Audit & Assurance- Professional Level and Stage December 2013

MARK PLAN AND EXAMINERS COMMENTARY

The marking plan set out below was that used to mark this question. Markers were encouraged to use
discretion and to award partial marks where a point was either not explained fully or made by implication.
More marks were available than could be awarded for each requirement. This allowed credit to be given for a
variety of valid points which were made by candidates.
General Comments
There was a small decline in the pass rate compared with recent sittings. However, it was pleasing to see a
large number of excellent high scoring scripts submitted from well-prepared candidates resulting in an
average mark comparable with recent sittings. The standard of answers to questions 8 and 9 and most of
question 7 was high but the standard of answers to question 7d and the short-form questions (SFQs) was
disappointing. In question 7d many candidates strayed beyond the requirement and wasted time providing
long answers that did not score any marks. In the SFQs many candidates failed to use information in the
open text and the majority of candidates failed to take advantage of the facility to present their answers in
note form. Overall candidates managed their time well and only a very few candidates displayed evidence
of time pressure at the end of the paper.

SFQ 1

Jane may continue as engagement partner

To maintain audit quality
ES3 permits when there are unexpected changes in the senior management of the audited entity
With safeguards
And no ongoing familiarity threat
Only for an additional 2 years/no longer than 7 years
Expanded review of audit work required
By the engagement quality control reviewer or an audit partner not involved in the audit
Facts and reasons to be disclosed to shareholders as early as practicable
If no disclosure to shareholders, should refuse the request

This question was well answered by those candidates who were aware of the provision, in paragraph 16 of
ES 3, which permits extension of the time for which an engagement partner may be a member of the
engagement team. Most of these candidates identified that there was a two-year time limit to the extension.
However, many failed to state that it was justified on the grounds of safeguarding the quality of the audit.
The points most commonly overlooked were those relating to the expanded review and the notification to
shareholders. A significant minority of candidates scored zero on this question as they incorrectly stated that
there was no option other than rotating the partner off the engagement team.
Total possible marks
Maximum full marks

5
3

SFQ 2
Threat
Self-interest threat
Financial incentive to sell services
Explanation
Audit manager may sell services not required by the client/make exaggerated claims regarding
benefits of services
Audit quality may suffer/errors may be overlooked/audit manager may be reluctant to raise
contentious issues with management

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Audit & Assurance- Professional Level and Stage December 2013

Is arrangement appropriate?
Not appropriate
No safeguards possible
ES4 requires audit firm to ensure that:
objectives of the members of the audit team do not include selling non-audit services
criteria for evaluating performance or promotion of the members of the audit team do not
include success in selling non-audit services
no specific element of remuneration of the members of the audit team is based on success in
selling non-audit services
This question was generally well answered as the majority of candidates identified the self-interest threat to
the manager's objectivity and that the proposal was inappropriate. A number of candidates strayed beyond
the requirement by listing the threats to the firm's objectivity in respect of the provision of non-audit
services and the safeguards to such threats. Many candidates listed a number of threats to objectivity
despite the requirement stating "the threat which implied only one threat was required. There were no
marks for these points.
Total possible marks
Maximum full marks

6
3

SFQ 3

Recruitment of appropriately qualified/experienced staff in Poland

Training of staff in Poland/staff exchange with UK office
Direction/supervision of local staff in Poland
Review of work by:
- Polish office
- UK office
Ensure instructions sent to Polish office were followed
Ethical and independence declarations in place

Although there were some good answers to this question, many were disappointing. Those candidates who
appreciated that the circumstances described in the question required the application of basic quality control
procedures, such as the use of competent and appropriately trained staff, coupled with direction,
supervision and review of their work, scored full marks. However, many failed to appreciate that the work
undertaken by the staff in Poland was of a junior nature and wasted time writing about engagement quality
control reviews, which was not appropriate given the nature of the tasks undertaken by the staff in Poland.
Total possible marks
Maximum full marks

6
3

SFQ 4

Request for confirmation that the component auditors will co-operate with the group audit team
- to ensure sufficient appropriate evidence is obtained
Timetable
- to allow component auditors to project manage their work/meet deadlines
Reporting requirements
- a specified format of response will promote consistency across all component
auditors/group auditor will get complete information
Detail of the work to be performed
to provide information that will allow the component auditors to decide whether to accept
the assignment/nothing overlooked
Ethical and independence requirements
to ensure that the group auditor can rely on the work/component auditors objective and act
with integrity

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Audit & Assurance- Professional Level and Stage December 2013

Materiality levels
to ensure items material to the group are audited
Significant risks that are relevant to the component auditors
to allow component auditors to focus work on high risk areas
A list of related parties
to allow collation of related parties for disclosure/representation purposes
Work to be performed on intra-group transactions, unrealised profits and intra-group account
balances
to ensure no duplication or omission of transactions
Instructions on subsequent events audit work
- to ensure that the component auditors extend subsequent events review beyond the normal
period if there is a delay between completion of the overseas audit work and the signing of
the group audit report.

Answers to this question were generally disappointing. Those candidates familiar with paragraph 40 and
Appendix 5 of ISA 600, were able to list relevant items to be included in the group auditor's email to
component auditors and, in the main, pr ovide plausible reasons for their inclusion. However, some
candidates struggled to provide plausible reasons and wasted time listing more than the three items
required.
Total possible marks
Maximum full marks

10
3

SFQ 5

Timely
- to allow management to take appropriate action promptly
In writing with clear language
- to avoid future misunderstanding/provide evidence
Communicated to those with authority to act
to ensure that there is authority to take corrective action
Include description of deficiency/consequences/recommendations
to ensure there is sufficient information to understand and correct the deficiency
Content appropriate for the audited entity
points included are of sufficient importance
to ensure recommendations are cost-effective
Include management comments/indicate if point accepted by management
to aid the understanding of those charged with governance
Include a disclaimer
purpose of the audit to express an opinion on the financial statements
no opinion expressed on effectiveness of internal control
matters reported are only those identified and of sufficient importance
restricted distribution to reduce likelihood that third parties seek to rely on the report

Answers to this question were generally disappointing. Those candidates who made use of the information
in paragraphs 10 and 11 of ISA 265 attained good marks. However, many candidates only identified the
attributes and failed to provide plausible explanations of the attributes. A significant number of candidates
failed to provide attributes other than the deficiency, consequences and recommendations to remedy the
deficiency. The points most commonly overlooked were those relating to the disclaimer, despite these
points being available in the open text.
Total possible marks
Maximum full marks

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SFQ 6

Review correspondence/consult with Banjo lawyers

About the expected outcome
Ascertain if covered by insurance
Review magazines for articles that triggered the claim
Review correspondence from Triangle or their lawyers about basis of claim
Review any similar legal cases for indication of potential outcome
Inspect minutes/discuss with management
Banjos intentions regarding accounting treatment
if damages probable ensure a provision is recognised
if damages possible ensure disclosed as a contingent liability
Obtain written representation
Regarding managements intention to fight claim or settle out of court
Examine cash flow forecasts
To ascertain if Banjo can afford to pay any damages

Answers to this question were mixed but a significant number of candidates did score full marks. Most
candidates appreciated the need to contact the lawyers regarding the expected outcome and consider
management's proposed accounting treatment. A significant number of candidates strayed beyond the
requirement and wasted time discussing the implications for the audit report and audit opinion for different
outcomes and/or inappropriate accounting treatment instead of listing the "audit procedures" to be
undertaken.
Total possible marks
Maximum full marks

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Audit & Assurance- Professional Level and Stage December 2013

Question 7
Total Marks: 37
General comments
Although the average mark in respect of this question was good, it was due to good performances on
parts (a), (b) and (c). Answers to part (d) were generally disappointing.

Question 7a
(i)
Identify the matters to be included in your firms engagement letter for the examination of the cash
flow forecasts in respect of:

(ii)

managements responsibilities;
the purpose and scope of your firms work; and
limiting your firms liability.

Explain why these matters should be included.

(i) Managements responsibilities

The engagement letter should state that management:
- is responsible for the preparation of the cash flow forecast and for the identification and disclosure
of the assumptions on which the forecast is based
- will provide the reporting accountant with all relevant information used in developing these
assumptions and written representations, specifically on:
- the intended use of the forecasts
- the completeness of significant assumptions; and
- managements acknowledgement of its responsibility for the forecasts.
Purpose and scope of your firms work
The engagement letter should state:
- that the reporting accountant will examine the cash flow forecasts for the three years ending 31
December 2016
- that the examination will consider the reasonableness of assumptions and whether the forecast is
properly prepared on the basis of those assumptions.
- whether the engagement is to be conducted in accordance with the provisions of ISAE 3400
- limited assurance will be provided by the reporting accountant expressed in a negative form
(nothing has come to our attention) as to whether the assumptions provide a reasonable basis
for the prospective financial information.
Limiting your firms liability
The engagement letter should identify the intended users, that is the management and the bank for the
purpose of obtaining funding and that the report should not be shown to any other party without
permission. A liability cap should be agreed (that is the maximum monetary amount of damages payable
by the reporting accountant). There should be a caveat explaining that there could be differences between
the forecast and actual performance due to unforeseen circumstances.
(ii) Explanation
The reasons why these matters should be included in the engagement letter are to reduce the risk of any
misunderstandings (bridge the expectation gap) and to make it clear that the examination of the cash flow
forecasts is limited in scope. By including the matters in respect of limiting liability, the firm limits the
amount of damages to which it is exposed and avoids liability to unforeseen third parties.
Generally, answers to this part of the question were good. The most common error was that many
candidates failed to demonstrate an appreciation that an engagement letter in respect of an examination
of cash flow forecasts would differ from an engagement letter in respect of a statutory audit and
consequently they wasted time covering the matters to be included in an engagement letter for a statutory
audit.

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Audit & Assurance- Professional Level and Stage December 2013

Candidates who focussed on an engagement letter for the examination of cash flows generally earned
marks from each of the three sections required and the majority correctly identified that narrowing the
expectations gap was a primary reason for including those matters in the engagement letter. Other
reasons, such as making it clear that the assurance work was limited in scope and restricting the amount
of damages the firm may be exposed to, were more frequently overlooked. Many candidates lost marks for
failing to appreciate that the firm would probably owe a duty of care to the bank and incorrectly stated that
a restriction on the distribution of the firms report would limit the firms liability to the bank. A minority of
weaker candidates wasted time discussing other means of limiting a firms liability, such as limited liability
partnerships, which was outside the scope of the question.
Total possible marks
Maximum full marks

16

Question 7b
From the information provided in the scenario, identify the key receipts and payments that you would
expect to be included in the cash flow forecasts prepared by the directors of HSE. For each receipt and
payment, identify the specific matters you would consider when reviewing the reasonableness of the
assumptions underlying that receipt or payment.
Key receipts and matters to consider
Funds received from the bank
The amount should be consistent with the amount needed to execute the three-year strategic plan. A
contingent amount should be built in to cope with any delay in selling the warehouse.
Sale proceeds of the warehouse
This should be a prudent estimate, net of selling costs, and in line with the market value of similar
properties in the locality. Consideration needs to be given to the likelihood of and timescales involved in
obtaining planning permission.
Sales receipts
The pattern of sales should reflect the closure of old stores, the opening of new stores and the re-launch
of the website.
Key payments and matters to consider
Interest on bank loan and repayments of capital
Prudent assumptions should be made regarding interest rates, for example, in line with market rates or
with rates on existing loans and should reflect the timing of repayments of capital, for example, quarterly
after receipt of the loan.
Payments to suppliers
These payments should reflect the level of sales and the credit terms agreed with suppliers.
Payments for website upgrade, management information and financial reporting packages
These payments should include the salary of the IT director which should be in line with other directors
pay or market rates. Subcontractors costs should be based on the number of subcontractors required or
the planned length of time of the project. The management information and financial reporting packages
payments should be in line with any quotes.
Staff payments
These should be based on the number of open stores and the number of staff required per store.
Payments should reflect the timing of the store closure programme and the acquisition of the Victory
Videos stores. Prudent assumptions should be made regarding wage levels and future increases in wage
levels.
Taxes
Any corporation tax should be consistent with the profit or loss figure shown in the profit forecast. All taxes
(VAT, corporation tax and PAYE) should be paid on the due dates. Payroll taxes should be monthly in
arrears.

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Audit & Assurance- Professional Level and Stage December 2013

Redundancy payments
The timing of redundancy payments should reflect the timing of the closure of the stores. The amounts
should be based on the number of staff made redundant and reflect legal or contractual obligations.
Store payments
Lease payments for the unprofitable stores should reflect the proposed closure timetable and lease
payments for the twenty new stores should reflect the proposed date of the transfer of the leases. The size
of the lease payments and any dilapidations payments in respect of the stores to be closed should be as
stipulated in the lease agreement. The lease payments for the new stores should be in line with the lease
agreement or any agreement with the administrator of Victory Videos. Refurbishment costs should be in
line with any quotes and the size of each store.
New warehouse lease payments
These payments should reflect the six-month rent-free period and then quarterly in advance and the
amounts should be in line with the lease agreement.
Vehicle costs (capital and running)
These costs should reflect market prices and be in line with the level of business activity.
Professional fees (including assurance firm fees and internal audit fees)
Professional fees should be in line with market rates or quotes. Assurance fees should be in line with any
engagement letter or tender document.
Dividends
The size of the dividends should be in line with the dividend policy of HSE.
General
The assumptions should take account of inflation and key variables should be subjected to sensitivity
analysis.
Answers to this part of the question were good. As in previous sessions, candidates were better at
identifying the key receipts and payments that would be expected to be included in the cash flow
forecasts, but were weaker at identifying the specific matters to be considered when reviewing the
reasonableness of the assumptions underlying the receipt or payment. Weaker candidates tended to
correctly identify a key receipt or payment but then state that the firm should consider its
reasonableness, this explanation was insufficient to score any marks. Payments to suppliers and
professional fees were the most commonly overlooked cash flows. A minority of weaker candidates
continued to confuse cash flow forecasts with profit forecasts and incorrectly included items such as
depreciation. Some candidates also included discussion of HSEs cash reserves which, whilst relevant to
the cash flow forecast, did not constitute a key receipt or payment and therefore earned no marks for this
point.
Total possible marks
Maximum full marks

28
11

Question 7c
Identify and explain the principal threats to independence and objectivity which may arise from the
provision of the non-audit services listed (1) to (3) above and state how your firm should respond to each
threat.
Management Information and financial reporting packages
Self-review and management threats arise when external auditors advise on the acquisition of
management Information and financial reporting packages.
A self-review threat arises when the results of a non-audit service performed by the firm are reflected in
the amounts included or disclosed in the financial statements. The external auditors will need to reevaluate the functionality of the new packages and may be reluctant to identify any weaknesses and rely
too heavily on the internal controls within the packages during their audit work.

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Audit & Assurance- Professional Level and Stage December 2013

A management threat arises because the external auditors may be expected to select the new packages
thereby making decisions and becoming too closely aligned with the views of management.
Response
To mitigate the self-review threat the external auditors could use different personnel for each service
provided and ensure that teams are briefed in respect of risks to objectivity. There should be an
independent partner review of audit work to ensure that the accounting system is properly assessed.
To mitigate the management threat the external auditors must not make management decisions but can
provide recommendations justified by objective and transparent analyses.
The external auditors should establish that there is informed management and that management is
capable of making decisions.
Forensic expert
Both the investigation and court hearing represent a litigation support service and this presents selfreview, management and advocacy threats.
The self-review threat arises because the expert will review internal controls and systems, make
recommendations and provide estimates of inventory losses which will be reflected in the financial
statements. This work will be subsequently reviewed during the external audit.
The management threat arises because the audit firm will help to determine the estimate of inventory
losses. This involves judgment and the amount may be material to the financial statements.
The advocacy threat arises because the firm will support managements position in legal proceedings and
will be perceived as adopting a position too closely aligned to that of management.
Response
Litigation support services are prohibited by ES5 and must be declined. The work in respect of the
quantification of the loss must also be declined because it would involve judgment by the audit firm and
substantial losses imply that the amount could be material to the financial statements.
Remuneration package
A familiarity threat arises when the external audit firm advises on the remuneration package of a key
management position such as the IT director. The firm is less likely to be critical and insufficiently sceptical
of information provided by the IT director.
Response
The work should be refused. The only exception is if the firms role is limited to applying proven
methodologies and using data for which management takes responsibility and safeguards are available.
In all of the above scenarios the ethics partner should be consulted.
Generally, answers to this part of the question were good. Advice on the acquisition of the new
management information and financial reporting systems was the best answered part of the question. The
majority of candidates correctly identified the self-review and management threats that would arise and
also appreciated that, as the directors wished to purchase an off-the-shelf package, safeguards, such as
separate teams and independent partner review, would mitigate the threats. Some candidates lost easy
marks by explaining a threat but omitting to identify the threat. Candidates did less well when discussing
the provision of forensic specialist services and advising on the remuneration package for the new IT
director. Stronger candidates correctly identified the advocacy threat, as well as the self-review and
management threats, in respect of the provision of forensic specialist services. Weaker candidates
incorrectly concluded that it was acceptable for the firm to accept the engagement and went on to suggest
a range of inappropriate safeguards to mitigate the threats. In respect of advising on the remuneration
package of the IT director, many candidates failed to identify the familiarity threat with a number of weaker
candidates incorrectly identifying a self-review threat.
A large proportion of candidates incorrectly stated that the work could be accepted and cited a range of
inappropriate safeguards to mitigate the threat.
Total possible marks
Maximum full marks

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Question 7d
Assuming the board of directors accepts the audit committees recommendation:
(i)
Outline three procedures that might be performed by HSEs internal audit function during
visits to the stores.
(ii)
Outline the effect on your firms approach to the external audit of HSE for the year ending
31 December 2014, if your firm decides to rely on the work of HSEs internal audit function.
(i) Procedures
The internal auditors of HSE might test that controls are operating effectively and that company
procedures are being followed at branches. During branch visits the internal auditors might physically
verify and inspect tangible assets and review the security arrangements over those assets. Internal
auditors could attend inventory counts and check that the correct procedures are being followed. They
could perform cash counts and reconcile cash balances with till records. Employee verification checks
could also be undertaken.
(ii) Effect on audit approach
By relying on the work of the internal audit function, the external auditors could reduce the level of
substantive and controls testing in those areas covered by internal audit. For example, there may be no
need to visit those branches where the results of internal audit work were satisfactory. However, there
would still be a need for the external auditors to undertake some controls testing and substantive
procedures of their own. Reliance on their work may be limited in the first year due to the lack of
cumulative knowledge of the function. The external auditors could also make use of the systems
documentation prepared by internal audit to assist with the evaluation of internal controls and the design of
substantive procedures.
This was the least well answered part of this question. A significant number of candidates failed to read
the requirement carefully and incorrectly listed general procedures that might be performed by an internal
audit function instead of those procedures that would be performed during visits to stores and
consequently scored very few marks. Many candidates did appreciate that reliance on the work of the
internal audit function would reduce the amount of substantive testing and tests of controls which would be
required to be performed during the firms external audit. However, a significant number of candidates
wasted time considering the effectiveness, reliability and competence of the internal audit function when
the requirement was to outline the firms approach to the external audit based on the fact that the firm had
already decided to place reliance on HSEs internal audit function. The most commonly overlooked points
were that the firm would be able to make use of systems documentation prepared by internal audit, reduce
the number of branch visits and that reliance may be limited in the first year due to lack of cumulative
knowledge of internal audit.
Total possible marks
Maximum full marks

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Question 8
Total Marks: 23
General comments
The overall average mark in respect of this answer was good. The areas of work in progress and freehold
premises have sometimes previously proved a challenge to many candidates so it was pleasing to note
improvements in these areas.
Justify why the items listed (1) to (4) in the scenario have been identified as key areas of audit risk and, for
each item, describe the procedures that should be included in the audit plan in order to address those
risks.
Revenue
Justification)
Audit plan)
The significant increase in revenue of 7.8% is
Discuss reasons for the increase in revenue with
not in line with prior years. This increase,
management
coupled with the increase in gross margin
Evaluate and test the system for recording
from 36% to 40%, is inconsistent with poor
deferred income and its transfer to revenue
trading conditions.
Vouch entries in the revenue account to invoices
and confirmation of successful installation
A risk of overstatement arises because
Perform cut-off tests
revenue could be recognised early. The up For a sample of contracts in progress at year-end
front initial payments of 40% could be
trace initial payment invoice to entry in deferred
recognised as revenue instead of deferred
income account
income and revenue could be recognised
Inspect post year-end credit notes which may
prior to receiving confirmation of customer
relate to the year under review
satisfaction.
Inspect post year-end management accounts to
ascertain if revenue is abnormally low as this may
indicate inflation of pre year-end sales.
Work in progress (WIP)
Justification
WIP days have increased from 75.6 days to
89 days (WIP increased by 18.9%) and this
may indicate overstatement.
Costing records are integrated with the
purchases and payroll systems and systems
issues were identified in the prior year audit.
The WIP calculation is complicated and
involves estimates. The overhead allocation
may be incorrect and the management
accounts, on which it is based, may be
unreliable.
Suppliers invoice in euro and there may be
errors in translation.
Cost overruns on fixed-price contracts may
result in losses and if losses are not provided
for this may result in the net realisable value
of WIP being lower than cost.

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Audit plan
Evaluate and test the controls exercised over the job
costing system
Enquire if there were any systems issues during
the year and if previous years issues have been
remedied
For a sample of contracts underway at the year
end, vouch entries for labour to payroll and vouch
entries for components/materials to suppliers
invoices
For a sample of material costs, reperform
exchange rate translation and check the rate to a
reliable source
Obtain workings for overhead allocation and
ensure only attributable overheads are included
Assess consistency of valuation with previous
years
Reperform overhead calculation and verify that it
is based on the figures in the management
accounts
Evaluate and test controls over the production of
management accounts
Compare actual costs to budget to identify cost
overruns which may indicate potential losses
Compare contract price to estimated total costs
for contracts in progress at the year end to
ascertain whether provision for losses is required
Inspect ageing of WIP to identify any
unbilled/irrecoverable WIP.

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Trade receivables
Justification
Receivable days have increased from 26.5 to
47.1 days (receivables increased by 91.9%)
which is higher than the 30 days payment
terms indicating possible overstatement or
insufficient provision against doubtful debts.
There is a material amount overdue from
Durcoal representing 3.6% of revenue/27.7%
of receivables and recoverability is in doubt
because of a dispute. If the overdue amount
from Durcoal is excluded then receivable
days fall to 34 days.
The dispute with Durcoal may indicate
potential disputes with other customers if
installations are not being carried out
correctly.
Freehold premises
Justification
The freehold premises valuation involves
judgement by the valuer.
Revaluation adjustments may not be
accounted for or disclosed correctly in the
financial statements and depreciation may
not be calculated correctly.
The Newcastle site has not been revalued
(accounting standards require all properties
in the same class to be revalued).

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Audit plan
Obtain aged receivable analysis and review for
evidence of overdue balances
Inspect customer correspondence and board
minutes for evidence of disputes
Vouch entries in receivables ledger with
confirmation of installation
Examine bank statement to see if receivables are
paid after year end
Review credit notes issued after year end
Direct confirmation of balances with customers
Enquire if credit terms have changed
Inspect contract with Durcoal
Ascertain basis for provisions for Durcoal and
other balances.

Audit plan
Obtain a copy of the valuers report and consider
the reliability of the valuation after taking account
of:
- the basis of valuation
- independence/objectivity
- qualifications
- experience//expertise and
- reputation/credibility
of the valuer.
Compare to the value of other similar properties in
the locality
Consider the use of an auditors expert valuer
Reperform the calculation of the revaluation
adjustments and ensure correct accounting
treatment
Ensure depreciation is based on the revalued
amount and the buildings element only
Recalculate depreciation
Inspect the notes to financial statements to
ensure appropriate disclosures
Ensure all assets in this class are revalued (no
cherry picking).

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There were some strong answers to this question and a small number of candidates scored maximum
marks. Generally the answers to the justification of the key risks were stronger than the procedures to
address those risks.
There were two issues raised in previous examiners' commentaries that are still relevant to this exam
sitting. Firstly, a significant minority of candidates do not use any of the financial information provided to
identify potential misstatements thereby losing the Maximum full marks for applying basic analytical
procedures. Secondly, the audit procedures cited by some candidates to address audit risks were often
too vague or unrelated to the justification of the audit risk. For example, comments such as ensure correct
valuation of WIP or test reasonableness of the provision, without setting out how this could be achieved
through audit procedures do not score any marks.
Revenue
Most candidates were able to provide appropriate reasons to justify why revenue was an area of audit risk
and provided some relevant audit procedures. Audit procedures commonly overlooked were the system
testing of deferred income, tracing the initial payment invoice to an entry in the deferred income account
for contracts in progress at the year end and the inspection of post year-end credit notes. Only the betterprepared candidates identified a review of the post year-end management accounts to see if revenue was
lower. A number of candidates incorrectly cited foreign exchange translation errors as a justification for the
audit risk but this was not relevant as all customers were invoiced in Sterling.
Work in progress
This is an area that has challenged candidates in previous exams so it is pleasing to note that there were
some very good answers which scored high marks. The most commonly overlooked points were those
relating to cost overruns on fixed-price contracts and the associated audit procedures. Very few
candidates mentioned looking at the consistency of the valuation with the prior year or evaluating the
controls over the production of the management accounts.
Trade receivables
There were a number of strong answers to this part of the question. Candidates that used the financial
information provided and correctly identified that overstatement was a risk went on to identify a number of
relevant audit procedures and scored high marks. The points most commonly overlooked were those in
respect of the significant outstanding receivable balance with Durcoal. Very few candidates mentioned
looking for disputes with other customers in light of the installation problems on the Durcoal contract.
Freehold premises
This again is an area that has challenged candidates in previous exams so it is pleasing to note an
improvement in the standard of answers. The points most commonly overlooked were the procedures to
check the disclosure of revaluation adjustments in the financial statements and to check that depreciation
should be calculated only on the buildings element.

Total possible marks

Maximum full marks

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Question 9
Total Marks: 20
General comments
This was the highest scoring question on the paper with a number of excellent answers particularly to part
(b).
Question 9a
Draft points for inclusion in your firms report to the management of Toledo. For each internal control
deficiency identified, you should outline the possible consequence(s) of the deficiency and provide
recommendation(s) to remedy each deficiency.
References and contracts
Consequences
If references are not obtained, tenants may
not be credit worthy and may damage the
properties. Toledo would then incur bad
debts as rent will be unpaid and will face
extra costs to evict tenants and repair
properties resulting in an adverse impact on
profits and cash flow.
If there are no signed contracts, tenants will
not be aware of the terms of their lease
leading to misunderstandings and a greater
chance of disputes. Tenants may leave at
short notice leading to lower occupancy
rates. Disputes between Toledo and the
tenant will take longer to resolve as it will be
difficult to take legal action if there is no
signed contract.
Asset verification
Consequences
Assets may be overvalued because:
-assets recorded in the register may not exist
or have been stolen.
- assets may be impaired or no longer in use
- disposals may not be recorded.
Assets may be undervalued because:
-acquisitions may not be recorded
-assets may still in use but fully written down.
As a result, incorrect capital allowances may
be claimed and depreciation charges/useful
life may be inappropriate.
Bank reconciliation
Consequences
If bank reconciliations are not reviewed, there
is a risk that the reconciliation is not
undertaken in a timely manner. Furthermore,
un-reconciled differences and ongoing errors
may not be followed up increasing the risk of
fraud. Additionally there may be mis-reporting
of cash balances leading to Toledo
exceeding overdraft limits or failing to invest
surplus balances.

Copyright ICAEW 2013. All rights reserved

Recommendations
References must be obtained and/or credit
checks undertaken prior to occupying the property
One reference must be from prospective tenants
bank or prior landlord
Contracts must be signed by tenants prior to
being given the keys for each property
Copies of contracts to be kept on file
Pre-letting checklist introduced and reviewed and
signed off by a responsible official
Review of all current tenancies to identify tenants
with no contracts or no references and follow up.

Recommendations
Annual reconciliations to be performed by a
person independent of the custodian of the assets
Physical assets should be checked to the register
to ensure completeness of records
Entries in the register should be checked to the
physical asset to ensure existence.
Inspections should include consideration of
condition and appropriateness of useful life of the
assets
Differences to be reported to a responsible official
who should investigate and resolve the
differences.

Recommendations
A responsible official should review the
reconciliation on a timely basis
Reconciliations should be signed as evidence of
the review
All reconciling items and unexplained differences
should be investigated and resolved.

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Audit & Assurance- Professional Level and Stage December 2013

In all of the above scenarios the following recommendations apply:

communication of procedures and staff training
disciplinary action if procedures are not followed and
regular monitoring of procedures by senior management.
Most candidates were able to outline the possible consequences of the three internal control deficiencies
and provide a number of suitable recommendations and, as a result, the standard of answers to this
question was particularly high. Common omissions were, in Scenario (2) that incorrect capital allowances
may be claimed and, in Scenario (3) that compensating errors may not be picked up and the opportunity
to invest surplus balances may be missed. When discussing Scenario (1) some candidates strayed and
considered issues which were not relevant such as money laundering and consequently wasted time.
Total possible marks
Maximum full marks

26
10

Question 9b
For each of the situations outlined above, state whether or not you would modify the audit opinion. Give
reasons for your conclusions and describe the modifications, if any, to each audit report.
Herald
As a result of the fire, there are no records to substantiate the inventory held by Herald at the year end
and therefore the auditor is unable to obtain sufficient, appropriate evidence (limitation on scope). The
value of the inventory recorded by Herald is 3% of total assets and 18.2% of profit before tax. This is
material but not pervasive as it is confined to specific elements in the financial statements and any error in
inventory is unlikely to represent a substantial proportion of the financial statements.
The audit opinion should be modified with a qualified except for opinion and the opinion paragraph
headed up qualified opinion on financial statements. An explanation of the matter giving rise to the
qualification should be included in the basis for qualified opinion paragraph immediately above the
opinion paragraph.
Following the opinion paragraph, the auditor should also report by exception under the Companies Act
2006 that:
- adequate accounting records were not maintained; and
- all information required for the audit was not obtained.
Acclaim
The audit opinion would not be modified because there is no material misstatement (no disagreement) as
the partner is satisfied that appropriate disclosures have been made and there is no limitation on scope.
As this issue is fundamental to users' understanding of the financial statements, the audit report will be
modified with an emphasis of matter paragraph below the opinion section of the report. The paragraph will
draw the users' attention to the uncertainties disclosed in the notes to the financial statements. It should
include a specific statement that the opinion is not modified/qualified in respect of this matter.

This part of the question was very well answered with a significant number of candidates scoring
maximum marks.
Herald
Most candidates attained the Maximum full marks for identifying the inability to obtain sufficient
appropriate evidence (limitation on scope), calculating and commenting on materiality, identifying that the
matter was not pervasive and reaching a correct conclusion on whether or not the opinion should be
modified.

Copyright ICAEW 2013. All rights reserved

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Audit & Assurance- Professional Level and Stage December 2013

Some candidates incorrectly thought that several items in the financial statements would be affected and
therefore the material error would be pervasive and this led them to recommend incorrectly a disclaimer of
opinion. Other candidates were unsure whether the issue was pervasive and 'hedged their bets' by
explaining how they would approach the situation if it was considered both material and material and
pervasive. The most commonly overlooked points were in relation to the description of the modifications to
the audit report in terms of the headings for the opinion and basis of opinion paragraphs.
Acclaim
Most candidates appreciated that there was no material misstatement (disagreement) because the partner
was satisfied that appropriate disclosures had been made in the financial statements. They also
appreciated that because the going concern uncertainty is fundamental to users' understanding of the
financial statements, the audit report should be modified with an emphasis of matter paragraph but the
audit opinion should be unmodified.
Some candidates overlooked the information in the scenario indicating that the issue had been disclosed,
to the engagement partners satisfaction, in a note to the financial statements and wasted time discussing
the options if the issue had not been disclosed. There were no Maximum full marks for the discussion of
the options. A number of candidates confused the audit report with the audit opinion and incorrectly stated
that they would modify the audit opinion and leave the audit report unmodified.

Total possible marks

Maximum full marks

Copyright ICAEW 2013. All rights reserved

15
10

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