The Professionals’ Academy of Commerce

Exam Focused Topic-wise Test for CFAP

28th March, 2024
2 Hours – 60 Marks
Test-04
Audit, Assurance & Related Services
Q.1
(a) You are working as an audit manager for N&M Chartered Accountants. You have been assigned as the
manager on the audit of West Engineering Limited (WEL) for the year ending 31 December 2019.
On 1 May 2019, WEL acquired 80% interest in Mega Motors (MG) which represents 30% of group
profit before tax and total assets. The audit of MG will be conducted by its existing auditor. As part of
the negotiation process, it was agreed that WEL would make an additional payment of Rs. 1,000
million on 31 March 2020, if MG successfully completes a contract negotiation with a new client by 1
March 2020. This negotiation is still ongoing. The MG is also undertaking important research.
WEL has provided following calculation of the goodwill arising on the acquisition of MG:
Rs. in million
Cash paid 6,000
Non-controlling interest at fair value 1,200
Acquisition costs 150
7,350
Carrying value of net assets 5,000
Fair value adjustment of property 650
(5,650)
Goodwill 1,700
The financial statements of MG for the year ended 31 December 2018 included a disclosure note for a
contingent liability of Rs. 250 million for a court case. MG had legal advice that the chance of paying
this amount was assessed as possible. The court case was settled in November 2019 and MG was
ordered to pay Rs. 500 million which it will pay in December 2019. MG will recognize this as an
expense in profit or loss, but the group plans to adjust the goodwill calculation for this payment.
At the beginning of the year, WEL acquired a building which is rented out under a series of short-term
leases as commercial offices. WEL has not previously owned any investment properties and has
chosen to account for the investment property using the fair value method. The valuation was
performed by an independent valuer, based on its use as a residential property and shows that the fair
value has increased by 25% since acquisition.
On 1 January 2019, WEL entered into two separate and significant lease agreements to obtain the use
of a factory and an office building for 10 years. The terms of both leases require that the lease
payment will increase every year in line with inflation. WEL has calculated the lease liabilities by
estimating the future lease payments, based on inflation of 10% per annum.
Required:
Identify and explain the key audit risks for WEL Group for the year ending 31 December 2019. (14)

(b) The audit team of Fine Telecom (FT) overheard a discussion between employees of FT in which they
mentioned that the company had been subject to a recent cyberattack. They mentioned that FT had not
reported this incident to the relevant authorities which concerned them as this was a breach of legal
regulations.
The audit team did not discuss this matter with the client as they did not identify any audit
implications and were concerned that they would be seen to have overheard a private conversation.
Required:
Discuss the auditor’s course of action in the above scenario. (06)
 Audit, Assurance & Related Services [Page 2 of 3]

Q.2 Your firm has been the external auditor of Century Plastics Ltd (CPL) for five years.
On 1 January 2019, Saima, a majority shareholder, sold her 100% shareholding in CPL to Millennium
Plastic Limited (MPL). MPL immediately appointed a new board of directors. Your firm has accepted
the new board’s offer of reappointment as the auditor of CPL for the year ended 31 July 2019.
You are the audit senior responsible for planning the audit of CPL. The engagement partner asked you
to consider the following three key areas of audit risk:
(1) Land and freehold factory
(2) Plant and machinery
(3) Related party transactions
CPL manufactures disposable plastic products, such as cutlery, plates and straws. It sells its products
to European distributors operating in the catering industry.
In 2018 the EU announced that it would ban a range of plastic items, such as those manufactured by
CPL. The ban is expected to come into effect in 2021. In response to the announcement, CPL invested
in the development of a new range of disposable products made from materials which degrade quickly
when disposed of. CPL believes that its new range will not be subject to the EU ban.
As part of your planning for the audit of the financial statements for the year ended 31 July 2019, you
met with CPL’s new finance director, Anwar Ali, who provided you with the following information:
 On 31 March 2019, CPL sold part of the land where its factory is located to Navas Ltd (Navas).
CPL’s new chief executive is the majority shareholder of Navas.
 CPL’s freehold factory and remaining land was revalued for the first time at 31 July 2019 to make
CPL’s accounting policy consistent with that of MPL. Anwar Ali obtained a valuation from
Beecher Associates, a firm of chartered surveyors where his wife, Olivia, is a partner. CPL has
recognised this valuation in the financial statements for the year ended 31 July 2019.
 To enable the manufacture of the new range of disposable products, CPL made several
modifications to its production plant. Some components of the existing machinery were replaced.
CPL has included the cost of the new components in plant and machinery. These components
were purchased, in euros, from suppliers in Europe. The labour costs associated with making the
modifications have also been included in plant and machinery.
 CPL’s board has received a report from the MPL internal audit team, which recently conducted an
audit of CPL’s internal controls. The report identified the following internal control deficiencies:
a. Several contracts negotiated with new customers during 2019 have terms of trade which are
more favourable to the customer than CPL’s standard terms.
b. Instances of management override were found in respect of the approval process for the
purchase of machinery components. This included transactions with suppliers that are not on
CPL’s list of approved suppliers.
Anwar Ali also provided you with the following financial information:
Notes to the financial statements for the year to 31 July 2019 (extract)
Property, plant and equipment
Freehold Plant and
Land
factory machinery
Cost/valuation Rs. 000 Rs. 000 Rs. 000
At 1 August 2018 7,000 10,675 2,136
Revaluation 2,000 2,325 -
Additions - - 597
Disposals (3,000) - (23)
At 31 July 2019 6,000 13,000 2,710

Depreciation
At 1 August 2018 - 8,302 1,208
Revaluation - (8,302) -
Charge for the year - - 189
 Audit, Assurance & Related Services [Page 3 of 3]
Disposals - - (10)
At 31 July 2019 - - 1,387
Carrying amount
At 31 July 2019 6,000 13,000 1,323
At 31 July 2018 7,000 2,373 928

From the previous year’s audit file, you note that plant and machinery is depreciated over 10 years
and that the charge for the year ended 31 July 2018 was Rs. 237,000.
Required:
(a) Justify why items (1) to (3) above have been identified as key areas of audit risk. For each key
area, describe the procedures that should be included in the audit plan to address those risks.
Present your answer using the following subheadings:
 Land and freehold factory
 Plant and machinery
 Related party transactions
(25)
(b) Outline the potential consequences of each of the internal control deficiencies (a) and (b) above.
(03)
Q.3 Sea view Limited is a manufacturing company. Behroze & Co., Chartered Accountants are their
auditors. The audit of financial statements of the Company for the year ended November 30, 2018 is
in progress. Sami, the senior in charge on the audit has received the first draft of the financial
statements from Kamil, the CFO of the Company. The abridged financial information of the Company
for the year ended November 30, 2018 is as follows:

2018 2017
---- Rs. in ‘000’ ----
Property, plant and equipment 2,325 1,210
Intangible assets 100 50
Inventories 650 460
Trade debts 210 80
Sales 4,300 6,700
Cost of sales 3,800 5,100
Gross Profit 600 1,600
Sami had a meeting with the CFO of the Company which revealed the following matters:
(i) The Company’s sales have suffered on account of depressed economic conditions in the
country;
(ii) The Company has introduced a new product ‘Cherry’ during the year in place of ‘Merry’ and
incurred substantial cost in the acquisition of property, plant and equipment; and
(iii) This year’s physical verification of stocks had not been carried out on November 30 on the plea
that the relevant staff was on leave. The stock check will now be carried out on December 15,
2018.
Required:
Given the above data and circumstances, identify the following:
(a) the risks that may result in material misstatements in the financial statements; and
(b) the implications of the risks identified along with audit procedures that would be most suitable to
mitigate those risks.
(12)

(THE END)