Mock Examination M kE i ti

: ACCA P Paper P7

Advanced Audit and Assurance

Session Set by

: June 2012 : AP Chee Hay Kheong

Your Lecturer AP Chee Hay Kheong Your Mailing Address : ______________________________________ ______________________________________ Your Contact Number : ______________________________________

I wish to have my script marked by my lecturer and collect the marked script at the SAA-GE Reception Counter y have the marked script returned to me by mail (Please submit your script latest by 16th May 2012 for marking)

SAA GLOBAL EDUCATION CENTRE PTE LTD

Company Registration No. 201001206N 20 Aljunied Road, #01-04, CPA House, Singapore 389805 Tel: (65) 6744 9700 Fax: (65) 6744 9796 Website: www.saage.edu.sg Email: acca@saage.edu.sg

Question 1 (a) Scorpio, a limited liability company, is a carpet manufacture. You are currently planning the audit of the financial statements for the year ending 31 August 2012. Your firm was appointed as auditor to Island Co for the first time in May 2012. You have received an email from Holly Elm, the audit engagement partner. To: Audit manager From: Holly Elm, Audit partner Subject: Scorpio audit planning Hello I would like you to start planning the audit of Scorpio. In the attachment, you find the information I have obtained from the planning meeting with the chief executive officer of Scorpio. Using this information, please prepare notes for inclusion in the planning section of the working papers, which identify and explain the risk of material misstatement to be considered in planning the final audit. (12 marks) Thank you.

Email Attachment The chief executive of Scorpio, Ursula Minor, believes that despite its current cash flow difficulties, Scorpios current trading performance is satisfactory and future prospects are good. Budget forecasts for Scorpio, for the current accounting year to 31 August 2012 and for the following year, reflect a rising profit trend. Scorpios results for the first half year to 29 February 2012 reflect a $800,000 profit from the sale of a warehouse, which had been carried in the books at historical cost. There are plans to sell two similar properties later in the year and outsource warehousing. Potential buyer has been found and preliminary negotiation has just begun. About 10% of Scorpios sales are to Andromeda, a limited liability company. Two members of the management board of Scorpio hold minority interests in Andromeda. Selling prices negotiated between Scorpio and Andromeda appear to be on an arms length basis. Scorpios management accounts for the six months to 31 May 2012 have been used to support an application to the bank for an additional loan facility to refurbish the executive and administration offices. These management accounts show inventory and trade receivables balances that exceed the figures in the accounting records by $150,000. This excess has also been reflected in the first half years profit. Upon enquiry, you have established that allowances, to reduce inventory and accounts receivable to estimated realizable values, have been reduced to assist with the loan application. Although there has been a recent downturn in trading, Ursula Minor has stated that she is very confident that the negotiations with the bank will be successful as Scorpio has met its budgeted profit for the first six months. Ursula believes that increased demand for carpets and rugs in the winter months will enable results to exceed budget. Ursula Minor, who is also a majority in Scorpio, is negotiating with a bigger competitor Bellatrix who is interested in acquiring Scorpio. As such, Ursula wishes the audit to be completed by 30 September 2012, one month earlier than originally agreed with the audit partner in audit appointment.

Required: Respond to the partners email. Note: Include 3 professional marks (15 marks) 2

(b) You are a senior manager in Dyke & Co, a small firm of Certified Public Accountants, which specialises in providing audits and financial statement reviews for small to medium-sized companies. You are responsible for evaluating potential assurance engagements, and for producing a brief report on each prospective piece of work to be used by the partners in your firm when deciding whether to accept or decline the engagement. Dyke & Co is keen to expand the assurance services offered, as a replacement for revenue lost from the many small-company clients choosing not to have a statutory audit in recent years. It is currently October 2011. Petsupply Co has been an audit client of Dyke & Co for the past three years. The company owns and operates a chain of retail outlets selling pet supplies. The finance director of Petsupply Co recently communicated with your firm to enquire about the provision of an assurance report on data provided in the Environmental Report published on the companys website. The following is an extract from the e-mail sent to your firm from the finance director of Petsupply Co: At the last board meeting, my fellow directors discussed the content of the Environmental Report. They are keen to ensure that the data contained in the report is credible, and they have asked whether your firm would be willing to provide some kind of opinion verifying the disclosures made. Petsupply Co is strongly committed to disclosing environmental data, and information gathered from our website indicates that our customers are very interested in environmental matters. It is therefore important to us that Petsupply Co reports positive information which should help to retain existing customers, and to attract new customers. I am keen to hear your views on this matter at your earliest convenience. We would like verification of the data as soon as possible. You have looked at Petsupply Cos Environmental Report on the company website, and found a great deal of numerical data provided, some of which is shown below in Table 1.

Required: Prepare a report, to be used by a partner in your firm, in which you identify and evaluate the professional, ethical, and other issues raised in deciding whether to accept the appointment as provider of an assurance opinion as requested by Petsupply Co. (12 marks) Note: this requirement includes three professional marks. (15 marks)

(c) You are an audit manager in a firm of Certified Public Accountants currently assigned to the audit of Cleeves Co for the year ended 30 September 2010. During the year Cleeves acquired a 100% interest in Howard Co. Howard is material to Cleeves and audited by another firm, Parr & Co. You have just received Parrs draft auditors report for the year ended 30 September 2010. The wording is that of an unmodified report except for the opinion paragraph which is as follows: Audit opinion As more fully explained in notes 11 and 15 impairment losses on noncurrent assets have not been recognised in profit or loss as the directors are unable to quantify the amounts. In our opinion, provision should be made for these as required by Financial Reporting Standard 36 (Impairment). If the provision had been so recognised the effect would have been to increase the loss before and after tax for the year and to reduce the value of tangible and intangible non-current assets. However, as the directors are unable to quantify the amounts we are unable to indicate the financial effect of such omissions. In view of the failure to provide for the impairments referred to above, in our opinion the financial statements do not give a true and fair view of the financial position of Howard Co as of 30 September 2010 and of its loss and its cash flows for the year then ended in accordance with Singapore Financial Reporting Standards. Your review of the prior year auditors report shows that the 2009 audit opinion was worded identically. Required: (i) Critically appraise the appropriateness of the audit opinion given by Parr & Co on the financial statements of Howard Co, for the years ended 30 September 2010. (7 marks) Briefly explain the implications of Parr & Cos audit opinion for your audit opinion on the consolidated financial statements of Cleeves Co for the year ended 30 September 2010. (3 marks) (10 marks)

(ii)

Question 2 (a) You are the manager responsible for the audit of Phoenix, a private limited liability company, which manufactures super alloys from imported zinc and aluminium. The company operates three similar foundries at different sites under the direction of Troy Pitz, the chief executive. The draft accounts for the year ended 31 May 2012 show profit before taxation of $1.7m (2011 $1.5m). The audit senior has produced a schedule of Points for the Attention of the Audit Manager as follows: 1. Current liabilities include a $500,000 provision for future maintenance. This represents the estimated cost of overhauling the blast furnaces and other foundry equipment. The overhaul is planned for May 2013 when all foundry workers take two weeks annual leave. (7 marks)

2. All industrial waste from the furnaces (clinker) is purchased by Cleanaway, a government-approved disposal company, under a five-year contract that is due for renewal later this year. A recent newspaper article states that substantial fines have been levied on Cleanaway for illegal dumping. Troy Pitz is the majority shareholder of Cleanaway. (7 marks) Required: For each of the above points: i. ii. comment on the matters that you would consider; and state the audit evidence that you would expect to find;

in undertaking your review of the audit working papers and financial statements of Phoenix. (14 marks) (b) You are the manager responsible for the audit of Eagle Energy, an energy generation company. The draft financial statements for the year ended 30 April 2012 show revenue of $287 million (2011 $262 million), profit before taxation of $72 million (2011 $23 million) and total assets of $242 million (2011 $221 million). The following issue arising during the final audit has been noted on a schedule of points for your attention: Eagle Energy receives significant funding from government sources and is required to report, monthly, on its financial performance and position. Every month end a journal entry is made, Debit Sundry 1 account/Credit Sundry 2 6

account. There is no narrative but the chief accountant explained that the journal is approved by the chief executive to ensure that reported debt ratios stay within government specified limits. The entries are then reversed at the beginning of the following month. The net movement on these accounts over the year to 30 April 2012 was $03 million. (6 marks) Required: For the above issue: (i) (ii) comment on the matters that you should consider; and state the audit evidence that you should expect to find, in undertaking your review of the audit working papers and financial statements of Eagle Energy for the year ended 30 April 2012. (20 marks) Question 3 You are the manager responsible for four audit clients of Alex & Co, a firm of Chartered Certified Accountants. The year end in each case is 30 September 2011. You are currently reviewing the audit working paper files and the audit seniors recommendations for the auditors reports. Details are as follows: (a) Manu Co is a subsidiary of Club Co. Serious going concern problems have been noted during this years audit. Manu will be unable to trade for the foreseeable future unless it continues to receive financial support from the parent company. Manu has received a letter of support (comfort letter) from Club Co. The audit senior has suggested that, due to the seriousness of the situation, the audit opinion must at least be qualified except for. (5 marks) (b) Lavin Co has changed its accounting policy for inventory during the year from first-in-first-out to weighted average basis. No disclosure of this change has been given in the financial statements. The carrying amount of inventory in the statement of financial position as at 30 September 2011 zero as it happened that there was no inventory at year end. The audit senior has concluded that a qualification is not required but suggests that attention can be drawn to the change by way of an emphasis of matter paragraph. (6 marks) (c) The directors report in the annual report of Abio Co states that investment property rental forms a major part of revenue. However, a note to the financial statements shows that property rental represents 7

only 16% of total revenue for the year. The audit senior is satisfied that the revenue figures are correct. The audit senior has noted that an unqualified opinion should be given as the audit opinion does not extend to the directors report. (4 marks) (d) Audit work on the after-date bank transactions of Jurong Co has identified a transfer of cash from Bedok Co. The audit senior assigned to the audit of Jurong has documented that Jurongs finance director explained that Bedok commenced trading on 7 October 2011, after being set up as a wholly-owned foreign subsidiary of Jurong. The audit senior has noted that although no other evidence has been obtained an unmodified opinion is appropriate because the matter does not impact on the current years financial statements. (5 marks) Required: For each situation, comment on the suitability or otherwise of the audit seniors proposals for the auditors reports. Where you disagree, indicate what audit modification (if any) should be given instead. Note: The mark allocation is shown against each of the four issues. Question 4 Aventura International, a listed company, manufactures and wholesales a wide variety of products including fashion clothes and audio-video equipment. The company is audited by Voest, a firm of Chartered Certified Accountants, and the audit manager is Darius Harken. The following matters have arisen during the audit of the groups financial statements for the year to March 2012 which is nearing completion: (1) The chief executive of Aventura International, Armando Thyolo, owns a private jet. Armando invoices the company, on a monthly basis, for that proportion of the operating costs which reflects business use. One of these invoices shows that Darius Harken was flown to Florida in December 2011 and flown back two weeks later. Neither Aventura nor Voest have any offices or associates in Florida. Last week Armando announced his engagement to be married to his personal assistant, Kirsten Fennimore. Before joining Aventura in December 2011, Kirsten had been Voests accountant in charge of the audit of Aventura. (20 marks)

(2)

Required: Discuss the ethical issues raised and the actions which might be taken by the auditor in relation to these matters. (10 marks) 8

Question 5 You are an audit manager in Robo & Co, a firm of Certified Public Accountants. One of your audit clients Beegees Co provides satellite broadcasting services in a rapidly growing market. In May 2011 Beegees purchased Mute Co, a large cable communications provider in India, where your firm has no representation. The financial statements of Mute for the year ending 30 April 2012 will continue to be audited by a local firm of Certified Public Accountants. Explain what effect the acquisitions will have on the planning of Robo & Cos audit of the consolidated financial statements of Beegees Co for the year ending 31 May 2012. (10 marks)