PROFESSIONAL LEVEL EXAMINATION

MONDAY 11 MARCH 2019

(2.5 HOURS)

AUDIT AND ASSURANCE

This exam consists of four questions (100 marks).

Marks breakdown

Question 1 20 marks
Question 2 37 marks
Question 3 20 marks
Question 4 23 marks

1. Please read the instructions on this page carefully before you begin your exam. If you
have any questions, raise your hand and speak with the invigilator before you begin.

2. Please alert the invigilator immediately if you encounter any issues during the delivery
of the exam. The invigilator cannot advise you on how to use the software. If you
believe that your performance has been affected by any issues which occurred, you
must request and complete a candidate incident report form at the end of the exam.
This form must be submitted as part of any subsequent special consideration
application.

3. Click on the Start Exam button to begin the exam. The exam timer will begin to count
down. A warning is given five minutes before the exam ends. When the exam timer
reaches zero, the exam will end. To end the exam early, press the Finish button.

4. You may use a pen and paper for draft workings. Any information you write on paper
will not be read or marked.

5. Answer question one, consisting of six short-form questions, in note form only.
Complete sentences are not required.

6. The examiner will take account of the way in which answers are structured. Respond
directly to the exam question requirements. Do not include any content or opinion of a
personal nature. A student survey is provided post-exam for feedback purposes.

7. You must make sure your answers are clearly visible when you submit your exam. Your
answers will be presented to the examiner exactly as they appear on screen: the
examiner will not be able to review your formulae, or expand rows or columns where
content is not visible.

Copyright © ICAEW 2019. All rights reserved

Question 1

1.1 Your firm issued an unmodified auditor’s report on the financial statements of Blade Ltd
(Blade) for the year ended 30 September 2018. In February 2019, Blade was placed
into administration due to insufficient cash to pay its debts on the due dates. Your firm
failed to complete its planned examination of Blade’s cash flow forecast during the
audit.

Outline:

(a) the possible consequences for your firm; and

(b) the quality control procedures your firm should have performed during its audit of
Blade to ensure the completion of the planned audit work.
(4 marks)

1.2 Circus Ltd (Circus), an audit client of your firm, has not complied with the EU's General
Data Protection Regulation (GDPR).

Identify the items in its financial statements which are at risk of misstatement due to
Circus' non-compliance with GDPR. (2 marks)

1.3 Your firm has accepted an engagement to examine the profit forecast, prepared by
Tailor Ltd (Tailor), for the two years ending 31 March 2021. Tailor supplies online
entertainment services in ten European countries and will soon launch a new service.
Tailor anticipates that some of its existing customers will immediately switch from their
current service to the new service, with more customers switching in the next two years.
It also hopes to attract new customers from competitors. The new service has two
packages available: ‘mini’ and ‘mega’. Customers will pay a monthly subscription fee, in
their local currency, for the package selected.

List the key variables, relevant to revenue, which should be subjected to sensitivity
analysis in the examination of Tailor’s profit forecast for the two years ending 31 March
2021. (4 marks)

1.4 Your firm is considering whether to accept appointment as external auditor of Wax Ltd
(Wax) for the year ending 30 June 2019. The partner considering the appointment has
asked you to obtain information to help him understand Wax’s business.

List the sources of information you should consider to help the partner gain a sufficient
understanding of Wax’s business. (2 marks)

1.5 Your firm is performing an assurance engagement to review the interim financial
information of Tattoo plc (Tattoo) for the six months ended 31 January 2019. Your firm
is due to sign its assurance report on 15 March 2019. Today, 11 March 2019, you
discover that Tattoo paid £5 million to a customer on 8 March 2019 in settlement of a
claim made by the customer against Tattoo.

Describe the steps your firm should take in respect of this discovery. (4 marks)

Copyright © ICAEW 2019. All rights reserved

1.6 During the external audit of Bailey Ltd (Bailey) your firm has concluded that there is a
material uncertainty over whether Bailey is a going concern.
State, with reasons, the implications for the auditor's report. (4 marks)

Total: 20 marks

Copyright © ICAEW 2019. All rights reserved

Question 2

Your firm, Hallett LLP (Hallett), has been appointed as the external auditor of PT Ltd (PT) for
the year ending 31 March 2019. Hallett is a small firm based in Wales. PT was incorporated
on 1 April 2017 and was not previously required to have an audit under the Companies Act
2006.

You are the audit senior responsible for planning the audit. The engagement partner has
asked you to consider the following key areas of audit risk:

 Payroll costs
 Trade receivables
 Provisions

PT provides corporate customers with an online employee benefit platform called ‘Vivify’.
Vivify gives customers’ employees access to a range of discounted leisure services. Leisure
services are advertised on the Vivify platform by external companies, such as restaurants
and cinemas, who then supply the service to the customers’ employees.

Each corporate customer pays a monthly fee to PT based on the number of employees it
registers on Vivify and the package it selects. Packages are priced as follows:

Package Price per employee per month

Standard £3
Deluxe £6

PT invoices corporate customers at the end of each month for the total number of employees
registered on Vivify on the first day of that month. Credit terms are 30 days.

As part of your audit planning for the year ending 31 March 2019, you met with PT’s finance
director, who provided you with the following information:

 One of PT’s customers, Trapeze plc (Trapeze) refused to pay an invoice sent to it by PT
on 31 January 2019. Trapeze’s directors were unhappy with the quality of benefits
available to its employees via Vivify. They claim that PT should not have invoiced
Trapeze because Trapeze removed its employees from Vivify on 30 December 2018.
However, due to a technical fault on Vivify the employees were not fully removed until 2
January 2019. Trapeze had 25,000 employees registered on the deluxe package.

 PT’s accounting policy is to make a 2% allowance against all trade receivables.

 In January 2019, PT replaced its accounting system.

 PT has grown rapidly and requires more office space. The board has approved the
relocation of PT’s offices from Wales to London. PT signed a lease for offices in London
which commences on 1 June 2019. On 1 March 2019, PT informed its employees that if
they do not wish to relocate to London they will be made redundant. Employees will
receive a redundancy payment equal to one month’s salary for each year they have
worked at PT. PT’s finance director estimates that 18% of PT’s employees will be made
redundant. PT's directors do not intend to include any amounts relating to the
redundancies in the financial statements for the year ending 31 March 2019.

Copyright © ICAEW 2019. All rights reserved

 A legal claim has been made against PT by Deng Tent, an employee of Lind Ltd (Lind).
Lind’s employees are registered on Vivify. Deng was seriously injured during an off-road
driving experience purchased on Vivify.

Drivenex Ltd (Drivenex), the company which supplied the experience, had inadequate
safety procedures in place. Deng believes PT was also negligent because PT did not
adequately evaluate Drivenex before allowing the driving experience to be offered on
Vivify. PT’s directors do not believe the claim will be successful and have not made any
provision for this claim in the financial statements. The outcome of the claim will not be
known until after the auditor's report has been signed.

PT’s finance director also provided you with the following financial information:

Statement of profit or loss for the year ending 31 March (extract)

2019 2018
(estimated) (unaudited)
£’000 £’000
Revenue 11,146 3,961

Profit before tax 1,413 133

Notes to the financial statements for the year ending 31 March (extract)

Employees – payroll costs

2019 2018
(estimated) (unaudited)
£’000 £’000
Wages and salaries 3,152 1,431
Social security costs 284 158
3,436 1,589

Average monthly number of employees during the year:

2019 2018
(estimated) (unaudited)
Total employees 97 38

Receivables
2019 2018
(estimated) (unaudited)
£’000 £’000
Trade receivables 1,526 325

After your meeting with PT’s finance director, the engagement partner left you the following
voicemail:

“PT’s finance director called me. He is not happy that we are asking so many questions as
part of our planning. He said it is taking up a lot of time and he doesn’t see what benefit PT is
getting from the audit – apparently, they managed very well last year without an auditor!

Copyright © ICAEW 2019. All rights reserved

“He said his accounting team are very busy because the company is currently negotiating
venture capital funding. In addition, PT is preparing to appeal a decision made by HMRC in
respect of PT’s treatment of VAT.

“It would be good if Hallett could offer some advice to PT on the appeal to HMRC. I am
worried that the rapid growth of PT and the office move to London will make it more difficult
for us to provide the services PT needs. I want our firm to be seen to be proactive and
improve our chances of retaining PT as a client, especially given the finance director’s views
on the amount of questions we are asking. Let me know what you think.”

Requirements

2.1 Justify why payroll costs, trade receivables and provisions have been identified as key
areas of audit risk and, for each key area, describe the procedures that should be
included in the audit plan to address those risks.

Present your answer using the following subheadings:

 Payroll costs
 Trade receivables
 Provisions
(30 marks)

2.2 Prepare a response to the voicemail from the engagement partner which:

(a) explains the benefits to PT of having its financial statements audited; and

(b) identifies and explains the ethical issues arising for Hallett LLP.
(7 marks)

Total: 37 marks

Copyright © ICAEW 2019. All rights reserved

Question 3

The following situations have been referred to your firm’s ethics partner by other partners in
the firm.

Lutz plc (Lutz)

The external audit team from your firm is working on the current year’s audit at Lutz’s head
office. On each day of the audit, the audit team eats lunch, free of charge, with Lutz’s
financial controller in the company’s staff canteen.

Stratton Ltd (Stratton)

Stratton’s financial controller unexpectedly left Stratton last month. Stratton’s directors have
requested that Lettie Yan, the audit senior assigned to the Stratton audit, assists the
company with the preparation of its financial statements before the external audit starts.

Juggler plc (Juggler)

Juggler is a UK listed company. Your firm has provided audit and non-audit services to
Juggler since the year ended 30 June 2015. In recent years your firm has earned the
following fees from Juggler:

Year ended Audit Recurring non-audit

30 June: services services
£’000 £’000
2017 1,700 900
2018 1,800 1,000

Juggler has significant growth plans and consequently the engagement partner anticipates
your firm will earn the following fees from Juggler going forward:

Year ending 30 Audit Recurring non-audit

June: services services
£’000 £’000
2019 2,500 1,200
2020 2,800 3,000

Your firm’s total annual fee income is £57 million in each year.

The non-audit services provided to Juggler are permitted under the FRC’s Revised Ethical
Standard and do not give rise to self-review or management threats.

Barnum School Ltd (Barnum)

Barnum operates a school which charges fees to the parents of children attending. Your firm
has accepted appointment as Barnum’s external auditor. Jenny Carlyle is the engagement
partner responsible for the Barnum audit. Jenny is married to Phillip Carlyle, a teacher
employed by the school. Phillip and Jenny intend to enrol their three children at Barnum in
September at a cost of £20,000 per child per year for school fees.

Copyright © ICAEW 2019. All rights reserved

Requirements

3.1 Explain why objectivity and independence are important principles in the context of an
external audit engagement.
(3 marks)

3.2 Identify and explain the threats to your firm’s objectivity and independence arising in
each of the situations above. State any actions your firm should take in respect of these
matters. (17 marks)

Total: 20 marks

Copyright © ICAEW 2019. All rights reserved

Question 4

Your firm has been the external auditor of Troupe Ltd (Troupe) for many years. The
engagement partner, Charity Wheeler, is reviewing the audit files prepared by the audit team
for the year ended 31 December 2018. The files include notes on the following internal
control deficiencies which were identified by the audit team when performing the planned
audit procedures:

(1) Bank reconciliations have not been performed since September 2018 due to staff
shortages in Troupe’s accounts department.

(2) Troupe’s purchase ledger clerk is responsible for placing orders with suppliers, posting
invoices to the purchase ledger and making payments to suppliers.

(3) Troupe does not have a policy in place requiring review of its aged receivables analysis.

Today, 11 March 2019, Charity was informed by Troupe’s directors that the company’s bank
has asked to review Troupe’s audited financial statements and the auditor's report for the
year ended 31 December 2018 before deciding whether to approve a recent loan application
by Troupe. Charity was not previously aware of the loan application or the bank’s reliance on
the audited financial statements.

Requirements

4.1 For each of the internal control deficiencies (1) to (3), outline the possible consequences
of the deficiency and provide recommendations to remedy the deficiency. (10 marks)

4.2 For each of the internal control deficiencies (1) to (3):

(a) identify the items in Troupe's financial statements that are at risk of misstatement
because of the deficiency; and

(b) list the audit evidence the audit team should have included in the audit file to
address each risk of misstatement.
(8 marks)

4.3 State the matters that Charity should consider in relation to Troupe’s loan application
and the bank’s reliance on both the audited financial statements and the auditor's report
for the year ended 31 December 2018. (5 marks)

Total: 23 marks

Copyright © ICAEW 2019. All rights reserved