Professional Level – Options Module

Paper P7 (INT)
Advanced Audit and
Assurance
(International)

Time allowed: 3 hours 15 minutes

This question paper is divided into two sections:

Section A – BOTH questions are compulsory and MUST be attempted

Section B – TWO questions ONLY to be attempted

Do NOT open this question paper until instructed by the supervisor.

This question paper must not be removed from the examination hall.
SECTION A- BOTH Questions are compulsory and MUST be attempted

Question 1
You are a manager in Dennis& Co, a firm of Chartered Certified Accountants responsible for the audit of
the Abbott Group. Your firm was appointed as auditor in January 2017, and the audit engagement
partner, Colin Brown, has sent you the following email:

To: Audit manager

From: Colin Brown
Regarding: Abbott Group audit planning

Hello
I need you to begin planning the audit of the Abbott Group (the Group). As you know, we have been
appointed to audit the Group financial statements, and we have also been appointed to audit the financial
statements of the parent company and of all subsidiaries of the Group except for an overseas subsidiary,
Slytherin Co, which is audited by a local firm, Susan& Co. All components of the Group have the same
year end of 31 July, report under IFRS and in the same currency.

I have provided you with some information about the Group’s general background and activities, and
extracts from the draft financial statements. Using this information, you are required to:

(a) Evaluate the audit risks to be considered in planning the audit of the Group and;
(20 marks)

(b) Explain the matters to be considered, and the procedures to be performed, in respect of planning to
use the work of Susan& Co.
(5 marks)

(c) For overseas located companies such as Slytherin Co, The group audit committee could also suggest
that due to the distant location, a joint audit should be performed.

Discuss the advantages and disadvantages of a joint audit being performed on the financial
statements of Slytherin Co.
(6 marks)

Please present your response as briefing notes for my attention.

Thank you.

Attachment: Background and structure of the Abbott Group

The Group operates in the Electronics Industry, mainly focus is on consumer electronics, they
manufacture a range of goods including Television, Refrigerators and Air Conditioners. Goods are sold
under the Abbott brand name. The Group consist of Gryffindor Co, Slytherin Co and Raven claw Co,
which are all wholly owned, acquired subsidiaries which manufacture different Electronics.
Gryffindor Co manufactures premium quality electronics, with almost all of its output sold through
approximately 400 department stores. Gryffindor Co’s draft statement of financial position recognises
assets of $21·5 million at 31 July 2017. Any unsold good within 24 months is transferred to Slytherin Co,
as the model gets old.

Slytherin Co is located overseas, where it can benefit from low cost labour in its factories. It produces
electronics for the mass market. A new inventory system was introduced in December 2016 in order to
introduce stronger controls over the movement of inventory between factories and stores. Slytherin Co is
audited by Susan& Co, and its audit reports in all previous years have been unmodified. Susan& Co is a
small accounting and audit firm, but is a member of an international network of firms. Slytherin Co’s draft
statement of financial position recognises assets of $24 million at 31 July 2017.

Raven claw Co, the company is cash-rich and surplus cash is invested in a large portfolio of investment
properties, which generate rental income. The Group’s accounting policy is to measure investment
properties at fair value. Raven claw Co’s draft statement of financial position recognises assets of $28
million at 31 July2017, of which investment properties represent $10 million.

Other information
As part of management’s strategy to increase market share, a bonus scheme has been put in place
across the Group under which senior managers will receive a bonus based on an increase in revenue.

Abbott Co imposes an annual management charge of $800,000 on each of its subsidiaries, with the
charge for each financial year payable in the subsequent August.

Extracts from draft Group consolidated financial statements

Draft consolidated statement of profit or loss and other comprehensive income

Year ended 31 July Year ended 31 July 2016

2017 Draft Actual
$ $

Revenue 725 650

Cost of Sales (463) (417.5)
Gross profits 262 232.5
Other Income 0.2 0.15
Operating expenses (250) (225)
Profit before tax 12.2 7.65
Income Tax expense (2.5) _(2)_
Profit for the year 9.7 5.65
Other Comprehensive Income
Gain on investment property Revaluation _1_ _3_
Total Comprehensive Income 10.7 8.65

Note: All figures are in millions.

Draft consolidated statement of financial position

31 July 2017 31 July 2017

Draft Actual

$ $
Non-Current Assets
Property Plant and equipment 50 45
Investment Property 10 7.5
Intangible asset 8 8
Investment in associates _12_ _-_
80 60.5

Current Assets
Inventory 12 6
Receivables 5.5 6.6
Cash _10_ _22_
27.5 34.6
Total Assets 107.5 95.1

Equity and Liabilities

Share Capital 55 55
Retained Earnings 34 24.6
89 79.6

Current Liabilities
Trade Payable 16 13.5
Tax Payable 2.5 2
18.5 15.5
Total equity and liability 107.5 95.1

Note: All figures are in millions.

Required:
Respond to the email from the audit partner.
(31 marks)
Note: The split of the mark allocation is shown within the partner’s email.

Professional marks will be awarded for the presentation, logical flow and clarity of
explanation of the briefing notes.
(4 marks)

(35 marks)
Question 2
Your firm has been approached by Weasley Co to provide the annual audit. Weasley Co operates a chain
of Joke shop across the country. The shops sell fancy dress for males and female and fancy dress
Accessories. The financial year will end on 31 December 2017, and this will be the first year that an audit
is required, as previously the company was exempt from audit due to its small size. Weasley Co’s
financial statements for the year ended 31 December 2016 included Profit before tax, Inventory, Total
assets and Recievables are $60,000, $35,000, $400,000 and $ 10,000 respectively.

The potential audit engagement partner, Amos Diggory, recently attended a meeting with Fred and
George, managing director of Weasley Co regarding the audit appointment. Fred and Amos were batch
mates in high school. In this meeting, George made the following comments:

‘Weasley Co is a small, owner-managed business. I run the company, along with my brother, Fred, and
we employ a part-qualified accountant to do the bookkeeping and prepare the annual accounts. The
accountant prepares management accounts at the end of every quarter, but Fred and I rarely do more
than quickly review the sales figures. We understand that due to the company’s size, we now need to
have the accounts audited. It would make sense if your firm could prepare the accounts and do the audit
at the same time. We don’t want a cash flow statement prepared, as it is not required for tax purposes,
and would not be used by us.

Next year we are planning to acquire another company, one of our competitors, which I believe is an
existing audit client of your firm. For this reason, we require that your audit procedures do not include
reading the minutes of board meetings, as we have been discussing some confidential matters regarding
this potential acquisition.’

Required:
a) Identify and explain the professional and ethical matters that should be considered in
deciding whether to accept the appointment as auditor of Weasley Co.
(14 marks)

b) In relation to opening balances where the financial statements for the prior period were
not audited:

Explain the audit procedures required by ISA 510 Initial Audit Engagements – Opening
Balances, and recommend the specific audit procedures to be applied to Weasley Co’s
opening balance of inventory. (6 marks)

c) You are aware that Weasley Co is seeking a listing. The listing rules in this jurisdiction require that
interim financial information is published half-way through the accounting period, and that the
information should be accompanied by a review report issued by the company’s independent auditor.

Required:
Explain the principal analytical procedures that should be used to gather evidence in a
review of interim financial information. (5 marks)
(25 marks)
Section B – TWO questions ONLY to be attempted

Question 3
You are an audit manager in Malfoy & Co, responsible for the audit of Dursley Co and Percy Co.

You are reviewing the audit working papers of Dursley Co, relating to the financial year ended 31 June
2016. Dursley Co is a manufacturer of chemicals used in the agricultural industry. The draft financial
statements recognise profit for the year to 31 January 2016 of $15 million (2015 – $20 million) and total
assets of $120 million (2015 – $110 million). The audit senior, Darco, has brought several matters to your
attention:

Dursley Co’s factories are recognised within property, plant and equipment at a carrying value of $26
million. Half of the factories produce a chemical which is used in farm animal feed. Recently the
government has introduced a regulation stipulating that the chemical is phased out over the next three
years. Sales of the chemical are still buoyant, however, and are projected to account for 45% of Dursley
Co’s revenue for the year ending 31 January 2017. Dursley Co has started to research a replacement
chemical which is allowed under the new regulation, and has spent $1 million on a feasibility study into
the development of this chemical.
(5 marks)

In December 2015, Dursley Co’s finance director, Dudley, purchased a car from the company. The
carrying value of the car at the date of its disposal to Dudley was $80,000, and its market value was
$95,000. Dursley Co raised an invoice for $80,000 in respect of the disposal, which is still outstanding for
payment.
(5 marks)

Percy Co is a company which manufactures tractors and other machinery to be used in the agricultural
industry. You are the manager responsible for the audit of Percy Co, and you are reviewing the audit
working papers for the year ended 28 February 2017. The draft financial statements show revenue of
$10·5 million, profit before tax of $3·5million, and total assets of $50 million.

Two matters have been brought to your attention by the audit senior, both of which relate to assets
recognised in the statement of financial position for the first time this year:

In July 2016, Percy Co entered into five new finance leases of land and buildings. The leases have been
capitalized and the statement of financial position includes leased assets presented as non-current assets
at a value of $4 million, and a total finance lease payable of $3·5 million presented as a non-current
liability.
(5 marks)

Non-current assets include financial assets recognised at $1·5 million. A note to the financial statements
describes these financial assets as investments classified as ‘fair value through profit or loss’, and the
investments are describedin the note as ‘held for trading’. The investments are all shares in listed
companies. A gain of $500,000 has been recognised in net profit in respect of the revaluation of these
investments.
(5 marks)
Required:
For both companies comment on the matters to be considered and explain the audit
evidence you should expect to find during your review of the audit working papers in respect
of each of the issues described above.

Note: The split of the mark allocation is shown against each of the issues above.
(20 marks)
Question 4
You are a manager in Sebastian& Co, a firm which offers a range of services to audit and non-audit
clients. You have been asked to consider a potential engagement to review and provide a report on the
prospective financial information of Orsino Co, a company which has been an audit client of Sebastian&
Co for eight years. The audit of the financial statementsfor the year ended 30 June 2017 has just
commenced.

Orsino Co operates a chain of hotels across the country. Management is planning to invest in all of its
hotels in order to attract more customers. The company has sufficient cash to fund half of the necessary
capital expenditure, but has approached its bank with a loan application of $18 million for the remainder
of the funds required. Most of the cash will be used to invest in building new wings. The remaining cash
will be used for refurbishment of the existing buildings
.
The draft forecast statements of profit or loss for the years ending 30 June 2018 and 2019 are shown
below, along with the key assumptions which have been used in their preparation. The unaudited
statement of profit or loss for the year ended 30 June 2017 is also shown below. The forecast has been
prepared for use by the bank in making its lending decision, and will be accompanied by other
prospective financial information including a forecast statement of cash flows.

Forecasted statement of profit and loss

Year ended Year ending Year ending

30 April 2017 30 April 2018 30 April 2019
Unaudited Forecast Fore cast
$000 $000 $000
Revenue 132 140 143
Operating expenses (15) (18) (19)
Operating profit 117 122 (124)
Finance costs (10) (12) (11)
Profit before tax 107 110 113

This is the first time that Orsino Co has requested such a report, and the directors are unsure about the
contents of the report that your firm will issue. They understand that it is similar in format to an audit
report, but that the specific contents are not the same.

Required:
(a)
(i) Explain the matters to be considered by Sebastian& Co before accepting the
engagement to review and report on Orsino Co’s prospective financial
information.
(6 marks)

(ii) Assuming the engagement is accepted, describe the examination procedures to

be used in respect of the forecast statement of profit or loss
(8 marks)
(b) Explain the main contents of the report that will be issued on the prospective financial
information.
(6 marks)

(20 marks)
Question 5
The audit of Russo Co, a software designer company, for the year ended 31 August 2017 is nearly
complete and the auditor’s report is to be signed imminently. The following outstanding matters still
require your consideration. The draft reported revenue, profit before tax and total assets for the year are
$25 million (2016 - $30 million) $80 million (2016 – $130 million) and $890 million (2016 – $930 million)
respectively. Russo Co is not a listed company.

Fire
During the year a major catastrophe took place when a fire caused significant damage to the operations
of the company, leading to production ceasing for several months. While operations have resumed,
repairs are ongoing and it is anticipated that full production will not resume for at least another six
months. Audit procedures revealed that the matter has been fully and satisfactorily reflected and
disclosed in the financial statements and that it does not pose a significant risk to the going concern
status of Russo Co.

Provision
Provision has been recognised in respect of a restructuring involving the closure of one of the steel
processing plants. Management approved the closure at a board meeting in August 2016, but announced
the closure to employees in September 2016. The restructuring provision is stated to be $500,000.The
audit conclusion is that the provision should not be recognised

Government Software project

During the year $7 million of expenses relating to a new Government software project was recorded in
the statement of profit or loss. The audit team was given brief summaries of the costs incurred but when
asked for further corroborating evidence; management stated that they had signed a confidentiality
agreement with the Government and were unable to provide any further details. The only additional
information provided was that they anticipated the project to last for three years and that it may lead to
a highly lucrative contract.

Share-based payment
Share-based payment scheme was established in January 2016. Management has not recognized any
amount in the financial statements in relation to the scheme, arguing that due to the decline in Russo
Co’s share price, the share options granted are unlikely to be exercised. The proposed amount for share
based payment is $8 million. The audit conclusion is that an expense and related equity figure should be
included in the financial statements.

Required:
In respect of each of the matters described above, discuss the implications for the auditor’s
report and recommend any further actions necessary.

Note: The total marks will be split equally between each matter.
(20 marks)