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Answer:
3-32 a.
1. Audit risk is the risk that the auditor may unknowingly fail to appropriately modify
the auditor's opinion on financial statements that are materially misstated.
3. Inherent risk and control risk differ from detection risk in that they exist
independently of the audit of financial statements, whereas detection risk relates
to the auditor's procedures and can be changed at the auditor's discretion.
Detection risk has an inverse relationship to inherent and control risk.
b.
3. The auditor's judgment about materiality for planning purposes may be different
from materiality for evaluation purposes because the auditor, when planning an
audit, cannot anticipate all of the circumstances that may ultimately influence
judgment about materiality in evaluating the audit findings at the completion of
the audit. If significantly lower materiality levels become appropriate in
evaluating the audit findings, the auditor should reevaluate the sufficiency of the
audit procedures already performed.
Materiality & Risk
Question 2
Your firm has recently been appointed as external auditor to EWheels. EWheels is a
private .dot.com. company that operates an internet auction service for the sale of used
motor vehicles. You are planning the audit of the financial statements. The company has
been in existence for four years and has grown rapidly. It was founded by three individuals
who are a former car auctioneer, an internet specialist with an interest in cars, and an
accountant. The company now has three offices and some 100 employees. The on-line car
auction market is very competitive. The company is the biggest provider of the service in
the south of the country, but the directors have ambitious plans which include an
aggressive marketing campaign, the take-over of a number of target competitors and
additional office space and staff, all of which will require considerable additional finance.
The company is financed partly by private capital brought in by the three founders, and
partly by bank loans. The three founders were all directors, but the accountant resigned six
months ago and has commenced a legal action against the company for a considerable
amount of money, claiming that he has effectively been excluded from management by the
other two directors. The company.s balance sheet shows net liabilities. The company has
not yet made a profit although preliminary figures indicate that it has reached break-even
point in the current year. Your firm has discovered that the previous auditors were not re-
appointed because they refused to issue an unmodified audit opinion on the previous year.s
financial statements, and instead made reference to the going concern status of the
company in their audit report. Your firm has made it clear to the directors that it may be
necessary to make reference to the going concern status of the company again in the
current year, but they have indicated that they would prefer an unmodified report if at all
possible. You are also aware that loan facilities for this type of company are becoming more
scarce, as there are too many companies seeking such finance.
The director who resigned six months ago was responsible for the day to day accounting
function and for the preparation of the financial and management accounts. The company
has been unsuccessful in recruiting a permanent replacement and has used a number of
temporary accountants. Your initial investigations have highlighted a number of weaknesses
in the operation of the accounting and internal control systems.
Required:
(a) Explain your understanding of audit risk. (4 marks)
(b) Describe the risks associated with the audit of EWheels. (7 marks)
(c) List the enquiries you will make and the procedures you will perform in deciding whether
to make reference to the going concern status of Ewheels in your audit report on the
financial statements. (5 marks)
(d) Describe the different ways in which your audit report might refer to the going concern
status of the company.
(4 marks)
(20 marks)
Materiality & Risk
Answer
(ii) the relationship between the company and its bankers should be investigated
thoroughly, because if the relationship is poor, additional finance is unlikely to be
forthcoming.
(iii) it is likely that financial information will sent to the bank on a regular basis and this
should be inspected. It will be necessary to inspect correspondence with the bank and
possibly for the auditors to make their own enquiries of the bank, although banks do not
normally provide much information to auditors in this context.
(iv) enquiries should be made of directors about that availability of additional equity and
other finance which will be necessary for the planned expansion. All statements in this
respect should be corroborated and supported by documentation.
(v) enquiries should be made of the company.s lawyers as to the nature and likely outcome
of the dispute with the exdirector.
It will be necessary to make either a provision or disclosure in the financial statements
unless it is very unlikely that any amount will be payable to him.
Answer:
4-36 a. The bank confirmation would be considered more reliable than the observation of
segregation of duties because an independent external party provided the
information. Observation is not as reliable because the individuals performing the
functions may not act properly when no one is observing them.
c. The bank statement would be considered more reliable than shipping documents
because the bank statement was prepared by an entity that is external to the
client.
Answer:
4-37
a. Type b. Reliability
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Audit Planning
c. The factors that influence an auditor's consideration of the reliability of data for
purposes of achieving audit objectives are whether the
• Independence of the source of the evidence.
• The effectiveness of internal controls.
• The auditor’s direct personal knowledge.
Question 2
Nepco is a European company that manufactures high quality computer components and
assembles computer parts. It has existed for some years and is part of a vertical supply
chain for a well-known brand of computer hardware. Profits are coming under increasing
pressure from manufacturers in the Far East and Asia with lower labour costs, and from
rising raw material costs. Nepco is listed on a stock exchange. There is pressure from
institutional investors for better returns in the form of dividends and the main institutional
investors are considering selling a proportion of their shares in the company. The directors
of Nepco are considering whether to move into new market areas.
Nepco has good accounting and internal control systems. Inventory is material to the
accounts, and there is a good set of permanent inventory records. No year-end inventory
count is conducted. Operational compliance issues are important to Nepco. Many countries
have inflexible quality standards and some projects are being held up because of difficulties
in obtaining approval from regulators for new components.
All staff and directors of Nepco are remunerated (at least in part) on a performance-related
basis, some with share options. Staff are generally highly qualified and wellpaid.
Audit Planning
This is your first year as auditors. Your firm has very little experience in this industry.
External audit costs are tightly controlled and your firm has agreed to a budget that will
allow very little flexibility.
Required:
(a) Describe the risks relating to Nepco under the headings of inherent risk, control risk and
detection risk. (12 marks)
(b) In the light of the risks identified in (a) above, list the matters to which you will pay
particular attention during the audit of Nepco and explain the work you will perform in
relation to them. (8 marks)
(20 marks)
Audit Planning
Answer
(a) Risks
ISA 400 .Accounting and Internal Control Systems. states that audit risk is the product of
inherent risk, control risk and detection risk.
(i) Inherent risks include:
(1) The competition from Asian and Far Eastern companies, and rising raw material prices.
This means that there is pressure on profits and the ability to reward employees and pay
dividends to institutional shareholders which increases the pressure to manipulate the
financial statements to show good returns.
(2) The potentially volatile market (computer components) in which new technology can
render hardware obsolete in a very short time. This means that there is an ongoing risk to
the business as a whole (a potential going concern risk) . the company must be adaptable.
(3) The risk that regulators may reject a product which has taken many months or years to
develop.
(4) The pressures for returns from institutional investors which means that there may be a
temptation to manipulate the financial statements.
(5) The possible sale of shares, increasing the pressure for returns in order to get the best
possible price, which increases the pressure to manipulate the financial statements.
(6) The inherent risks in diversification into unknown areas (the supply of other customers) .
but these are not current risks.
(ii) Control risks: there are apparently very few except for the performance-related
payment, including share options, which provides an incentive to produce .acceptable.
figures.
(iii) Detection risk: this is the firm.s first year as auditors and there are tight controls on
audit costs, which may lead to inadequate audit evidence unless the audit is properly
directed, supervised and reviewed. This is compounded by the firm.s lack of experience in
this area. It is important that those with experience are employed on this audit, at least in a
review capacity.
Answer:
6-34 a. For purposes of an audit of financial statements, an entity's internal control system
consists of the following components:
• The control environment
• Risk assessment
• Control activities
• Information and communication
• Monitoring
c. An auditor may assess control risk at the maximum level for some or all assertions
because the auditor believes controls are unlikely to pertain to an assertion, or are
unlikely to be effective, or because evaluating their effectiveness would be
inefficient.
d. To support assessing control risk at less than the maximum level, an auditor must
determine whether the controls are suitably designed to prevent or detect material
misstatements in specific financial statement assertions and obtain evidence that
the controls are operating effectively.
e. When seeking a further reduction in the assessed level of control risk, an auditor
should consider whether additional evidential matter sufficient to support a further
reduction is likely to be available and whether it would be efficient to perform tests
of controls to obtain that evidential matter.
Question 2:
There are many reasons for maintaining internal control systems. These include the need to
ensure that:
(i) transactions are properly authorised
(ii) transactions are promptly and accurately recorded
(iii) access to assets and records is properly authorised
(iv) recorded assets represent actual assets.
In the absence of internal controls, errors, omissions and misappropriation of assets are
likely and external and internal auditors pay particular attention to both the design and
operation of internal control systems.
Receivables is an area in which most organisations expect internal controls to be operating
effectively.
Required:
(a) In the context of receivables, list and describe the types of error, omission and
misappropriation of assets that can occur in practice where internal controls are weak or
non-existent. (4 marks)
(b) Explain why even a good system of internal control will not necessarily prevent or detect
errors, omissions and the misappropriation of assets in a receivables system, and explain
why a good system of internal control is important to auditors. (4 marks)
(c) List the main internal controls that you would expect to be in operation in the
receivables system at a small manufacturing company with a computerised accounting
system. (9 marks)
(d) Explain why external auditors seek to rely on the proper operation of internal controls
wherever possible. (3 marks)
(20 marks)
Answer
(a) Error, omission and misappropriation
(i) where internal controls are weak, the errors that occur may include the issue of invoices
and credit notes for the wrong amounts, the issue of invoices and credit notes to the wrong
customers, the incorrect recording of invoices, credit notes, cash and contras in the ledgers
and daybooks, and the incorrect setting of credit limits.
(ii) where internal controls are weak, invoices, credit notes cash and contras may simply go
unrecorded.
(iii) the effect of this will be that receivables may be under or over-stated in the records and
that the company will not receive that money that is due to it, or that goodwill with
customers is damaged.
(iv) the assets that may be misappropriated include cash and inventory. If records are poor,
it will be easy to hide the misappropriation of cash that is received from customers. It will
also be possible for inventory to be misappropriated and hidden by the issue of false or
incorrect invoices, credit notes or contras.
cancel them out may be issued just after the year-end. This is sometimes known as
.window-dressing..
(iv) fraudulent collusion can happen both within the company and outside the company.
Those who have the right to authorise the issue of credit notes may authorise false credit
notes for customers who are their friends. Those who have access to cash and the
receivables records may collude to misappropriate cash, and make entries in the accounting
records to hide the misappropriation. This is sometimes known as .teeming and lading..
Answer:
7-36 a. 4
b. 5
c. 2
d. 3
e. 1
Answer:
7-38 a. Based upon the information given, the computer may be used by Hastings to do
the following:
• Test extensions and footings of computerized sales records that
serve as a basis for the preparation of the invoices and sales journal.
• Verify the mathematical accuracy of postings from the sales
journal to appropriate ledger accounts.
• Determine that all sales invoices and other related documents
have been accounted for (e.g., by accounting for the integrity of the numerical
sequence).
• Select sales transactions for review (based upon predetermined
criteria) through a review of the sales journal or the accounts receivable
subsidiary ledger.
• Print a workpaper that lists each item selected, with relevant data
inserted in applicable columns.
• Select all debits posted to the sales account and all postings to
the sales account from a source other than the sales journal.
• Analytically review recorded sales by use of predetermined
criteria (percentage relationships, gross margin, trends, and so forth, on a
periodic or annual basis).
• Compare duplicate data maintained in separate files for
correctness. For example, the computer may be used to compare the client's
records of quantities sold with the client's records of quantities shipped.
• Examine records for quality (completeness, consistency, and so
forth). The quality of visible records is readily apparent to the auditor. Sloppy
record keeping, lack of completeness, and so on, are observed by the auditor in
the normal course of the audit. If machine-readable records are evaluated
manually, a complete printout is needed to examine their quality. Hastings may
choose to use the computer to examine these records for quality.
8-34 The computed upper deviation rate and the auditor's decision for each
control procedure are:
Control Procedure
Results
1 2 3 4
Number of deviations 0 5 4 3
Sample size 156 181 94 98
Sample deviation rate 0.0 2.8 4.3 3.1
Computed upper deviation rate 2.0 6.9 8.7 7.3
Support Does Does Supports
Auditor's decision s not not
support support
Question 4
Wong and Kasim were conducting the audit of Syarikat ABC Berhad for the
year ended 31 December 2004. Jerry, the senior in charge of the audit, plans
to use monetary unit sampling (MUS) to audit ABC’s inventory account. The
balance at 31 December 2004 was RM9,000,000.
Sampling tables:
5% ARACR
Estimate Tolerable exception rate (%)
d
populati 2 3 4 5 6 7 8 9 10 15 20
on
exceptio
n rate
(%)
0.00 149 99 74 59 49 42 36 32 29 19 14
0.25 236 157 117 93 78 66 58 51 46 30 22
0.50 * 157 117 93 78 66 58 51 46 30 22
0.75 * 208 117 93 78 66 58 51 46 30 22
1.00 * * 156 93 78 66 58 51 46 30 22
1.25 * * 156 124 78 66 58 51 46 30 22
1.50 * * 192 124 103 66 58 51 46 30 22
1.75 * * 227 153 103 88 77 51 46 30 22
2.00 * * * 181 127 88 77 68 46 30 22
2.25 * * * 208 127 88 77 68 61 30 22
2.50 * * * * 150 109 77 68 61 30 22
2.75 * * * * 173 109 95 68 61 30 22
3.00 * * * * 195 129 95 84 61 30 22
3.25 * * * * * 148 112 84 61 30 22
3.50 * * * * * 167 112 84 76 40 22
3.75 * * * * * 185 129 100 76 40 22
4.00 * * * * * * 146 100 89 40 22
5.00 * * * * * * * 158 116 40 30
6.00 * * * * * * * * 179 50 30
7.00 * * * * * * * * * 68 37
* sample is too large to be cost-effective
Required:
b. Sheila, an audit assistant, used the sample items selected in part (a)
and performed the audit procedures listed in the inventory audit
programme. She notes the following misstatements:
4
Overstatement Errors
Sampling
Risk
.33 57,692 19,038 1.75 33,317
.25 57,692 14,423 1.55 22,356
.20 57,692 11,538 1.46 16,846
Total 72,519
Known misstatement from error 2 60,000
Basic Precision (3.0 x 57,692) 173,076
ULM 305,595
Since the ULM ($305,595) is less than the tolerable misstatement 2
($360,000), Van Pelt can accept the inventory account as being fairly
stated since there is only a 5 percent risk that the account contains a
misstatement greater than $360,000.
Understatement Errors
2
Error Book Audit Tainting
Number Value Value Factor
5 6,000 6,500 .083
6 750 800 .067
Factor Interval
Misstatemen
t
.083 57,692 4,788
.067 57,692 3,865
Adjustment to ULM 8,653
d. Discuss the possible courses of action the auditor can take when he or
she has concluded that the population is misstated by more than a
tolerable misstatement.
(7 marks)
10-46The computer can be used in the following way to aid the auditor in examining
accounts receivable in a highly computerized system:
• Testing extensions and footings: The computer can be used to perform simple
summations and other computations to test the correctness of extensions and
footings. The auditor may choose to perform tests on all records instead of just on
samples, since the speed and low cost per computation of the computer enable
this at only a small amount of extra time and expense.
• Selecting and printing confirmation requests: The computer can select and
print out confirmation requests on the basis of quantifiable selection criteria. The
program can be written to select the accounts according to any set of criteria
desired and using any sample plan.
• Summarizing data and performing analyses useful to the auditor : The auditor
frequently needs to have the client's data analyzed and/or summarized. Such
procedures as aging accounts receivable or listing all credit balances in accounts
receivable can be accomplished with a computer program.
The computer may be programmed to compare the customer's account balance with the
customer's history of purchases or to determine whether credit limits have been exceeded.
Revenue Cycle
Question 3
Syarikat Hanif Sdn Bhd processes its sales and cash receipts transactions in the manner
described below:
Sales:
Customers purchase products directly from sales clerks who prepare a three-part sales
invoice which are not pre-numbered. The top two (2) copies of the sales invoice are given to
the cashier. The third copy of the sales invoice is retained by the sales clerks. Where the
sale is for cash, the payment is also given to the cashier by the sales clerks.
When the sale is for credit, it is approved by the cashier by reference to the approved credit
list. Exceptions to the credit list are cleared by the cashier at his discretion.
After receiving payments and approving the credit sales, the cashier validates the second
copy of the invoice and gives it to the customer. At the end of each day, the cashier
summarizes the sales and cash receipts and forwards the cash (including cheques) and the
top copy of the sales invoices to the accounts receivable clerk. The accounts receivable
clerk balances the cash received with cash sales invoices and prepares a daily sales
summary. The credit sales invoices are posted to the accounts receivable ledger, and then
all invoices are forwarded to the inventory clerk for posting to the inventory control card.
After posting, the inventory clerk posts the daily sales summary to the cash receipts book
and the sales journal, and files the sales summaries by date.
The cash from cash sales is combined with cash received on account (see below), for daily
deposit to the bank.
Cash received on account is initially received by a mail clerk in the sales department. A
remittance advice either accompanies each receipt or the mail clerk prepares one. The
cheques and remittance advices are forwarded to the sales department supervisor who
reviews each cheque and then forwards all items to the accounting department supervisor.
The accounting department supervisor, who also functions as the credit manager reviews all
cheques for payment of past due balances and then forwards all items to the accounts
receivable clerk who arranges the remittance advices in alphabetical order. The remittance
advices are posted directly to the accounts receivable ledger cards. The cheques are
stamped and totalled. The total is posted to the cash receipts book. The remittance advices
are filed chronologically.
After receiving the cash from the previous day’s cash sales, the accounts receivable clerk
prepares the daily deposit slip in triplicate. The third copy of the deposit slip is filed by date
and the first and second copies accompany the bank deposit.
Required:
ii. Comment on the strengths and weaknesses of the existing internal control system
over cash receipts and sales.
(15 marks)
No segregation of duties.
Since accounts receivable clerks posts all details and
totals to the records, there is no independent
reconciliation function regarding sales. The situation is
better for cash receipts, but still not satisfactory as far
as details in accounts receivable ledger are concerned.
iii. List three (3) recommendations to management as to how you can improve the
weaknesses of the two internal control systems in (ii) above.
(7 marks)
Revenue Cycle
Total: 25 marks
Purchase Cycle
Question 1
(a) Internal control systems are designed, amongst other things, to prevent error and
misappropriation.
Required:
Describe the errors and misappropriations that may occur if purchases and capital
expenditure are not properly controlled. (5 marks)
(b) Cosmo is a high-quality, private motor manufacturing company. It has recently joined a
consortium for the purchase of parts. Cosmo’s purchases and capital expenditure systems
are not integrated.
Purchase orders
Purchase orders are generated automatically by the computerised inventory system when
inventory levels fall below a given level in the context of scheduled production. This system
does not work well because the system uses outdated purchasing and production patterns
and many manual adjustments are required. The orders are reviewed by the production
controller and her junior managers and changes are made informally by junior clerical staff
in the production controller.s department.
Some of the purchases are input into the buying consortium system which shows the
optimum supplier for any combination of cost, delivery time and specification. This system
has only been in operation for a few months. The system takes up a substantial amount of
disk space on the company.s computers and is suspected of causing problems in other
systems. It is difficult to use and so far, only two of the production controller.s junior
managers are able to use it. As a result, the parts ordered through the system are
sometimes of the incorrect specification or are delivered late. The remaining purchases are
ordered directly from manufacturers, as before, through a reasonably well-controlled buying
department.
Required:
Set out, in a form suitable for inclusion in a report to management, the weaknesses,
potential consequences and your recommendations relating to the purchases and capital
expenditure systems of Cosmo. (15 marks)
(20 marks)
Inventory Cycle
13-32The audit tests, including analytical procedures, that Dunne should apply are as
follows:
• Trace entries to perpetual inventory records from receiving reports and shipping
reports.
• Trace entries from perpetual inventory records to receiving reports and shipping
reports.
• Compare records of monthly physical counts with perpetual inventory records.
• Ascertain whether perpetual inventory records have been adjusted based upon
physical counts.
• Test the arithmetic accuracy of perpetual inventory records.
• Reconcile beginning inventory quantities with ending inventory quantities.
• Ascertain the consistency of the methods of determining cost and market value.
• Compare unit costs on inventory listings with paid vouchers (purchase orders and
vendor's invoices).
• Compare financial information with information for comparable prior periods
(e.g., inventory turnover, gross profit percentage, dollar and unit sales, and so
forth).
• Compare financial information with anticipated results based upon budgets,
forecasts, trends analysis, long-term agreements, commitments, and so forth.
• Study the relationships of elements of financial information that would be
expected to conform to a predictable pattern based upon the entity's experience
(e.g., by performing a comparison of statistical data from sales departments with
accounting records or relationships between changes in sales and changes in
accounts receivable balances).
• Compare the financial information with similar information regarding the industry
in which the entity operates (e.g., in government publications, trade association
data).
• Study the relationships of the financial information to relevant nonfinancial
information (e.g., by relating insurance coverage to inventory amounts, comparing
inventory quantities with the capacity of storage facilities, and so forth).
• Apply other appropriate audit procedures which may be deemed necessary in the
circumstances.
Question 2
Your firm is the external auditor of Chingford Potteries, and you recently attended the year-
end inventory count at the company.s warehouse. The company manufactures high quality
tableware (plates, cups and saucers etc.) and it maintains an integrated computerised
system that shows the inventory held at any given point in time. At the yearend inventory
count, the various categories of inventory (but not the quantities) are printed off the system
and the quantities of inventory actually counted are inserted manually by the counters, for
later comparison with the computerised quantity. This system has proved successful in
recent years but unfortunately, your notes show a number of weaknesses in the current
year-end inventory count.
The count instructions were received by both you and the counters the day before the count
was due to take place. Many areas in which the count took place were untidy and inventory
was sometimes difficult to find, because it was not in the allocated area. The same
categories of inventory were sometimes found in several different areas and some inventory
Inventory Cycle
was incorrectly labelled. The count was conducted in a hurry in order to close the
warehouse before a public holiday and there were insufficient counters to conduct the count
properly in the time available. The issue and receipt of inventory sheets (on which the
quantities were recorded by counters) was not properly controlled. It was difficult to
reconcile the inventory quantities recorded at the count to the computerised records and
some significant
differences remain outstanding.
Required:
(a) Explain why the inventory valuation and the year-end inventory count are important to
the audit of financial statements and describe the alternatives to a year-end count as a
basis for the year-end valuation. (4 marks)
(b) Draft for inclusion in a report to the management on Chingford Potteries:
(i) the weaknesses you found
(ii) the potential consequences
(iii) your recommendations for remedying the weaknesses in the current year count, and
your
recommendations for future years. (6 marks)
(c) describe the basis for valuing inventories as required by FRS 102 Inventories, and list the
types of inventories which may be worth less than cost at Chingford Potteries. (5 marks)
(d) Describe the work that you would perform to establish which inventories are worth less
than cost at Chingford Potteries. (5 marks)
(20 marks)
Answer
There is also a possibility that certain inventories may be incorrectly classified. This may
ultimately mean that inventory is materially misstated both in the financial statements, and
in the internal inventory records.
Recommendation
The accuracy of the inventory quantities and valuation in the current year may be
confirmed by means of analytical procedures which focus on unusual movements in
inventory quantities, or in gross margins, for example. The company should also consider
the possibility of recounting certain areas of inventory where significant errors or omissions
are suspected, and performing a .roll-back. to the year-end. In future years, it is important
to ensure that the count is better planned; that instructions are received on time, that
inventories are properly labelled, that they are in their proper places before the count starts
and that there are sufficient resources in terms of both time and manpower to conduct the
count
properly.
(ii) Weakness
The issue and receipt of inventory sheets was not properly controlled and there are
significant differences outstanding between the computerised records and the quantities
actually recorded.
Potential consequence
If inventory sheets are missing, it is possible that certain areas of inventory were not
counted at all, resulting in the under-valuation of inventories. The fact that there are
significant differences outstanding reinforce this view.
Recommendation
The inventory sheets that were issued should be reconciled to a schedule of inventory
sheets that should have been issued. If certain sheets have been duplicated or omitted, and
the amounts involved are potentially material, it will be necessary to re-perform a count in
those areas, as noted above. Analytical procedures should also be performed to confirm the
accuracy of quantities, as suggested above. In future years, it is essential that all inventory
sheets are properly recorded before they are issued (by means of pre-numbering, for
example), and are properly accounted for when they have been completed.
(ii) it will be useful to inspect sales, marketing and other reports, and to review the extent to
which inventories which are worth less than cost have been reduced to net realisable value
in prior years. Analytical procedures may be performed
to evaluate the appropriateness of the write-down in the current year.
(iii) an analysis of the computerised records should enable the identification of goods that
are old or slow-moving. The records may also show seconds and damaged goods. The
system may automatically produce such information for management purposes, or the
information may be specifically extracted at the year-end. Computer assisted audit
techniques may be used for these purposes.
(iv) what is old or slow-moving will be determined by the business; in this case it is high
quality pottery and as such inventories may be held for a considerable period of time before
they are considered to be slow-moving.
(v) at the inventory count, a note should have been made of any items that appeared to be
old, slow-moving or damaged and the count records should be inspected to see if they do
show such goods.
Property, Plant & Equipment
Answer
14-32A program for accumulated depreciation and depreciation expense accounts should
include the following:
• Review internal controls over the computation and determination of depreciation
charges.
• Review company manuals or other management directives that set forth
depreciation policies to determine whether the methods are carefully designed
and intended to allocate costs of plant, and equipment equitably over their useful
lives.
• Determine the propriety of estimated salvage values for fixed assets.
• Consider the propriety of useful lives for the client's assets.
• Inquire whether extra working shifts or other conditions of accelerated production
are present which might warrant adjustment of normal depreciation rates.
• Discuss with executives the possible need for recognition of extraordinary
obsolescence resulting from inventions, design changes, or economic
developments.
• Obtain or prepare a summary analysis of depreciation allowances for the major
property classifications as shown by the general ledger control accounts, listing
beginning balances, provisions for depreciation during the tear, retirements, and
ending balances.
• Compare beginning balances with the adjusted amounts in last year's working
papers.
• Determine that the totals of accumulated depreciation recorded in the plant and
equipment subsidiary records agree with the applicable general ledger control
accounts.
• Compare depreciation rates and methods used in the current year with those
employed in prior years and investigate any variances.
• Review computations of depreciation provisions for a representative number of
units and trace them to individual records in the property ledger.
• Compare credits to accumulated depreciation accounts for the year's depreciation
provisions with debit entries to unrelated depreciation expense accounts.
• Verify deductions from accumulated depreciation for assets retired by tracing
deductions to the working papers, analyzing retirements of assets during the year,
and testing the accuracy of accumulated depreciation to the date of retirement
• Examine intercompany, interdivision, and interplant transfers.
• Compare the percentage relationships between accumulated depreciation and
related property accounts with those prevailing in prior years and discuss
significant variations from the normal depreciation program with appropriate
members of management.
• Review appropriateness of proposed disclosure of depreciation methods, annual
expense, and accumulated provisions.
• Summarize conclusions as to whether all material elements of accumulated
depreciation and depreciation expense have met the financial statement
objectives.
Question 2
Property, Plant & Equipment
Your firm is the auditor of Springfield Nurseries, a company operating three large garden
centres which sell plants, shrubs and trees, garden furniture and gardening equipment
(such as lawnmowers and sprinklers) to the general public. You are involved in the audit of
the company’s non-current assets. The main categories of non-current assets are as follows:
(i) land and buildings (all of which are owned outright by the company, none of which are
leased)
(ii) computers (on which an integrated inventory control and sales system is operated)
(iii) a number of large and small motor vehicles, mostly used for the delivery of inventory to
customers
(iv) equipment for packaging and pricing products.
The company holds records of these assets on a computerised non-current asset register.
The depreciation rates used are as follows:
(i) buildings 5% each year on cost
(ii) computers and motor vehicles 20% each year on the reducing balance basis
(iii) equipment 15% each year on cost
You are concerned that these depreciation rates may be inappropriate.
Required:
(a) Explain the main risks associated with financial statement assertions relating to non-
current assets.
(3 marks)
(b) List the sources of evidence available to you in verifying the ownership and cost of:
(i) the land and buildings
(ii) the computers and motor vehicles. (9 marks)
(c) List the procedures you would perform to check the appropriateness of the depreciation
rates on each of the three categories of non-current asset. (5 marks)
(d) Describe the action you would take if you disagreed with any of the depreciation rates
used and explain the potential effect of the disagreement on your audit report. (3 marks)
(20 marks)
Answer
. ownership may also be evidenced indirectly by the payment of insurance premiums and
other costs associated with the ownership of land and buildings
. the cost of land and buildings may be shown in the purchase documentation, and also in
documentation relating to the taxes that are payable when land and buildings are
transferred
. payments should be traced through the cash records.
(ii) computers and motor vehicles
. both ownership and cost of computers and motor vehicles will be shown in the purchase
documentation and in the cash records
. motor vehicles also normally have associated documentation that show the tax payable
and the history of ownership
. it is common to mark both computers and vehicles with security codes designed to prevent
and detect theft, these codes may be invisible to the eye, but visible by using special lights;
the knowledge of and a proper record of these codes provide some evidence of ownership
. computers and motor vehicles may be held on leases, in which case the leasing
documentation should be inspected
. the physical existence and use by company of the computers, motor vehicles (and land
and buildings) also provide some evidence of ownership.
(iii) if there is a serious disagreement, it may be necessary to review other areas in which
management estimates form the basis of the accounting treatment.
Long-term liabilities, shareholders’ equity & Income Statement items
15-26a. The procedures that Maslovskaya should employ in examining the loans are as
follows:
• Obtain an understanding of the business purpose of the loans made by the president.
• Confirm the loans, including terms, by direct communication.
• Recompute (or verifying) interest expense and interest payable.
• Recompute the long-term and short-term portions of the debt.
• Review minutes of meetings of the board of directors for proper authorization.
• Verify payments made during the year and transactions after year-end.
• Read the financial statements, including footnotes and loan agreements, and evaluating
the adequacy of disclosure and compliance with restrictions.
• Consider any tax implications for the interest on the loan from the company’s president.
• Obtain a management representation letter.
15-27The substantive audit procedures that Lee should apply in examining the common
stock and treasury stock accounts of Wu, Inc., are as follows:
• Review the corporate charter to verify details of the common stock such as authorized
shares, par value, etc.
• Obtain or prepare an analysis of changes in common-stock and treasury-stock accounts.
• Compare opening balances with prior year's working papers.
• Foot the total shares outstanding in the stockholders' ledger and stock certificate book.
• Determine authorization for common-stock issuances and treasury-stock transactions by
inspecting the minutes of the board of directors' meetings.
• Verify capital-stock issuances by examining supporting documentation and tracing
entries into the records.
• Verify treasury-stock transactions by examining supporting documentation and tracing
entries into the records.
• Examine all certificates canceled during the year.
• Inspect all treasury-stock certificates owned by the client.
• Reconcile the details of the individual certificates in the stock certificate book with the
individual shareholders' accounts in the stockholders' ledger.
• Compare the totals in the stockholders' ledger and the stock certificate book to the
balance sheet presentation.
• Recompute the weighted average number of shares outstanding.
• Compare the financial statement presentation and disclosure with generally accepted
accounting principles.
Long-term liabilities, shareholders’ equity & Income Statement items
• Determine the existence of and proper accounting for common-stock and treasury-stock
transactions occurring since year-end.
• Obtain written representations concerning common and treasury stock in the client
representation letter
Long-term liabilities, shareholders’ equity & Income Statement items
Question 3
Moonlight Sdn Bhd, another client company having only ordinary share capital, issued new
shares during the year under audit. Large transfers of shares also took place during the
year. Interim and final dividends were also distributed during the year.
Develop substantive audit procedures to audit the share capital account, assuming that
control risk is high.
(11 marks)
Verify that the authorized share capital agrees with statutory documentation (MOA). Any 2
change must be made through authorized resolutions. File a copy of certificate from any
central registry (where appropriate) on the permanent file.
Verify that the issued share capital as stated in the accounts agrees with the total in the 2
share register.
For the issue during the year, check the minutes, the memorandum and articles and the 2
receipt of the proceeds.
Verify transfers of shares by reference to: 2
- correspondence
- completed and stamped transfer forms
- cancelled share certificates
- minutes of directors meetings.
If shares have been issued at a premium verify that the premiums have it has been credited 2
to share premium account.
Check the balances on shareholders’ accounts in the register of members and the total lists 2
with the amount of issued share capital in the nominal ledger.
Verify authority for dividend payments in the minutes and check calculation with total share 2
capital issued.
Check dividend payments with documentary evidence for example copies of dividend 2
warrant.
Verify taxation on dividends. 2
Reconcile movements on share capital and reserves to the supporting board resolutions. 2
Check the register of director’ holding. 2
Compare the financial statements presentation and disclosure with generally accepted 2
accounting principles.
Obtain written representations concerning share capital in the client representation letter. 2
Cash & Investments
16-34 a. 4, 9
b. 1, 7, 8, 9, 10
c. 2, 7, 8, 9, 10
d. 5
e. 5, 9
f. 3
Question 2
You work at an audit firm called AAB. AAB is the external auditor of Villawood Computers, a
private company. Accounting records are maintained on a computer using special software.
You have worked on the audit for three (3) years and this year you are the leader of the
audit team. Your assistant is a new accounting graduate with no practical experience.
Because of the small size of the company there is limited opportunity for segregation of
duties. You decide, as in previous years, that the appropriate audit strategy is to obtain
evidence through the performance of substantive procedures. You also plan to perform the
audit around the computer as the software is known to be reliable and details of all
transactions and balances can be readily printed out.
On arriving at the company’s premises in February 2005 to perform the final audit on the 31
December 2004 financial statements, you obtain a copy of the year end bank reconciliation
prepared by the bookkeeper and checked by the managing director. This is reproduced
below.
Villawood Computers
Bank Reconciliation as at 31 December 2004
RM RM
Balance per bank statement as at 31 18,375·91
December 2004
December 348·00
Bank charges December 90·00
Balance per books as at 31 December 2004 16,683·11
You have already obtained the bank confirmation and lists of cash (and cheque) receipts
and payments printed out from the computer. These lists have been added and the totals
agreed with ledger postings. You decide the first task to set for your assistant is the
verification of the bank reconciliation.
Required:
a. i. list the audit procedures to be followed by your assistant in verifying the bank
reconciliation. The procedures should be described in enough detail to be
followed by an inexperienced staff member.
(7 marks)
b. discuss the reliability of bank statements as audit evidence. What steps can be taken
to increase their reliability?
(3 marks)
ii. explain the circumstances when the auditor should not rely on auditing around
the computer.
(4 marks)
Total: 25 marks
Answer
Auditing through the computer is where the audit verifies the processing of
the transaction by the computer using computer assisted audit techniques 2
(CAATs).
(ii) Inappropriateness of auditing around the computer 1 mark x
Auditing around the computer is inappropriate where: 4=4
1. Auditing around the computer is impractical. (total)
– Source documents are not available in hard copy form
– It is not possible to follow the audit trail from input to output or vice versa
because there is no hard copy of the output
– the output summarises input data in such a way that reconciliation is
impractical such as where sales and cash receipts data are input into the
system but the output is in the form of unpaid invoices listed by customer.
– Control risk assessment is based on computerised application controls which
cannot be verified by comparison of input with output, such as credit approval
of sales orders evidenced electronically by the credit manager’s password.
Question 3
The scrutiny of the Investment Accounts of a client company reveals that the company
holds shares in Mega Bhd, a listed company, and two (2) private companies Garuda Sdn Bhd
and Daulat Sdn Bhd. Shares in Mega Bhd are actively traded on the Bursa Malaysia Stock
Exchange and are used as collateral for a bank loan. Shares in Garuda Sdn Bhd and Daulat
Sdn Bhd are free of any encumbrances.
Required:
Explain how you would verify the ownership, existence and valuation of investments in
Mega Bhd.
(6 marks)
Describe the audit procedures to be undertaken in auditing the investments in Garuda Sdn
Bhd and Daulat Sdn Bhd.
(8 marks)
Answer
Existence: Bank to confirm directly to the auditor that the bank is holding the 2
shares as collateral against the bank loan.
Ownership: Bank to confirm that the shares are registered under Jaya Bhd’s 2
name.
Valuation: As the shares in Mega Bhd are actively traded on the Kuala Lumpur 2
Stock Exchange its value on the balance sheet date can be determine by
examining any investment journal or local newspaper.
17-29a. The two types of subsequent events that require Namiki’s consideration and
evaluation are:
• Events that provide additional evidence concerning conditions that existed at
the balance sheet date and affect the estimates inherent in the process of
preparing financial statements. This type of subsequent event requires that the
financial statements be adjusted for any changes in estimates resulting from
the use of such additional evidence.
• Events that provide evidence concerning conditions that did not exist at the
balance sheet date but arose subsequent to that date. Such events result in
financial statement disclosure.
Question 2
You are in charge of the audit of Growfast Computers Bhd, a public-listed company, for the
financial year ending 31 December 2004. A review for subsequent events after the balance
sheet date is necessary prior to completion of the audit and signing of the audit report.
Required:
a. Explain the importance of a review for subsequent events after the balance sheet
date.
(4 marks)