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AUDITING AND ASSURANCE SERVICES QUESTION 1 A. i. Measures to help safeguard auditors independence include: 1. Professional code of ethics relating to integrity, objectivity consistency, etc. 2. Prohibition of acts and behaviour that impair independence, for example, avoid holding of financial interest and official position in clients company. 3. Educational, training and experience requirements for entry into the profession 4. Continuing education requirement 5. Monitoring and disciplinary processes 6. External and peer review and quality control standards and processes. (Any 3 for 3 marks) ii. Categories of threats to auditors independence when accepting audit engagement: 1. Self - interest threat Self-interest threats, which may occur as a result of the financial or other interests of a professional accountant or of an immediate or close family member; 2. Self- review threat Self-review threats, which may occur when a previous judgment needs to be reevaluated by the professional accountant responsible for that judgment; Familiarity threat Familiarity threats, which may occur when, because of a close relationship, a professional accountant becomes too sympathetic to the interests of others; Intimidation threat Intimidation threats, which may occur when a professional accountant may be deterred from acting objectively by threats, actual or perceived and; Advocacy threat Advocacy threats, which may occur when a professional accountant promotes a position or opinion to the point that subsequent objectivity may be compromised. (any 3 x 1 mark = 3 marks) Provision of internal audit services to audit clients may create self-review and selfinterest threats. Mr Tan must ensure that the safeguards suggested in the code of ethics are applied to reduce such threats to an acceptably low level. Under the MIA by-laws, provision of internal audit services to clients which are listed entities is prohibited. Gifts and actions of hospitability from clients may create self-interest or intimidation threat to objectivity. Unless the value of gift and hospitability is clearly insignificant, a professional accountant in public practice should not accept such gifts or hospitality. In this case, the audit team members should not accept the gifts. (4 marks) (Total: 10 marks)

3.

4.

5.

B.

i.

ii.

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QUESTION 2 A. i. The two forms of accounts receivable confirmation requests are the positive and the negative form. The positive form requests the debtor to respond whether or not the debtor is in agreement with the information on the confirmation request form. The use of the positive form is preferable when individual account balances are relatively large and when there is reason to believe that there may be a substantial number of accounts in dispute, or with inaccuracies or fraud. The negative form requests the debtor to respond only if the debtor disagrees with the information on the confirmation request. The negative form generally requires follow-up by the auditor in the form of practicable alternative procedures that are used to obtain necessary evidence. The negative form is useful when the internal control surrounding accounts receivable is considered to be effective and a large number of small balances is involved. (6 marks) ii. The confirmation procedures for the accounts receivable balance 1. Design stratified sampling by classifying the population of accounts receivable balances by size of the accounts, which include negative and zero balances. 2. For each stratum, select the sample based on certain technique such as random sampling or systematic sampling. 3. For the selected sample, prepare the confirmation letters containing details of the debtors and get the authorisation of the company personel. 4. Indicate the request for positive or negative reply from the debtors. 5. For each confirmation letter, prepare a prepaid envelope. 6. Mail the confirmation letters together with the prepaid envelopes to the debtors. 7. Carry out the follow up procedure: Compare each confirmation received with the recorded balance. For each discrepancy, prepare reconciliation of balance and make the necessary adjustments to the balance or do the follow up with the debtors if the discrepancy cannot be resolved. For the non-confirmation, send a follow-up confirmation letter. Determine on the response rate and decide on whether the response is sufficient to support the assertions of the item. 8. Draw the conclusion from the confirmation exercise on the account receivable balances. (Any 6 points for 6 marks) iii. The allowance for doubtful accounts is an accounting estimate made by management that involves both objective and subjective considerations. The auditors responsibility is to judge the reasonableness of the related allowance for doubtful debts. The audit procedures for the evaluation of the allowance for doubtful debts are: 1. Review the clients credit policy whether remained unchanged or changes made to reflect changes in economic conditions 2. Examine clients credit files and discussions with the credit manager 3. Examine the accounting policy and accounting treatment for non-current receivables. 4. Review, analyse, and interpret the aging schedule to determine whether the client's allowance for doubtful debts is adequate. Review subsequent errors of the customer A/C balance and vouched subsequent receipts

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5.

Review the results of the tests of aging analysis and compare the size and age of the unpaid balances to similar information from previous year (analytical review) (5 x 1 mark = 5 marks)

B.

Audit procedures that should be performed to verify investment in securities: 1. Check whether the previous years figures agreed to opening balances brought forward. 2. Compare and analyse the balances in the current years investment accounts with prior years balances (analytical review) 3. Test check on the additions and disposals of investments during the year. 4. Verify the investment income for each investment 5. Physical examination of documentary evidences such as investment certificates 6. Confirmation with the issuers of new investment certificates 7. Determine that any impairments in the value of investments have been properly recorded 8. Verify that transfer from the current to the non-current investment portfolio have been properly recorded 9. Verify that investments are properly described and classified in the financial statements. 10. Confirmation from central depository system (CDS). (any 8 x 1 mark = 8 marks) (Total = 25 marks)

QUESTION 3 i. Differences between a review and audit of financial statements: Audit of financial statements 1. The objective is to express an opinion whether the financial statements give a true and fair view. 2. Provides positive assurance on engagement. 3. Provides reasonable but not absolute assurance. 4. Auditors apply approved standards on auditing as performance criteria. 5. Perform auditing procedures such as confirmation, inquiry, physical examination, inspection, computation and observation. 6. Require an understanding of internal control. 7. Auditor issues an auditors report. (6 x 0.5 marks = 3 marks) Review of financial statements 1. The objective is to state whether anything has come to the auditors attention that causes him to believe that the financial statements do not present a true and fair view. 2. Provides negative assurance on engagement. 3. Provides limited assurance (lower than assurance provide by audit). 4. Auditors to comply with auditing standards applicable to review engagements. 5. Perform primarily procedures such as inquiry and analytical procedures. 6. Does not ordinarily involve on assessment of accounting and internal control. 7. Auditor provides a review report. (6 x 0.5 marks = 3 marks)

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ii.

General procedures for a review of financial statements would involve the following: 1. Obtain an understanding of the entitys business and the industry in which the entity operates. This would include knowledge of the entitys organisation, production, distribution, and operating locations. 2. Obtain an understanding of the accounting systems and the nature of the entitys assets, liabilities, revenues, and expenses. This would include inquiries about the entitys procedures for recording, classifying, and summarising accounting transactions; and the entitys accounting policies and practices. 3. Inquires of the entitys personnel responsible for financial reporting about all the material assertions in the financial statements, changes in accounting policies, and subsequent events. 4. Inquire about the actions taken at meetings of the board of directors, shareholders, and other relevant board committees. 5. Perform analytical procedures to identify relationships and individual items that appear to be unusual. 6. Read the financial statements to determine if they conform to the identified financial reporting framework. 7. When considered appropriate, obtain written representations from management responsible for the financial statements. (6 x 1 mark = 6 marks) In providing a negative assurance in a review engagement, the practitioner provides limited level of assurance and a negative form of expression of the conclusion. For example in an engagement to review financial statements, the practitioner states in his report that nothing has come to his attention that causes him to believe that the financial statements do not give a true and fair view and not in accordance with approved accounting standards. (3 marks) (Total: 15 marks)

iii.

QUESTION 4 i. Financial statement assertions are the representations of the directors, explicit or otherwise, that are embodied in the financial statements, as used by the auditor to consider the different types of potential misstatements that may occur. By approving the financial statements, directors are making representations about the information contained therein. (2 marks) The two (2) categories of financial statements assertions used by the auditor in identifying and assessing the risks of material misstatements are: 1. Assertions about classes of transactions and events for the period under review 2. Assertions about account balances at the period end 3. Assertions about presentation and disclosure (Any 2 categories for 1 mark) ii. Four (4) financial statements assertions, relating to account balance category, used by auditors in the audit of financial statements include: 1. Existence Assets, liabilities and equity interests exist

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2. Rights and obligations The entity holds or controls the rights to assets, and liabilities are obligations of the entity; 3. Completeness All assets, liabilities and equity interests that should have been recorded have been recorded. 4. Valuation and allocation Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded. (4 marks) iii. Three (3) risk assessment procedures to obtain an understanding of the entity and its environment, including its internal control. 1. Inquiry of management and others within the entity The auditor may make inquiries to management, those charged with governance, personnel from various departments and also other people such as legal counselors etc 2. Analytical procedures Use of analytical procedures will help the auditor to identify any unusual items. 3. Inspection and observation The auditor may observe the entities activities and operations. Inspection may include an examination of records and documents or tangible assets. (3 marks) (Total: 10 marks)

QUESTION 5A i. In the context of financial reporting, information is material if its omission or misstatements could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatements. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have for it to be useful. (2 marks) When planning the audit of financial statements, auditor makes judgements about levels of materiality. These judgements provide a basis for: Determining the nature, timing and extent of risk assessment procedures; Identifying and assessing the risks of material misstatement; and Determining the nature, timing and extent of further audit procedures. (3 marks) ii. Materiality and audit evidence are inversely related that is the smaller the level of materiality, the greater the amount of evidence needed. (2 marks)

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QUESTION 5B i. The matters to be considered prior to accepting the appointment as auditor include: Professionally qualified Must consider whether disqualified on legal or ethical grounds Competent to act Must ensure the availability of necessary staff with appropriate competencies to complete the audit Existing resources adequate Must consider availability of time, staff and technical expertise Independent of client company Must ensure the firm is independent of UPAY Sdn Bhd Communication with the present auditor Seek directors permission to communicate with the present auditor and ensure communication is granted by them Management integrity Consider the integrity of those managing the company particularly if the company is controlled by one or few dominant personalities. Reason for regular changes of auditors Must determine reasons why the company has been changing its auditors regularly. (Any 5 for 5 marks)

ii.

The purpose of an engagement letter is to confirm the auditors acceptance of the appointment and constitutes a contract between the auditor and the client. It also summarises the respective responsibilities of both directors and auditors and so minimise the possibility of any misunderstandings between the client and the auditors. (2 marks) Its main contents include: The objective of the audit of financial statements The managements responsibility for the financial statements The responsibilities of auditors and the scope of the audit The form of report to be issued The basis for the calculation of fees Applicable legislation Unrestricted access to whatever records, documentation or other information in connection with the audit Expectation of receiving management written confirmation of representations made in connection with the audit. (Any six for 3 marks)

iii.

Three (3) matters to be considered in the risk assessment of UPAY Sdn Bhd include: First year audit

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The audit is risky for the audit firm because it is the first year of an audit. This increases the detection risk for the auditor, as the firm has no previous experience of the company. Firms lack of experience Audit risk is compounded by the firms lack of experience in this area. It is important that those with experience are employed on this audit, at least in a review capacity. Nature of business (Online ordering and payment) This may increase the control risks as the order and payment system is reliant on the security and control procedures of UPAY Sdn Bhd. Nature of business (High Technology Product) The goods are subject to trends (volatile industry) and is a very competitive business where there is a need to cut prices to compete with other business. As a result inventory value could be overstated if some model cannot be sold or have to be sold at substantially discounted prices. (Any 3 x 3 marks) (Total: 20 marks)

QUESTION 6A i. Qualified opinion is given due to limitation on scope or material misstatements in the financial statement. The matters are considered material but not so pervasive as to give an adverse or disclaimer of opinion. Disclaimer of opinion is considered when sufficient appropriate audit evidence cannot be gathered to express an opinion. The effect of limitation on scope of the auditors work is material and pervasive. An adverse opinion is issued when sufficient appropriate audit evidence is obtained. However the financial statements contain misstatements (individually or in aggregate) which are material and pervasive. (6 marks) ii. An emphasis of matter paragraph is added to highlight a matter affecting the financial statements which is included in a note to the financial statements that more extensively discusses the matter. The inclusion of such section does not affect the auditors opinion. (2 marks) Circumstances in which an emphasis of matter is appropriate are: Additional disclosures with which the auditor concurs and which make the accounts true and fair for example in situation where the auditors find that there is threat to the going concern status of the entity and it has made adequate disclosures regarding the threats in the financial statements. An inherent uncertainty relating to the future outcome of exceptional litigation or regulatory action that is adequately disclosed The financial statements being reissued due to subsequent events. (Any 3 for 3 marks)

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QUESTION 6B i. Business failures are caused by management inefficiency where objectives of the entity cannot be met. Audit failures are failures by the auditor to comply with the generally accepted auditing standards in the performance of an audit. (2 marks) The elements to be proven by third parties to succeed in an action for negligence against the auditor are: The auditor owed a duty of care to the plaintiff There is a breach of duty of care to the plaintiff There is a causal relationship or connection between the auditors negligence and the plaintiff damage The plaintiff suffered financial loss or damage. (4 marks) Ways that can be taken by the individual firms to reduce such claims include: Instituting sound quality control and review procedures Carry adequate insurance coverage professional indemnity insurance Letter of engagement concerning the duties should be clear & precise, in writing and confirmed/approved Perform quality audits by Performing and documenting work diligently. Ensuring that members of the firm are independent Following sound client acceptance and retention procedures Being alert to risk factors that may result in lawsuits Limited Liability partnership (Any 3 for 3 marks) (Total: 20 marks)

ii.

iii.

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