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Answers

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(c) Audit procedures

In the case of Green Co, audit procedures on going concern will include:

Obtaining cash and profit forecasts from the directors. Ensure that these have been properly prepared (for example are

arithmetically correct) and show that Green will continue trading. Appropriate adjustments should have been made for

the decrease in sales resulting from contamination of Green Cos farm.

Review the order books for Green Co to determine the level of future sales.

Contacting Green Cos lawyers to determine the progress, if any, on the court case against Black Co.

Review the financial status of Green Co during the audit to identify other indicators of a going concern problem such as

failure to repay loans or decrease in sales.

Review correspondence, if any, with the organic certification authority to determine whether Green Cos organic status

has been withdrawn.

Contacting Green Cos bank to ascertain whether any loan or overdraft agreements are due for renewal and whether

these will be renewed.

Obtaining written representation from the directors confirming that they are not aware of any circumstances other than

those evaluated by the auditor, so they expect Green Co to continue as a going concern.

2 (a) Factors affecting sufficiency

Assessment of inherent risk

As inherent risk increases, then more audit evidence will be required to reduce detection risk.

Materiality of the item

A decrease in materiality means that more audit evidence will be required to ensure that no material error has occurred.

Nature of the accounting and control systems

Where the accounting and control systems are poor then more audit evidence is necessary as less reliance can be placed on

those systems.

Control risk

Determine the extent to which the directors have implemented a sound system of internal control; poor internal controls

increase control risk, decreasing reliance that can be placed on those controls.

Experience from previous audits

Good experience from previous audits will decrease the amount of evidence required as the auditor can place reliance onprevious review of clients systems.

Result of audit procedures

Where the results of different audit procedures agree with each other then overall less evidence is needed overall the

evidence is more persuasive; however, where results are in conflict then more evidence is required.

Quality of information available

Some sources of audit evidence are more reliable than others meaning less evidence is needed when relying on those

sources for example, documentary evidence is more reliable than oral evidence.

(b) (i) Trade payables

Audit procedure Reason for procedure

Cast the list of trade payables and agree the total to the To confirm that the list is complete, is accurately stated

payables ledger and then to the general ledger. in the general ledger and contains no unusual orreconciling items which must be investigated.

Test, on a sample basis that payables on the list agree to To confirm that the list agrees to the payables ledger.

the individual ledger balance and from the ledger to the list.

Compare trade payables individually and in total to prior To explain changes in the balances. For example, the

year balances and explain any unusual changes. increase in payables could indicate cash flow problems

and Metcalf & Co is delaying payment to suppliers in

response to this.

Comparison may also indicate lack of completeness of

the list where payables balances have been omitted.

Select a sample of individual payables accounts for testing, Material balances should always be tested to ensure

focusing on material balances, zero balances and a sample correctness and test a large amount of payables by

of other items. value. Some zero balances are tested to ensure thatinvoices have not been omitted from one supplier.

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Select population from purchase invoices received after Confirm completeness of recording of purchase invoices.

the year-end. Trace to evidence of goods receipt and where

goods received prior year-end, ensure invoice amount

included in purchase accrual.

Obtain year-end supplier statements (either from Metcalf & Agree the payables balance to independent third party

Co or direct from the individual supplier via a circularisation evidence to confirm accuracy, completeness and

letter). Agree the balance on the statement to the individual existence of the ledger balance.

account in Metcalf & Cos payables ledger. Where necessary,

reconcile the balances taking into account cash and

invoices in transit.

Take a sample of purchase invoices recorded in the To ensure that liabilities recorded in the PDB are

purchase day book (PDB) just prior to the year end and represented by goods received during that year, and

trace to goods received note (GRN), ensuring that the goods recorded in the correct period (cut-off testing).

were received prior to the end of the year.

Take a sample of GRNs prior to the end of the year and To ensure completeness of recording of amounts

trace to purchase invoice or the goods received not invoiced payable.

accrual in the financial statements.

Take a sample of GRNs just after the end of the year and To ensure that the purchases figure is not overstated in

trace to purchase invoice. Ensure that the invoice is this years financial statements.

recorded in the PDB after the year-end.

List all debit balances and obtain an explanation from the To confirm why the balance arose and consider

client. re-classifying the amounts as receivables. Debit

balances may indicate control weaknesses with

additional implications for audit testing.

(ii) Accruals


Cast the list of accruals and agree individual amounts to Confirm that the list is complete, the balances are

the general ledger accounts. accurately stated in the general ledger and contains no

unusual or reconciling items which must be

investigated.

Compare individual accruals with amount in the prior year To account for unusual differences and identify

accounts. omissions from the list this year.

Agree accruals to payments made after the end of the year To help ensure the accuracy of the amounts paid and

for example, amounts payable for tax deducted from wages confirm that the accruals are genuine.

payments to remittance to the tax authority.

Review payments after the year-end to determine whether To confirm completeness of the accruals listing.

any accruals are required. Where the need for an accrual is

identified, ensure this is included in the accruals list.

Check calculations of individual accruals to supporting To check that the accrual has been calculated correctly

documentation for example, tax deductions from wages to and therefore testing for over or understatement of each

to the amount shown on the payroll as deducted from wages accrual.

for the last month of the year.

(iii) Provision for legal action


Discuss the provision with the directors. To attempt to confirm whether the company is liable for

the payment and confirm that an out-of-court settlement

is appropriate.

Obtain a letter from Metcalf & Cos lawyers. To provide evidence on whether Metcalf may be liable

for payment and check the amount provided is

approximately correct.

Review any correspondence with the customer. To help determine Metcalf & Cos liability and determine

whether the customer may accept the out-of-court

settlement.

Obtain a letter of representation from the directors. To confirm that the directors are considering settlement

out of court.

If possible, trace the payment made after the end of the To confirm the accuracy of the amount stated in

year to receipt from the customer stating that the payment is accruals.

accepted in full and final settlement i.e. no other payments

are expected to be made.

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3 (a) Report to audit committee

Inventory control and Sales System

Seed division

12 June 2007

The internal audit of the inventory and sales system identified the following weaknesses:

Weakness Potential effect of weakness Recommendation

Recording of orders

Orders placed on the Internet site are Customers will be sent incorrect The computer systems are amended so

transferred manually into the inventory goods resulting in increased customer that order details are transferred directly

and sales system. Manual transfer of complaints. between the two computer systems. This

order details may result in information will remove manual transfer of details

being transferred incompletely or limiting the possibility of human error.

incorrectly, for example, order

quantities may be incorrect or the

wrong product code recorded.

Control over orders and packing lists

Each order/packing list is given a Packing lists can be lost resulting Orders/packing lists are controlled with a

random alphabetical code. While this either in goods not being despatched numeric sequence. At the end of each

is useful, using this type of code to the customer (if the list is lost prior day, gaps in the sequence of packing lists

makes it difficult to check to goods being despatched) or the returned to accounts are investigated.

completeness of orders at any stage customers credit card not being

in the despatch and invoicing process. charged (if lost after goods despatched

but prior to the list being received in

the accounts department).

Obtaining payment

The customers credit card is charged Rhapsody Co will not be paid for the Authorisation to charge the customers

after despatch of goods to the goods despatched where the credit credit card is obtained prior to despatch of

customer, meaning that goods are company rejects the payment request. goods to ensure Rhapsody Co is paid for

already sent to the customer before Given that customers are unlikely to all goods despatched.

payment is authorised. return seeds, Rhapsody will

automatically incur a bad debt.

Completeness of orders

The computer system correctly Entire orders may be overlooked and The computer is programmed to reviewensures that order details are consequently sales and profit the order file and orders where there is no

available for all charges to customer understated. corresponding invoice for an order, these

credit cards. However, there is no should be flagged for subsequent

overall check that all orders recorded investigation.

on the inventory and sales system

have actually been invoiced.

Summary

We look forward to arranging a meeting to discuss these weaknesses with you in more detail.

Note to candidates: the marking scheme shows other valid points.

(b) Advantages of having an audit committee to Rhapsody include:

It provides the internal audit department with an independent reporting mechanism compared to reporting to thedirectors who may wish to hide or amend unfavourable internal audit reports.

The audit committee will assist the internal auditor by ensuring that recommendations in internal audit reports are

actioned.

Shareholder and public confidence in published financial information is enhanced because it has been reviewed by an

independent committee.

The committee helps the directors fulfil any obligations under corporate governance to implement and maintain an

appropriate system of internal control within Rhapsody.

The committee should assist in providing better communication between the directors, external auditors and

management by arranging meetings with the external auditor.

Strengthens the independence of Rhapsodys external auditor by providing a clear reporting structure and separate

appointment mechanism from the board of Rhapsody.

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4 (a) Audit report element Reason for that element

Title of independent auditor To identify this as an audit repor t and distinguish it from other reports

on financial statements that might be issued by others, directors, etc.

Addressee (according to local regulations) To identify the person(s) who may use or rely on the report.

Opening or introductory paragraph identifying

the financial statements audited and To make it clear which pages of an annual report have been audited.

responsibilities of entitys management and To make clear that the directors prepare the financial statements and

auditors the auditors audit them following international standards on auditing(ISAs).

Scope paragraph describing the nature of the To explain the scope of the audit so the standard of the auditors work

audit in terms of ISAs followed and the work is clear and other factors such as limitation of audit testing (for

performed by the auditor example, not tested all items) is known.

Opinion paragraph referring to the financial To provide the auditors opinion on the financial statements in terms of

reporting framework followed and expressing the true and fair view, to assure the reader that the audit has been carried

auditors opinion out in accordance with established principles and practices.

Date of the report To inform the reader that the auditor has considered effects of

transactions that the auditor became aware of on the financial

statements up to that date.

Auditors address This is normally the city where the auditor responsible for the audit is

located so he/she can be contacted, if necessary.

Auditors signature This is normally the signature of the audit firm as the firm assumes

responsibility for the audit, not the individual engagement partner.

(b) Issue one Understatement of sales income

(i) If possible, conduct day-by-day analytical review to determine the extent of the misappropriation.

Discuss the situation with the other directors to ascertain their knowledge of the situation.

Ask the other directors what action they will take regarding the director who appears to have misappropriated

money from the company.

Recommend in the management letter that strict numeric sequence is maintained over sales invoices and that two

directors are always on duty to prevent misappropriation of income.

Obtain a letter of representation to confirm the directors estimate of the extent of the fraud and confirm that the

directors are not aware of any other instances of fraud.

(ii) The misappropriation is material, being about 5% of income for the year. Therefore:

Modify the auditors report with an except for opinion on limitation of scope of audit work on sales income.

Explain the reason for the understatement of income in the basis of opinion paragraph above the opinion

paragraph.

Issue two Directors use of yacht

(i) Ask the director why the yacht is located at his house.

Ask the director whether any payment was made for the yacht confirm payment to the cash book and company

bank statements.

If the yacht is for private use only, check that disclosure of the benefit has been made in the directors emolumentsnote in the financial statements.

Depending on the law of your jurisdiction, recommend to the director that any tax return clearly shows the benefit

in kind derived from the companys asset.

Ensure the company has provided relevant information to the benefit authority and accrued any penalty for non-

disclosure.

Consider additional audit work to determine whether or not any other company assets have been used in a similar

fashion.

(ii) Assuming that disclosure of the benefit has not been shown in the financial statements then:

Modify the auditors report using an except for opinion disagreeing with the amount of information disclosed.

As the lack of disclosure relates to directors emoluments, provide information on the benefit in the audit report

itself.

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5 (a) The purposes of audit working papers include:

To assist with the planning and performance of the audit.

To assist in the supervision and review of audit work, and

To record the audit evidence resulting from the audit work performed to support the auditors opinion.

(b) Documentation Information obtain

Memorandum and articles of association Details of the objectives of Specs4You, its permitted capital structure

and the internal constitution of the company.

Most recent published financial statements Provide detail on the size of the company, profitability, etc as well as any

unusual factors such as loans due for repayment.

Most recent management accounts/budgets/ Determine the current status of the company including ongoing

cash flow information profitability, ability to meet budget, etc as well as identifying any

potential going concern problems.

Organisation chart of Spec4You To identify the key managers and employees in the company and other

people to contact during the audit.

Industry data on spectacle sales To find out how Specs4You is per forming compared to the industry

standards. This will help to highlight any areas of concern for example,

higher than expected cost of sales, for investigation on the audit.

Financial statements of similar entities To compare the accounting policies of Specs4You and obtain additional

information on industry standards.

Prior year audit file To establish what problems were encountered in last years audit, how

those problems were resolved and identify any areas of concern for this

years audit.

Internet news sites To find out whether the company has any significant news stories,

(good or bad) which may affect the audit approach.

(c) The audit working paper does not meet the standards normally expected in a working paper because:

The page reference is unclear making it very difficult to either file the working paper in the audit file or locate the working

paper should there be queries on it.

It is not clear what the client year end date is the year is missing. The working paper could easily be filed in the wrong

years audit file. There is no signature of the person who prepared the working paper. This means it is unclear who to address queries

to regarding the preparation or contents of the working paper.

There is evidence of a reviewers signature. However, given that the reviewer did not query the lack of preparers

signature or other omissions noted below, the effectiveness of the review must be put in question.

The test objective is vague it is not clear what correct means for example, it would be better to state the objective

in terms of assertions such as completeness or accuracy.

The test objective is also stated as an audit assertion. This is not the case as no audit assertions are actually listed here.

It is not clear how the number for testing was determined. This means it will be very difficult to determine whether

sufficient audit evidence was obtained for this test.

Stating that details of testing can be found on another working paper is insufficient time will be wasted finding the

working paper, if it has, in fact, been included in the audit working paper file. Information on the results of the test is unclear the working paper should clearly state the results of the test without

bias. The preparer appears to have used personal judgement which is not appropriate as the opinion should be based

on the facts available, not speculation.

The conclusion provided does not appear to be consistent with the results of the test. Five errors were found therefore

it is likely that there are some systems weaknesses.

6 (a) Advantages of perpetual inventory systems

There is no disruption caused by an annual inventory count.

There is more accurate and regular inventory counting, which enables errors and slow moving or damaged inventory to

be identified earlier.

Actual inventory balances are known at any time, allowing re-ordering of best selling books to take place on a timely

basis. There will also be fewer causes of inventory reaching zero causing stockouts with orders not being fulfilled.

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Increased control over storekeepers because inventory is being reviewed regularly; this should decrease any pilferage.

Auditors can rely on the computerised inventory system, reducing substantive audit tests of inventory during the year

and at the year end.

(b) Audit procedures

Audit procedure Physical count Reason for procedure

Arrange a meeting with the internal audit Determine the extent to which reliance can be placed on the work of the

department. Discuss the procedures carried out internal audit department.and review working papers produced during the

continuous inventory checks. For any errors

identified, ensure that appropriate adjustments

were made to the perpetual inventory system.

Visit the warehouse and:

Obtain a sample of inventory items already To ensure that the inventory recorded on the computer system actually

recorded on the perpetual inventory system and exists.

agree to the book inventory.

For a sample of books in the warehouse, obtain To ensure that all inventory is recorded on the inventory computer

details and agree perpetual computer system system and there is completeness of recording.

records.

Review the condition of the books, taking details To confirm that any inventory which is damaged or unsaleable is

of any which appear to be old or damaged. correctly valued.

Form an opinion regarding the overall accuracy To confirm that inventory quantities have been correctly recorded.

of the perpetual inventory system.

Ensure all inventory lines are counted at least To confirm that all inventory is counted regularly.

once per year in discussion with the internal

audit department.

(c) Fundamental ethical principles

Integrity

Integrity is essential for all people operating in the public interest. Integrity implies not only honesty, but also related qualities

of fairness, candour, intellectual honesty and confidentiality.

During an audit it is essential that directors can rely on an auditor to keep information about the company confidential. If this

was not the case then directors may be less forthcoming with essential information, decreasing the effectiveness of the audit.

Objectivity

Objectivity is a state of mind that excludes bias, prejudice and compromise and that gives fair and impartial consideration to

all matters that are relevant to the task in hand, disregarding those that are not.

Accountants have to be objective because many of the factors which make up an opinion on a set of financial statements

relate to questions of judgement rather than fact. Accountants therefore need to be unbiased and impartial in making their

decisions, especially where they may need to challenge assumptions already made by the directors.

Independence

Independence is freedom from situations and relationships which make it probable that a reasonable and informed third party

would conclude that objectivity is either impaired or could be impaired. Independence is therefore related to and underpins

objectivity.

Accountants will therefore not participate in any activity or relationship that may impair, or appear to impair, their judgement.

They will also not accept anything which may appear to impair their judgement.

(d) Actions in respect of the engagement letter not being signed

Discuss the matter again with the directors in an attempt to reach a suitable compromise.

Remind the directors that statutory audits require the directors to make all the necessary information and explanations

available to the auditor.

Explain that lack of information on the website will result in a limitation in scope of the audit work.

Further explain that because the lack of evidence appears to relate to a material amount that the auditors report will

have to be modified with an except for qualification due to the lack of information and the possibility of misstatement

of non-current assets.

Finally note that auditor may have to decline to work for MistiRead unless suitable terms of engagement can be agreed.

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Part 2 Examination Paper 2.6(INT)

Audit and Internal Review (International Stream) June 2007 Marking Scheme

Marks

1 (a) 05 for identifying threat, 1 mark each for point (05 where not explained)

Self-review threat

Management threat

Advocacy threat

Familiarity threatFee income

Association threat

Other relevant points (each)

Maximum marks 8

(b) Key points 1 for each point

(i) State going concern (enterprise operational existence) 1

Not used when liquidation or ceased trading 1

Not used when directors will liquidate or cease trading 1

Maximum marks 3

(ii) Directors responsibilities prepare FS 1Evidence produce 1

Auditor responsibilities check GC concept 1

Collect audit evidence 1

Disclosure of going concern concept if necessary 1

Maximum marks 4

(c) Key points 1 for each point

Profit and cash flow forecasts 1

Review order books 1

Contact lawyers 1

Review financial status other GC indicators 1

Correspondence organic certification 1Contact bank 1

Representation letter 1

Other good relevant points 1

Maximum marks 5

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Marks

2 (a) 1 mark per point (05 for point and 05 for explanation)

Assessment of inherent risk

Materiality of the item

Nature of the accounting and control systems

Control risk

Experience from previous audits

Result of audit procedures

Source and reliability of information availableOther relevant points

Maximum marks 4

(b) (i) Trade payables (05 for test and 05 for explanation)

List of payables cast and agree to general ledger

Agree list to payables ledger and ledger to list

Analytical procedures

Select sample for testing rationale for sample

Supplier statement reconciliation agree balances

Treatment of non-reconciling items

Cut-off prior year end invoice to GRN

GRN to invoice prior year end.

Cut-off post year end

Debit balances treatment 9

(ii) Accruals (05 for test and 05 for explanation)

Obtain list cast and agree general ledger

Analytical procedures

Payments made post year end

Supporting documentation 3

(iii) Legal provision (05 for test and 05 for explanation)

Discuss with directors

Lawyer letter

Correspondence with customer

Letter of representation

Post year end payment (if possible) 4Maximum marks 16

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Marks

3 (a) Content of report 1 mark each for

Identifying weakness

Effect of weakness

Recommendation to remove weakness

Recording of orders 3

Control over orders and packing lists 3

Obtaining payment 3

Completeness of orders 3No check on goods in inventory when ordered 3

Two part packing slip insufficient 3

Sales invoice not sent to customer 3

Inventory only updated on despatch 3

Other relevant points 3

Maximum marks 12

Format of answer appropriate headings 1

Format of answer report format 1

Maximum marks this section 14

(b) 1 mark per relevant pointIndependent reporting 1

Help internal audit implement changes 1

Shareholder/public confidence 1

Directors obligations 1

Communication external auditors 1

Independence external auditor 1

Other relevant points (each) 1

Maximum marks 6

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Marks

4 (a) Elements of audit report. 1 mark for each of the following (being 05 for the element and

05 for explanation for that element).

Title of report 1

Addressee of report 1

Introductory paragraph 1

Scope paragraph 1

Opinion paragraph 1

Date of report 1Auditors address 1

Auditors signature 1

Maximum marks 6

(b) Maximum 14 marks this section (8 for (1) and 6 for (2))

(i) Additional audit procedures

Issue one up to 6 marks

Additional audit work 1

Discuss with directors 1

Action against director 1

Management letter 1

Letter of representation 1Other relevant points (each) 1

Issue two up to 4 marks

Talk with director 1

Asset transferred to director? 1

Ask whether any payment made for yacht 1

Check disclosure financial statements 1

Check tax return 1

Other relevant points (each) 1

(ii) Effect on audit report

Issue one up to 3 marks

Amount is material 1

Modify except for uncertainty 1

Explain why modified 1Issue two up to 3 marks

Modify except for disagreement 1

Provide disclosure 1

Maximum marks 14

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Marks

5 (a) 1 mark per point

Assist planning 1

Assist supervision 1

Record of audit evidence 1


Maximum marks 3

(b) 05 for document, 05 for information obtained

Memo and articles 1

Financial statements 1

Management accounts 1

Organisation chart 1

Industry data 1

Financial statements similar companies 1

Prior year audit file 1

Internet news sites 1

Permanent audit file 1

Board minutes 1


Maximum marks 8

(c) 1 mark per relevant point (05 for area, 05 for explaining why working paper poor quality)

Page reference 1

Year end 1

No preparer signature 1

Poor job from reviewer 1

Vague test objective 1

Not an audit assertion 1

Sufficient audit evidence obtained? 1

Lack of appropriate referencing 1

Test results unclear 1

Conclusion not consistent with results found 1

Other relevant points (each) 1Maximum marks 9

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Marks

6 (a) 1 mark each advantage

No disruption 1

Identify slow moving damaged inventory quicker 1

Always have actual inventory details available 1

Increased control storekeepers 1

Limit audit tests 1


Maximum marks 4

(b) 05 for procedure, 05 for explaining purpose

Meeting with internal audit 1

Continuous inventory > book inventory 1

Book inventory > continuous inventory 1

Condition of books 1

Opinion on accuracy continuous inventory system 1

All lines counted once per year 1

Computer record amendment to actual inventory levels 1

Acceptable procedures on return of inventory 1


Maximum marks 6

(c) 1 mark for explaining concept and 1 for applying to accountants

Integrity 2

Objectivity 2

Independence 2

Maximum marks 6

(d) 1 mark each

Discuss with directors 1

Requirement to make information available to auditor 1

Limitation in scope of audit work 1

Modification of audit report 1Possibly not work for client 1


Maximum marks 4

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Documents

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