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ACCA
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PL
ACCA
PAPER F8
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2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(i)
No responsibility for loss occasioned to any person acting or refraining from action as a result of any
material in this publication can be accepted by the author, editor or publisher.
This training material has been prepared and published by Becker Professional Development
International Limited:
16 Elmtree Road
Teddington
TW11 8ST
United Kingdom
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No part of this training material may be translated, reprinted or reproduced or utilised in any form either
in whole or in part or by any electronic, mechanical or other means, now known or hereafter invented,
including photocopying and recording, or in any information storage and retrieval system without
express written permission. Request for permission or further information should be addressed to the
Permissions Department, DeVry/Becker Educational Development Corp.
Acknowledgement
Past ACCA examination questions are the copyright of the Association of Chartered Certified
Accountants and have been reproduced by kind permission.
(ii)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Page
Answer
1
1
1001
1002
16
20
1003
20
EXTERNAL AUDIT
1
2
International auditing
ISA 200
Audit committee
AUDIT APPOINTMENT
7
8
DOCUMENTATION
9
Working papers
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AUDIT PLANNING
10
2
3
3
1007
1010
1012
20
20
20
PL
4
5
6
CORPORATE GOVERNANCE
Planning documentation
4
5
1014
1016
20
15
1019
20
1023
20
6
7
7
1025
1028
1032
20
20
20
1034
20
9
10
11
12
1037
1041
1043
1045
20
20
20
20
13
1047
15
Norbert
Audit risk
Hivex (ACCA J03)
TESTS OF CONTROL
15
16
17
18
Knits
Ibson
Eastwood engineering (ACCA J98)
SHW (ACCA J10)
AUDIT EVIDENCE
19
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(iii)
Page
Answer
13
14
1050
1053
20
20
15
15
1055
1057
15
20
ANALYTICAL PROCEDURES
20
21
Delta
Zak Co (ACCA J08)
22
23
Accounting estimates
Estimates
WRITTEN REPRESENTATIONS
24
16
1059
20
1061
1064
20
20
17
1066
20
18
19
19
1068
1071
1073
20
20
30
20
21
21
22
1078
1080
1082
1084
20
14
20
30
23
1087
20
24
1090
20
24
25
1092
1095
20
20
25
26
1097
1099
20
20
NON-CURRENT ASSETS
27
INVENTORY
Basis of valuation
Rocks Forever (ACCA J08)
Redburn (ACCA D09)
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28
29
30
16
17
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25
26
ACCOUNTING ESTIMATES
Cromwell
AUDIT FINALISATION
39
40
(iv)
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Page
Answer
27
27
28
1102
1104
1106
20
16
20
29
29
1108
1110
20
20
Audit scope
Theta
Hood Enterprises (ACCA J05)
44
45
INTERNAL AUDIT
46
30
47
1113
20
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GOING CONCERN
31
1115
20
31
32
34
1118
1120
1122
15
12
20
37
37
38
39
40
42
42
1123
1124
1126
1128
1133
1137
1139
10
10
20
30
30
20
20
Quick questions
Jasper, Ruby, Garnet & Emerald
Burton Housing
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52
53
54
55
56
57
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(v)
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(vi)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Define an audit.
(b)
(c)
(d)
(2 marks)
(4 marks)
(5 marks)
(16 marks)
PL
ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance
with International Standards on Auditing deals with, amongst other matters, the responsibility for
financial statements and the concept of reasonable assurance.
In general, ISA 200 considers that an audit in accordance with ISAs is designed to provide reasonable
assurance that the financial statements taken as a whole are free from material misstatement.
Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary for the
auditor to conclude that there are no material misstatements in the financial statements taken as a whole.
Reasonable assurance relates to the whole audit process.
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However, there are inherent limitations in an audit that affect the auditors ability to detect material
misstatements. In addition, the work undertaken by the auditor to form an opinion is, in many areas,
determined by the judgement of the auditor.
Required:
(a)
State the respective responsibilities for financial statements of the management of the
entity and of its external auditors.
(6 marks)
(b)
(c)
in gathering evidence;
in arriving at an opinion on the financial statements.
(6 marks)
(4 marks)
(4 marks)
(20 marks)
The objective of a system of corporate governance is to secure the effective, sound and efficient
operation of companies. This objective transcends any legislation or voluntary code. Good corporate
governance embraces not only making the company prosper but also doing business in a legal and
ethical manner.
A key element of corporate governance is the audit committee. In many countries the audit committee
is a committee of a single board of directors and is of a voluntary nature regulated by voluntary codes.
In other countries there are committees which are of a supervisory nature and these are regulated by
statute. For example in Germany all large public companies must have a supervisory board which
contains non-executive directors who elect the board.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Explain how an audit committee could improve the effectiveness of the external
auditors work.
(10 marks)
(b)
Discuss the problems of ensuring the independence of the members of the audit
committee where the membership is regulated by a voluntary code of practice. (5 marks)
(c)
Discuss the view that the role of the audit committee should not be left to voluntary
codes of practice but should be regulated by the law in all countries.
(5 marks)
(20 marks)
PL
Your firm is the external auditor of Eastfield Distributors, a listed company, which has sales of $25
million and a profit before tax of $17 million. The company operates from a head office at Eastfield
and has sales outlets and warehouses around the country. The directors have decided the company has
reached a size when it needs an internal audit department. As is becoming increasingly common, the
directors have asked your firm to provide this service to the company as well as being the statutory
auditor of the companys annual financial statements. In answering the question, you should consider:
(i)
the effects of the Association of Chartered Certified Accountants Code of Ethics and
Conduct in relation to providing an internal audit service to Eastfield Distributors;
(ii)
the extent to which your audit firm can rely on the internal audit work when carrying out the
statutory audit of Eastfield Distributors;
(iii)
the arrangements over control of the work and reporting of the internal audit staff:
the extent to which the internal audit staff should be responsible to Eastfield
Distributors, and who should control their work;
the extent to which the internal audit staff should be responsible to a manager or
partner of the external audit firm, and whether the same manager and partner should
be responsible for both the internal audit staff of Eastfield Distributors and the
external audit.
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Required:
(a)
Describe the matters you should consider and the action you will take to ensure your
firm remains independent as external auditor of the annual financial statements.
(8 marks)
(b)
(c)
Describe the advantages and disadvantages to your audit firm of providing an internal
audit service to Eastfield Distributors.
(5 marks)
(20 marks)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(b)
The management accountant of another listed company client had an accident and was away
from work for three months. At the time of the accident the audit senior was winding up the
prior years audit and, because of his familiarity with the companys management accounting
system, it was agreed that he would take over as management accountant for the three months.
(5 marks)
(c)
In its management letter to another audit client, Abel & Co warned the company that their
computer system lacked essential controls. The company decided to install a totally new
computer system and Abel & Cos management consultancy department was appointed to
design the new system.
(5 marks)
(d)
Abel & Co was recently approached by a large company that was not, then, an audit client,
for a second opinion. The company was in dispute with its existing auditors who were
proposing to issue a modified auditors report because of disagreement over inventory
valuation. Abel & Cos technical partner reviewed the evidence provided by the company
and advised the company that its accounting treatment was in order. Shortly afterwards Abel
& Co was invited to accept nomination as auditors. The reply to the letter of enquiry to the
existing auditors made it clear that the inventory valuation dispute was not as straightforward
as the company had made it out to be.
(5 marks)
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(a)
Required:
Discuss the possibility that Abel & Co had impaired their independence or otherwise acted
unprofessionally in each of the situations described.
(20 marks)
Question 6 PROFESSIONAL ETHICS
You work for a medium-sized firm of Chartered Certified Accountants with seven offices and 150
employees. Your firm has been asked to tender for the provision of statutory audit and other services to
Billington Travel, a private company providing discounted package holiday services in the
Mediterranean. The company is growing fast and would represent a substantial amount of fee income
for your firm. The finance director has explained to you that the company would like the successful
firm to provide a number of different services. These include the statutory audit and assistance with the
preparation of the financial statements. The company is also struggling with a new computer system
and the finance director considers that a systems review by your firm may be helpful. Your firm does
not have much experience in the travel sector.
Required:
(a)
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(4 marks)
(4 marks)
You are a student Chartered Certified Accountant and you are one of four assistant internal
auditors in a large manufacturing company. You report to the chief internal auditor. You
have been working on the review of the payables system and you have discovered what you
consider to be several serious deficiencies in the structure and operation of the system. You
have reported these matters in writing to the chief internal auditor but you are aware that none
of these matters have been covered in his final report on the system which is due to be
presented to management.
(b)
Required:
Question 7 VISWA
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(i)
(ii)
(6 marks)
(3 marks)
(20 marks)
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Viswa is a company that provides call centre services for a variety of organisations. It operates in a
medium sized city and your firm is the largest audit firm in the city. Viswa is owned and run by two
entrepreneurs with experience in this sector and has been in existence for five years. It is expanding
rapidly in terms of its client base, the number of staff it employs and its profits. It is now 15 June 2014
and you have been approached to perform the audit for the year ending 30 June 2014. Your firm has
not audited this company before. Viswa has had three different firms of auditors since its
incorporation.
Viswas directors have indicated to you informally that the reason they wish to change auditors is
because of a disagreement about certain disclosures in the financial statements in the previous year.
The directors consider that the disagreement is a trivial matter and have indicated that the company
accountant will be able to provide you with the details once the audit has commenced. Your firm has
explained that before accepting the appointment, there are various matters to be considered within the
firm and other procedures to be undertaken, some of which will require the co-operation of the
directors. Your firm has other clients that operate call centres. The directors have asked your firm to
commence the audit immediately because audited accounts are needed by the bank by 30 July 2014.
Your firm is very busy at this time of year.
Required:
(a)
Describe the practical and ethical matters to consider within your firm and procedures
that must be undertaken before accepting the appointment as auditor to Viswa.
(10 marks)
(b)
(c)
(5 marks)
(20 marks)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(ii)
the audit partner attends the monthly board meetings, mainly to explain the management
accounts to the other directors.
(i)
Required:
Describe the matters that you would consider in deciding whether or not to accept
appointment as auditor and provide the additional services requested.
(8 marks)
(b)
List the actions you would take before reaching a decision whether or not you should
undertake any assignments for Carling.
(5 marks)
(c)
Assuming that there are no professional reasons why the audit appointment should not
be accepted, reach a conclusion on whether on whether or not you should provide the
additional services requested.
(2 marks)
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(a)
(15 marks)
According to ISA 230 Audit Documentation, the auditor is required to document evidence that the
audit was planned and performed in accordance with ISAs and applicable legal and regulatory
requirements.
Required:
(a)
Describe the working papers which would be of particular assistance to you as a newly
appointed senior in charge of a recurring audit at the final audit stage (the previous
senior having left the firm after the interim audit):
(i)
(ii)
(b)
(12 marks)
Identify and explain the criteria which you would use to judge the quality of working
papers.
(8 marks)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(20 marks)
(b)
(c)
Viewco is a manufacturer of TVs and video recorders. It carries out a full physical inventory
count at its central warehouse every year on 31 December, its financial year end. Inventories
of finished goods are normally of the order of $3 million, with inventories of components and
work in progress normally approximately $1 million.
(6 marks)
Required:
PL
You are the audit senior responsible for the audit of Viewco for the year ending 31 December.
Together with a junior member of staff, you will be attending Viewcos physical inventory
count.
State, with reasons, what information the working papers relating to this attendance
should contain.
(8 marks)
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Question 11 NORBERT
(20 marks)
Norbert is a local company which designs and builds racing yachts. It has a small yard 400 kilometres
away which it purchased recently. Most of the yachts are built to customer specification. However, as
trade has been slack recently, the company is building some yachts without orders in the hope of
obtaining buyers when the market picks up. Most of the companys output is for export and it quotes
its prices in Euros1.
You have been asked to act as senior in charge of the audit. The company has a year end of
30 September. It is apparent from the previous years audit file that the company has always had weak
internal controls.
The company is currently amending its designs to take advantage of new technology and has invested a
considerable amount of time and money in this. Consequently it is heavily indebted to the bank. The
bank overdraft facility is to be reviewed in November and the bank manager has requested that the
latest audited accounts be available for that review.
The chief executive has asked you to complete the audit by 31 October as he wishes to ensure the
continuing availability of the overdraft facility before attending a major trade fair in late November.
Required:
(a)
Describe the matters that you should consider when planning the audit of Norbert.
(10 marks)
Explain why each matter must be taken into account and how it may be dealt with in the
audit plan.
(10 marks)
(20 marks)
inherent risk;
control risk; and
detection risk.
Required:
(a)
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(i)
(ii)
(iii)
(iv)
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(1)
(2)
(3)
The auditor should plan and perform the audit to reduce audit risk to an acceptably low level. Whilst
there are many audit risk models used by auditors, ISA 200 Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing has
categorised audit risk into:
(4 marks)
(b)
(c)
Describe the work you will carry out to quantify the control risk in a purchases system.
(5 marks)
In relation to detection risk:
(d)
(6 marks)
(i)
explain the effect on the detection risk of the inherent risk and control risk if
the auditor requires a particular level of audit risk;
(ii)
briefly describe the audit checks you will perform in verifying trade payables
and accruals, and how these tests are affected by the value of the detection risk.
(5 marks)
(20 marks)
Question 13 HIVEX
You have been presented with the following draft financial information about Hivex, a very successful
company that develops and licences specialist computer software and hardware. Its non-current assets
mainly consist of property, computer hardware and investments, and there have been additions to these
during the year. The company is experiencing increasing competition from rival companies, most of
which specialise in hardware or software, but not both. There is pressure to advertise and to cut prices.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Profit
Retained profits
Dividends paid
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Operating profit
Net interest receivable
Income tax expense
Gross profit
Distribution costs
Administrative expenses
Selling expenses
12,197
10,517
3,006
1,996
994
1,768
3,002
274
5,195
6,479
995
395
3,104
1,452
3,086
5,422
1,617
3,983
$1,469
$1,439
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043
080
104
078
020
007
020
034
015
013
002
048
Required:
(a)
Using the information above, comment briefly on the performance of the company for
the two years.
(8 marks)
(b)
Use your answer to part (a) to identify the areas that are subject to increased audit risk
and describe the further audit work you would perform in response to those risks.
(12 marks)
(20 marks)
Fraud and error present risks to an entity. Both internal and external auditors are required to deal with
risks to the entity. However, the responsibilities of internal and external auditors in relation to the risk
of fraud and error differ.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Explain how the internal audit function helps an entity deal with the risk of fraud and
error.
(7 marks)
(b)
Explain the responsibilities of external auditors in respect of the risk of fraud and error
in an audit of financial statements.
(7 marks)
(c)
Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes
commission on holidays sold to customers through its chain of high street shops. Staff are
partly paid on a commission basis.
Well-established tour operators run the holidays that Stone Holidays sells. The networked
reservations system through which holidays are booked and the computerised accounting
system are both well-established systems used by many independent travel agencies.
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Payments by customers, including deposits, are accepted in cash and by debit and credit card.
Stone Holidays is legally required to pay an amount of money (based on its total sales for the
year) into a central fund maintained to compensate customers if the agency should cease
operations.
Describe the nature of the risks to which Stone Holidays is subject arising from fraud
and error.
(6 marks)
Question 15 KNITS
(20 marks)
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Knits is a small company which manufactures and sells high quality knitwear. Its customers are mainly
fashion boutiques.
Knits has two directors, one of whom is non-executive. The other is involved in the day-to-day
administration of the company. There are forty other employees. Most of these work in the factory,
two work in the warehouse, four are sales representatives and two are accounts staff. The accounts staff
are Miss Jones, who is responsible for processing sales and accounts receivable, and Mrs Singh, who is
the purchases and wages clerk. Mrs Singh works part-time, five mornings a week.
Each of the sales representatives visit shops throughout a region; taking orders from customers which
are recorded on pre-numbered two-part order forms. Completed forms are passed to the accounts
department. Miss Jones files one copy of the order form in numerical sequence and passes the other to
the warehouse.
The completed order is despatched from the warehouse by carrier, accompanied by one copy of a
despatch note. The other copy is sent to Miss Jones, who prepares an invoice based on the information
it contains and on the companys price list. She sends one copy of the invoice to the customer, and a
second copy of the invoice is retained.
Each Friday, Miss Jones inputs the weeks invoices to the computerised sales ledger. She then files the
invoices alphabetically by customer name. Despatch notes are not retained because filing space is
limited.
Miss Jones opens the post daily and lists remittances received from customers. Every Friday, she
inputs the information listed to the sales ledger. Cheques received are banked daily by the executive
director.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(b)
Describe controls that a small firm such as Knits could feasibly adopt to overcome the
weaknesses you have identified.
(8 marks)
(a)
Question 16 IBSON
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Note: You are NOT required to consider the system for dealing with returns and credit notes.
(20 marks)
You work in the newly established internal audit department of Ibson which supplies frozen seafood to
supermarkets. The accountant has provided you with the following information about the purchases
system. Your enquiries about the system indicate that there are no relevant procedures other than those
described.
Requisition and ordering
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Salesmen raise 2-part purchase requisitions (PRs). The buying department raises three-part, prenumbered purchase orders (POs). These are authorised by the buyer. The first copy is sent to the
supplier, the second to stores and the third is filed in the buying department.
Receiving
On receipt of goods the quality and quantity is checked immediately and, if unacceptable, the whole
consignment is refused. If accepted, a two-part goods received note (GRN) is raised. If the goods
received match the PO, the top copy of the GRN is filed in numerical sequence with the PO attached.
The bottom copy is sent to the accounts department and filed pending receipt of invoice. In the event of
a part-consignment the GRN (both parts) is kept with the PO until the order has been fulfilled.
Recording
All invoices received for goods are matched against GRNs before recording details in the purchase day
book. The invoices, with GRNs attached, are kept in a pending payment file, until the month end, in
alphabetical order.
Payment
Every month end, a bought ledger clerk prepares a payment requisition (PR) for each supplier. The
invoices and GRNs are stapled to the PRs which are then authorised for payment by the buyer. A
payment listing including suppliers bank details is prepared by the clerk, checked by the buyer, and
given to the chief finance office for signature and delivery to Ibsons bank.
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2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
List the procedures which should be in operation in the purchases system to exercise
control over:
(i)
(ii)
(b)
(10 marks)
Comment on specific weaknesses which might exist in Ibsons purchases system and give
recommendations for improvement.
(10 marks)
(20 marks)
PL
Your firm is the external auditor of Eastwood Engineering, a listed company, which has annual sales of
$100 million. The head office site includes the manufacturing unit, the accounting functions and main
administration. There are a number of sales offices in different parts of the country. Eastwood
Engineering does not have an internal audit department.
At the interim audit you have been assigned to the audit of the wages system. This will involve
obtaining an understanding of the wages system; testing the controls and performing substantive
procedures in order to verify wages transactions.
The wages records are maintained on a computer and all the wages information is processed at the head
office. Some of the employees in the manufacturing unit are paid in cash and all other employees have
their wages paid directly into their bank account.
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Manufacturing employees are paid their wages a week in arrears. All other employees are paid at the
end of each week or month.
There is a personnel department which is independent of the wages department. The personnel
department maintain records of the employees, including their starting date, grade, current wage rate
and leaving date (if appropriate).
Previous years audits have revealed frauds by wages department staff which have been facilitated by
weaknesses in controls in the wages system. These frauds have included:
(i)
(ii)
(iii)
A check of current controls in the wages system has revealed that the company has failed to instigate
controls to prevent these types of fraud recurring. So, the audit programme requires extensive
substantive procedures to be carried out to ensure that recorded wages transactions have not been misstated by similar frauds taking place in the current year.
The existence of employees at the head office site can be verified by physical inspection. From a cost
effectiveness point of view, only a small sample of sales offices will be visited. The audit manager has
asked you to consider the audit procedures you would carry out to obtain sufficient appropriate
evidence of the existence of employees at sales offices not visited by the audit staff.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
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(b)
Describe the audit procedures you would carry out in connection with attending a payout of wages in cash to manufacturing employees.
(5 marks)
(c)
Describe the substantive checks of transactions you would carry out on the unclaimed
wages system.
(5 marks)
(d)
Describe the evidence you would obtain to verify the existence of employees whose wages
are paid directly into their bank account, including those at sales offices.
(5 marks)
Question 18 SHW
(20 marks)
(i)
(ii)
State ONE test of control and ONE substantive procedure in relation to sales
invoicing.
(2 marks)
(2 marks)
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(a)
PL
(a)
(b)
Shiny Happy Windows Co (SHW) is a window cleaning company. Customers windows are
cleaned monthly, the window cleaner then posts a stamped addressed envelope for payment
through the customers front door.
SHW has a large number of receivable balances and these customers pay by cheque or cash,
which is received in the stamped addressed envelopes in the post. The following procedures
are applied to the cash received cycle:
12
1.
A junior clerk from the accounts department opens the post and if any cheques or
cash have been sent, she records the receipts in the cash received log and then
places all the monies into the locked small cash box.
2.
The contents of the cash box are counted each day and every few days these sums
are banked by which ever member of the finance team is available.
3.
The cashier records the details of the cash received log into the cash receipts day
book and also updates the sales ledger.
4.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(3 marks)
(ii)
(3 marks)
(iii)
List tests of controls the auditor of SHW would perform to assess if the
controls are operating effectively.
(3 marks)
(c)
(i)
(20 marks)
PL
The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions on which to base the audit opinion.
Sufficiency is the measure of the quantity of audit evidence; appropriateness is the measure of the
quality of audit evidence and its relevance to a particular assertion and its reliability.
Required:
Discuss the extent to which each of the following sources of audit evidence is appropriate and
sufficient:
oral management representations in respect of the completeness of sales where the
majority of transactions are conducted on a cash basis;
(ii)
flowcharts of the accounting and control system prepared by a companys internal audit
department;
(iii)
(iv)
(v)
comparison of items of income and expenditure for the current period with
corresponding information for prior periods.
(15 marks)
SA
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(i)
Question 20 DELTA
Delta operates a chain of 30 shops throughout the country, dealing in car and van spare parts. It has
150 employees, of whom 30 work at its headquarters and central warehouse and the remainder at its
shops. At its year end, 31 May, inventory of spare parts totalled $2.2m, of which $1.4m were held at
the individual shops and the remainder at the warehouse. Inventory represented 75% of Deltas net
assets.
Deltas sales are almost entirely for cash or cheques. It has few trade receivables.
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13
(8 marks)
(8 marks)
(4 marks)
(i)
(ii)
(iii)
Question 21 ZAK CO
(a)
(ii)
(iii)
(2 marks)
(3 marks)
Zak Co sells garden sheds and furniture from 15 retail outlets. Sales are made to individuals,
with income being in the form of cash and debit cards. All items purchased are delivered to
the customer using Zaks own delivery vans; most sheds are too big for individuals to
transport in their own motor vehicles. The directors of Zak indicate that the company has had
a difficult year, but are pleased to present some acceptable results to the members.
SA
M
(b)
PL
Your answer should include the purpose of each procedure you identify and how it would be used
in the audit.
(20 marks)
The statements of profit or loss for the last two financial years are shown below:
Revenue
Cost of sales
Gross profit
Operating expenses
Administration
Selling and distribution
Interest payable
Investment income
Profit/(loss) before tax
2014
$000
7,482
(3,520)
3,962
2013
$000
6,364
(4,253)
2,111
(1,235)
(981)
(101)
145
1,790
(1,320)
(689)
(105)
(3)
253
(950)
14
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ISAs do not override local regulations governing the audit of financial statements in
a particular country. In the event that local regulations differ from or conflict with
ISAs, member bodies should comply with obligations of membership (e.g. to work
towards implementation of ISA or equivalent within that jurisdiction).
(a)
the preparation and presentation of financial statements which give a true and fair
view (or are presented fairly) in accordance with the financial reporting framework
and statutory requirements. This responsibility includes:
SA
M
PL
The auditors are responsible for forming an independent opinion (e.g. in true and fair terms
in accordance with an identified financial reporting framework) based on their audit and for
reporting that opinion to the addressees of the auditors report.
(b)
Tutorial note: It is vital to read requirements carefully. In an exam many candidates will
write about inherent risk when something else inherent is called for; in this case, limitations.
1002
The inability to examine each transaction and each item making up an account
balance within normal time and cost constraints. This results in the necessity to rely
on evidence from samples and the consequent risk of sample error.
Even given reasonable professional scepticism the inability of the auditor to detect
fraudulent misstatements carefully concealed by collusion or deliberate
misstatement by senior management.
The fact that audit evidence, mostly relating to past events, is rarely wholly
conclusive and the necessity for reliance on judgement as to the persuasiveness of
evidence.
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In gathering evidence
Assessing risk and determining the appropriate audit strategy to be adopted. This
includes assessing:
the nature and degree of risk of misstatement at both the financial statement
level and the level of the account balance or class of transactions;
the design of internal controls and the effectiveness of the control environment
in determining the nature and extent of possible misstatements.
Planning tests of controls and evaluating the results of tests as to whether they
confirm the preliminary assessment of control risk.
Given the assessed levels of inherent and control risk, planning substantive
procedures as to their nature, timing and extent.
(ii)
PL
(c)
In arriving at an opinion
SA
M
Over the last few years the value of audit committees has been recognised and these
committees have been established in many countries. Their development has varied
from country to country and has often been stimulated by corporate failure.
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1003
An audit committee can improve the effectiveness of the external auditors work by
increasing the assurance that the external auditors can derive from systems of
corporate governance and internal financial controls.
The committee will be involved in ensuring that the external auditor is independent
and will participate in the selection of the auditor by recommending certain firms
who have knowledge of their industry and reviewing the source and rationale for
selecting certain firms of auditors.
Additionally the terms and scope of the external audit and corporate governance
engagement will be discussed as will the management letter and its effect on the
current years audit.
The committee will encourage discussions with the external auditor as to how
internal controls might be improved, and the rationale as to the use of specialist
departments of the audit firm and specialist advisors.
A meeting of internal auditors, external auditors and the audit committee will
review the audit plan with a view to minimising duplication of work, the impact of
new auditing standards and providing value for money for the company. The
timing and nature of reports from the external auditors will be reviewed as to their
effectiveness and any contentious accounting issues discussed.
The opening up of communication channels between the external auditor and the
audit committee and two-way discussions enhances the quality of the audit and adds
value to the audit process.
The audit committee will further discuss with the internal and external auditor the
intended scope of their work with a view to satisfying itself that no unjustified
restrictions have been imposed by executive management.
Additionally the following duties of the audit committee may assist in the external
audit process.
SA
M
PL
1004
dealing with difficulties in the performance of the audit such as nonavailability of client personnel;
Audit committees are seen as valuable not only for overseeing the external reporting
process and external audit but as a means of ensuring responsible corporate
governance. They are an aid in ensuring the professional independence of auditors
and the efficiency and effectiveness of the audit and the system of corporate
governance.
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Where the audit committee is voluntary, the general absence of regulations in this
area (e.g. only guidelines are followed) means that independence is often hard to
achieve. For example, what if NEDs sit on committees of several companies, there
may well be conflicts of interest. What if executive directors from one company act
as NEDs for another and vice-versa? Again, can they be considered as
independent? Additionally the company pays the NEDs salaries and this fact
ensures that independence is difficult to achieve under a voluntary code.
The NEDs often sit not only on the audit committee but also on several other board
committees making strategic contributions to the running of the business. They
have to balance their role as audit committee member and the monitoring of
executive directors and management with their role as corporate strategist.
In this situation, they are acting in several capacities and because of the complexity
of the NEDs role it may be difficult to act independently when it comes to
exercising their corporate governance role.
The internal structure of the company and the perception of the role of the audit
committee by the main board will determine the ability of the NEDs to exercise
independent judgement.
SA
M
PL
(c)
Some members of the audit committee may have previous executive involvement
with the company and have participation in share option schemes which is
inconsistent with the exercise of independent judgement.
If the audit committee is not governed by statute or the rules of the stock exchange,
then several issues arise. One of the problems of allowing self-regulation in the area
of corporate governance and audit committees is that if prescriptive approaches are
advocated, they may not receive the support of key industry groups and in the
absence of major corporate failure or fraud, governments may be reluctant to
impose regulations on industry as it may be seen to be a further burden to
management.
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1005
Many smaller companies would not see the benefits of appointing an audit
committee and they may feel that statutory regulation is counterproductive, with the
costs outweighing any benefits. However it is important that some form of
monitoring report is made to shareholders even in the case of small publicly quoted
companies.
If audit committees are unregulated then there is little formal requirement for
adherence to professional values of competence, independence or effective
reporting to shareholders. The identity and experience of the audit committees
members becomes an important issue in these circumstances.
Accountancy bodies will find it difficult to set standards for NEDs on audit
committees where such persons are non-accountants and the problems of
independence of NEDs set out in part (b) above may dictate that some form of
statutory regulation may be required.
SA
M
PL
1006
Unlike Sarbanes-Oxley in the USA, the Corporate Governance Code of the London
Stock Exchange (LSE) does not prescribe by law the use of audit committees it is
a requirement under the regulations of the LSE on the basis of comply or
explain.
Thus, although the audit committee requirements are strictly voluntary, the public
disclosure requirement means that UK-listed companies do have fully operational
audit committees following the Code they do not wish to have to justify why they
do not have such committees. Once established they must follow the spirit, as well
as the letter, of the Code.
The impact of this is that UK companies have the flexibility of applying the Code to
their circumstances and then justifying any departures the comply or explain
principle rather than a prescriptive one size fits all approach.
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fees from the external audit, the internal audit and other recurring work
performed for Eastfield Distributors should not exceed 15% of the practice
income for more than two consecutive years;
the audit firm should not prepare the annual financial statements (except in
emergency situations);
internal audit services can only be provided by the external auditor if they do
not cover a significant part of the internal controls over financial reporting;
financial accounting systems that generate information that is significant to
the accounting records or financial statements or amounts or disclosures that
are material to the financial statements; and
the audit committee must decide if there are any independence issues that
prevent the external auditor from providing the internal audit service.
PL
(a)
With providing internal audit services, a self-review threat may arise where the
work carried out by the internal auditors will be relied upon and reviewed by the
external auditor. The fact that both the internal and external audit staff are provided
by the same firm makes the self-review threat.
This is thus a typical example of the use of the conceptual framework. There should
therefore be independence between the internal and external audit functions within
the audit firm. Different staff should carry out internal audit work from those who
undertake the statutory external audit. Ideally such staff should be from different
sections (e.g. internal audit services, external audit services) or even different
offices.
SA
M
The internal audit staff should be careful not to assume the role of management
when carrying out their work. This may create problems if the internal auditors are
asked to design the companys accounting systems in order to provide adequate
controls (which would be in breach of ACCAs Code of Conduct and Ethics, as the
company is listed).
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1007
For the internal auditors to be truly independent of the external auditors, they should
not report to partners in the audit firm. However this is impractical and unrealistic.
There will have to be a decision about which members of the audit staff should
perform this internal audit service. The staff should have a range of skills and range
from junior to qualified staff. It is important that internal audit staff are competent,
as otherwise this could adversely affect Eastfield Distributors opinion of the audit
firm. This will create the risk that Eastfield Distributors will want to change the
external auditor with the consequent risk to the external auditors independence
There will have to be an agreement about how much should be charged for the
internal audit service, and the services that will be provided. The charge will
probably be based on the number of hours worked by staff at Eastfield Distributors
and their level of experience.
An engagement letter should be agreed with Eastfield Distributors for the internal
audit work, which includes most of the matters listed above.
Whilst internal audit work is permitted with safeguards under the ACCA/IFAC
regulations, it is of interest to note that it would not be allowed under the SarbanesOxley Act of the USA. So if Eastfield Distributors was also listed in the USA, or
was a subsidiary of a holding company that was listed in the USA, acting as internal
auditors for Eastfield would be specifically barred.
SA
M
PL
(b)
The new internal auditors will be skilled in carrying out audit work, so the learning
time for the staff should be short compared with setting up an internal audit
department within the company.
The audit procedures and standard should be consistent with those of the external
audit. Thus, the external audit staff should be able to place reliance on the internal
auditors work in coming to understand, for example, the clients business risk
systems. This could reduce the cost of the external audit.
The audit firm may be able to provide staff with a wider range of skills than
Eastfield Distributors would be able to recruit as employees. For instance, the audit
firm may be able to provide specialists in computer auditing, where it would not be
economical to have a computer audit specialist as an employee.
Tutorial note: Another advantage, which is outside of the scope of the current F8 syllabus,
is the concept of extended assurance services. Basically the external auditor would carry out
extended testing of the financial systems, as required by the client, beyond that required for
audit purposes. This very often replaces internal audit testing of the systems and is overall
cost effective for the client.
1008
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Because of the ACCAs Code of Ethics and Conduct, the internal auditors will be
restricted in the work they do. For instance, as Eastfield Distributors is a listed
company, they will be prevented from working on a significant part of the internal
controls over financial reporting and financial accounting systems that generate
information that is significant to the accounting records or financial statements.
The internal audit staff will be skilled at performing work similar to the external
auditors, but they may have limited skills and experience of other work carried out
by internal auditors (e.g. advising on the purchase of a business).
Using the external audit firm to perform internal audit work on non-financial
controls and systems may be more expensive than the company employing its own
internal audit staff, as the external audit firm will want to cover its costs and make a
profit on the work.
There may be problems with the internal audit staff changing from time to time.
This will require the new staff to learn about Eastfield Distributors business. This
learning time is likely to be greater than if Eastfield Distributors employed its own
staff.
The requirement of the external audit firm to have to perform external audits (when
it is busy) may mean that Eastfield Distributors does not have sufficient internal
audit staff during periods when it wants them (e.g. at the end of the reporting period
for inventory counts and to help in preparation of the annual financial statements).
SA
M
PL
(c)
By having the internal auditors as part of the audit firms staff, the confidence of the
audit firm in their work will probably be greater than if the internal auditors were
employees of the client company. For audits of non-public interest clients, the
external auditor will probably be able to achieve a greater reduction in the external
audit work.
The service will provide additional income and profits to the audit firm. It may
provide a wider experience to the audit staff.
It may be possible to use the internal audit work to fill in periods when there is little
external audit work. For instance, in jurisdictions dominated by December 31 year
ends, there is little audit work from July to early September so more staff could be
employed in internal audit work during this period.
The firm must be careful that independence is not contravened. It may be difficult
to ensure that none of the staff employed on internal audit work are part of the
external audit team. It may be very difficult to ensure that professional
independence is complied with at all times, as the internal auditors may be required
to make executive decisions or be involved in the preparation of the annual financial
statements.
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1009
If a dispute arises with the client over the internal audit work this is likely to affect
the audit firms relationship with the client. This may have implications on the
external audit.
The self-review threat is always present in that external auditors may not test work
done by internal audit adequately due to assuming that it will be of good standard.
A major fraud of failure of internal control and related publicity will be particularly
serious when both functions are performed by the same firm. Despite all
precautions the firm is unlikely to be seen to be independent.
(a)
PL
While partners are not allowed to hold shares in client companies there is no specific
prohibition in the ACCAs Code of Ethics and Conduct (the Code) on the holding of shares
in audit clients by audit staff providing the staff members concerned are not personally
involved in the audit of such clients.
However, many audit firms have adopted a prohibition on the holding of shares in audit
clients by audit staff as an in-house rule. If so, the firm should not make exceptions to its own
rules.
The argument that independence is not impaired because the holding is insignificant is
incorrect. If the holding is of such a size as is likely to influence the behaviour of the audit
staff member, then it is material. If the staff member was allowed to retain the shares then he
or she should not have been included in the audit team.
SA
M
If the partner advised the staff member not to sell the shares until after the audit was
completed, this implies that that the firm has a general prohibition on audit staff holding
shares in audit clients. The audit partner is therefore encouraging the staff member to breach
the firms own rules.
In addition, the partner probably carried out insider dealing the use of privileged
information to secure a personal advantage (or advantage for others) in the trading of shares.
This is illegal in most jurisdictions.
(b)
1010
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(c)
This raises a controversial area in auditor independence. While the reporting of control
weaknesses discovered during the audit is a required procedure, advising on the development
of new systems to overcome those weaknesses is seen by some critics as a possible threat to
independence. There is both a general and a specific issue.
PL
The general issue is that audit firms generate revenues from clients for both audit and nonaudit work. However, contracts for non-audit work are given by management. In performing
the audit, the auditors may be reluctant to disagree with management for fear of losing nonaudit contracts.
The specific issue is that known as self-review. Since the firm designed the new internal
control system, there is a presumption, when evaluating control effectiveness at the next audit,
that there will be no weaknesses in the system.
SA
M
The Code does not prevent auditors from providing non-audit services within the overall fee
limit of 15%. However, it does stress that, in advising the client, the audit firm must not make
executive decisions. The implementation of advice is the responsibility of management over
which the auditor has no control. At the next audit the auditor must check that the system has
been properly put into operation and that it is being operated effectively.
In addition, where the client is a public interest client, the firm could not provide this service
if it related to a significant part of the internal controls over financial reporting.
(d)
Although Abel & Co are not threatening their own independence, their action is in breach of
professional rules on second opinions. By offering advice they are prejudicing the
independence of the auditors of the company they are advising. In extreme cases they may be
helping to apply an intimidation threat to the auditor. Giving advice without being aware of
all relevant issues may also breach other principles (competence, integrity, professionalism).
This practice is sometimes referred to as opinion shopping and is carried out by companies
in order to exert pressure on their existing auditors. This casts doubt about the integrity of
this clients management which has implications for the inherent risk assessment of such a
client.
When invited to provide such advice, professional rules require Abel & Co to communicate
directly with the companys auditors to ensure that their advice is based on all available facts
relevant to the judgement. Abel & Co are under an ethical responsibility to decline to be
nominated as auditors and to write to the company retracting the advice previously given in
the light of further information.
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1011
(b)
Independence
It is important for external auditors to be independent of their audit clients because
external auditors act on behalf of the owners of the business (normally the
shareholders) and report on the financial statements prepared by management for
the benefit of shareholders.
They also have a duty to act in the public interest. Whilst they do not report to any
group other than the owners of the business, users of the business should be able to
expect that auditors are objective in their work and would thus flag any financial
difficulties with the entity (e.g. going concern).
If external auditors are not independent of their clients, for example if they hold
shares in the companies that they audit, their ability to form an objective opinion on
the financial statements is impaired.
External auditors must also be seen to be independent because if they are not, the
shareholders of the business and other users of the financial statements will not have
confidence in the auditors reports.
The ACCAs Code of Ethics and Conduct (the Code) requires that auditors are
independent, and that they are seen to be independent. The Code covers a number
of areas in which the auditors independence may be, or be seen to be, impaired.
Billington Travel
Statutory audit
SA
M
(i)
PL
(a)
1012
The Code states that it is important that the firm is competent to undertake the audit;
it must have adequate resources in terms of staff with sufficient experience in this
sector. The fact that the services to be provided would constitute a substantial
amount of fee income indicates that the firm might not, at present, have those
resources.
The firm should consider whether staff are available at the right time of year and
whether the work fits in with the firms existing obligations.
The Code also states that the firm must be independent of its clients; in particular,
this means that it must not be considered to be dependent on the fee income from
one client (or group of clients).
As Billington Travel could be considered a public interest company, the fee income
(including income from additional services) should not exceed 15% of the gross
practice income for two consecutive years.
As the fee from the company would represent a substantial amount of fee income
and it is growing fast (implying fees are likely to grow) it is likely that the total
fees would well exceed 15% of the gross practice income. Unless the practice
would be able to reduce the % to below 15% (e.g. through growth of the practice)
within the two year period, the work should be declined.
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It is important to know why Billington Travel needs assistance in this area and it
would be preferable in the long run for the company to be able to prepare its own
financial statements.
Systems review: the external auditor is often well placed to provide assistance with
such reviews as the firm obtains a working knowledge of systems during the course
of the audit.
It is critical that this is just a review of the internal controls of the system and is not
involving any design or implementation function of the systems themselves.
If it is just a review, the requirements of the company may be covered through the
standard audit procedure of understanding the design and implementation of internal
control. If the client requires a separate assurance report on the system (covering
more than just the financial controls), then an appropriate safeguard would be that
the review team should not be the same as the audit team.
SA
M
PL
(ii)
(c)
(i)
Actions to be taken
Review any code of conduct implemented by the company that deals with the
approach to use in such situations. If there is a procedure to follow (e.g. approach
the audit committee or senior director operating a whistle blowing function).
If no code
It may be appropriate to discuss the matter, discreetly, with other staff members to
establish whether or not it is of concern to them. It would be preferable to discuss
the matter with persons who are known to be reliable.
If the concerns are shared, it will be appropriate to discuss the matter with the chief
internal auditor to try to establish why the matter has not been reported, as there
may be a good reason.
If the chief internal auditor is able to offer assurance either that it is not necessary to
report the matter, or that the matter will be reported, no further action will be
necessary. Notes of the discussion should be documented.
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1013
If still not satisfied and the matter appears sufficiently serious it may be appropriate
to voice concerns to a more senior member of management for self-protection.
On the assumption that the matter is one of internal concern to the company and
there is no question of illegality, the question of reporting the matters to third parties
outside the organisation does not arise.
(ii)
Doing nothing
The main danger of doing nothing is to risk facing accusations of not bringing
managements attention to the matter or of being actively involved in a cover-up.
(a)
PL
Answer 7 VISWA
SA
M
The firm needs to consider a variety of commercial issues and ethical matters (under ACCAs
Code of Ethics and Conduct).
Internal matters
it has the necessary staff with appropriate competencies to complete the audit (this
seems likely given that the firm has other clients in this sector);
the staff are available at what is a busy time of year for the firm (it may be possible
that all of the staff with the necessary competencies are otherwise occupied);
the firm is independent of Viswa. It is unlikely that there will be any issues
concerning shareholdings in the client (because it is owned and run by two
entrepreneurs), however, there may be staff or partners who are related to the client
or are otherwise connected with it; and
Other procedures
The firm should:
1014
seek the directors permission to communicate with the company accountant about
the nature of the disagreement and the directors should authorise the accountant to
co-operate with the firm;
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ask the client to write to the incumbent auditors notifying them of the change and
giving them permission to communicate with the firm (if Viswa refuses to give
permission to the incumbent auditors the appointment should not be accepted);
communicate with the incumbent auditors (preferably in writing) requesting all the
information which ought to be made available to enable the firm to decide whether
or not to accept the appointment (if there are no such matters, the incumbent
auditors should inform the firm of this);
seek appropriate transfer information (such as a copy of the last set of accounts and
a detailed trial balance reconciled to the accounts);
indicate a likely fee (or the basis on which fees are calculated) to Viswa, ensure that
this is acceptable and that the client is able to pay (by some form of credit check);
ensure that the incumbent auditor has properly resigned, been dismissed or has not
sought re-appointment in accordance with legal requirements.
PL
(b)
It is inappropriate to start the audit before the procedures referred to above have been
completed because:
without the staff with appropriate competencies the firm will be in breach of the
Code (and may be found negligent if things were to go wrong);
without communicating with the accountant and the incumbent auditor, it is quite
possible that disagreements over disclosures will arise, similar to those that have
arisen in the past;
SA
M
(c)
Engagement letter
The engagement letter is of benefit to both the client and auditor and helps prevent
misunderstandings. It confirms the auditors acceptance of appointment and constitutes a
contract between the auditor and the client. It summarises the respective responsibilities of
directors and auditors.
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1015
the responsibilities of auditors and the scope of the audit (their duty to conduct an
audit in accordance with auditing standards, to review accounting policies and
disclosures, to perform tests and to form an opinion on the financial statements);
applicable legislation.
(a)
Matters
Reason for dissatisfaction
PL
Answer 8 CARLING
The reason behind the change in appointment could indicate that it may not be appropriate to
accept the nomination. For example, if the present auditors have:
qualified the current years audit opinion (e.g. on-going concern grounds); or
declined to provide the additional services (e.g. on ethical grounds).
SA
M
Permission to communicate
If permission to communicate freely with the current auditor is not granted the nomination
should be declined.
Inherent risk
Reliance by the bank on the audited financial statements (as well as the unaudited
management accounts); and
Objectivity
1016
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Depending on the nature of Carlings business and the complexity of its cost and management
accounts, there may not be an employee or audit partner with the necessary expertise
available to provide the additional services.
Responsibilities
Package of services
PL
SA
M
The fees for the additional services could easily exceed the audit fee. It may not be possible
for Mr Thorburn to justify such costs, especially when the company is dependent on the
banks support. Also, the company may not be able to pay promptly for the audit and
additional services provided.
(b)
Actions
Write to the current auditor to enquire of any professional reason why the
nomination should not be accepted.
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1017
(c)
Review the bank overdraft facility and correspondence with the bank to assess the
degree of going concern risk.
Review employees suitability for the preparation of management accounts and their
availability.
Conclusions
Assuming that there are no professional reasons why the audit appointment should not be
accepted:
(ii)
it is unlikely that the audit partner could attend the board meetings as this would be
seen to detract from objectivity.
PL
(i)
Marking scheme
(a)
Marks
Matters
Generally mark each matter identified
+ up to 1 marks for description up to a maximum
risk
resources
expertise
services
fees
SA
M
Professional
Practical
(b)
(c)
1018
Actions
Generally 1 mark each matter (relevance should be
made apparent) up to a maximum
Conclusion
Generally 1 mark each conclusion on additional services
clearly derived from the preceding analysis
2
__
15
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The entitys strategy, objectives, business risks and approach to selecting and
applying accounting and financial reporting policies.
The latest available financial information which may be last years published
financial statements or this years draft financial statements as well as management
accounts and budgets for the year to date. This information will help to clarify the
current operating results and financial conditions of the client.
An organisation chart setting out the operating structure, geographical spread and
management reporting structure. This will give an idea of how the enterprise is run
and will help to identify the personnel most likely to be key audit contacts.
SA
M
PL
Industry data showing an analysis of the key financial and operating ratios typical of
this type of business and thereby permitting comparisons to be made. Such data can
be obtained from both government and industry sources or may be maintained
internally within the auditing firm.
Last years current audit file with particular reference to the problems arising during
the audit and how they were resolved in reaching the conclusion in the auditors
report (e.g. partner review notes, contentious issues, management letter, control
weaknesses letter, representation letter, revision of strategy and audit plans).
Press articles, reports, features concerning the client, and the industry that the client
operates in, would help to provide an awareness of any current developments
affecting the client.
Copy board minutes including sub-committees of the board (e.g. audit committee,
remuneration committee, risk committee) to determine any current plans,
developments or problems affecting the client.
The income tax file and relevant returns together with any correspondence with the
taxation authorities.
Copies of brochures and marketing literature will help to give an idea of the product
range and customer base for this client.
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1019
The correspondence file for details of all issues arising during the year which might
impact the audit.
The permanent file will also contain useful background information including
details of bankers, solicitors, related parties, major customers, suppliers, standards,
reporting and regulatory framework, extracts from statutory books.
Internal audit reports to establish the extent of the work performed by the
department and its findings.
Audit strategy and audit plan determined at the time of the interim audit visit.
Interim audit and year-end inventory observation files to update the audit strategy
and approach, the need to carry out further work covering the time between the
interim visit and the end of the reporting period, and the use of substantive testing
procedures.
Last years current audit file with particular reference to the final audit notes for any
matters which will have continuing relevance to the year-end audit.
Notes made last year which were to be carried forward as important for this year.
Minutes of the final audit planning meeting (assumption that interim and inventory
observation meetings already held) with the client and audit committee (if there is
one) which would cover, for example, the following issues:
PL
SA
M
(ii)
1020
The audit engagement letter to clarify the scope of our responsibilities and the form
of our auditors report.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(b)
Criteria
Tutorial note: Audit working papers must provide a documentary record of an audit
assignment and support the conclusions reached.
PL
Working papers must indicate the clients name, accounting period, a file reference, the areas
of the audit being covered and details of who performed the work and when. As an overall
requirement working papers should be neat, clear and concise with sufficient details to enable
someone, not involved in the audit, to understand what work has been performed.
In the interests of clarity, detailed explanatory information should be provided on supporting
schedules which should be suitably referenced and cross-referenced.
Record of information received, problems encountered and conclusions reached
Documenting details of all findings during the audit encourages the auditor to adopt a
methodical approach and ensures that problems are not overlooked. The working papers
should always summarise any significant matters or problems, and highlight any judgmental
aspects together with the auditors conclusions thereon.
SA
M
Where judgmental areas have been reviewed it is important to note all relevant information
received from the client together with managements views, so that these views can be
compared with the auditors views.
Evidence of review
All working papers prepared by each member of the audit team must be reviewed by a more
senior member. Such a review must be evidenced on the working paper, detailing who has
performed it and when. This review is important as it ensures that sufficient work has been
performed and that the findings and results support the audit conclusions.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
1021
In the event of the auditors opinion being challenged, the working papers will provide
evidence that the auditor followed the basic principles prescribed by International Standards
on Auditing, the appropriate application of Practice Statements (IAPS) and any national
auditing standards over and above those required by ISAs. They will also illustrate that the
auditor has been competent in applying proper standards of skill and care in arriving at the
audit opinion.
Marking scheme
Marks
1
PL
For each relevant audit working paper adequately described (i.e. content and purpose)
Familiarisation
legal structure/constitution
financial statements
organisation chart
industry information
prior year current audit file
permanent audit file
brochures
(ii)
Planning
SA
M
(i)
Part (a)
+1
1022
12
Part (b)
8
20
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Ascertaining the reporting objectives. This deals with the timing of the audit and
communications required, deadlines for interim and final reporting; key dates for
expected communications with management and those charged with governance.
Establishing the direction of the audit. This deals with, for example, determination
of appropriate materiality levels, preliminary identification of areas where there may
be higher risks of material misstatement, preliminary identification of material
components and account balances, evaluation of whether the auditor may plan to
obtain evidence regarding the effectiveness of internal control, identification of
recent, industry, financial reporting or other relevant developments impacting upon
the entity.
PL
SA
M
The process of establishing the audit strategy helps the auditor to ascertain the nature, timing
and extent of resources necessary to perform the engagement
The detailed approach for the nature, timing and extent of the audit procedures is set out in
the audit plan.
The plan is more specific and concerns the principal audit areas. For example, tangible
assets, inventory, revenue cycle (i.e. sales, receivables and cash receipts), subsequent events
and going concern.
The plan consists of an audit programme for each area. Each programme typically contains:
The audit programme has to be much more detailed than the overall strategy in order to serve
as a set of instructions.
(b)
Tutorial note: The Q refers only to the use of standardised AUDIT PROGRAMMES and not
working papers in general. Thus references to the use of standard letters and
documentation other than programs are not relevant to answering the question set.
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1023
Disadvantages
There is a risk that sufficient, relevant and reliable audit evidence may not be
obtained. For example, standard programs may not include tests on certain unusual
transactions or for specialised clients. Alternatively, some standard tests may be
marked as not applicable without considering a suitable alternative test.
SA
M
Conclusion
PL
(c)
1024
Pre-selected (e.g. high value) or randomly selected items chosen to ensure that an
adequate proportion or suitable sample of the final inventory value is tested (to
conclude satisfactorily on the population).
Test counts also enable the auditor to assess whether the clients count procedures
and controls are working properly.
The sequence of count sheets issued and used will detect any additional items being
included subsequently to attending the count.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Items owned by third parties must be recorded to ensure exclusion from the final
inventory valuation sheets.
Last goods movement document references for 31 December (i.e. goods received
note, stores requisition, despatch note/sales invoice) are needed to check the
accuracy of the year-end cut-off.
Movements, if any, during physical inventory counting to ensure items are not
omitted or double-counted in error.
Other points
A floor plan (sketch) of central warehouse should ensure complete coverage (by
management and auditor) of the physical inventory count.
Details (e.g. serial numbers) of finished goods held by third parties are required to
confirm the validity of their inclusion in the final inventory value.
The degree of assembly of incomplete TVs and VRs must be noted to assess
appropriateness of stage of completion used in valuing WIP.
Instances where the clients procedures have not been satisfactorily carried out (e.g.
damaged items not set aside) will be required for the report to management with
recommendations for improvements (e.g. in standing instructions for physical counts).
Answer 11 NORBERT
Matters
SA
M
(a)
PL
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(b)
Explanation/Planning point
1025
Matters
(b)
Explanation
SA
M
PL
1026
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Matters
(b)
Explanation
PL
SA
M
Marking scheme
Marks
1
1
branch visit
staff continuity, availability
nature of business, specialised
business/economic environment
control environment
accounting policies (R&D), trade fair
management bias
third party reliance
reporting deadline
availability/sufficiency of evidence
going concern, management projection
reliance by bank
exchange risk
inventory valuation
Part (a)
Part (b)
10
10
20
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1027
Audit risk
The risk that the auditor gives an inappropriate audit opinion when the financial
statements are materially misstated. It comprises two elements:
that the financial statements contain material errors before audit (may be
considered as inherent risk and control risk); and
(2)
that the auditor fails to detect those errors (detection risk, sometimes
referred to as residual risk).
(1)
Inherent risk
(iii)
Control risk
The risk that a misstatement that could occur (at the assertion level) and be material
(individually or in aggregate) will not be prevented (or detected and corrected on a
timely basis) by the internal control system.
PL
(ii)
SA
M
(a)
(b)
(iv)
Detection risk
The risk that the auditor will not detect a misstatement that exists (in an assertion)
that could be material.
In some business areas the inherent risk is small, because the value of the transactions and the
balance in the accounts are immaterial. For example, the petty cash transactions and balance
in many businesses.
Certain management and business factors do increase the audit risk, and this type of risk may
be classified as inherent risk.
Factors to be considered in determining inherent risk
1028
Companies that operate strong business risk processes and procedures may be
considered as having lower inherent risk.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
A company which has going concern problems (e.g. is making losses and/or has
liquidity problems) has a higher inherent risk than a company with good profits and
no liquidity problems. Pressure may be placed on management to improve results
and the entitys financial position or assets will be overstated and liabilities
understated if the entity is not a going concern.
Changes in accounting systems and procedures may increase inherent risk (e.g.
greater risk of operational errors whilst the systems are being embedded and
operators being trained; risk of error as data is transferred from the old system to the
new).
Past audit experience may indicate higher inherent risk (e.g. a history of errors
found in year-end inventory valuation, estimates of provisions and cut-off
procedures).
Some types of business are riskier than others. For example, high technology
industries have a greater inherent risk because the companys products may become
obsolete and research and development may not be effective at producing
replacement products.
Small businesses usually have a higher risk of failure than large ones as they have
less financial resources and possible concentration on a single market or product
increases risk.
Companies which rely on a single customer or a single product are higher risk.
SA
M
PL
(c)
Companies which operate in capital industries (e.g. building companies, steel and
manufacturers of industrial plant) have a higher risk because demand falls more in a
recession than with companies which produce or sell products that are essential for
current consumption (e.g. staple food, basic clothing).
There is a higher risk where the company is raising new capital, purchasing another
business through a share swap or is defending itself against a takeover bid.
Management may be biased in reporting results and financial position in order to
maintain a high share price.
Where the businesss income is cash based, the inherent risk is high. However most
of these businesses have strong controls to reduce the risk of misappropriation of
the cash.
The inherent risk will be lower where the company has an effective internal audit
department (this could be considered as an element of the control risk).
In order to understand the entity and its internal control, the auditor must ascertain, record and
evaluate the internal controls. For the purchase system, this will specifically mean those
operating and financial statement controls at the assertion level.
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1029
PL
The internal control questionnaire asks specific control questions such as is a purchase order
raised for all goods and services ordered by the company. A yes answer indicates the
control exists, and a no answer shows there is a weakness in the control or no control exists.
An alternative method, using key controls in an ICEQ, sets broader questions requiring the
auditor to identify which steps or combination of procedures provide management with
assurance that a control objective is achieved (e.g. How does the client ensure that a
purchase order is raised for all goods and services required?).
Walk-through checks
SA
M
Normally, a walk-through test (i.e. checking a small sample of items from the start to end of
the process) is used to check that the purchases system operates as recorded.
The flowchart will be corrected if the walk-through test shows the system operates in a
different manner from that originally recorded.
Alternatively, if the system is computerised, using CAATs would essential in order to walk
through the system.
Design and implementation of the control system
By considering the documented system notes and the answers to the ICQ or ICEQ the
effectiveness of the design of the system of internal control can be evaluated (on paper).
By carrying out a walk-through test the implementation of each control can be evaluated.
Both of these processes are essential requirements of ISA and must be carried out for every
entity that is audited.
Tests of control
The above procedures provide an understanding of the control system in theory. If it appears
to be providing the necessary control assurance the auditor may wish to rely on it to reduce
audit risk. Having so decided he needs to test if the controls have operated appropriately
through the reporting period.
1030
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If errors are found in the operating effectiveness of controls, the auditor will ascertain why
those errors have occurred. He may increase the sample of transactions in order to achieve
the required level of confidence (i.e. to within the tolerable error) if no further errors found.
Alternatively, there may be other controls which would prevent errors arising. Finally, he
may ascertain that the error was an explainable isolated incident (e.g. occurred on one day
only due to a particular reason) that had no material impact on the assertions, so there would
be little effect on the substantive audit work.
PL
If it is clear that he cannot rely on the operating effectiveness of the controls, the auditor will
reassess audit risk with an appropriate change to the nature, timing and extent of substantive
tests.
In all cases where the auditor finds weaknesses within the system, he reports these to
management.
(d)
Detection risk
(i)
SA
M
Essentially, the auditor wants to achieve a particular level of detection risk so that the audit
risk can be reduced to an acceptable level.
If the auditors risk assessment (i.e. inherent and control risk components) that financial
statements will contain material errors is low, the detection risk can be taken to be relatively
high. This implies that a higher level of audit assurance is being obtained from the operating
effectiveness of controls and a lower level from substantive testing.
Where no assurance can be placed upon the operating effectiveness of internal controls, the
level of assurance to be placed on substantive testing is higher. Hence, the extent of
substantive testing will need to be greater, or the nature or timing different.
In all cases, there must be some level of substantive testing (e.g. analytical procedures). The
operating effectiveness of controls can never be 100% because of the inherent limitation of
controls.
(ii)
If a low value of detection risk is required (i.e. little if any reliance on effectiveness of
controls), the auditor will have to perform detailed substantive tests in verifying trade
payables and accruals. With a higher value of detection risk, limited substantive tests will be
carried out.
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1031
In agreeing the financial statements with the books and records, control risk will be relatively
high when a manual accounting system is used, and relatively low when it is computerised.
So, with a computerised system less detailed checks (or 100% by using CAATs) will be
performed than with a manual system.
If the company has good controls over purchases cut-off, the auditor will check fewer
transactions than if controls are weak. In addition, if risk is low he may rely on requesting
supplier statement reconciliations from the client. If risk is higher confirmation of balances
through circularisation of suppliers directly would be carried out.
PL
If risk is high (in particular because the operating effectiveness of controls is weak) the
auditor would carry out substantive transaction tests on the purchases system as well as
analytical review.
The auditor must assess the risk of material misstatement in accruals through understanding
the business and the nature of the types and value of accruals expected to be needed.
If controls are strong over recognising and recording accruals, the auditor may only check
accruals for those items considered material and also carry out analytical review in comparing
levels and types of accruals with previous years and from expectations through the audit of
other areas. Any unexpected fluctuations would be investigated.
SA
M
If controls are weak, he would pay closer attention to the level of accruals, including the
possibility of overstatement as well as understatement of accruals, checking back to
supporting evidence.
Answer 13 HIVEX
(a)
1032
Performance
The company has increased its revenues by 12% and its gross profit by 16% which
in a competitive market is very good. However, increased operating expenses have
resulted in a reduction in operating profits of 20%.
The gross margin is very high; this is not abnormal in this sector, especially for
software (although the margin is high for hardware), but it may also be the result of
errors, because the information has been produced very quickly. This is also true of
the other figures.
The increase in the selling expenses as a percentage of revenue may reflect the need
for the company to spend more on advertising.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
The reduction in operating profits has been partially offset by increased net interest
receivable but profit before tax is still down 10%.
The reduction in profit before tax and the increased tax charge have resulted in a
reduction in profit after tax of over 40%.
The reduction in earnings per share is partly due to the reduction in profits but there
is insufficient information to state whether it is also attributable to an increase in the
number of shares, although this seems likely.
PL
(b)
Obtain a detailed schedule of revenue and cost of sales showing the opening and
closing inventory figures for both software and hardware and perform a detailed
review of changes on (say) a monthly, quarterly and half-yearly basis.
Ascertain the accounting policies for revenue recognition for both software and
hardware and ensure that they were in accordance with IAS 18 Revenue. The
application of these policies to individual transactions should be tested. IAS 38
Intangible Assets requires that certain development costs be capitalised in the
statement of financial position and that research costs and costs that do not meet the
criteria for capitalisation be expensed.
SA
M
Establish why all three categories of operating expenses have changed by enquiry
and by obtaining a schedule of operating expenses and a breakdown of the figures.
It is possible that some reclassifications or errors have been made. Enquire and
verify reasons for the significant fluctuations.
The extent of substantive procedures will depend on the extent to which controls are
shown to be effective and satisfactory results to analytical procedures obtained.
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1033
Perform further analytical procedures on the interest costs and income and ensure
that these are in line with current interest rates and the values and types of
investments and borrowing held by the company.
Taxation
Obtain copies of the tax calculations for detailed review, and to corroborate
explanations provided by management.
Establish whether there had been any share issue during the year that had affected
the calculation of the earnings per share and, if there had been, the purpose of the
share issue. Verify the transaction, including checking completeness of receipt of
proceeds and accuracy of processing the newly-issued shares.
PL
The internal audit function in any entity is part of the overall corporate governance
function of an entity. Corporate governance objectives include the management of
the risks to which the entity is subject that would prevent it achieving its overall
objectives such as profitability. Corporate governance objectives also include the
overarching need for the management of an entity to exercise a stewardship function
over the entitys assets.
SA
M
1034
A large part of the management of risks, and the proper exercise of stewardship,
involves the maintenance of proper controls over the business. Controls over the
business as a whole, and in relation to specific areas, include the effective operation
of an internal audit function.
Internal audit can help management manage risks in relation to fraud and error, and
exercise proper stewardship by:
(1)
(2)
(3)
(4)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
It should be recognised however that many significant frauds bypass normal internal
control systems and that in the case of management fraud in particular, much higher
level controls (those relating to the high level governance of the entity) need to be
reviewed by internal audit in order to establish the nature of the risks, and to
manage them effectively.
In practice, the work of internal audit often focuses on the adequacy and
effectiveness of internal control procedures for the prevention, detection and
reporting of fraud and error. Routine internal controls (such as the controls over
computer systems and the production of routine financial information) and nonroutine controls (such as controls over year-end adjustments to the financial
statements) are relevant.
External auditors are required by ISA 240 The Auditors Responsibility Relating to
Fraud in an Audit of Financial Statements to consider the risks of material
misstatements in the financial statements due to fraud. Their audit procedures will
then be based on a risk assessment.
Regardless of the risk assessment, auditors are required to be alert to the possibility
of fraud throughout the audit and maintain an attitude of professional scepticism,
notwithstanding the auditors past experience of the honesty and integrity of
management and those charged with governance.
Members of the engagement team must discuss the susceptibility of the entitys
financial statements to material misstatements due to fraud as part of their planning
procedures.
Auditors should:
PL
enquire of those charged with governance (e.g. the audit committee) about the
oversight process and their understanding of managements assessment and
controls;
evaluate the design of relevant internal controls, and determine whether they
have been implemented;
SA
M
(b)
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1035
In addition, whilst the quantitative element of the fraud may not be material, the
qualitative element may be (i.e. the fact that a fraud took place may be considered
material to the users of the financial statements).
Where auditors encounter suspicions or actual instances of fraud (or error), they
must consider the effect on the financial statements, which will usually involve
further investigations. They should also consider the need to report to management
and those charged with governance.
Where serious frauds (or errors) are encountered, auditors need also to consider the
effect on the going concern status of the entity, and the possible need to report
externally to third parties, either in the public interest, for national security reasons,
or for regulatory reasons. Many entities in the financial services sector are subject
to this type of regulatory reporting and many countries have legislation relating to
the reporting of money laundering activities, for example.
Auditors are only concerned with risks that might cause material error in the
financial statements. External auditors might therefore pay less attention than
internal auditors to small frauds (and errors) although they must always consider
whether evidence of single instances of fraud (or error) are indicative of more
systematic problems.
PL
(c)
Stone Holidays is subject to all of the risks of error arising from the use of computer
systems. If programmed controls do not operate properly, for example, the
information produced may be incomplete or incorrect. Inadequate controls also
give rise to the risk of fraud by those who understand the system and are able to
manipulate it in order to hide the misappropriation of assets such as receipts from
customers.
SA
M
1036
All networked systems are also subject to the risk of error because of the possibility
of the loss or corruption of data in transit. They are also subject to the risk of fraud
where the transmission of data is not securely encrypted.
All entities that employ staff who handle company assets (such as receipts from
customers) are subject to the risk that staff may make mistakes (error) or that they
may misappropriate those assets (fraud) and then seek to hide the error or fraud by
falsifying the records.
Stone Holidays is subject to problems arising from the risk of fraud perpetrated by
customers using stolen credit or debit cards or even cash. Whilst credit card
companies may be liable for such frauds, attempts to use stolen cards can cause
considerable inconvenience.
There is a risk of fraud perpetrated by senior management who might seek to lower
the amount of money payable to the central fund (and the companys tax liability)
by falsifying the companys sales figures, particularly if a large proportion of
holidays are paid for in cash.
There is a risk that staff may seek to maximise the commission they are paid by
entering false transactions into the computer system that are then reversed after the
commission has been paid.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
(a)
Potential weaknesses
(a)
Tutorial note: Although a weakness letter was not required a similar style is used combining part (a) with (b). This makes it easier to mark. Also note that
some controls are made feasible by the small number of transactions per week (e.g. the sales rep telephoning to check customer creditworthiness, and the
factory supervisor checking goods despatches).
Reason
(b)
PL
Sales ordering
Goods may be supplied to a bad credit risk
resulting in financial loss to the company. (This
risk is made more acute by the lack of credit
control procedures.)
SA
M
Credit control
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Controls
lost goods
invoice error or omission (see below)
lost payment
customers taking advantage of poor credit
control (see below).
The sales representatives should be given up-todate customer balance listing for their clients.
They should telephone Miss Jones to check on a
customer account balance if they suspect that the
credit limit may be exceeded by a new order being
placed.
1037
Potential weaknesses
(a)
Reason
(b)
Controls
Invoicing
There are no procedures to ensure the
completeness and accuracy of
invoices raised.
1038
SA
M
PL
Goods despatch
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Potential weaknesses
(a)
Reason
(b)
Controls
Recording
No hard copies of sales ledger
accounts are produced.
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SA
M
mail opening
sales ledger control a/c reconciliations.
PL
Remittances
cash receipts
sales ledger balances
sales ledger control a/c reconciliations.
1039
(a)
Reason
(b)
Other points
Goods despatch
Goods are despatched without any
specific authorisation.
Remittances
The mail opening is not supervised
and remittances are not checked.
Recording
1040
SA
M
PL
Controls
(a)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Marks
For each internal control weakness (max two weaknesses per system area) comprising
potential weakness
persuasive reason (possible effect)
feasible recommendation
Recommendations
sales ordering
credit control
goods despatch
invoicing
remittances
recording
error (e.g. omission)
loss of asset (e.g. inventory, accounts receivable, cash)
consequential loss (e.g. customer goodwill)
select from control environment + individual controls
but must be feasible to the business and circumstances of Knits
Effects ideas
PL
Areas of system
1
1
1
20
Tutorial note: Although not specifically called for, the control objectives give structure. A flow
diagram of a typical purchase system would have also aided the planning of an answer.
Purchase and receipt of goods
SA
M
(a)(i)
GRNs are matched with orders before the goods are accepted.
There are adequate procedures to deal with part delivery of orders.
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1041
PL
Tutorial note: Note the difference in style when compared to Question 16 (Knots). Here you are asked
for procedures in a general purchase system. Specific weaknesses from the scenario are not asked for
until part (b).
Weaknesses which might exist in the system
SA
M
(b)
Weakness
1042
Recommendation
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Recommendation
PL
SA
M
(a)
Select two payrolls, the first at the start of the companys financial year and the second a
recent payroll and note:
employees not on the first payroll who are on the second payroll. These are
starters;
employees on the first payroll who are not on the second. These are leavers.
For both starters and leavers, ascertain the date each employee started or left from the
personnel department.
For starters check to the relevant payrolls that they were not paid before they started
employment. For most employees, the first payment should be at the end of the week or
month they started work and not for the previous week or month: in the case of manufacturing
employees, payment is a week later.
For leavers check to the relevant payrolls that they were not paid after they ceased
employment. For a sample check that pay for the correct number of days in the week or
month of departure was made, including any holiday pay or overtime/bonus entitlement.
An alternative way of performing this test is to start from the personnel records of staff who
have started or left during the period and checking to payroll as above.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
1043
(c)
Wages pay-out
Attend a weekly pay packet preparation and ensure that it is secure. Select a small
sample of pay packets before they are sealed and confirm that all cash per payroll
totals is accounted for.
Before the wages are paid, take a copy of the payroll and check there is a pay packet
for each employee.
When the employee is given his wage, he should sign for it. The signature should
be test checked to the employees signature kept by the personnel department.
Mark the list as each employee collects his wage.
Observe to ensure that no employee receives more than one pay packet or one for
another employee. Note if this is happening.
At the end of the wages pay-out, check that there is a wage packet for each
employee who has not collected his wage. These will be the unmarked items on the
payroll list. These are unclaimed wages.
Check that these unclaimed wages are recorded in the unclaimed wages book. The
information recorded in the unclaimed wages book should include the payroll date
(and payment date, if different), the employees name and number, and the net
wage. Note any cases where unclaimed wages are not recorded in the unclaimed
wages book.
Unclaimed wages
Check the number of unclaimed wage packets is about the same each week. If they
are significantly less in other weeks, this indicates that some unclaimed wages are
not recorded in the unclaimed wages book.
SA
M
PL
(b)
Check that there is a wage packet for each unclaimed wage recorded in the
unclaimed wages book.
Where employees have collected their wages, check that they have either signed for
the wage or there is a letter from the employee authorising another person to collect
the wage packet (e.g. when the employee is ill). Check the employees signature to
the personnel records.
Enquire into any wages not claimed within a reasonable period (e.g. two weeks).
The company should pay into the bank wage packets which have been unclaimed
(say) for more than a month. The date the wages were banked should be recorded
against details of each wage packet in the unclaimed wages book. For a sample of
bankings of unclaimed wages, check that the amount banked (per the cash journal)
agrees with the total net wages of the employees as recorded in the unclaimed
wages book. Enquire what steps the company took to pay the employee.
Report any weaknesses found to the companys management. The unclaimed wage packets
should be kept in a secure place (e.g. a safe). Ideally, unclaimed wages should not be dealt
with by employees in the wages department, and there should be an independent check
(probably by the accounts or personnel department) to ensure that proper procedures are
carried out and there is no fraud.
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Existence of employees
To verify the existence of employees, select a sample of employees from the most recent
payroll. The procedures for checking the existence of the employees will include:
For employees at head office and at sales branches visited, identify employees and
ask for a signature which will be checked to the personnel records.
Department managers could be asked to sign a list of employees who work for them
and return it direct to the auditor.
If the employees are paid by cheque, the cheques can be inspected before they are
given to the employee or sent to their bank. If the bank is sent a list of employees to
be paid, the name of the employee on the list should be the same as on the payroll.
Other evidence of the existence of employees will include records of tax and health
insurance. For instance, there could be notifications from the tax authorities of
changes in tax allowance, and there will be an annual return to the tax authorities (at
the end of the tax year) which lists each employee.
PL
Based on the results of these tests, determine whether all the employees on the payroll
actually work for the company. (It should be noted that the checks above are the variety of
methods which can be used to verify employees on the payroll, and in practice not all of them
would be used.)
Answer 18 SHW
(i)
SA
M
(a)
Inspect numerical sequence of sales invoices, if any breaks in the sequence noted,
enquire of management as to missing invoices.
Select a sample of pre and post year end goods despatch notes and follow through to
pre or post year end sales invoices, to ensure the sales cut-off has been correctly
applied.
Perform an analytical review of monthly sales, compare any trends to prior years
and discuss significant fluctuations with management.
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1045
Deficiency report
Control
1046
Test of Control
Enquire of management
where the cash receipts not
banked are stored. Inspect
the location to ensure cash is
suitably secure.
PL
Deficiency
SA
M
(b)
Review post year end credit notes to identify if any pre year end sales should be
removed.
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Verify the balance per the bank statement to an original year end bank statement
and also to the bank confirmation letter.
Verify the reconciliations balance per the cash book to the year end cash book.
Trace all of the outstanding lodgements to the pre year end cash book, post year end
bank statement and also to paying-in-book pre year end.
Examine any old unpresented cheques to assess if they need to be written back into
the purchase ledger as they are no longer valid to be presented.
Trace all unpresented cheques through to a pre year end cash book and post year
end statement. For any unusual amounts or significant delays obtain explanations
from management.
PL
SA
M
(c)
Agree all balances listed on the bank confirmation letter to the companys bank
reconciliations or the trial balance to ensure completeness of bank balances.
Review the cash book and bank statements for any unusual items or large transfers
around the year end, as this could be evidence of window dressing.
Examine the bank confirmation letter for details of any security provided by the
company or any legal right of set-off as this may require disclosure.
There is a high risk of management bias in this area which makes this evidence on its own,
unreliable. Internally-generated evidence is less reliable than external evidence. As oral
evidence is less reliable than written, the directors must confirm their representations in a
letter or board minute.
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1047
(ii)
Flowcharts provide background information to be used at the planning stage. They are
relevant to obtaining an understanding of the accounting system and control environment.
PL
Their reliability depends on the competence of the internal audit staff, how long ago they
were updated and whether there have been subsequent changes. Walk-through tests of a
few transactions should be carried out each year to assess their reliability.
These flowcharts provide no persuasive evidence as to the completeness and accuracy of the
accounting records or the effective operation of internal controls. The auditor must perform
tests of the identified controls and substantive procedures to provide that evidence.
(iii)
These provide reasonable evidence as to the existence, completeness and valuation, but not
presentation of liabilities. They also provide evidence as to the recording of inventory cutoff.
SA
M
Although they are more reliable than documents from within the enterprise, they could
contain errors or discrepancies (e.g. year-end cash in transit). They may also not be received
from some suppliers, or be withheld (completeness).
To increase their reliability, they should be directly obtained from the supplier by the auditor
and reconciled (audited) to the payables balance.
As trade payables are a material balance in the statement of financial position and there is the
risk of understatement, this evidence alone, although critical, is not sufficient. Further
evidence would include specific cut-off analysis, analytical procedures on margins and
expenses and review of invoices recorded and payments made in the subsequent period.
(iv)
Inspection
This is relevant to the existence, but not the presentation of non-current assets. It provides
corroborative evidence as to the rights to benefits from an asset. The physical condition of
assets is relevant to their valuation.
Direct observation by the auditor is the most reliable evidence available as to the existence
and condition of tangible assets.
This is sufficient evidence as to the existence, condition and possible impairment of a tangible
non-current asset. In conjunction with documentary evidence (e.g. a purchase invoice) rights
to benefits may also be verified when initially purchased. In subsequent years the fact that it
is still in use indicates control. Valuation will need to be verified through checking the annual
depreciation charge and expected useful life.
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This procedure may provide sufficient evidence as to the completeness and accuracy of
trading results of low risk, immaterial, separately identifiable components of the business.
The persuasiveness of this evidence will depend upon the auditors previous experience of the
reliability of the accounting records and knowledge of the business.
Marking scheme
15
SA
M
PL
For each comment on appropriateness (i.e. relevance and reliability) and sufficiency
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1049
Planning stage
Calculate ratios (e.g. gross profit %,
1050
SA
M
PL
(i)
Purpose
Analytical procedures
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(ii)
Purpose
Substantive procedures
Analytical procedures
PL
SA
M
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1051
Purpose
PL
Analytical procedures
SA
M
Tutorial note: It has been assumed that the computerised information system
provides budgeted information against which to compare the monthly
management accounts described in the question.
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2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Marks
max 3
8
4
inventory
statement of comprehensive income
statements of financial position
sales/cash receipts
employee costs
property costs
distribution costs
Procedures
use of ratios
comparison of information
review of unusual items
confirmation of consistency
Purpose
To . . .
Use
20
SA
M
Answer 21 ZAK CO
PL
Audit areas
(a)
ISA 520
(i)
Analytical procedures are used in obtaining an understanding of an entity and its environment
and in the overall review at the end of the audit.
Analytical procedures actually means the evaluation of financial and other information, and
the review of plausible relationships in that information. The review also includes identifying
fluctuations and relationships that do not appear consistent with other relevant information or
results.
(ii)
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1053
E
PL
Project Management
Healthcare
SA
Tutorial notes
SA
M
PL
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