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Paper F8 (INT & UK)

Audit and Assurance

Revision Mock Examination

December 2010

Answer Guide

Health Warning!
How to pass Attempt the examination under exam conditions
BEFORE looking at these suggested answers.
Then constructively compare your answer,
identifying the points you made well and
identifying those not so well made.

How to fail Simply read or audit the answers congratulating
yourself that you would have answered the
questions as per the suggested answers.
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The Accountancy College Ltd, November 2010
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the prior written
permission of The Accountancy College Ltd. udyi nteracti ve. org 3
Question 1

Tutorial help and key points
This question is typical of the 30 mark case study you can expect to see in Q1 of
the F8 paper. 30 marks may seem rather daunting at first! Our best advice is
deal with each individual requirement as though it were a separate question and
this will help you to manage your time more effectively.
Part (a) asks you to identify FIVE weaknesses in a clients payroll system then
to say what the consequences of those weaknesses are and to suggest controls
to mitigate the weaknesses. You should be identifying the more obvious
weaknesses such as the lack of authorisation of timesheets, the fact that there
is little segregation of duties, no checking of the payroll and no authorisation
needed to make changes to the system
Parts (b) is more theoretical and asks you to think about why control systems
are never 100% perfect at preventing and detecting fraud. Remember that
controls are operated by humans, so there is always a chance that they will
make mistakes or worse, deliberately override the controls to commit fraud.
Part (c) may seem tricky at first. The way to approach this question is to
remember which types of analytical procedures the auditor can use:
This year to last year
Actual to budget
Client to industry
Auditor calc to client calc
Then apply these ideas to the payroll costs.
Part (d) is a popular type of question asking you how audit software can be
used to audit payroll costs. It helps to think about the type of substantive
procedures that would normally be carried out on payroll and then choose the
ones that can be done with the help of a computer, rather than manually.
Part (e) Those of you who have thoroughly revised the class notes should have
no problem listing the disadvantages and advantages of using audit software.
Marking scheme
(a) Each weakness 1 mark/max 5
Each consequence 1 mark/max 5
Each control 1 mark/max 5
(b) Each reason 1 mark/max 5
(c) Each procedure 1 mark/max 3
(d) Each procedure 1 mark/max 3
(e) Each advantage or disadvantage 1 mark/max 4
Total maximum marks = 30
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Weakness Consequence Recommended Control
Timesheets are not
reviewed or
authorised by a
supervisor or manager
before submission to
the payroll
Employees may be
claiming for hours that
they did not actually
work and as a result, the
companys cashflow will
be adversely affected

All timesheets should be
reviewed and signed by
the relevant site supervisor
and manager before
submission to payroll
The timesheets are
not numbered in a
Timesheets may go
missing en-route to
payroll leading to
employees not being
All timesheets for the week
should be sequentially
numbered and Lynn should
check the sequence for
missing numbers
Lynn does not
formally stamp or file
away the time sheets
once the hours have
been entered onto the
Lynn may accidentally
enter the details on a
timesheet twice so an
employee is paid for
extra hours
Each time sheet should be
stamped and filed away
once the details have been
entered onto the system.
An exception report should
be printed off the PC
detailing employees who
have worked over the
average number of hours
in the week and this
should be investigated
The MD signs the
payroll but does not
scrutinise it or carry
out spot checks
There may be obvious
errors in the payroll that
will not be picked up
The payroll list should be
scrtuinised by a manager
before sending to the MD
to check.
A spot check should be
carried out on some of the
calculations and a sample
of hours worked should be
agreed back to time sheets
The payroll details are
kept on a disc in
Lynns drawer
This is not a very safe
location and could lead
to the disc being stolen,
tampered with or
The disc should be kept in
a safe in a director s office udyi nteracti ve. org 5
Supervisors do not
need authorisation in
order to ask Lynn to
add new joiners onto
or take leavers off the
Lynn does not repeat
the details back to the

The supervisors could
give fictitious employee
details for Lynn to add
to the system or, Lynn
could add the fictitious
employees herself
Lynn may take the
details down incorrectly
leading to the wrong
people being paid/wrong
amounts being paid

Authorisation should be
obtained in writing from a
director before an
employee is added or
removed from the system

Before adding an
employee, Lynn must
check that there is a
contract/offer letter and a
form of ID for that
New joiner details/leaver
details must be provided to
Lynn on a written form
which is sent to the MD for
authorisation before a
change can be made to the
The MD should obtain a
monthly print off of
changes to standing data
and review it for
Overall there is a lack
of segregation of
duties in the payroll
If Lynn has control over
too many parts of the
process, she will be able
to keep fraud hidden
Duties should be shared
out between a number of

(b) Why an internal control system cannot give complete assurance
There is potential for human error/misunderstanding
Senior staff members may use their authority to override controls
People may collude to override controls
Internal controls may become inadequate overtime especially if the
business changes rapidly/significantly
Non-routine transactions will usually not have established internal

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(c) Analytical procedures employment costs
Recalculate total employer tax liability as total salaries x tax rate and
compare to the clients calculation to ensure it is reasonable
Divide total payroll costs by average number of employees and compare
to prior year
Compare current year payroll costs with budget to assess the overall
reasonableness of salary costs.

(d) Ways in which audit software can assist in the audit of payroll costs
Cast the payroll list to ensure that the totals agree with the amount in
the control account
Assist with analytical procedures such as recalculation of employee tax
figures and average wage per employee
Stratification of balances so that material balances can be identified and
items chosen for testing
Produce an exception report detailing any employee working more than
a specifies number of hours or earning more than a specified amount so
that this can be investigated

(e) Benefits and disadvantages of using audit software on the audit of
Fitta Ltd
Benefits Disadvantages
Once suitable audit software has
been designed for the client, it
can speed up the audit and
ultimately reduce costs
If the auditor uses live client
files to perform the tests on,
they can be sure that data has
not been tampered with

The development of suitable
audit software requires a
thorough understanding of the
clients system which will
enhance the auditors knowledge
of the client for future years
There can be significant set up
costs when developing audit
software for the first time

Use of audit software limits
audit tests to test on data in
electronic form for inventories,
a number of physical tests will
still need to be carried out such
as test counts
If the client provides copy files
the auditor needs to be sure
that they have not been
tampered with udyi nteracti ve. org 7
Question 2

Tutorial help and key points
The 10-mark knowledge Q on the F8 paper is often a good place to start. There
is very little application needed here you will either know the answer or not!
If you know the answer, use this opportunity to gain some quick, easy marks.
If not, do not spend ages trying to remember it! Leave yourself some time at
the end of the paper to come back and try and jot down as many points as
Marking scheme
(a) For each relevant point 1 mark/max 2
(b) Definition of detection risk 1 mark/max 1
Each factor 1 mark/max 3
(c) For each factor 1 mark/max 4
Total maximum marks = 10

(a) Engagement letter
Sets out the respective responsibilities of the directors and the auditors.
Minimises the possibilities of misunderstandings between the client and
Legally binding contract once signed that sets out the scope of the work
and creates a legal basis for payment.
(b) Detection risk
If detection risk is high, it means that there is a high risk that the auditors
procedures will fail to spot a material misstatement
Detection risk will be higher where:
Client is new.
Auditor chooses unrepresentative samples.
Auditor is inexperienced or untrained.
Client has placed pressure on auditor to meet a tight deadline.
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(c) Reliance on external experts
Is the expert independent?
Qualifications and experience.
The scope of their assignment.
Was their work adequately planning, supervised, reviewed and
Did they have the necessary resources?
Were their assumptions and methods reasonable? udyi nteracti ve. org 9
Question 3

Tutorial help and key points
Explaining ethical issues and safeguards is a very popular requirement at F8.
Part (a) asks you consider why the concept of independence is crucial to
external auditing. Pick up an easy mark by explaining the term independence
and then go on to explain why it is important that the external auditors are
independent, ie to protect the shareholders who are relying upon their opinion.
Part (b). In this part of the question, you need to explain the threats that arise
specifically from the provision of other services (here, internal audit and
consultancy services to the client). These will be the self-review threat (as we
may be giving advice on systems that we then come to audit at a later date),
the management threat and the self-interest threat (as the increased fee
income from the services may result in the auditor becoming too dependent on
the client).
Remember to explain the threats fully in order to gain the marks available
Part (c). If you have revised your class notes carefully you should easily be
able to explain the activities carried out by the internal audit department within
a company.
Marking scheme
(a) For each relevant point 1 mark/max 5
(b) For each threat explained 1 mark/max 6
For each safeguard 1 mark/max 6
(c) For each activity 1 mark/max 3
Total maximum marks = 20

(a) Independence
Auditors should be free from influence/be unbiased/have an objective state of
They should also be seen to be independent.
Users need financial statements that portray as closely as possible the true
financial position of the company. However, management may desire to show
the results of its stewardship in the most favourable light.
Auditors are therefore required to be independent to protect shareholders
If users do not perceive auditors to be independent there will be:
A lack of credibility in the financial information
A loss of confidence in the profession.

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(b) Threats to independence and how they many be resolved
The provision of internal audit services presents a self-review threat as
those carrying out the audit may:
Place too much reliance on the work of colleagues
Be reluctant to inform management of any shortcomings in their
colleagues work.
It also represents a management threat which may be unacceptably high.
By taking on the role of internal auditors, the external auditors may have to
take decisions or make judgements that are the responsibility of
Ensure that audit firm does not make management decisions regarding:
o the scope and nature of the internal audit services to be provided;
o the design of internal controls or the implementation of changes to
internal controls.
The audit should be reviewed by an independent partner not involved in
the audit engagement.
Acting for a long period of time poses familiarity, self interest and self-
review threats as the auditor may be too sympathetic to their client/too
trusting/have reduced professional scepticism.
As Stanley plc is a listed company the engagement partner should be
changed every five years.
Key audit partners and senior staff should be rotated regularly (every
seven years).
The provision of additional services (ongoing consultancy work) presents a
self-interest/fee dependency threat as fear of losing the fee may tempt
the auditor to ignore any problems found. There is also depending upon the
actual work, a self-review threat.
Such work should not be taken on if a reasonable and informed third party
would perceive that the work is incompatible with an independent audit.
Ensure that fees from Stanley plc are less than 10% of total fee income.
Use a separate team for the additional services.
Do not take on management role.
Ensure an independent partner review is carried out on the audit files. udyi nteracti ve. org 11
(c) Activities of internal auditors
Review of the economy and efficiency of operations.
Special investigations.
Review of compliance with laws and regulations.
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Question 4

Tutorial help and key points
Part (a) is a typical audit risk style question where you are asked to explain
the audit risks from the information in the scenario. It helps to think of two
i) What is the factor that concerns you?
ii) How can that lead to an error in the financial statements?
You must be very careful to explain the risk properly, ie focus on the errors
that could arise in the FS. No credit is given in these questions for explaining
the risks to the business they must be audit risks.
Part (b). Once you have identified the possible risks to the audit, you must
then say what the auditors will do to address them.
The answers to questions such as this lend themselves very nicely to a column
Marking scheme
(a) For each risk explained 1 mark/max 10
(b) For each procedure 1 mark/max 10
Total maximum marks = 20

Audit risks Audit work
Import/export trade may involve
foreign currencies
Misstated amounts in respect of
translation of purchases, payables,
receivables, revenue or inventory if
wrong FX rates are used.
Check appropriate exchange rates have
been used
Garden furniture is sold with a 10
year warranty
Warranty provision is judgemental
and/or difficult to calculate and may be
Re-perform calculation
Assess reliability of provision calculation
in the past
Compare post year end warranty costs
to the provision
Online ordering
May give rise to income recognition
problems/incomplete recording of data
Check cut off procedures udyi nteracti ve. org 13
Investment in the website
Inappropriate accounting treatment of
development costs
Review costs incurred on website to
ensure appropriate capitalisation
Lack of familiarity with payroll
processing due to previous
Failure to account for payroll costs and
liabilities in particular, tax liabilities
Evaluate and test controls over payroll
Perform detailed analytical procedures
on payroll costs
Confirm that tax liabilities are paid on
Cancellation of contract with service
Failure to disclose provision/contingent
liability for damages
Inspect correspondence with legal
Inspect terms of contract for potential
penalties to be paid on cancellation
Pending sale of business
Overstatement of assets and
understatement of liabilities to impress
new buyer (especially receivables and
Receivables circularisation
Review after date receipts from
Evaluate controls over inventory
Attend inventory count
Limited period to complete audit
Audit may be rushed so not enough
attention paid to risk areas or failure to
spot material misstatements
Limited time for identification of events
after the reporting period.
Independent partner review of files
Remind current owner of importance of
the audit and stand firm in face of
pressure to rush.
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Question 5

Tutorial help and key points
Question 5 on the paper often covers issues such as audit reports, going
concern or subsequent events.
Part (a). It will help to break down your answer as per the requirement.
Explain the term = define materiality and explain that items in
the FS can be material by size or by nature
Discuss its role in the audit = auditors only care about errors
that are material
Explain why it its a difficult area for the auditors =
remember that it is subjective and judgemental and will change
for every client.
Part (b) describes three separate audit clients, each with an issue with their FS.
You are then asked how the auditors will need to modify the audit report in each
case. For each scenario describe:
The type of problem (disagreement or insufficient audit evidence)
Its materiality
The resulting modification
Marking scheme
(a) For each relevant point 1 mark/max 8
(b) For each relevant point 1 mark/max 12
Total maximum marks = 20

(a) Materiality
A matter is material if its omission or misstatement would reasonably
influence the decisions of the users of the financial statements.
Materiality is determined either by the size of an item or its nature.
To determine whether or not something is material by its size, yardsticks are
used such as % of pretax profit or a % of revenue.
Items that are material by their nature include transactions such as directors
Role in the audit
Materiality influences:
The nature, timing and extent of the audit work.
Whether or not an error is corrected before the financial statements are
published. udyi nteracti ve. org 15
Whether the audit report is modified.
Why it is a difficult area for the auditor
The users of financial statements are diverse and so will all have a different
opinion as to what is material or not.
Materiality does not have a mathematical definition and requires the use of
professional judgement and should be determined by a responsible person.

(b) Audit report modifications
Vista plc
The repairs and maintenance costs should have been expensed and not
Since $8.5m exceeds pre-tax profits, if the error were to be adjusted the
profit would turn into a loss so the matter is clearly material, most
probably pervasive considering its significance.
Modify the audit opinion with an adverse opinion due to the material
The report would state that the financial statements do not give a true
and fair view with the reason and amount stated before the opinion
Rayton Ltd
There is a difference between cost and NRV of $60,000.
Cost = $240,000.
NRV = $320,000-$140,000 = $180,000.
At 2.5% of pre-tax profits it is unlikely to be considered material.
Audit opinion will not be modified.
All audit differences however should be noted on a schedule of
Viva Ltd
The payment to Mary Benton represents a related party transaction and
must be disclosed regardless of its size.
It is material by nature.
The audit opinion will be modified with an except for due to a material
The reason and amount involved would be stated in a paragraph before
the opinion paragraph.