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ADVANCED AUDIT & ASSURANCE

STRATEGIC LEVEL EXAMINATION

APRIL 2021

Notes: Section A: Answer Question 1 and Section B: Answer any two questions from Questions, 2, 3 and 4.

TIME ALLOWED: 4 hours, plus 20 minutes to read the paper. EXAMINATION FORMAT: This is an open book examination. Hard copy material may be consulted during this examination, subject to the limitations advised on the Institute’s website. INSTRUCTIONS: During the reading time, candidates are encouraged to use this time to read each Question carefully. Please note, however, candidates will not be prevented from using this time to start typing notes and solutions. Marks for each question are shown. The pass mark required is 50% in total over the whole paper.

You are reminded to pay particular attention to your communication skills, and care must be taken regarding the format and literacy of your solutions. The marking system will take into account the content of your answers and the extent to which answers are supported with relevant legislation, case law or examples, where appropriate. N.B. Please note that the right click function has been disabled during your examination. Should you wish to copy and paste, please use the following shortcuts: Copy (Ctrl + C) and Paste (Ctrl + V).

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Section A: Answer Question 1

Question 1 It is April 2021, and you are Liam O’Callaghan, an audit senior working for Malcolm & Co. who will lead the fieldwork team on the audit of CJM Gardens Ltd (CJM). Your manager, Laura O’Brien, arrives to brief you on the forthcoming assignment: “Hi Liam, this is the first year we will be auditing the financial statements of CJM. They were audited for a number of years by another firm that has recently closed following the retirement of their partners. We have completed the pre-engagement acceptance procedures and found no reason not to accept appointment as auditors for the year ended 31 March 2021.” Laura also provided you with the following background information: CJM operates a chain of 25 retail garden centres throughout Ireland, supplying customers with trees and plants as well as related gardening products such as lawn mowers, tools and pesticides. The managing director, John Martin, recently said, “Although COVID-19 has hit a lot of businesses very hard, we have been very successful. The government restrictions, the lockdown and the great weather in Spring/Summer 2020 resulted in people spending more time in their homes and gardens. We are delighted with our results for the current financial year.” Plants and trees are purchased, ready for sale, from a variety of specialist suppliers in the UK and Europe. Suppliers in the UK invoice CJM in pound sterling (£). Customers pay for purchases using cash or debit/credit cards. CJM carried out a full inventory count at each garden centre on 31 March 2021, where representatives from Malcolm & Co were present. Employees at each garden centre include permanent gardening staff, who maintain the trees and plants available for sale, and permanent retail and customer services staff. In addition, a large number of temporary staff are employed between April and September due to the increased volume of sales in this period. In July 2020, the directors commenced building work to increase the size of their garden centres to cope with increased demand and social distancing requirements. As a result of the highly seasonal nature of the business, the directors obtained a bank loan in September 2020 to ensure sufficient cash was available to continue the building works during the winter months, November 2020 - March 2021. The bank loan is repayable over five years with interest payable quarterly in arrears at a rate of 5.25%. The bank loan has strict covenants attached and, if there is a breach, the loan may become repayable immediately. The managing director, John Martin, wants to expand the business even further, and would like to diversify the business in September 2021, by introducing a gourmet food hall and gift shop into each garden centre. He believes that this will help to reduce the impact of seasonality as these products will be more popular with customers from October to December each year. In order to fund the proposed diversification, a new loan application has been submitted to the company’s bank. The bank wishes to examine the audited financial statements for the year ended 31 March 2021, together with the profit and cash flow forecasts in respect of the proposed diversification, for the three years ending 31 March 2024.

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CJM has adopted a revaluation policy under IAS 16, and carry out a valuation of Property, Plant & Equipment on an annual basis. The matter that will demand the most audit work is the valuation of properties currently under development, especially the determination of the percentage completion of each development at the reporting date. According to the previous auditor, an external valuer was engaged to value the properties at the reporting date. However, CJM has recently employed a newly qualified architect, who will be happy to provide evidence concerning the stage of completion of each property development contract at the financial reporting year end date. The use of this architect to produce a report on all properties being developed will save time and costs. In January 2021, CJM launched a new website allowing customers to purchase products online. The finance director, Lisa Sharpe, explained the company has spent significant money on IT this year. The company has developed its website, and updated IT systems in order to integrate website sales directly into the general ledger and to provide an easier interface for customers to use when ordering and entering their credit card details. However, Lisa expressed concern that the IT system will not be able to cope with the added pressure of the website, as it has recently caused some major system failures, resulting in loss of customers. Further details are provided in Appendix 1. The managing director, John Martin, emailed a set of draft financial statements to the audit manager, Laura O’Brien. Laura has forwarded them onto you (see Appendix 2) and requested you to make a start on the planning section of the audit file.

Appendix 1: IT System Failures (i) The system produces management information which is often incorrect. Unfortunately, we

haven’t always noticed that it was incorrect, and decisions have been based on this information, particularly on purchasing products. We ended up overstocking, so had to reduce prices to clear inventories.

(ii) On the day of the website launch, some parts of the website didn’t work, and customers were confused. The issue took a month to sort out. The software supplier is now in liquidation, leaving us without a maintenance contract.

(iii) Yesterday, we lost our internet connection due to a virus, and had to turn to our backups which unfortunately were corrupt. Data has definitely been lost, including orders with suppliers, although we have re-input some data.

(iv) Our management report identified a number of large inventory adjustments. I am not sure who made the adjustments, as every member of staff has access to the system. We are careful when an employee leaves to remove them from the system within one month, so the adjustments were probably made by a current employee.

(v) I am aware that we are not using all functionality of the system, and that it can do more and give more information, but due to the above problems encountered, we are currently using the system only when we need to.

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Appendix 2: CJM Gardens Ltd – Financial Statements

CJM Gardens Ltd Statement of profit or loss for the year ended 31 March 2021

2021 2020 €'000 €'000

Revenue 172,656 128,577 Cost of sales (109,499) (90,005) Gross profit 63,157 38,572 Wages and salaries (18,716) (11,265) Administrative expenses ( 30,615) (18,345) Finance cost (389) - Profit before tax 13,437 8,962

CJM Gardens Ltd Statement of financial position at 31 March 2021

2021 2020

€'000 €'000 Noncurrent Assets 29,434 16,434 Intangible Assets 235 -

Current Assets Inventories 10,500 6,165 Cash and cash equivalents 121 239 Other receivables 87 24

10,708 6,428

Total Assets 40,377 22,862

Current liabilities Trade payables 9,278 8,956 Other payables 144 98 Borrowings 3,000 -

12,422 9,054

Non-current liabilities Borrowings 12,000 - Total Liabilities 24,422 9,054

Net Assets 15,955 13,808

Equity 15,955 13,808

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REQUIREMENT:

(a) Using the information provided:

(i) Prepare a detailed preliminary analytical review of the financial statements. (5 marks)

(ii) Draft an email to the managing director, John Martin, requesting any additional information which may be helpful to complete a more detailed analytical review.

(11 marks)

(b) Prepare a materiality workpaper to be included within the planning stage of the audit file. (6 marks)

(c) Identify and explain SIX significant areas of audit risk in respect of the audit of the financial

statements of CJM for the year ended 31 March 2021. (12 marks)

(d) Analyse key risks pertaining to the IT system set out in Appendix 1 and recommend controls

to minimise those risks. (8 marks)

(e) Technology is becoming increasingly more important in today’s audit environment. Data

analytics is perceived as a means of improving audit quality, from its use in the risk assessment process through to the testing of controls and substantive procedures.

Explain how the use of data analytics may improve audit quality. (8 marks)

[Total: 50 Marks]

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Section B: Answer any two questions from Questions, 2, 3 and 4. Question 2 You are an audit manager in Fitzpatrick & Co. Certified Public Accountants and Registered Auditors. You are working on the following clients, and the audit engagement partner has asked you to assess the below client situations: Aqua Ltd (Aqua) Aqua has been a client of your firm for several years. The draft financial statements show that Aqua’s profit before tax is €3.1 million. Prior to the year end, Aqua received legal correspondence which stated it is being sued for a breach of contract with an important customer. The customer is threatening to claim damages of €6.5 million. The audit team has reviewed correspondence and obtained legal confirmations from Aqua’s solicitors. Aqua’s solicitors stated that, due to the subjectivity of the matter, they are unable to conclude whether it is likely that Aqua will win or lose the case. Therefore, Aqua has not made any provision in the financial statements; however Aqua has made the relevant note disclosures. The engagement partner agrees with the accounting treatment and is satisfied that the note includes all the necessary information for the users of the financial statements to understand the situation. Bongo Ltd (Bongo) Your firm is the external auditor of Bongo for the year ended 28 February 2021. Bongo is a clothing retailer and maintains a perpetual inventory system which it uses to calculate the value of inventory at the year end. In March 2021, a computer virus corrupted the data held on the inventory system resulting in the loss of records relating to the value of inventory at 28 February 2021. The finance director was responsible for taking back-ups. However, he was very busy preparing the financial statements at the year end, and he forgot to take a back-up. The last available one was dated 23 December 2020. The directors have estimated the value of inventory at year end to be €1.95 million; however, they are not able to provide suitable documentation to support this. The profit before tax per the draft financial statements is €15.4 million. Windsor Ltd (Windsor) You have almost completed the external audit of Windsor for the year ended 31 January 2021. However, on completion of your subsequent events review, you noticed a letter dated 1 March 2021 from the administrator of Yellow Ltd (Yellow), a customer of Windsor. From the letter you can see that Yellow is in administration and will not be able to pay the balance of €785,000 due to Windsor at 31 January 2021. The directors in Windsor are adamant they are not making a provision for the balance, as they are relying on a loan from the bank, and a bad debt provision will significantly decrease their profit. Windsor’s draft financial statements for the year ended 31 January 2021 show a profit before tax of €3.9 million and total assets of €28.3 million. The directors also said, “sure the letter was not received until after the year end anyway, so there is no need for a provision”.

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REQUIREMENT: (a) Critically appraise the potential impact on the audit report for each of the situations described.

(12 marks)

(b) According to ISA 200 - (Ireland) Overall Objective of the Independent Auditor and the Conduct

of an Audit in Accordance with International Standards on Auditing, the main duty of the auditor is to express an opinion on the truth and fairness of a set of financial statements. You recently attended a staff briefing in relation to ISA 200, where the following key message was communicated: “Should the auditor provide an incorrect opinion, he may be held liable for damages to injured parties.” Critically discuss this statement. (13 marks)

[Total: 25 Marks]

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Question 3 You are a manager in the audit department of Murray Certified Public Accountants and Registered Auditors. You are responsible for the audit of Blue Ltd, an electrical manufacturer and retailer. The final audit for the year ended 28 February 2021 is nearing completion and you are reviewing the audit working papers. The draft financial statements recognise total assets of €215 million (2020 - €208 million), revenue of €165 million (2020 - €148.4 million) and profit before tax of €41 million (2020 - €56.4 million). Three issues from the audit working papers are summarised below: Warranty provision Each year, management makes a provision for electrical goods returned under warranty. It is based on an estimate of return levels for each product type (washing machines, fridges, ovens, TVs etc) and is calculated on an annual basis by the sales director. The breakdown for the current provision, as extracted from the notes to the financial statements, is as follows:

€ million At 1 March 2020 9.5 Provisions charged during the year 1.5 Provisions utilised during the year (1.9) Unutilised provisions reversed (1.1) At 28 February 2021 8.0

Inventory Inventory has been included at €9,350,000 in the Statement of Financial Position at 28 February 2021. Three members of the audit team attended the inventory count on 28 February 2021. You have already reviewed the audit work completed in respect of the inventory count and did not identify any issues. Due to the government restrictions in March 2021, Blue Ltd decided to have an online sale, giving all customers 30% discount off all products. The finance director said it was important to sell all existing inventory before new inventory arrived. The finance director also stated he was confident Blue Ltd would be able to sell all inventory, and a provision was not required at the year-end. Non-Current Assets On review of the board minutes, you see that, in December 2020, the company decided to sell some of its retail units. They are currently on the market for sale, and management is hoping for a quick sale. Non-Current Assets of €16,500,000 have been classified as held for sale at the year-end. From discussions with the finance director, the fair value of the non-current assets less cost to sell is €13,250,000. REQUIREMENT:

(a) In respect of each of the three issues:

(i) Describe the audit evidence required whilst completing the review of an audit file. (18 marks)

(ii) Prepare a statement of material uncorrected misstatements for any misstatements

identified in the question. (3 marks)

(b) In accordance with ISA 560 - Subsequent Events, outline the audit procedures that should be

carried out prior to signing the auditor’s report. (4 marks)

[Total: 25 Marks]

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Question 4 Your audit manager has recently provided a training update on professional ethics. To test your knowledge, she has provided you with the below three situations which have recently arisen at three unrelated firms of Certified Public Accountants and Registered Auditors and has asked you to assess the professional and ethical issues in each case. Atlanta Group Ltd (Atlanta) Grant & Co is the external auditor of Atlanta and its Irish subsidiaries. Atlanta has recently acquired 100% of the share capital of Chen Ltd (Chen), a company incorporated and operating in China. The directors of Atlanta have requested that Grant & Co accepts appointment as external auditor of Chen and undertakes a one-off engagement to review and report on the adequacy of internal controls at Chen. Grant & Co’s annual audit fee for the Atlanta group is expected to rise to €996,700 if it accepts appointment as auditor of Chen. The fee to review and report on internal controls at Chen is expected to be €175,000. Grant & Co’s total annual fee income is expected to be €7.56 million. None of the entities within the Atlanta group are listed. Nolan Ltd (Nolan) The audit engagement partner has discovered that, during the external audit of Nolan for the year ended 31 December 2020, a member of the engagement team accepted an expensive watch as a gift from Nolan for his hard work during the audit. The auditor’s report for the year ended 31 December 2020 has been published. Edge Plc (Edge) Edge is a major audit client of an accounting firm. It is listed on a major Stock Exchange. The audit team consists of eight members, of whom Paul is the most junior. Paul has just joined a personal pension plan that invests in all the listed companies on the Exchange. REQUIREMENT:

(a) Draft a memo to your audit manager which identifies and explains the professional and ethical issues arising in each of the situations above. State any actions that each firm’s partners or its other employees should take to address these issues.

(13 marks)

(b) Set out the specific matters, arising from the acquisition of Chen Ltd, that Grant & Co should consider when planning the audit of Atlanta Group Ltd.

(6 marks)

(c) Describe the audit work Grant & Co should perform during the audit of Atlanta Group Ltd to gain comfort over intra-group balances. (6 marks)

[Total: 25 Marks]

END OF PAPER

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

ADVANCED AUDIT & ASSURANCE STRATEGIC LEVEL ­ APRIL 2021

SOLUTION 1 (a) (i) Analytical review: Calculations

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(ii) Email: To: John Martin, Managing Director From: Liam O’Callaghan, Audit senior Date: April 2021 Subject: CJM Gardens Limited – YE 31.03.21 – Planning Hi John, I hope you are well. I am currently working on the audit of CJM Gardens Limited. I have just reviewed the financial statements and I was wondering if you would be able to help me with some queries I have please? Also, would you be able to provide me with the below documents? I am happy to discuss the below via a phone call if that is easier? I look forward to hearing from you. Kind regards Liam

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The student must ask valid questions following their analytical review and request appropriate documents to help them with their audit of the financial statements.

[2.5 marks available for calculation of 5 key ratios] [Maximum 5 marks available for evidence of detailed calculations/analytical review, including the calculation of 5 key ratios]

[1 mark available for each valid point up to a maximum of 10 marks (to be split equally between enquiries and

documentary information requested)] [1 mark for format]

[Total: 16 marks]

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Page 14

Inte

rnal

Strengths •! Ms. Dunne’s experience and ability •! Market recognition and band name •! Effective competitive strategy •! Modern IT and administrative systems •! Very large fleet of tractors and trailers

Weaknesses •! Overall performance is deteriorating, even

before the current crisis •! Relatively high level of staff turnover,

especially drivers •! Reliance on UK market

Ext

ern

al

Opportunities •! Consolidation in the sector as smaller

competitors may not survive the Covid-19 pandemic and Brexit crisis

•! Increasing TFLI’s market share on routes into the EU

•! Increase the number of multinational clients on annual transport contracts

•! Rebound in international trade once the Covid-19 pandemic and Brexit crisis end

Threats •! The economic impact in Ireland of the

Covid-19 pandemic •! The continuing uncertainty resulting from

the implementation of the Brexit agreement

•! Environmental concerns about the impact of transport !! Eg, CO2 emitted

•! Price competition in the transport market •! The cost of inputs, in particular, fuel

Porter’s Generic Strategies

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(d)

(e) Data analytics can improve audit quality by:

­ Providing the auditor with a deeper understanding of the entity; ­ Facilitating the focus of audit testing on the areas of highest risk through stratification of large

populations ­ Facilitating the exercise of professional scepticism. ­ Improving consistency and central oversight in group audits ­ Enabling the auditor to perform tests on large or complex datasets where a manual approach would not

be feasible ­ Improving audit efficiency ­ Identifying instances of fraud ­ Enhancing communications with audit committees

[1 mark for each valid point above] x 8 = 8 marks

Note: The student will only obtain 0.5 mark for identifying each of the points listed above. They are expected to provide an explanation for each point identified.

Page 19

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SOLUTION 2 (a) Aqua Ltd

• The claim is material as it is 209% of profit before tax. • There is a significant uncertainty, however there is no limitation of scope. • The claim is fundamental to the users understanding of the financial statements, as a successful claim

would turn Aqua’s profit into a loss. • Therefore, the audit report should be modified using an Emphasis of Matter paragraph and a brief

description should draw the users’ attention to the relevant disclosure note. The opinion is not modified in respect of this matter.

Bongo Ltd • The value of inventory is material as it is 12.66% of profit before tax. • The opinion should be modified due to the inability to obtain sufficient appropriate audit evidence –

Limitation of Scope. • The issue is not pervasive as it is isolated to the inventory balance. • The auditor should issue a qualified opinion (‘except for’). Windsor Ltd • The receipt of a letter from the administrator of Yellow provides evidence of conditions existing at the

year end and is therefore an adjusting subsequent event under IAS 10. The amount due from Yellow should be written off.

• The amount is 20.13% of profit before tax and 2.77% of total assets and is therefore material. • A modified auditor’s report/opinion should be issued due to material misstatement. • The matter is not pervasive as it only affects specific items in the financial statements and therefore a

qualified (‘except for’) opinion should be issued.

[1 mark for each valid point to a maximum of 4 marks] x 3 = 12 marks (b) The student should critically discuss the statement.

The below points are suggestions of what the student may include within their discussion:

­ ISA 200 requires the auditor to obtain reasonable assurance as to whether the financial statements as a whole are free from material misstatements whether due to fraud or error.

­ ISA’s require the auditor to exercise professional judgement and professional scepticism throughout the

course of the audit. ­ ISA 500 requires the auditor to gather sufficient and appropriate audit evidence to support their opinion,

and ISA 230 requires all evidence to be documented appropriately. ­ Many different parties may rely on the audited financial statements from a range of stakeholders,

shareholders, potential investors, the bank etc. ­ If the auditor provides an incorrect opinion that causes financial loss to one of the parties relying on the

financial statements, and they have been found to not complying with the ISA’s and carrying out the audit with professional integrity, they may be sued for damages.

­ If a party believes a duty of care existed, and that the duty of care was breached due to the auditor’s

negligence which resulted in a financial loss to them then they may have a strong legal case against the auditor.

Page 20

­ If a legal case is taken up against the auditor for negligence, they must be able to provide the audit evidence they obtained that led to their audit opinion. Therefore, the requirements from ISA 500 & ISA 230 are key.

­ Audit firms do not like to face legal claims, as it is costly, and it can damage their reputation. ­ The student should make reference to examples (case law and recent examples in today’s audit

environment). ­ Audit firms can reduce their exposure to claims from unforeseen third parties by including the following

in their audit and assurance reports:

• Specific addressee(s)/intended users of the report • A clear statement of management’s and the assurance provider’s responsibilities • Reference to the intended purpose(s) of the report • In the case of external audits, a Bannerman paragraph which explicitly states the firm does not

accept responsibility to anyone other than the company/members

Where possible the firm should seek to restrict the distributions of its report.

The engagement letter (ISA 210) should state that the client must seek the firm’s written consent before disclosing the firm’s report to a third party. The firm should then refuse any requests to disclose to a third party where the risk of inappropriate reliance is considered too high.

[1 mark will be awarded for each valid and developed point] – Maximum 13 marks

Page 21

SOLUTION 3 (a) (i) Warranty provision:

• The year­end provisions represent 3.72% of total assets and 19.51% of profit. It is therefore material to the financial statements.

• The estimate of returns is clearly subject to significant subjectivity. This increases the risk of material misstatements due to both error and manipulations.

• The sales director estimates the returns made; however this may be better suited to someone such as a production manager/quality control manager. A quality control manager may be aware of an electrical fault with the goods.

Evidence expected to be found on file: • Copies of sales contracts with customers to include details of terms and conditions and the length of the

warranty period. • Discussions with the sales director, to check the assumptions made, and their calculations. • Discussions with the production manager/quality control manager to see if the estimated returns appear

reasonable, and if there are any known issues in respect of the goods sold. • A copy of the calculation of the warranty provision. The audit team should have carried out an analytical

review, and discussed any significant movements with prior years. • The audit team, should have recalculated the provision, and discussed any differences. • The audit team should review the calculation of the total unutilised provision reversed during the year,

and discuss with management as to why it is no longer needed. Inventory: • Inventory is a material balance, as it is 22.8% of profit before tax, and 4.34% of total assets. • Inventory is a risky area, as we are looking at an electrical manufacturer, and due to the nature of the

business, goods can become obsolete. We know that post year end, Blue Ltd, decided to give 30% off all products.

• According to IAS 2, inventory should be stated at the lower of cost and NRV. Evidence expected to be found on file: • List of all items held in stock at the year end, and details of their cost. • The audit team should have recalculated the schedule, and ensured the total cost agrees to the figure of

€9,350,000 included within the Statement of Financial Position. • The audit team should have discussed with the Finance Director/management, why they believe a stock

provision is not necessary. • The audit team should take a sample of inventory at the year end. They should agree the original cost to

purchase invoices, and they should agree the selling price of the inventory to post year end sales invoices, to see if the goods are held at the lower of cost and NRV in accordance with IAS 2.

• The audit team should discuss with management whether the inventory is being sold in the sale, and look at supporting documentation (sales invoices, bank statements).

• On completion of their NRV testing, the audit team should post any journals required to ensure inventory is recorded at the lower of cost and NRV within the financial statements.

Page 22

Fixed Assets • The retail units have been classified as assets held of sale at the year end. • The balance is material, as it is 40.24% of profit before tax, and 7.67% of total assets. • It is clear the assets are correctly classified as assets held for sale, as they meet the criteria stated in IFRS

5 “Non­current Assets Held for Sale and Discontinued Operations”: o Management is committed to sell o The assets are available for immediate sale in their present condition o The retail units are on the market, and management are looking for a quick sale. o The sale is highly probable, as management are looking for a quick sale, so should therefore be sold

within 12 months. Evidence expected to be found on file: • A copy of the board minutes, where it was noted, the company decided to sell some of their retail units. • Evidence that the retail units are already on the market (brochure from the estate agents/evidence

online) • Physical inspection of assets to confirm they are saleable in the present condition. • Written representation from management to confirm they are committed to selling within 12 months. • Details on the carrying value of the assets at €16,500,000. • Confirmation that depreciation ceased on reclassification of the assets. • Evidence to support the fair value of the assets less cost to sell. • Discussions with management to make them aware the assets held for sale should be measured at the

lower of the carrying amount and fair value less costs to sell, which in this situation is €13,250,000. Therefore, a journal should be proposed of €3,250,000 to reduce the value of the assets to the fair value of the assets less cost to sell.

[[1 mark for each valid point] x 6] x 3 = Maximum 18 marks

(ii)

Statement of Comprehensive Income Statement of Financial Position DEBIT € CREDIT € DEBIT € CREDIT €

DR Impairment 3,250,000 CR NCA Assets Held for Sale 3,250,000 Being journal to reduce NCA Held for Sale to €13,250,000.

[2 marks for the journal entry] [1 mark for format]

(b) In accordance with ISA 560 “Subsequent Events”, the auditor should:

• Obtain an understanding of any procedures management establishes to ensure they identify subsequent events;

• Read the post year end board minutes and inquire with those charged with governance of any matters discussed which have not yet been included within the minutes.

• Discuss with management and those charged with governance whether any subsequent events have occurred post year end.

• Review the company’s post year end management accounts/budgets/cash flow forecasts.

[1 mark for each valid point] x 4 = 4 marks

Page 23

SOLUTION 4 (a) Memo – Professional and ethical issues: To: Audit Manager From: Audit senior Date: August 2021 Subject: Professional and ethical issues following training update I have looked at each of the situations you have provided me with. In the table below, I have identified and explained the professional and ethical issues arising in each one, and I have identified the actions that each firm’s partners or its other employees should take to address the issues.

Page 24

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Page 25

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(b) • The group engagement team needs to obtain an understanding of Chen to ascertain whether Chen is a

significant component and assess the risks of material misstatement. • Materiality for the group financial statements as a whole and component materiality should be

determined. • If Chen is not significant then only analytical procedures at a group level need to be planned.

If reliance is to be placed on a local auditor, the firm must consider whether:

o They will comply with ethical requirements relevant to group audit. o They are competent. o The group audit team will be involved in their work to the extent necessary to obtain sufficient

appropriate audit evidence. o They operate in a regulatory environment that actively oversees auditors. Communication will be required with Chen’s auditor on timely basis and will need to cover: o The work to be performed, o The use to be made of the work, and o The form and content of Chen auditor’s communication with the group audit team

[1 mark for each valid point] x 6 = 6 marks (c) • Intra­group balances should agree because, in the preparation of consolidated accounts, it is necessary

to cancel them out. • If they do not cancel out then the group accounts will be displaying an item which has no value outside

the group and profits may be correspondingly under or over­stated.

[1 mark for each valid point] x 2 = 2 marks

• The audit work required to check that intra­group balances agree would be as follows:

(i) Obtain and review a copy of the holding company’s instructions to all group members relating to the procedures for reconciliation and agreement of year end intra­group balances. Particular attention should be paid to the treatment of ‘in transit’ items to ensure that there is a proper cut­off.

(ii) Obtain a schedule of intra­group balances from all group companies and check the details therein to the summary prepared by the parent company. The details on these schedules should also be independently confirmed in writing by the other auditors involved.

(iii) Nil balances should also be confirmed by both the group companies concerned and their respective auditors.

(iv) The details on the schedules in (ii) above should also be agreed to the details in the financial statements of the individual group companies which are submitted to the parent company for consolidation purposes.

[1 mark for each valid point] x 4 = 4 marks

[Maximum 6 marks available]

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