SECTION B

MILLA COLA CO (MILLA CO)

(a) Audit risk and components of audit risk

Audit risk
Audit risk is the risk that the auditor expresses an unmodified opinion when the financial
statements are materially misstated. Audit risk comprises of three elements, namely
inherent risk, control risk and detection risk.

Inherent risk
Inherent risk is the susceptibility of an assertion about a class of transaction, account
balance or a disclosure to a statement or a class of transaction either individually, or in
aggregate, before taking any related controls.

Control risk
Control risk is the risk that the misstatements in an assertion of a class of transaction,
account balance or a disclosure to a statement or a class of transaction either individually or
aggregate with other misstatements, will not prevent or detect and control the
misstatement which could be material.

Detection risk
It is the risk where the procedures performed by the auditor to reduce a risk to an
acceptably low level will not detect any misstatements which exists and which could be
material, either individually or in aggregate. Detection risk is affected by sampling and non-
sampling methods.

(b) Audit risk and auditor’s responses

AUDIT RISK
Milla Co’s investment has resulted in
expenditure of $5m on updating, repairing
and replacing a significant amount of the
machinery used in the production.
If this expenditure is capital related, it
should be treated as per IAS16 Property,
Plant & Equipment. But if it is related to
repairs, then it should be expenses to
statement of profit and loss.
If not treated correctly, asset may be under
or overvalued.
The company now utilizes 15 warehouses,
some are owned by Milla Co and some are
rented to third party.
Only the warehouses owned by Milla
should be included in PPE. There is a risk of
warehouses being overstated if not
segregated properly.
Inventory counts will be taken place at all
15 sites at the year end.
AUDITOR’S RESPONSES
Review a breakdown of the costs to assess
whether the amount has been treated
properly and has been included in correct
class of transaction.
Testing should be taken in order to assess
the classification in the financial
statements.
The auditor should obtain the
documentation regarding the warehouse
and make sure that warehouses owned
only by Milla are included in PPE.
The auditor should decide which
warehouses should be visited depending on
the materiality. Auditor should make sure
 It is physically important for the auditor to
visit all the 15 warehouses for inventory
counts. Hence they need to obtain
sufficient appropriate evidence over counts
if all inventories and confirm the existence
and completeness of the same.
A new accounting general ledger has been
introduced at the beginning of the year and
old systems being run in parallel.
There is a risk that the amount of opening
balances might be misstated and risk of
losing the data if all files are not transferred
properly.
Milla Co has incurred expenditure of $4.5m
on developing a new brand of fizzy soft
drinks.
This expenditure is related to development
and should be capitalized as intangible
assets under IAS38 Intangible Assets.
If this cost is treated correctly, the assets
could be overstated.
A number of products were damaged and
due to complaints by customer, no further
sales have been made.
The company may need to pay refund to
these customers.
Revenue may be overstated if the sales
returns are not accurately recorded.
No adjustments have been made to
valuation of damaged inventory, they will
still be held in the inventory at year end.
The valuation of inventory as per IAS2
Inventory should be lower of cost or net
realizable value.
Hence it is likely that the inventory might
be overvalued of not valued properly.
to visit these warehouses for inventory
counts.
For those not visited, the auditor should
will need to review the level or existence if
the inventory.
The auditor should undertake detailed
testing to confirm that correct opening
balances have been recorded and also all
files have been correctly transferred
without any error.
The auditor should obtain a breakdown to
ensure that this development expenditure
has been correctly included in intangible
asset as per relevant IAS38
Obtain and review the breakdown of
revenue to ensure that sales returns have
been accurately recorded.
Detailed testing of cost and net realizable
value should be performed to check if
inventory is valued as per IAS2 and how
much of damaged inventory needs to be
written down.

(c) Audit strategy document

The audit strategy document sets out the scope, timing and direction of the audit and helps
the development of audit plan.
It should identify the main characteristics of the audit. For example,
 Whether financial statements have been prepared in accordance with all relevant
IFRS.
 Whether the computer assisted techniques will be used and impact of IT controls on
audit.

It should ascertain the nature, timing and scope of the audit and the resources available to
perform the audit. For example,

 Setting the audit budget

  Selection of audit team members with required expertise and knowledge of the
industry.

(d) Interim audit

It is the type of audit which takes place before the year end.
The auditor carries out all the procedures which would be difficult to carry at the end of the
year.
It is not necessary to carry out interim audit, it depends on the size and complexity of the firm
to be audited.
Final audit
It is the type of audit that is performed at the year end.
It concludes with the auditor forming and expressing an audit opinion based on the financial
statements prepared for the whole year.
The audit opinion takes into account procedures performed at bot interim and final audit.

(e) Procedures to be undertaken during an interim audit

 Review and updating of the documents of Milla Co
 Assessment of risk which could impact the final audit of Milla Co.
 Undertake test of control on key transactions on Milla Co.

Impact of interim audit on final audit

 The increased substantive procedures performed during the audit will reduce the
number of procedures to be performed during final audit as they will be able to rely
on the controls.
 As the testing has been undertaken during the interim audit, it will reduce the time of
testing to be performed during final audit, resulting in the audited financial
statements being available earlier.

BAGGIO INTERNATIONAL CO

(a) Deficiencies, recommendations and test of controls

CONTROL DEFICIENCY CONTROL TEST IF CONTROL
RECOMMENDATION
The website is not The website should be Test of data could be
integrated into inventory updated to include inventory assessed to place orders via
system. levels so that the order is the system for inventory
This will result in allowing recorded only when the that are out of stock.
the customers to order inventory is available. The system should flag
directly without knowing insufficient inventories and
the inventory levels. This the sales order and should
can result in the loss of indicate an approximate
goodwill. waiting time.
Goods are dispatched via The couriers should be asked Select a sample from
local couriers who do not to take signatures if the dispatches and ask Baggio
 always record customer’s
signatures as s proof of
delivery of goods.
There is no proof of the
delivery of goods. The
customers can wrongly
claim that they haven’t
received the good.
There have been delays
between sales order and
receipt of goods for a
longer period of time. As
the sales orders entered
into system are not
forwarded correctly, this
will result in customers not
receiving their good and
loss if customer goodwill.
Credit limits are set by the
sales ledger clerk.
The sales ledger clerk may
not be sufficiently senior
and may set the credit level
too high which would result
in increase of irrecoverable
debts.
The sales team decides the
discount level for the
orders places. In order to
increase the sales, the tem
may set higher level of
discounts to achieve the
target, resulting in loss of
revenue.
Supplier statement
reconciliations are no
longer performed.
This can result in the errors
in recording purchases, and
payables not being
identified on a timely basis.
customers to whom the
good are delivered for the
proof.
Once the goods are
dispatched they should be
marked as fulfilled. The
orders that are yet to be
dispatched should be
flagged.
This report should be
reviewed by a responsible
official.
A senior should be asked to
set the credit levels in order
to avoid setting of incorrect
credit levels.
This should be reviewed by
the responsible official.
The member of sales teams
should be given authority to
set discount level upto a
certain limit.
This should be reviewed by
the managers on a regular
basis.
The purchase ledger
department should be told
to reconcile the statements.
This should be reviewed by
the responsible official on a
regular basis.
to check for the signatures
as a proof of delivery.
Review the sample of sales
orders and discuss with
management the reason for
outstanding sales.
Select a sample of sales
orders and compare with
the date of order, to ensure
that the good are delivered
within the given period.
Enquire the sales ledger
clerk as to who can set the
credit limits.
Ensure that the responsible
official has performed the
work of setting credit limits.
Review the sales discount
reports to ensure that
discount levels are not set
above the given limit.
Enquire with the team the
process for setting these
levels.
Obtain the file of
reconciliations to ensure
the statements have been
reconciled and have been
reviewed by the
responsible official.

(b) Substantive procedure to confirm plant and equipment additions

 Obtain a breakdown of additions, cast the list, and compare to the list of non-current
assets register to confirm the completeness and accuracy of the additions.
 Select a sample of additions recorded in PPE and physically verify them to ensure the
existence.
 Select a sample of additions and agree the cost to supplier invoices to confirm
valuation.
VIERI MOTOR CARS CO (VIERI CO)

(a) Factors Rossi & Co should consider when placing reliance on the work of independent
auditor
ISA 500 Audit Evidence requires the auditor to evaluate the completeness, capabilities and
the objectives of the management senior.
This also includes considering the qualification of the members and assessing whether they
are the member of any professional body.
Rossi & Co should discuss with them the valuation of PPE whether they have done in the same
way as Vieri had done before and should confirm whether the valuer understands the
accounting and valuation requirements as per IAS 16 Property, Plant and Equipment.
They should assess the auditor’s independence, considering the potential threats such as
undue reliance on Vieri Co and self-interest threats.
Any assumptions made should be evaluated. These assumptions should be carefully revalued
and discuss with the management and the valuer the basis of these assumptions.

(b) Substantive procedures in relation to revaluation of land and building and warehouse
 Obtain a breakdown of costs, cast the list and compare to the list of land & building
register to confirm the completeness and accuracy of revaluation.
 Agree whether the revalued amounts are accurate by comparing with non-current
asset register.
 Recalculate the depreciation to confirm that the depreciation charged to the assets is
accurate.
 Auditor should confirm that the warehouse is owned by Vieri Co though the title deed.
 Agree the initial cost of warehouse to the asset register to ensure the cost recorded
is accurate.
 Review the financial statements disclosures to ensure that the revaluation is done as
per requirements of IAS 16 Property, Plant and Equipment.

(c) Substantive procedures in relation to valuation of work in progress

 Obtain a breakdown of all cots, cast the list and compare to the work in progress
register to confirm the completeness and accuracy of valuation.
 Discuss with the management the basis of the standard costs applied to the
percentage of completion.
 Obtain a breakdown of these standard costs, select a sample and agree to the actual
costs to assess reasonableness.
 Observe the procedure carried out by Vieri Co during the counts and in assuming the
costs of WIP to obtain reasonableness of assumptions used for valuation.

(d) Steps Rossi & Co should take and the impact on auditor’s report in relation to director’s
refusal to amend the financial statements
Rossi & Co should discuss with the management the reason as to why they are refusing to
amend issue related to WIP in the financial statements. The auditor should assess the
materiality. If immaterial, there will be no impact on the audit report.
If material, the auditor should discuss with the management to amend the financial
statements. If the management refuses to do so, auditor’s report will have to be modified.
As the WIP in total is material, it is unlikely to have a pervasive effect on the financial
statements as a whole. As the managers have not complied with requirements of IAS2
Inventory while valuation, the error is material but not pervasive.
Hence the auditor will issue a qualified opinion. The opinion paragraph will the qualified
‘except for’.
The basis for opinion paragraph will explain the material misstatements related to the
valuation of work in progress and the effect of it on the financial statements.
This will be included after the opinion paragraph.