solution – Term Test 2

(c)

(i) Nature of the Event:

The lawsuit was filed after the fiscal year-end. However, the incident that led to the lawsuit occurred before
the year-end. This indicates that the event provides evidence of conditions that existed at the balance sheet
(01 mark)
date. Therefore, it qualifies as an adjusting event.

(ii) Impact on Audit Opinion:

• Materiality of the Claim:
Assuming the claimant's expected lifetime to be around 50 years, the total potential settlement
(01 mark)
could be material (Rs. 150,000 x 50 years).
• Consequences of Non-Adjustment:
If the directors refuse to adjust the financial statements for this material contingent liability, it
(01 mark)
would lead to a significant misstatement in the financial statements.
• Auditor’s Response:
The auditor should express a qualified opinion if the effect of the non-adjustment is material but
not pervasive. If the effect is determined to be pervasive, impacting the financial statements as a
(01 mark)
whole, an adverse opinion may be necessary.

Answer # 5

Scope Limitation:
• This situation represents a scope limitation, as the auditor is restricted from obtaining
necessary information due to confidentiality constraints. The auditor is generally entitled
(01 mark)
to access all information deemed necessary for the audit.
Materiality of the Amount Involved:
• The amount of PKR 900,000 is material in context, considering a materiality level of
PKR 300,000 (6,000,000 * 5%). This significant amount affects the overall reliability of
(01 mark)
the financial statements.
Qualified Opinion:
(01
• The auditor should express a qualified opinion on Leviathan's financial statements.
mark)

Basis for Qualified Opinion:

• The auditor should clearly explain the nature of the scope limitation in the 'Basis for
(01 mark)
Qualified Opinion' section of the audit report.

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 CAF 8: Audit & Assurance
Suggested Solution – Term Test 2

Answer # 6

Issues with Independence and Recommendations:

1. Reporting Structure:
• Issue: The head of internal audit reports to the CFO.
• Recommendation: The head of internal audit should report to the audit committee to
ensure independence from the management being audited.
2. Scope Determination:
• Issue: The internal audit's scope of work is influenced by the CFO.
• Recommendation: The scope of work should be determined independently by the head
of internal audit, potentially in consultation with the audit committee, to prevent any bias
or undue influence.
3. Tenure of Internal Audit Staff:
• Issue: The long tenure of internal audit staff at Zirconia may lead to familiarity threats.
• Recommendation: Implement a rotation policy for internal audit staff to avoid long-term
associations with particular departments or processes, thus maintaining objectivity and
fresh perspectives.
4. Appointment of the Head of Internal Audit:
• Issue: The head of internal audit is appointed by the CEO.
• Recommendation: The appointment should be made by the audit committee or the
board of directors to enhance independence from the executive management.
5. Role in Control Systems:
• Issue: The internal audit department is involved in advising on and implementing
controls.
• Recommendation: Internal auditors should maintain a monitoring and advisory role
rather than being directly involved in the design and implementation of control systems.
This separation ensures that they can objectively assess the effectiveness of these systems
without conflict of interest. (0.75 for each issue, 0.75 mark for each recommendation)

Answer # 7
(a)
(i) Assessment of AAL’s Competence, Capabilities, and Objectivity:
1. Professional Qualifications:
• Verify whether AAL's team members hold relevant professional qualifications and licenses
appropriate for actuarial valuations.
2. Experience and Reputation:
• Evaluate AAL's experience in pension valuation, considering their track record and
reputation in this specialized field.
3. Independence:
• Ascertain AAL’s independence from GEL, ensuring there are no conflicts of interest, such
as financial stakes, personal or business relationships, or other provided services.

(ii) Evaluating the Adequacy of AAL’s Work:

1. Data Review:
• Assess the accuracy, completeness, and relevance of the significant data used in AAL's
valuation.
2. Assumptions and Methods:
• Critically examine the relevance and reasonableness of the assumptions and
methodologies applied by AAL.
3. Findings Consistency:
• Evaluate the reasonableness of AAL’s findings and conclusions, ensuring they are
consistent with other audit evidence gathered.

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 CAF 8: Audit & Assurance
Suggested Solution – Term Test 2

(b) Actions If AAL’s Work is Inadequate:

i. Additional Work: - Request AAL to perform additional work to address any deficiencies.

ii. Alternative Audit Procedures: - If issues persist, consider performing alternative audit procedures,
which may include engaging another expert.

iii. Audit Opinion: - In the event that the work remains inadequate, recognize it as a scope limitation.
Depending on the materiality, issue either a qualified opinion (if the impact is material) or a disclaimer of
opinion (if the impact is pervasive).
(01 mark for each relevant point in each part)

(THE END)

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