Audit and Assurance (AA) Solution Pack

S. No Syllabus Area Question ACCA Exam Paper

1 Audit Framework and Regulation Ruby Ltd -

2 Audit Framework and Regulation Emerald Ltd -

3 Audit Framework and Regulation Bark Ltd -

4 Planning and Risk Assessment Brooklyn & Co Sep/Dec 2019

5 Planning and Risk Assessment Daffodil & Co Mar/Jun 2019

6 Planning and Risk Assessment Earl and Co Sep/Dec 2018

7 Planning and Risk Assessment Loganberry Mar/Jun 2018

8 Planning and Risk Assessment Dower Ltd -

9 Planning and Risk Assessment Head -

10 Planning and Risk Assessment Glass Ltd -

11 Planning and Risk Assessment Recorder -

12 Internal Control Amberjack Ltd Sep/Dec 2019

13 Internal Control Freesia Mar/Jun 2019

14 Internal Control Raspberry Mar/Jun 2018

15 Internal Control Murray Ltd -

16 Internal Control Becker Ltd -

17 Internal Control Nadal Ltd -

18 Internal Control Cherry -

19 Internal Control Knowledge -

20 Audit Evidence Spadefish & Co Sep/Dec 2019

21 Audit Evidence Hyacinth Co Mar/Jun 2019

22 Audit Evidence Jasmine Co Sep/Dec 2018

23 Audit Evidence Camomile Sep/Dec 2018

24 Audit Evidence Cranberry Mar/Jun 2018

25 Audit Evidence Pearl Ltd -

26 Audit Evidence Tickam Ltd -

27 Audit Evidence Mast Ltd -

28 Review and Reporting Pizza Ltd -

29 Review and Reporting Lesley and Co -

30 Review and Reporting Gavin Ltd -

31 Review and Reporting Bullfinch -

Ruby Ltd - Answer a) Principles based approach This involves a set of basic guidelines that provide a framework that can be applied to a range of ethical situations. The principles do not tell you exactly how each situation must be dealt with, but do provide best practice guidelines. A principles based approach is flexible and can be used in rapidly changing situations. It is not an approach that is restricted by national laws or boundaries and it encourages the responsible application of judgement. Rules based approach This is definitely an easier approach to follow because the specific rules are clearly defined. However, this approach will need constant updating, as rules will need to be adapted to deal with new and different situations. It will also be quite de-motivating for auditors because it does not encourage the use of responsible professional judgement - no thinking for yourself! The ACCA Code of Conduct adopts a principles based approach. b) Regular change of auditors Threat - This suggests that the client may be quite demanding during the audit and is an intimidation threat because we may not feel that we can do our job without being questioned and pressured. Action - It would be a good idea to contact the previous auditors - and maybe some of the other previous audit firms as well - to establish what problems have been encountered with client 'interference ' to see if it is too big a problem to manage effectively. Fee Pressure Threat - A client that is very concerned about fee levels can put pressure on the audit firm to 'cut corners ' during the audit so that things are done quickly, but work quality suffers as a result. Action - The fee should be explained and agreed with the client before any work is undertaken. If the client refuses to accept the fee level quoted then the work should be refused. Specialist Industry Issue - From a quality point of view, there is a chance that the staff assigned to the audit of Ruby Ltd does not have enough specialised knowledge about the diamond industry. Action - We must ensure that staff has the requisite knowledge. It may be advisable to use the work of an expert as part of our audit work. Bank Pressure

Issue - The pressure from the bank means time for the completion of the audit work is short so there is a risk that work will not be done properly, and that the client may be tempted to manipulate the financial statements in order to present a favourable view to the bank in order to increase the chances of getting the loan. Action - We must ensure that sufficient numbers of audit staff are available so that the work can be completed on time. We must also ensure that professional scepticism is applied to the figures in the financial statements in view of the increased possibility of manipulation. Family Members Issue - This is a potential familiarity threat. It would look as though the two staff who have relatives working at the client would possibly overlook some issues because they do not want to fall out with members of their own family. Action - These two staff members should not be assigned to the audit of Ruby Ltd. They are, however, free to work on any other unconnected audit engagements. Request for Help with Accounts Issue - The help with maintenance of accounting records and the preparation of financial statements is a self-review threat because the audit firm would be giving an opinion on something that they have helped to prepare. Action - I would suggest segregation of duties. This is not a listed company so it is acceptable to undertake the work, but there should be one team of audit staff doing the accounts work and a separate team doing the actual audit. Takeover Advice Issue - Any advice creates a management, or advocacy threat. Any decisions on how the client is going to operate - including what companies they may buy - should be made by the management of Ruby Ltd. If we do it, then it looks as though we are making management decisions. Action - We can help them by providing some guidance on the potential acquisition BUT we must ensure that the management of Ruby Ltd are aware that the actual decision is down to them. Making sure management are aware of this is called ensuring Informed Management, in other words we make sure that management know what they are supposed to do.

Emerald Ltd - Answer The answer to this part is perfectly acceptable in a two column table. a) Objective Internal and external audit have different objectives. Internal audit aims to add value to an organisation by improving its operations. An external audit provides an opinion on the truth and fairness of the financial statements. Reporting Internal auditors usually report to the board of directors or the audit committee. External auditors always report to the shareholders. Scope The internal audit scope of work is determined by the client and will vary according to the desired objective. The external auditor can ask for any information or explanation that they consider necessary. The scope of their work is determined by them. Status Internal auditors are usually employees of the client. External auditors are totally independent of the client, never employees. b) Internal audit The position of the internal audit function will be stronger. They will not have to report directly to the board of directors. Neither will they be monitored and controlled by the board. Reporting directly to the audit committee will improve their ability to act in the best interest of the company as a whole, not just for the benefit of the directors. This could directly help solve the current problems of a lack of support that are being experienced by the chief internal auditor. External auditor The position of the external auditor will be stronger and more effective as well. The audit committee is a very useful point of contact for external auditors. They can use this channel of communication to voice any concerns about the internal audit work or the activities of the main board. Non-Executive director

At present there are no non-executive directors, but Emerald is going to appoint one to serve on the audit committee. Non-executive directors are able to use their business experience and to provide unbiased advice to Emerald in order to help them operate effectively. It would be advisable for Emerald Ltd to have a balance of executive and non-executive directors, so more than one would be necessary. Finance The bank is more likely to provide the finance that is required Emerald Ltd. Audit committees increase the confidence of possible finance providers, they see it as an extra level of protection for their investment. Shareholders The introduction of an audit committee is likely to increase the confidence of the shareholders as well. As well as making existing shareholders feel more at ease that Emerald Ltd is operating effectively, it may also attract new ones which could mean more investment becoming available. Finance Director The increased confidence provided by the audit committee may make it easier to fill the gap left by the departure of the finance director. It may also enable Emerald Ltd to attract a higher level of employee. The Hands on Approach An audit committee would provide a control over the very close relationship that the current board has with the operations of Emerald Ltd. Even if the board is actually operating ethically and effectively, having a degree of autonomous input is generally viewed as an improvement, something that will make them more responsible in the decision making process.

Bark Ltd - Answer a) An auditor CAN disclose confidential information in certain circumstances; - A client may give you permission to do so. It is essential that this is documented in case the client tries to deny giving consent at a later date. - If disclosure is in the public interest, then an auditor can make disclosure of any necessary information. There are also a number of situations where an auditor MUST disclose; - We must disclose in order to comply with any quality control review that is being carried out by a regulatory body, such as the ACCA. - We must disclose if we are under investigation by a professional body. - If we are required by law to act as a witness in a court case, then disclosure will also be necessary. - Sometimes auditors will find that the client has broken the law, or is potentially going to do so. We would have to disclose this. - Some specific issues will need to be disclosed relating to any assurance client. If they are guilty of terrorism money laundering or drug trafficking, then these must always be disclosed. b) Size of client Threat There could be an increased self-interest threat due to our concern over losing the large amount of fee income that is obtained from Bark Ltd. There are a number of services that are being provided on a recurring basis. Safeguard The level of recurring fees should be constantly monitored to ensure that it does not exceed the permitted level. If necessary, some work could be passed on to a different firm. This would mean a loss of some income but at least the client would still be kept. Length of time Threat There is a familiarity threat associated with long association - carrying out an audit for a number of years will make it look as though the audit firm is too relaxed in their audit work so may not do it properly. Safeguard Bark Ltd is not listed so all that needs to happen is that the relationship needs to be reviewed, but staff could be swapped to be seen to be acting as responsibly as possible. Advice

Threat Tax and management consultancy advice can create a management threat. This is the danger that the audit firm may be making decisions that are normally made by the client. Safeguard We should make sure that Bark Ltd has “informed management". This means that it should be clarified with the directors that they know it is their responsibility to make the decisions and that we cannot do it for them. Former employee Threat There is a self-review threat because one of the audit staff used to work for the client. If they are involved in the audit, then they may well end up reviewing their own work. Safeguard The former employee should not be assigned to the audit of Bark Ltd for the next two years. This is considered to be an acceptable "cooling off” period. Finance Director Threat There is a familiarity threat because of the personal relationship between one member of your staff and the finance director of Bark Ltd. The perception would be that any required professional scepticism would not be applied by the individual who is auditing the work of their own father. Safeguard The individual involved should not be assigned to the audit of Emerald Ltd. They have shown sound ethical behaviour by informing us of the relationship though - we may not have found out otherwise. Meal Threat This is a self-interest threat. It may be offered with the best of intentions, but it could be perceived as a bribe to overlook any problems that may be found during the audit. Safeguard It is advisable for this tradition to be stopped. If the reason for doing so is explained carefully, then there is no reason that it should sour the relationship with Bark Ltd.

Brooklyn & Co - Answer Part (a) – Fraud Responsibility As per ISA 240 ‘The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements’, the auditors are required to obtain reasonable assurance that the financial statements are free from material misstatement. These misstatements can be caused by fraud or error. The auditor also needs to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to fraud through designing and implementing appropriate responses. The auditors maintain professional scepticism throughout the audit, considering the potential for management override of controls and recognising the fact that audit procedures which are effective in detecting error may not be effective in detecting fraud. A discussion is held with the entire engagement team to ensure everyone is aware of the risks and responsibilities for fraud and error. For members not present at the meeting, the audit engagement partner should determine which matters should be communicated to them. Part (b) – Ratios

20X5 20X4

Gross profit margin 4,500/23,200 = 19·4% 4,600/21,900 = 21%

Inventory holding period 2,100/18,700 * 365 = 41 day 1,600/17,300 * 365 = 34 days

Gearing ratio 13,000/(10,000 + 13,000) = 56·5% 11,000/(9,500 + 11,000) = 53·7%

Interest cover (450 + 290)/290 = 2·6 (850 + 250)/250 = 4·4

Part (c) – Audit risks and auditor’s response

Audit risk Auditor’s Response

The prior year management report highlighted significant deficiencies relating to the purchases cycle. If these deficiencies have not been rectified, the controls over purchases and payables may continue to be weak leading to increased control risk and risk of misstatements arising.

Discuss with management whether the purchases cycle recommendations suggested by Brooklyn & Co were implemented successfully this year. If so, undertake tests of these controls to assess if they are operating efficiently.

It is the plan of finance director to reduce the estimated return rate for goods sold on a sale or return basis to wholesale customers from 10% to 5%. IFRS 15 provides that revenue and cost of sales should only be accounted for to the extent that the company foresees that the goods will not be returned. For the goods which may be returned, the company should recognise a refund liability. By reducing the return rate, there is a risk that revenue and cost of sales may be overstated and liabilities understated

Discuss the basis of 5% assumption. Review a period of 60 days to quantify the levels of return in the specified period and compare this to the assumed rate of 5%.

A patent was purchased for $800,000 last year, which has a useful life of four years. The carrying amount in the forecast financial statements is $800,000 which is the same as the prior year. In accordance with IAS 38 Intangible Assets, this intangible asset should be amortised. It does not appear that management has correctly accounted for the amortisation and as a result, intangible assets and profits are overstated.

Agree the useful life of the patent with the supporting documentation. The amortisation charge should be calculated and the appropriate journal adjustment discussed with management,

Unusually high profits or losses on disposal are an indication that the depreciation policy of plant and machinery may not be appropriate. Therefore, depreciation may be understated and profit and assets overstated.

Discuss the depreciation policy for plant and machinery with the finance director to assess its reasonableness. Review for other significant gains or losses on disposal of property, plant and equipment to assess the reasonableness of the company’s depreciation policies.

Harlem Co’s financial controller has allegedly carried out a number of fraudulent transactions at the company. There is a risk that she may have undertaken a significant level of fraudulent transactions leading to an increased control risk which has not yet been identified.

Discuss with the finance director the details of the fraud perpetrated by the financial controller and what procedures have been adopted to date to identify any adjustments which are needed in the financial statements. Additional substantive testing should be conducted over the affected areas of the accounting records.

The financial controller was dismissed and is threatening to sue the company for unfair dismissal. A provision (or disclosure) for unfair dismissal is required to comply with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. If Harlem Co has not done this, there is a risk over the completeness of any provisions or contingent liabilities disclosures.

Discuss with management and request confirmation from the company’s lawyers of the existence and likelihood of success of any claim from the former financial controller

Harlem Co has had production problems which have affected the quality of a significant batch of tyres. In addition, the inventory holding period has increased from 34 to 41 days.

Discuss with the finance director whether any write downs will be made to the affected tyres, and what, if any, modifications may be required with regards to the quality.

A significant customer has been granted a six-month payment break and the receivables collection period has increased from 38 to 51 days. An allowance for receivables has historically been maintained, and it is anticipated that it will remain at the prior year level.

Review and test the controls surrounding how the finance director identifies old or potentially irrecoverable receivables balances and credit control to ensure that they are operating effectively.

Part (d) – Substantive procedures for valuation of trade receivables

Obtain a breakdown of the opening allowance and consider if the receivables provided for in the prior year have been recovered to assess the reasonableness of the prior levels of allowances.

Review the aged trade receivables ledger to identify any slow moving or old receivable balances and discuss the status of these balances with the credit controllers to assess whether they are likely to be received.

Review whether there are any after-date cash receipts for slow moving/old receivable balances. Part (e) – Substantive procedures for disposals of plant and machinery

For a sample of disposals, agree sale proceeds to supporting documentation such as sundry sales invoices.

Recalculate the profit/loss on disposal, and agree to the trial balance and statement of profit or loss.

Review the disclosure of the disposals in the draft financial statements, and ensure it is in line with IAS 16 Property, Plant and Equipment.

Daffodil & Co - Answer a) Under IAS 320 auditors must establish materiality levels for the financial statements as a whole and

performance materiality levels for individual balances.

Overall materiality: Misstatements in the financial statements are material if either individually, or in aggregate, they result in the financial statements not presenting a true and fair view of the position and performance of the company. Thus, they could influence the decisions taken by users of the financial statements.

A misstatement could be material due to its size, its nature or a combination of both.

The level of materiality is often calculated based on benchmarks, such as 5% of profit before tax. However, it is ultimately based on the auditor’s professional judgment, considering factors such as the needs of the users and the perceived level of risk.

Performance materiality is used to test individual transactions balances and disclosures. It is set at a lower level than overall materiality and aims to reduce the risk that the aggregate errors in the balances, transactions and disclosures exceed overall materiality.

b)

Audit Risk Audit Response

Over-reliance on internal audit’s (IA’s) testing of controls, leading to an incorrect assessment of the strength of those controls. This may increase detection risk if insufficient substantive testing is carried out

Meet with IA and carry out a review of their work. Tests on this should be carried out to ensure its adequacy prior to placing any reliance on it. Some re-performance of the testing carried IA should also occur

The gross margin is forecast to increase significantly from 56% to 60%. This is inconsistent will the forecast fall in operating margin from 21% to 18%

This may indicate misclassified expenses which would create an understatement of cost of sales and an overstatement of operating expenses

Review the classification of costs between cost of sales and operating expenses and compare to the prior year

Investigate any inconsistencies

Inventory should be valued at the lower of cost and NRV, but Peony value inventory based on selling price less average profit margin. If this is not a close approximation to cost then inventory could be misstated

Inventory could also be misstated if the perpetual inventory counts are not fully completed

The interim audit found significant exceptions where the inventory in the warehouse was lower than the inventory records. The year-end figures are likely to be based on the records and therefore overstated.

Sample testing of inventory items to ensure they have been valued correctly

Valuation testing to confirm selling price less average profit margin is a close approximation to cost

Review timetable of, and controls over, perpetual inventory counts

Discuss with management the extent to which inventory records at the year-end can be relied upon and recommend a full year-end inventory count if necessary

Assets that had not been fully depreciated were identified as obsolete, suggesting the depreciation policy is insufficient

Obsolete items should be written off to the statement of profit or loss

Depreciation may be understated, and profits

Discuss the depreciation policy with the finance director and assess reasonableness

Enquire if obsolete assets have been written off, and review any adjustments for completeness

and assets may be overstated

Advertising costs relating to adverts shown in the prior year should be expensed, not included as a current asset as planned

If these costs are not expensed, current assets and profits will be overstated

Discuss the rationale for inclusion as a current asset, and request evidence to support the assessment of probable future value

Review documentation to confirm the adverts were shown prior to the year end

Request the amount is removed from current assets and charged to operating expenses

Outsourcing of the payroll function during the year increases detection risk if Peony does not have sufficient appropriate evidence to confirm the completeness and controls over the payroll cycle and liabilities at the year end

Errors during the transfer process could result in the misstatement of wages and salaries

Determine what records are held at Peony since payroll was outsourced and how controls over payroll are monitored

Confirm controls in place with the outsource company

Discuss with management the controls that were in place over the transfer process

Test the effectiveness of transfer controls where possible

Perform substantive testing on the transfer of information to the new system

The loan of $3m should be allocated between non-current and current liabilities and adequately disclosed. Failure to classify it correctly may result in misclassified liabilities

Check the split of the loan by re-performing the calculations carried out by Peony Co

Confirm $3m was received by checking loan documentation.

Review disclosures to ensure sufficient detail is provided

A redundancy provision will need to be made if the announcement to staff is made before the year end. If this is not done, or the amount is insufficient, there will be an understatement of provisions and expenses

Discuss the status of the redundancy announcement with management

Review the basis of, and recalculate, the redundancy provision

Earl & Co - Answer Part (a) Analytical procedures are useful when reviewing or auditing areas of the financial statements. In particular for those that are difficult to obtain external evidence. ISA 315 identifying and assessing the risks of material misstatement, and ISA520 Analytical procedures, state there are three stages to use them as part of the audit. Analytical procedures are used at the planning stage to compare the draft financial information with the previous year, budgets or forecasts and industry averages. This is carried out as part of the risk assessment process to help understand the entity and identify the risk of material misstatements. ISA320 states we should use analytical procedures at the completion stage to ensure the evidence collected throughout the audit is consistent with the financial statements and conclusions made look reasonable. They can also be used at the testing stage of the audit. Substantive analytical procedures and be used to obtain sufficient appropriate evidence. Part (b) Ratio calculations – calculate 3

20X8 20X7

Gross profit margin

7410/19580 X 100 = 37.3%

6190/16990 X 100 =36.4%

Receivables day Ratio

2750/19850*365 = 51 DAYS

1780/16990*365 = 38 DAYS

Current ratio

4600/2780 =1.65

3670/1190 =3.08

Part (c) Audit risks in scenario

Audit risk Auditors response

Darjeeling has spent $0.9m on the development of new product lines, some of which are in the early stages of development. This is all in intangible assets. There is a risk that some, of not all of this does not reach the criteria required for it to be an intangible asset as per IAS38. Assets and profit may be overstated and expenses understated.

Obtain a breakdown of the capitalised development costs. Review the costs by comparing to cost documentation and discuss any changes required with the finance director.

Darjeeling have also purchased and installed a new manufacturing line. All the costs have been capitalised including servicing and maintenance plan for $0.5m.

Ensure the servicing and maintenance plan is $0.5m by agreeing to documentation. Calculate the correct treatment and discuss changes with the finance director.

This cost does not qualify as an asset according to IAS16. It should be an expense released over the 5-year plan and therefore assets and profit are overstated and expenses understated.

To finance the new projects, they have taken a $4m loan from the bank to be paid over 8 years at 5%. There is a risk that disclosure of the loan may not be adequate. The loan must be split between current and non-current liabilities.

Agree the receipt of the loan with bank records. Calculate the correct split and compare to the disclosure of the note in the financial statements.

Darjeeling has extended their credit terms to its customers if they increase their credit terms. In addition receivable days has increased from 38 days to 51 days. There is a risk that this could increase sales that cannot be paid for if reasonable credit checks are not carried out. This could lead to an increase in bad debts. Receivables and profit could both be overstated.

Increase testing on post year-end cash receipts to identify further customers who may not yet have paid. Inspect customer correspondence further into the following year to identify customers who may be struggling to pay and ensure a thorough aged receivable analysis review.

They have introduced a price promise to match prices with competitors. They can claim the difference within one month of the date of purchase of goods. There is a risk that the refund liability they have included may not conform with IFRS 15 revenue from contracts with customers. As it is a new initiative the directors may not have disclosed this correctly leading to over or understated profits and liabilities.

Discuss the basis used to form the $0.25 liability with the directors with a thorough review of supporting documentation and calculations.

There were faulty paint products detected in the year due to customers complaining about the goods. There is a risk that customer refunds may not have been accounted for correctly. Inventory figures should be adjusted for the current year and provisions made for an estimate of the refunds. This could lead to overstated revenue, understated liabilities and over/understated inventory.

Obtain a breakdown of sales of the faulty batch. Ensure the sales have been removed for these in the year and that inventory and liabilities are reasonable.

There were other products that were not sold but still faulty.

Ensure a detailed review of the inventory valuation to identify the cost and NRV and ensure the lower of the two has been used in

There is a risk that valuation of these products may not have been adjusted correctly leading to inventory being misstated.

valuation.

There has been a fall in this year’s current ratio from 3.08 to 1.65. The bank balance has also seen a change from a positive $560k to an overdraft of $810k. There is a risk that they are struggling with cash flow. With the addition of the new $4m loan to pay these are all going concern indicators and going concern disclosure may not be adequate in the financial statements.

Going concern testing should be increased. Any issues should be followed up with management to be satisfied that the going concern status is reasonable. Any disclosures included in the financial statements should be carefully reviewed.

Part (d) Substantive audit procedures for faulty paint in inventory Obtain a schedule of the faulty paint in inventory showing the cost and NRV breakdown and the returns made by customers and cast it for accuracy. From the schedule, agree the costs of damaged goods to production records to confirm the amounts shown are accurate. For products where the inventory should be adjusted, agree the adjustment required to the inventory records to ensure this has been carried out. For a sample of returns made by customers on the schedule, agree the return to any supporting documentation and ensure it is adjusted in the ledger to confirm the accuracy of the returns adjustment. Discuss with management what their plans are for production. Identify whether this is an isolated case or if controls need to be reviewed to ensure further cases cannot arise. Part (e) Substantive audit procedures in relation to revenue. Compare the current total revenue figure to the previous year and the budget and investigate significant differences. Obtain a breakdown of sales into product categories and compare to last year for each category and budget and investigate significant differences and possible misallocations. Calculate the gross profit margin for current and previous year and discuss significant differences with management. Select a sample of sales invoices in the year from the sales daybook, agree to the source documents including the order and despatch note to ensure the accuracy and existence of sales recorded. For a sample of sales invoices, recalculate the total and agree prices used with client price list to confirm accuracy of total.

Loganberry - Answer

a) Responsibilities of Loganberry in relation to fraud and error.

As Loganberry are the auditors, they have a responsibility to follow their international auditing standards, including ISA240, the Auditors Responsibilities relating to fraud in an Audit of the Financial Statements.

ISA240 states that the Auditors have a responsibility to assess the risk of fraud and error being

present in the Financial Statements in the form of material misstatements. Overall, the Auditors have a responsibility to obtain reasonable assurance that the financial statements are free from material misstatements, whether caused by fraud or error.

In order to comply, the Auditors must design and carry out appropriate audit procedures during the course of the audit, which will help assess the risk.

The audit team must also ensure they communicate the risks and responsibilities to the whole team. If the risk is high, the audit team must adapt their work and be aware of why they are doing it.

If fraud or a significant risk of fraud is found, they must respond appropriately on a timely basis.

b) Audit risk and responses in relation to Blackberry Co. There are 8 needed.

Audit Risk Auditor’s response

Inventory includes raw materials and costs of conversion, which includes general overheads. As IAS2 does not permit general overheads, there is a risk that some of these costs are not allowed and inventory may be overstated in the financial statements.

Discuss the inclusion of overheads with management and obtain a breakdown of these costs to identify if they comply with what is allowed as per IAS2.

There are 3 warehouses and full counts will be taken on 2, 3 and 4 April, when the year-end is 31 March. There is a risk that the adjustments for movements made after the year-end will not be carried out accurately and inventory may include material misstatements.

The auditor should attend all of the inventory counts and observe the process of adjusting for movements and inspect all documentation to identify if it has been controlled appropriately.

Blackberry has paid $1.1m to purchase a patent that will help them gain competitive advantage. This has been expensed. IAS38 states that this patent should be capitalised and then amortised over its useful economic life. As a result, assets and profit are understated.

The auditors must discuss this matter with the directors and instruct them of the correct treatment and the impact it has on the financial statements and audit report if not corrected.

Blackberry financed the patent with an The auditor’s must confirm the split for the

issue of shares at a premium for $1.2m There is a risk that this share issue has not been disclosed correctly in the financial statements, and the equity split and disclosure notes may be misstated.

share premium and ensure the amounts in the financial statements are correct. They must also confirm the $1.2m received was from shares.

A significant fraud has been carried out during the financial year. There is a risk that the full amounts involved have not been identified and the fraud impact may be misstated in the financial statements.

The auditor’s must review the fraud evidence and discuss what the procedures were for identifying the amounts stolen from the company.

The sales ledger processing has now been outsourced after the dismissal of the individuals who carried out the fraud. There is a risk that the controls over the transfer process to the outsourced company were insufficient and the sales ledger may contain material misstatements.

Discuss the transfer process with management and what controls were in place to ensure the new sales function is effective for the company.

In December, the financial accountant was dismissed and has now threatened to claim against the company for unfair dismissal. There is a risk that disclosure of this potential liability may be insufficient in the financial statements, leading to a material misstatement.

Discuss the potential case with management and inspect legal correspondence to identify how possible this potential liability could be.

Now the financial accountant is no longer working for blackberry, there have been no supplier statement reconciliations or purchase ledger control account reconciliations carried out for the last 3 months of the year. There is a significant risk that there could be material misstatements present and not detected in the purchase ledger, leading to the financial statements.

There must be an increased level of work carried out by the audit team on the purchase ledger, including a significant sample of supplier statement reconciliations, to identify potential misstatements. They could discuss whether year-end purchase ledger control account reconciliation can be carried out.

There were other audit risks contained within the scenario. There were also other ideas for auditor’s responses that could be used. Remember to stick to the number of risks required in the question and write enough about them to gain maximum marks.

Dower Ltd - Answer a)

Planning will help identify relevant audit risks, which is likely to make audit work more effective.

Planning will enable effective staff allocation, to ensure the right level of staff is allocated to the right level of assignment.

Planning will help protect against liability claims. If a client accuses an auditor of not doing their job properly, evidence of planning will re assure the client.

Planning will help enable audit firms to pass any quality control checks that are carried out, either internally or externally, by the profession.

b) We could compare the client results and position for this year with the previous year and make a note of any significant differences. We could calculate some financial ratios for this year and compare them to last year and, again, make a note of any discrepancies to be followed up at a later date. We could compare the actual results for the financial year with any available budgets for the same period. c) New computer system The new computer system may not operate effectively due to inadequate testing or poor back up facilities, which increases the risk of the figures it produces being wrong. Warehouse extension The costs incurred may be misclassified. All directly attributable expenses should be capitalised and there is a risk that this has not been done. Also the extension needs to be depreciated and may not have been. Alternatively, the warehouse may have been depreciated but over an inappropriate length of useful economic life. Bank Loan The bank loan is dependent upon the audited financial statements, so there is a risk that the management of Dower Ltd will manipulate the figures to show a very positive position in order to increase the chances of receiving the loan. This increases the risk of misstatement and makes our job harder. Bonus There is additional incentive for the management of Dower Ltd to manipulate the financial statements because they are paid a sales related bonus. The fact that sales has increased by 30% this year may well be an accurate reflection of performance, but it may well be a falsification.

Lots of cash Dower Ltd is a largely cash based business. Having lots of cash means that there is a chance that the cash could get lost or stolen. As a result the cash position of the business could be overstated. Money laundering is much more likely to occur in a cash based business, which will also increase the risk of misstatement. The vans The vans are going to be used for longer than originally expected, so the useful economic lives should be reviewed and changed. If this is not done, then the assets would be misstated. Due to the age of the vans, some of them may need impairing. If this is not done, then assets will be overstated. Being sued If it is felt that the customer will win their case, then a provision would be required in the financial statements. There is a risk that this has not been done, which would understate liabilities. If it is felt that the customer is not likely to win the case, then a disclosure note would be required for the contingent liability. There is a risk that this may not have been done either. Late payments The fact that some credit customers have started to pay late will increase the risk of bad and doubtful debts existing. If these have not been recognised then the current assets of Dower Ltd will be overstated. d) Detection risk is the risk that our audit work will fail to identify a material misstatement. Basically, the more we do, the more likely we are to find something wrong. Detection risk can be decreased by; - Changing the extent of our work - doing more. For Dower Ltd, this could involve performing more audit work on a larger sample of vehicles seeing as we expect there to be problems with valuation/ useful economic lives. - Changing the nature of our work - obtaining a different, more reliable type of evidence. For Dower Ltd, this could involve carrying out a direct confirmation of receivables which is an external source, instead of relying on the client records to confirm the existence of the debt. - Changing the timing of the work done - carrying out audit work at the year- end instead of waiting until the final audit. For Dower Ltd, this could involve counting and monitoring the cash at the year end, seeing as it is such a large and high risk item. e) Quantitative materiality is when a value is used to determine the significance of an item.

Most items in the financial statements are said to be material if their value is high. However, some things are material due to their nature - because of what they are. It does matter about the value; it is the type of item that makes it a material one. This is qualitative materiality and an example would be a transaction involving a related party.

Head - Answer a) Audit risk is the risk that an auditor will arrive at an inappropriate audit opinion. It is made up of; Inherent risk - the risk that material misstatements will occur due to the circumstances surrounding the client and the environment in which they operate Control risk - the risk that the client's system of internal control will fail to identify the misstatements that exist Detection risk - the risk that our audit work will fail to identify a material misstatement b) Guidelines The strict guidelines that relate to the running of the charity are often complex and time consuming to observe and apply. There is a chance that this has not been done properly by Head. The auditors will have to spend time familiarising themselves with the detail of the legal requirements. Breach If these guidelines are breached, then Head may incur penalties and fines from the regulatory authorities that may have been missed, so not recorded properly. The auditors should consider direct confirmation with the regulatory authorities to confirm whether or not this may have occurred. Expenditure The limit imposed on the level of permitted expenditure creates a risk that the level will be breached. Management may even deliberately misstate the expenditure levels in order to create the illusion of compliance. More audit work should be done on the expenses of Head to ensure that misstatement has not occurred. Donations The donations come from different sources. There are potentially a large number of donors that will be difficult to control so income could be lost. This will be an area that the audit firm will need to concentrate on by doing a lot of testing trying, to ensure that there is no understatement of income due to donations not being recorded. Cash Lots of the above donations would be in cash, which is easily lost or stolen, so increases the risk of misstatement. There should be extensive testing of the controls that relate to cash collection and cash recording to ensure that Head has addressed this issue. Tax situation The complex tax rules may not be understood by Head, or may be deliberately avoided. Either way, there would be misstatements as a result. The auditors should discuss with the management of Head to establish the extent of the knowledge that have about the regulations and the importance that is place upon them.

Expenditure Capital and revenue expenditure having different definitions for accounting and tax purposes will increase the risk of misclassification between the two if the definitions get mixed up. Extensive analysis of all repairs, maintenance and capital items should be undertaken by the auditors to try and maximise the chances of finding any misclassification errors. Uncertainty over donation income This may require disclosure in the financial statements and may even threaten the going concern status of Head Ltd. Auditors must carry out sufficient going concern procedures in order to form an opinion on whether the correct basis of preparation has been used by Head and that any uncertainty has been adequately disclosed. c) The control environment is the overall attitude that Head adopts to the importance of having well controlled operations. It may well be weak because of;

A lack of understanding of the charity regulations surrounding Head.

A lack of understanding concerning the complexity and importance of the tax rules.

The fact that a lot of volunteers are involved in the operation of Head, who perhaps do not have the same firm-wide values that employed members of staff may have.

Insufficient emphasis placed upon the risks of having lots of cash.

A lack of awareness as to how important it is for Head to keep a good relationship with its major contributors.

A possible lack of segregation of duties as everyone tries to help out wherever possible, instead of sticking to clearly defined roles.

The probability that no internal audit department or the audit committee exists. Either or both would increase the potential for good control.

Glass Ltd - Answer a) Purpose of working papers: - To help with the planning of an audit. - To document all work. - To assist with review and supervision. - To help ensure audit quality. - To help achieve a standardised approach. - To help protect against liability claims. b) Previous year audit file - this will tell us where the risk areas were last year as well as the audit approach that was used. Previous year financial statements - these will help us carry out relevant analytical procedures. Forecasts / budgets - this will give us some going concern information as well as helping with analytical procedures. Store location lists -this will help us allocate staff and organise inventory count attendances. Organisation chart / key staff members - this will help us assess the control environment and enable us to arrange discussions with key personnel. Internet search results - this could identify possible adverse publicity experienced by Glass Ltd that may affect its operations. Board minutes / memorandum and articles of association - these will help establish company structure and confirm any significant events that may have occurred. Lawyer correspondence - this would help confirm the existence of any court cases either for or against Glass Ltd. c) The working paper does not give the name of the preparer, making it difficult to get any amendments made if required. There is no specific mention of the year-end to which the working paper relates - it could be a different year in the wrong audit file and no one would know. “The purchase day book is correct" is not actually an audit assertion. It is more of an objective than an assertion, so the wrong terminology is used here. There should be an assertion and an objective, so there is some information missing. There is no specific reference to the actual document that contains the sample details, making it difficult to find. There is no explanation of how the sample was selected. There are a number of statistical and non-statistical methods that could have been used, so it is important to clarify this. There is no reference on the working paper so it may not get filed in the correct part of the audit file.

The conclusion contradicts the results. 5 items were not found but the conclusion says that everything was agreed. This is not consistent. The method is not specific enough. It just refers to details being checked. There should be a description of exactly what is being agreed - prices? quantities? coding?

Recorder - Answer a) 1) Recorder is a new client for Piano. This is an audit risk as the auditors may lack a fundamental

understanding of the business and miss key information in identifying material misstatements. This increases detection risk.

The auditors response will be to ensure the planning phase is longer, spend more time understanding the entity and its environment and to include more experienced audit team members so they can deal with issues in a speedier manner.

2) They purchase goods from South Asia and they are in transit for 2 weeks. This is an audit risk

because the delay in receipt of goods could cause errors in cut-off of payables and purchase transactions. Only goods actually received should be recorded in these balances before the year end.

The auditors response should be to increase sample sizes for cut-off testing for purchases from South Asia to identify if the recording of goods in transit at the year end is accurate.

3) There is a new bonus for sales staff, giving them a target of increasing customer sign ups for

24 month phone contracts. This is an audit risk as it encourages sales staff to include sales contracts that actually relate to the following year, to ensure their bonus is higher. It could also potentially encourage fictitious contracts to be included to increase their sales.

The auditors response should be to increase cut off testing over sales made from the 24 month phone contracts. They should also review any cancelled contracts after the year end and compare to the previous year.

4) The receivable levels are considerably higher this year and there is a concern for the

creditworthiness of customers. This is an audit risk as it suggests there could be bad debts that have not been adjusted. This means that the receivables balance could be overstated, along with the profit for the year.

The auditors response should be to perform analytical procedures on the receivables balance. Inspect the aged receivables list and investigate any slow moving and old balances with the client to decide if adjustments are needed. They should also review the allowance for receivables and consider whether the balance is adequate.

5) They have revalued all land and buildings this year. This is an audit risk as the adjustment to the

land and buildings balance may not be in accordance with IAS16, the property plant and equipment standard. The balance could now contain a material misstatement and the disclosure in the financial statements on this could be inadequate.

The auditors response should be to compare the process of revaluation carried out by the client to the IAS16 standard. This should be done by enquiry with the client management. They should identify if an expert had been used to conduct the valuation.

b) The auditor should perform the following on the inventory count for Recorder at the year end - The auditors should attend a sample of the monthly inventory counts. While present, they should

review the controls over the count and ensure they are happy they are adequate;

- The could also consider attending the final month inventory count at the year end, June 2014. This would enable them to test for potential misstatements by counting a sample of inventory in the warehouse and agreeing to the inventory records. Then also for a sample of items on the inventory records, find in the warehouse and recount and agree to what was recorded;

- The auditors should ensure that each product line has been counted at least once in the year. The

monthly count sheets should be reviewed and compared to the product list and any products not included should be flagged up to the client.

c) The auditors should perform the following procedures on the bonus in question: - They should obtain a schedule of directors pay, including the bonus, and add it up to confirm the

accuracy of the balance. - They should then agree the bonus in the schedule agrees to the payroll records by matching the

individual amounts for each director to the payroll system. - The auditors should then confirm they have been paid these amounts by agreeing the individual

bonus amounts on the schedule to the bank statements and cashbook. d) Auditors must keep client information confidential as it is one of the Ethical fundamental principles followed by the profession. Where a conflict of interest is present, the auditors must inform both clients of the conflict and must have agreement from both parties before they can continue. Each client should be recommended that they seek independent advice before they continue. If both clients agree, then the audit firm must ensure they have separate engagement partners, and separate teams for the audit work to be completed. If possible, separate offices should deal with each client. The auditors who are involved on either team could also sign confidentiality agreements to reinforce the importance of keeping client information confidential. Other controls such as a focus on physical security of client information. Locking client files away and encrypted passwords on computer systems should be in place. Training on confidentiality and its importance would also benefit the audit firm.

Amberjack Co - Answer Part (a) – Control objectives for sales and dispatch system

To ensure that goods are only supplied to customers with reasonable credit ratings.

To ensure that goods are dispatched for all orders on a timely basis.

To ensure that the correct quantity of goods are dispatched, and they are of an adequate quality.

To ensure that all goods dispatched are correctly invoiced at authorised prices. Part (b) – Report to management Board of directors

Amberjack Co

21 Under the Sea

Shorelife City

Shark Country

1 July 20X5

Dear Sirs, Audit of Amberjack Co for the year ended 30 April 20X5 The report to management on deficiencies in internal controls identified during the audit for the year ended 30 April 20X5 is enclosed. The appendix to this report considers deficiencies in the sales and dispatch system, and provides recommendations to address those deficiencies. Please note that this report only addresses the deficiencies identified during the audit, and if further testing had been performed, then more deficiencies may have been reported. This report is solely for the use of management and if you have any further questions, then please do not hesitate to contact us. Yours faithfully An audit firm Appendix

Control Deficiency Control Recommendation

The credit controller is currently on secondment to the internal audit department, and has not been replaced. During this period, it does not appear that anyone else has been responsible for monitoring ageing receivables.

During the period of the secondment, an alternative member of the finance department should be trained in the credit control role and assigned responsibility for reviewing the aged receivables listing and following up on any overdue customers.

Credit limits are set by receivables ledger clerks. Receivables ledger clerks are not sufficiently senior and so may set limits too high, leading to irrecoverable debts.

Credit limits should be set by a senior member of the receivables ledger department and not by receivables ledger clerks. These limits should be regularly reviewed by a responsible official.

Goods dispatch notes (GDN) are given the same number as the order number to which they relate. The sales invoices are only raised on receipt of a GDN, and without separate sequential numbers, it is difficult for Amberjack Co to identify if any GDNs are missing. If GDNs are missing and the company fails to raise invoices in a timely manner, this could lead to a loss of revenue.

GDNs should all be sequentially numbered using a sequence which is different to the order number. On a regular basis, a sequence check of GDNs should be undertaken to identify any missing dispatch notes.

After order processing, the sales order department of Amberjack Co does not receive a copy of the GDN.

The GDN should be amended to be at least four-part. One copy should be sent to the sales order department.

Additional staff has been drafted in to help the sales clerks produce the sales invoices. As the extra staff will not be as experienced as the sales clerks, there is an increased risk of mistakes being made in the sales invoices.

Only the sales clerks should be able to raise sales invoices. As Amberjack Co is expanding, consideration should be given to recruiting and training more permanent sales clerks who can produce sales invoices.

The receivables ledger control account is only reconciled at the end of April in order to verify the year-end balance. If the receivables ledger is only reconciled annually, there is a risk that errors will not be spotted promptly and receivables may be misstated.

The receivables ledger control account should be reconciled on a monthly basis to identify any errors which should be investigated and corrected. The reconciliations should be reviewed by a responsible official and they should evidence their review by way of signature.

Customer statements are no longer being generated and sent to customers. Disputed invoices may arise, leading to cash flow issues.

Amberjack Co should produce monthly customer statements for all customers and send them out promptly.

Discounts given to customers who purchased goods during the 10% off weekend are manually entered onto the sales invoices by sales clerks. This could result in unauthorised sales discounts being given.

During the period of any special offers, such as the 10% off weekend, the authorised sales prices file should be updated by a responsible official. These changes should be reviewed for any input errors, this review should be evidenced.

Freesia - Answer

a)

(i) Description (ii) Advantages

Narrative notes Document the system. They explain each stage of the system and any controls involved

Easy to produce following discussion or system walkthrough

Easy to understand

Questionnaires A list of questions for major transaction cycles to determine

What controls exist

Effectiveness of those controls

Time effective; quick to compile

Missing controls can be clearly identified

b) Tutorial note: You are only asked for SIX deficiencies, more have been provided here for tuition purposes.

Control deficiency Control recommendation Test of control

Credit limits are set by junior staff

Inappropriate credit limits may lead to loss of sales (if too low) or bad debts (if too high)

Credit limits should be set by senior member of sales department and reviewed regularly

Ask sales ledger clerks who is authorised to set credit limits

Sample test authorisation of credit limits for new customers

Non-sequential customer orders; makes it hard to identify missing orders and track timeliness of dispatch. Missing or late orders may reduce customer goodwill

Orders should be numbered sequentially and checked regularly to identify missing orders

Carry out a sequence test of sales orders and discuss gaps identified with sales team

Lack of segregation of duties in the cash receipts system. This reduces the timely identification of errors, and increases the risk of fraud

Posting bank receipts, updating the sales ledger, and carrying out bank reconciliations should be carried out by different members of staff

Ask the financial controller who carries out these tasks

Check ID logs in the finance system to determine who carried out the tasks

GRNs are not sent to the department that placed the order, so level of unfulfilled orders cannot be monitored potentially leading to stock-outs and loss of sales

GRN copy should go to the warehouse, the ordering department and the finance department

GRN should be matched to the purchase order

Unfulfilled orders should be regularly reviewed and followed up with suppliers

Sample check GRNs to ensure match to orders

Review unfulfilled orders and discuss any overdue items with ordering clerk

Lack of controls over invoice input; existing control verifies

Invoices should be input in batches and application controls e.g. control totals

Using test data, input dummy invoice batch without using control totals

completeness, but not accuracy or validity

Suppliers may be paid late, the wrong amount, or not at all leading to loss of suppliers and/or supplier credit facilities

should be in place to check accuracy and completeness of input

Sequence checks in the system should be established to check input completeness

to determine what the system will allow

Observe the invoice input process and note the controls utilized

Out dated standard costs used to value inventory, leading to misstated inventory and profit

Valuation may not be in line with IAS2 which only allows standard costs to be used if they are a close approximation to actual costs

Standard costs should be regularly reviewed and compared with actual costs to ensure they are a close approximation

Revised standard costs should be reviewed and authorised by the production director

Determine the date at which standard costs were last reviewed, and ensure this review was evidenced by the production director

Overtime not authorised before payment

Incorrect amounts may be paid, increasing the payroll cost

Suitably authorised individual should review overtime payments prior to payment

Sample check overtime payments for evidence of authorisation and ensure this took place before payment was made

Checking bank transfers against payroll records will not identify missing, or fictitious employees. Incorrect or fraudulent payments could be made as a result

The finance director should sample check the payment list to the HR records and vice versa when authorising payments and sign the payment list to evidence the checks

Review payment lists for finance director signature confirming the checks have been carried out

c) Substantive procedures to audit accrual for employment tax payable:

Compare accrual to the previous year and investigate differences

Confirm accuracy of accrual by agreeing it to payroll records

For a sample of employees, re-perform the calculation of the accrual

Proof in total text by multiplying the June 20X9 payroll cost by the appropriate tax rate. Compare to accrual and investigate differences

Confirm completeness by agreeing subsequent payment to post year-end cash book and bank statements

Review tax authority correspondence to determine if there are any outstanding payments and confirm these are included in the accrual

Review disclosures relating to the accrual to ensure they comply with accounting standards and legislation

d) Corporate governance weaknesses and recommendations

Weakness Recommendation

The finance director is an audit committee, this compromises independence

The finance director should resign from the audit committee; the committee should

comprise exclusively of NEDs

The finance director sets director’s salaries. Inappropriately high pay may be set if directors set their own salary

Directors pay should be set by a remuneration committee consisting of NEDs. NED pay should be set by the board as a whole

Annual profit related bonus may encourage directors to focus on the short term profit rather than long term maximisation of shareholder wealth

Executive remuneration should be restructured so that a significant proportion is based on long-term success, eg share options

Liaising with shareholders is carried out by the chairman only

All member of the board should liaise with shareholders.

The annual report should include a statement from the board explaining the steps taken to ensure the views of major shareholders are understood

Raspberry – Answer

a) i) Five key controls the auditor may seek reliance on ii) Test of control to perform to assess these controls

KEY CONTROLS OF PAYROLL TEST OF CONTROL

i) ii)

Raspberry has a human resources department, which is responsible for setting up all new employees. This control reduces the control of the payroll department over employee information. It is a segregation of duty and reduces the risk of payroll fraud.

Discuss with members of the payroll and HR department what the process for setting up new employees is and confirm this is carried out by HR.

Standard pre-printed forms are completed for each new employee in the HR department, which are then sent to the payroll department. These forms will ensure the payroll department receives all the relevant information needed for the new employee.

For a sample of recently appointed employees, inspect the joiner forms and verify they have been completed fully and payroll received the form before adding to the system.

Production employees are issued with clock cards and must swipe them at the beginning and end of their shift. This is also supervised by security staff. This control will ensure employees are paid for the hours they attend work. It reduces the risk of payroll fraud.

Observe the process of clocking in and out for employees. Verify that this is supervised by security staff.

The clock card information is linked to the payroll system and links in the hours worked. This transfer of information reduces the risk of human input error when calculating the employee pay.

Using test data, input dummy clock card information and verify this has been updated in the payroll system.

Exception reports are produced on a quarterly basis. These relate to any changes in standing data and are reviewed by the payroll director. This control will ensure any unauthorised changes are picked up on a timely basis and investigated.

Inspect the exception reports produced during the year and identify if there is any evidence of review by the payroll director, for example, a signature.

(Note that there are many other key controls in the scenario that could have also been included)

b) Five deficiencies in the payroll system and provide recommendations

CONTROL DEFICIENCIES RECOMMENDATIONS

The production supervisors determine the amounts for the bonus to be paid to production staff. They then inform the payroll department. They may lack objectivity in making decisions on who gets paid and how much is awarded. This could lead to excess amounts paid to friends and could lead to staff morale issues if paid amounts not deemed fair.

Bonus decisions should be made by a senior official. The production director would be ideal and base decisions on standard feedback. Any large bonuses could be authorised by the board to ensure decisions are made fairly.

The payroll system automatically calculates gross, net pay and other deductions, but these calculations are not checked. There is a risk that calculations may be incorrect, leading to over or underpayments relating to payroll.

The payroll team should be responsible for making checks to the system to ensure it is running properly. Taking samples of deductions and performing recalculations would be recommended.

Raspberry get the employee to complete the student loan form from the government and make payments automatically until the employee tells HR the loan has been paid. This could lead to overpayment of loans if the employee fails to inform them the loan is paid up. There could also be fines imposed by the government if the information sent is not correct.

The payroll department should keep records on the loans and deductions to be aware of when the loans are paid in full. They should also ensure regular reconciliations are carried out on the information in the payroll system and the loan statement sent by the government.

Holiday forms are supposed to be completed and authorised by relevant line managers, however, this does not always occur. Employees may be able to take more annual leave than is allowed. This could lead to a shortage in production staff available and economic loss to Raspberry.

No annual leave should be allowed without a completed holiday request form. This must be authorised and a record of annual leave remaining should be kept.

Management accounts are produced but there is no review of variances in wages and salaries as there are no overtime costs. If variances are not reviewed, it could lead to errors not picked up. Evidence of unauthorised decisions being made will go undetected.

Management accounts should be reviewed in more detail. Wages and salaries should be compared to budget, previous periods and the previous year. A breakdown of costs for each department would also be useful.

(There were more deficiencies in the scenario that could also have been included in your

answer)

c) Assignments the internal audit department could carry out.

Internal Audit departments can have a varied role within an organisation. Some of the assignments that could be carried out by them include the following; System review Raspberry will need to ensure their systems are up to date to be efficient and maximise productivity. Internal auditors can carry out regular reviews of the computer systems in place and recommend any changes required on a timely basis. Compliance Raspberry operates an electric power station and therefore will have to adhere to laws and regulations. Internal auditors can review these and ensure compliance to avoid fines and negative press. Value for money audit This is where internal auditors can carry out an assessment on whether Raspberry is getting the best value for money for specific areas of their business. They review the economy, efficiency and effectiveness when carrying out this work. Controls review Internal auditors review the controls within systems to ensure they are sufficient enough to reduce error and fraud. They could review the cash controls at Raspberry, as cash is used to pay production staff. Fraud investigations Internal auditors are often best placed for special investigations such as fraud investigations. They may be asked to investigate where there is evidence of fraud. With payroll control deficiencies increasing the risk of fraud, they can look at controls to reduce this risk for Raspberry.

d) Substantive procedures to perform on year-end accrual for tax payable on employment income.

Agree the accrual shown in the financial statements to the payroll records and supporting client workings to confirm accuracy of balance.

Agree the amount to post year-end bank statements to confirm accuracy and completeness of accrual. Recalculate the accrual balance and investigate any significant differences to confirm accuracy. Compare the accrual to last years accrual balance and investigate significant differences, verifying completeness and accuracy.

Inspect correspondence from the tax authorities to assess if there are further amounts to be included relating to outstanding liabilities, verifying completeness.

Murray Ltd - Answer a) Control Environment - This is the attitude and awareness of the management of the client company. It is a question of how much importance is placed by them upon having a sound system of internal control. Risk Assessment Process - This is the way in which the management of a company identifies the risks that are relevant to its operations and the way in which these risks are addressed. Information Systems - This is all the business processes that are relevant to reporting and communication. It includes both automated and manual systems. Control Activities - These are the individual policies and procedures to ensure that management processes are carried out effectively. Monitoring - All activities should be reviewed to ensure that they are operating effectively. If they are not, then changes will need to be made. b) Sales order Control objectives To ensure that all orders are processed. To ensure that goods are only supplied to customers who will pay on time. Control activities All sales orders should sequentially numbered. A creditworthiness check should be carried out on all customers before the order is processed. Sales despatch Control objectives All orders are despatched. Good quality goods are despatched to customers. Control activities All despatches should be matched against orders before they are sent out. All goods despatched should be quality control checked before they are sent out. Sales invoicing Control objective Sales are recorded at the correct price. Only valid, authorised sales are recorded. Control activity Invoice prices/values are agreed to an authorised price list. Sales invoices are matched with authorised despatch notes.

This is not much volume for 12 marks, but the most important thing, with an answer such as this, is to be brief and relevant. Also, only pick something as a control objective if you can think of a related control activity - no good having one without the other ! c)

Purchase orders are raised by a number of different staff members. This will mean that it is difficult to confirm who is ordering what. Some things may get ordered twice, whereas other items may not get ordered at al.

There is no central ordering system. This means that Murray is unlikely to be able to take advantage of any discounts that may be available for purchasing in bulk. Company costs will be high as a result.

Orders are handwritten. There is no mention of any sequential numbering which means that orders may get lost - there may be a completeness issue.

Not all goods received are not checked against the original order when they are received. This could mean that the wrong goods are accepted into inventory.

Goods received are not checked for quality before they are put into inventory. This results in damaged goods being accepted into inventory.

The goods received notes do not appear to be sequentially numbered. This will result in a completeness problem; some goods received may get lost or not end up being recorded.

The invoice prices / values are not checked against a price list. This could result in the wrong amount being charged for goods.

Nobody checks that the invoice has been coded correctly. This could result in misallocation of expenses.

The accounts clerk is able to create new suppliers in the purchase ledger. They may create a fictitious one, or order goods from an unreliable supplier that is of poor quality.

There is a lack of segregation of duties; the accounts clerk is involved in far too many stages of the system with no one checking their work. This includes actually authorising the payments. This will mean that errors or deliberate misappropriation will not be identified.

d) All weaknesses that are found during the normal course of an audit need to be presented, with a covering letter, in a report to management. The covering letter will emphasise that the auditors have not found all existing weaknesses, they are just highlighting any that they have come across as a result of their normal audit work. The normal format for the weaknesses themselves is; - Weakness. - Consequence. - Recommendation. The covering letter will usually request a response from the client management, so we have an idea as to what they are likely to do about the points raised in the letter.

Becker Ltd - Answer a)

Weakness Consequence Recommendation

Orders are manually transferred onto the computerised system.

This could be a completeness problem because orders may get lost.

The ordering system could be integrated with the inventory and sales system, thus removing the need for a manual transfer.

Each order is given a random code.

This will increase the risk of lost orders so some customers may never receive their goods.

A numerically sequenced number should be automatically allocated to each order as it is received.

The customer's credit/debit card is charged AFTER the goods have already been despatched.

Card details may be wrong, or false, meaning some good may not end up getting paid for.

The credit/debit card should be charged as soon as the order is taken, or at least the future sale should be authorised at this point by confirmation with the card company.

No copy of the Packing list is kept in the warehouse.

If there is a problem with an order, then the warehouse staff has no way of checking the original order details.

It should be a three part form that is used so that one copy can be filed in the warehouse for use to rectify any potential problems with the order.

The accounts department do not appear to raise a sales invoice when they receive notification of despatch.

Sales income may not be recorded.

A sales invoice should be raised at the point when the accounts department are notified of the goods being despatched.

b) The covering letter should say that the weaknesses included are the ones that were identified during the normal course of the audit. It should clarify that it does not include all of the weaknesses that may exist, just the ones that have come to light in the audit. It should also include reference to the fact that a response would be useful, so that we can confirm whether or not the problems will still exist next year. It should also include a disclaimer stating that we accept no responsibility for any unidentified weaknesses. c) Benefits of an internal audit department The overall control environment of the client will be stronger which would increase auditor and shareholder confidence.

The internal control system will be more effective an able to identify control weaknesses more efficiently. External auditors may be able to use and rely on the internal audit work in order to reduce the external audit fee. The internal audit function could save the client money be suggesting a series of controls that could boost revenue and/or cut costs. The directors of the client may improve their performance if they believe that their work will be monitored more closely by an internal audit function. d) Audit committee responsibilities

Directing and monitoring the work of the internal audit department

Increasing the level of communication and co-operation between internal and external auditors

Monitoring the activities of the executive directors and even disciplining them if they are doing things that are worthy of such action

The establishment of various sub committees, such as a Nomination committee and a Remuneration committee

Nadal Ltd - Answer

a)

b)

Weakness Control Activity

Employees can get someone else to clock them in because there is no control over the process.

The site foreman should observe the clocking in/out procedure on a random basis.

The foreman at each site can create fictitious employees by taking advantage of the fact that they can create temporary numbers.

The issue of new employee numbers should be authorised by a senior member of staff at head office.

Overtime is automatically calculated by the computerised system so could be subject to error.

All overtime should be authorised and checked for accuracy before payment.

The two staff in the wages department can make changes to the data for illness and holiday with no one checking their work so errors could go unidentified.

All changes to holiday and sick pay should be authorised by a senior manager.

No confirmation is done on any of the calculations carried out by the computer in respect of gross pay, net pay and deductions so errors may be made and not spotted.

A selection of calculations and deductions should be confirmed by a member of the wages staff on a regular basis.

The pay packets include a handwritten confirmation of gross pay which may be inaccurate.

The computer system could produce a printed payslip to reduce the chances of errors being made.

Each foreman is responsible for the distribution of the wage packets so could misappropriate any uncollected packets.

Two people should distribute the pay packets and any uncollected wages should be returned to head office.

Cash being delivered in large quantities on a regular basis to a number of sites increases the risk of loss or theft, even if it is by secure courier.

Nadal Ltd should actively encourage as many employees as possible to be paid by direct transfer into a bank account.

c) Nadal Ltd should try to use a consultant who has a good reputation for a high quality of service. They should go for someone who has relevant experience in designing systems for the construction industry and the specific problems with having lots of employees that are mostly paid in cash. Nadal Ltd should, ideally, find someone who is qualified as a computer software designer or a company that has a lot of experience in selling bespoke packages to the construction industry. Nadal Ltd would have to consider the fee level. On one hand, they may want a very competitive fee. Alternatively, they may be willing to pay a higher price in order to try and guarantee a high quality service.

Nadal Ltd may also wish to appoint a company that would be able to provide them with a number of other services as well. This would be a quick and easy solution to a number of specialist issues that can be dealt with “under one roof ". It would also be essential to establish the legal situation with any software licence that will be required, how long it will last and what kind of support will be available. d) Self interest We may be tempted to recommend a software package that will make the audit easier and not one that necessarily suits all of the client's needs. Self-review We may end up reviewing the system that we suggested should be adopted by the client - this is quite likely to be what happens during the normal audit work. Management If we actually select the computer package for use by the client, then we will be making a decision that should be made by the client's management, not us. Increased negligence We may over rely on the new system (we recommended it so it must be right) so the quality of our work would suffer and the risk of being sued for not doing a decent quality audit would increase. e)

- External auditors have no specific responsibility for the prevention and detection of fraud.

- They do, however, have to make sure that the audit work that they carry out gives them a reasonable chance of finding MATERIAL fraud.

- To summarise, if a small fraud is missed we are ok but if we miss a big one then we are not

doing our job properly.

- Internal auditors are part of the client's system of internal control.

- One of the responsibilities of every client is to design a system of control that will prevent and detect fraud.

- An internal audit function is a direct attempt to achieve this because internal auditors will test

controls and, potentially, uncover fraud.

- To summarise, internal auditors DO have a duty to prevent and detect fraud - it is assigned to them by the client management by appointing them and directing their work.

Cherry - Answer Cherry Blossom Co’s (Cherry) purchasing system deficiencies and controls

Deficiencies Controls

Requisition forms are completed by production supervisors but are not authorised. This increases the risk of fraudulent purchases, or of goods being ordered which are not required, leading to unnecessary cash outflows.

Requisition forms should be authorised by the production manager or director prior to being sent to the purchase ordering department. This department should not process any unauthorised requisitions.

Orders are being placed for goods without the inventory levels being checked first. This could result in goods being ordered which are not required, leading to unnecessary cash outflows.

The inventory system should be updated to record minimum/maximum required levels of raw materials. When completing the purchase order, the ordering clerk should check the current level of inventory on the system and only order if the quantity is within the set parameters.

In addition, as the company does not currently monitor inventory levels, it could experience stockouts resulting in the company being unable to meet customer orders.

The company should set minimum authorised reorder levels for inventory items.

The purchase ordering department maintains an approved supplier list; however, this has not been updated for 24 months. As this list has not been recently updated, the suppliers being used may not be ideal with regards to price, quality and delivery times. This could result in Cherry paying increased costs for raw materials or receiving poorer quality goods.

The approved supplier list should be reviewed and updated as necessary. Going forward, it should be updated regularly, at least on an annual basis

Knowledge - Answer a) A value for money audit is one of the many services that can be provided by the internal auditor. This type of work is concerned with ensuring the entity makes decisions within the business that achieves their overall objectives. Examples include making decisions on suppliers to use, increasing credit terms to customers and expanding their product range. These decisions may have many benefits, but the business must consider whether there are any drawbacks and whether these drawbacks outweigh the initial benefits. Therefore the internal auditors can conduct a value for money audit. This looks at getting the best possible service for the least resources. It is otherwise regarded as a review of the 3 E’S The 3 E’s stand for: - Economy. To review economy is to obtain the best quality of resources for the least amount of cost; - Efficiency. To review efficiency is to gain the maximum output with minimum resources needed; - Effectiveness. To review for effectiveness is to look at whether the project will achieve the

company objective or goal. b) ISA 230 is the auditing standard that tells us what is needed in terms of audit documentation and why they should do it. Here are a few ideas of the benefits:

- By recording evidence in the audit file, it proves that the auditor did the work. It makes them accountable for their work;

- This then gives evidence that they followed the auditing standards and any other relevant laws and regulations. It proves the work was completed in detail in case there was ever a need to prove it;

- The evidence documented will assist when forming the independent opinion on the financial statements at the end of the audit process. As we know, audits can take a long time to complete with a lot of detail to cover. The audit supervisors will need to review the work, and by having documented audit work they will be able to assess what has been done and whether it is enough;

- Documentation will also assist the engagement partner. They will need to form the opinion on the financial statements at the end of the audit process. They will, therefore, benefit from a review of the completed audit work and notes regarding issues found during the audit when making this important decision;

- By keeping a record of the work completed, the evidence obtained by the auditors and the conclusions drawn from the work, it will assist with future audits. The following year’s audit team will be able to review the work when planning what to do for their current year.

c) Audit sampling is defined in ISA 530. The official definition is that sampling is ‘the application of audit procedures to less than 100% of items within a population of audit relevance, such that all sampling units have a chance of selection in order to provide the auditor with a reasonable basis on which to draw conclusions about the entire population’. The need for sampling is largely because they cannot possibly test every single transaction for every audit. For a large number of statutory audits, there are too many transactions and therefore the auditor must choose a sample to decide if there could be a material misstatement present in the balance. If misstatements are found, the auditor will very often go on and increase the sample to test if there could

be a larger problem in the balance. The other reason is that the auditor is not expected to provide absolute 100% assurance on the financial statements. Remember they are supposed to provide reasonable assurance which required a high level of detailed work in forming a conclusion. This does not expect them to look at every single transaction.

Spadefish & Co - Answer Part (a) – Exceptions in the receivables circularisation The following procedures should be performed to resolve the exceptions: Albacore Co

With the client’s permission, the team should arrange to send a follow-up circularisation for Albacore Co.

If no response is received, then with the client’s permission, the auditor should telephone the customer and ask whether they are able to respond in writing to the circularisation request.

If there is still no response, then the auditor should undertake alternative procedures to confirm the balance owing from Albacore Co. For instance, by agreeing to sales invoices to goods dispatched notes (GDN).

Flounder Co

With a difference of $5,850, the auditor should identify any disputed amounts, and identify whether these relate to timing differences or whether there are possible errors in the records of Triggerfish.

If the difference is due to timing, such as cash in transit, this should be agreed to post year-end cash receipts in the cash book.

If the difference relates to goods in transit, then this should be agreed to a pre year-end GDN. Menhaden Co

The reason for the credit balance should be discussed with the credit controller or finance department to understand how a credit balance has arisen.

Review the payables ledger to identify if Menhaden is a supplier as well as a customer; if so, a purchase invoice may have been posted in error to the receivables rather than payables ledger.

If the difference is due to credit notes, this should be agreed to pre year-end credit notes dispatched around the year-end date.

Part (b) – Substantive procedures for allowance for trade receivables

Inspect the aged trade receivables ledger to identify any slow moving, and discuss the status of these balances with the credit controllers to assess whether they are likely to be received.

Review whether there are any after-date cash receipts for identified slow moving/old receivable balances.

Review customer correspondence to identify any balances which are in dispute or are unlikely to be paid and confirm if these have been considered when determining the allowance.

Inspect board minutes to identify whether there are any significant concerns in relation to payments by customers and assess if these have been considered when determining the allowance.

Part (c) – Going concern indicators Some suppliers have been paid considerably later than usual and only after many reminders; hence some of them have withdrawn credit terms meaning the company must pay cash on delivery. This suggests that the company was struggling to meet their liability as they fell due and will also put significant additional pressure on the company’s cash flow. Marlin Co’s main supplier who provides over 60% of the company’s specialist equipment has just stopped trading. If the equipment is highly specialised, there is a risk that Marlin Co may not be able to obtain these products from other suppliers which would impact on the company’s ability to trade. The overdraft has grown significantly during the year and is due for renewal within the next month. If the bank does not renew the overdraft and the company is unable to obtain alternative finance, then it may not be able to continue to meet its liabilities as they fall due. Part (d) – Going concern procedures

Evaluate management’s plans for future actions, including their contingency plans in relation to ongoing financing and plans for generating revenue, and consider the feasibility of these plans.

Review the company’s post year-end sales and order book to assess if the levels of trade are likely to increase and if the revenue figures in the cash flow forecast are reasonable.

Review any agreements with the bank to determine whether any covenants have been breached, especially in relation to the overdraft.

Review any bank correspondence to assess the likelihood of the bank renewing the overdraft facility.

Review post year-end correspondence with suppliers to identify if any have threatened legal action or any others have refused to supply goods.

Hyacinth Co - Answer

a) Inventory valuation (note only six needed to score full marks)

Sample check WIP from inventory count to WIP schedule to check correct percentage completion is recorded at inventory count

Sample check of inventory items back to relevant cost sheets: invoices, time sheets and overheads

Review post year-end credit notes for returns that could indicate a write down is required

Sample check cost of year end-finished goods with post year-end sales invoices to determine if NPV is above cost or if adjustment is needed.

Determine the basis of WIP valuation and assess reasonableness

Identify slow moving inventory from aged inventory reports and enquire why they have not been written down, or if allowance required

Review board minutes and discuss with management the plans for selling defective batch of Crocus and how the NPV of $90,000 was determined

Confirm the value of the final adjustment for the damaged product, ask if the adjustment has been made and follow through any write down to confirm

b) Research and development (note only four needed to score full marks)

Determine the rationale for the 4 year useful life and assess reasonableness

Agree closing balance from schedule of intangible assets to general ledger, trail balance and draft financial statements

For a sample of intangible assets, recalculate the amortisation charge and ensure it is line with amortisation policy

Discuss the stage of development of the new computer software projects and whether it has been capitalised or expensed

o Agree costs for any expensed as research to invoices and to inclusion in profit or loss

o Agree costs capitalised as development to invoices

Confirm the ability to sell the product once complete and probable economic benefits against market research reports

Review intangible asset disclosures in the financial statements and confirm in accordance with IAS 38

c) Sales tax liability (note only four needed to score full marks)

Agree sales tax liability in trial balance to tax return

Agree quarterly sales tax charged to 15% of last quarter sales Recalculate amount payable to tax authority (sales tax charged – sales tax incurred)

Compare year-end sales tax liability to prior year. Investigate significant differences

Agree subsequent payment to post year-end cash book and bank statements

Review correspondence with tax authority for outstanding payments. Ensure any outstanding payments included in year-end liability

Review disclosures to ensure sales tax is shown as a current liability and is in line with accounting standards

d) Subsequent event

(i) $0.7m of inventory has been damaged in a flood that occurred after the year end. The event is non-adjusting as it does not provide evidence of condition at the year end.

The inventory has no scrap value, and the directors do not expect to be able to claim for it on insurance.

$0.7m is 10.9% of profit before tax and 3% of total assets, therefore this is material.

Material non-adjusting events do not need to be written down to zero in this financial year, but the directors should disclose the details of flood and value of assets lost in a note to the accounts.

(ii) Audit procedures:

Agree net book value of damaged property, plant and equipment (PPE) to the non-current asset register

Physically inspect the damaged inventory

Agree original costs of inventory to schedule of damaged inventory

Review the condition of other PPE and inventory to ensure all damaged items have been identified

Discuss with management the basis of zero scrap value assessment

Determine why management don’t believe they can claim on insurance. If a claim was made, only the uninsured amount would need to be disclosed, which may not be material

Determine intention of management in relating to disclosing the event in the notes to the financial statements

Jasmine Co - Answer Part (a) Substantive procedures in relation to trade receivables Obtain the aged receivables list. Add up to agree the total. Agree the total to the sales ledger control account and trial balance to confirm accuracy and completeness of document. For a sample of outstanding amounts from receivable customers on the ledger at the year-end, agree the amount has been paid by tracing to the bank statements and investigate non-payments with the client. For a sample of GDN’s just before and after the year-end, agree to the sales invoice and ensure it has been recorded in the correct accounting period. Inspect the aged receivables list. Identify very old or slow moving accounts and investigate whether adjustments are required with the client. Calculate receivables days’ ratio for this and the previous year. Investigate significant differences with the client. Part (b) Substantive audit procedures in relation to bank balances With the permission of the client, write to the bank and request a bank report or letter confirming the bank balances held by the client at the year-end. Agree the bank accounts on the bank report with the trial balance and general ledger to confirm all bank accounts are included in the accounting system and the total agrees with the balance in the financials statements. Obtain a copy of the bank reconciliation statements at the year-end and add up to confirm the totals agree. Agree the balance per the cashbook to the balance on the general ledger and trial balance. For unpresented cheques listed in the bank reconciliation, agree the amounts to the cashbook and ensure they were recorded before the year-end. Also agree the amounts have since cleared in the bank account by inspecting post year-end bank statements. Part (c) Going concern procedures for Jasmine Inspect bank correspondence for evidence of disputes or details of the bank overdraft review coming up which could indicate cash flow problems. Obtain the cash flow forecast. Conduct a detailed review of the content and assess the assumptions made to ensure they appear reasonable. Discuss any issues with the client. Discuss with the client management any plans they may have for managing the financing for the company and inspect the board minutes since the year-end for evidence of any plans that may have been discussed. Inspect customer and supplier correspondence for evidence of disputes, which could lead to a loss in customers or problems with production.

Inspect the management accounts since the year-end. Also inspect sales orders received since the year end and compare to the previous year to assess whether sales volume is consistent or lower than previously and if performance looks likely to aid Jasmine in improving their cash flow levels. (d) The outcome of the overdraft review is not going to be known before the audit is finalised and if it is not reviewed this could have a significant impact on Jasmine’s future. We therefore have a material uncertainty relating to going concern. This will affect the audit report whether they have disclosed correctly or not. If the disclosure is adequate, the opinion will be unqualified as the financial statements show a true and fair view. However, the auditors have an obligation to draw attention to the issue. They will therefore modify the audit report to include an additional paragraph section in the audit report headed ‘material uncertainty relating to going concern’. This will make reference to the disclosure to ensure the users are aware of how important it is. If the disclosure is inadequate, the auditors will not be satisfied that the financial statements are showing a true and fair view. They will modify the audit report by qualifying the audit opinion. The outcome of the review is uncertain and so they would state that the issue is material but not pervasive. They will therefore include an ‘except for’ opinion to ensure the users know that the rest of the financial statements are true and fair except for the inadequate disclosure on this issue.

Camomile – Answer

a) i) It is important for auditors to communicate throughout the audit with those charges with governance for the following reasons: Those charged with governance are responsible for the organisations financial reporting. If there is anything specific that requires explanation regarding the client records or operations, they are best placed to assist the audit team in understanding the entity. By assisting the audit team it helps those charged with governance show evidence of their responsibility for financial reporting matters. ii) Two examples of matters that the audit team may communicate are: Any key audit risks that have been identified at the planning stage Any significant matters such as material accounting adjustments that have been discovered during the course of the audit. b) Deficiencies in cash receipts and payments system

CONTROL DEFICIENCIES CONTROL RECOMMENDATIONS

The petty cash float is held at each of the venues. To purchase sundry items, employees get money from the tin and then return any change and the receipt back to the restaurant manager. It is likely that mistakes will made and purchases could be for non-business expenses.

There should be a petty cash book kept with details of amounts spent, description of goods and name of employee. Receipts should be kept for all expenses and referenced in the book.

It has been noted by the internal audit team that on some occasions the petty cash float and receipts do not equal $400. If this is not regularly controlled it could indicate money not being returned to the tin after a purchase or receipts not being handed in.

The petty cash float should be reconciled on a regular basis, ideally weekly to ensure the float and receipts agree to $400. If there is a discrepancy, this should be investigated that week to increase the chance of errors being resolved.

There is one log code for each of the five tills in a restaurant. There is no way of identifying the employee taking the payment with this

Each employee should have his or her own log in for the till. No payments should be allowed to be taken without using their own code.

system, which would make fraud easier to carry out and not be detected.

At the end of the day the manager counts the total cash and credit card vouchers for all of the tills together. This would make it very difficult to identify which till contained an error if differences were found, increasing the risk of fraud.

Despite it being a slower process, each till should be reconciled individually and the restaurant manager should investigate discrepancies.

The restaurant manager is the only person counting the till takings each day. There is an increased risk of human error in recording this information. There is also an increased risk of fraud as there is no segregation of duties.

2 people should carry out this process. By sharing this responsibility they can check each other’s work and reduce errors.

Cash is stored in safe at the venues, which is locked by a key, which is kept in the drawer of their desk. There is an increased risk of the key being lost or accessed by someone not authorised, which could lead to theft.

The safe should be locked by a code, which is only known to those authorised to have it.

They receive monthly credit card statements for the 6 venues, which is filed by the cashier. There is no evidence that these statements are reviewed against the records held by the restaurants, which could lead to payments to the restaurants missing, and not detected.

There should be a monthly reconciliation of the credit card statements to the vouchers. The amounts on the statement should then be agreed to the bank statements to ensure they have been received.

The bank reconciliation is carried out every 2 months. This is not on a timely basis. Differences detected may not be resolved easily which could be due error or fraud.

The bank reconciliation should be carried out on a monthly basis. It should also be reviewed by someone senior and proof shown such as a signature and date on the reconciliation.

Cranberry – Answer

a) Substantive audit procedures in relation to research and development expenditure

Obtain a breakdown of the research and development costs including the opening, closing balances and additions amounting to $1.9m and cast to confirm accuracy. Agree the closing balance to the trial balance, general ledger and financial statements. Enquire with management, which of the nine new health and beauty products have been completed and production commenced. Also, obtain details of the stages of development the remaining projects are at present. For research amounts expensed, agree to invoices and supporting documentation and ensure they have been posted in the profit and loss. For development costs, agree to invoices and supporting documentation and agree they are allowed as per IAS38 by discussing with management and reviewing the standard.

b) Substantive audit procedures in relation to depreciation of property plant and equipment

Discuss with management and obtain evidence from them to explain why the change in depreciation was made. Review typical industry depreciation rates, useful lives of assets etc. and compare them to the revised rates that have been introduced by Gooseberry. Discuss significant differences with management. Obtain a list of disposals made by them in the year. Recalculate the profit or loss on disposal and review whether; based on the amount calculated, a change in rates is reasonable. Inspect the non-current asset register and review the depreciation information to ensure the revised rates have been applied. Select a sample of assets and recalculate the depreciation charge and agree this to the amount included in the asset register.

c) Substantive audit procedures in relation to the Bonus Obtain a breakdown of the bonus payments made to the directors and recalculate them and add up schedule to confirm accuracy. Agree the director bonus payments to the payroll records and bank statements. Inspect each director service contract to confirm the bonus entitlement agrees with what has been paid. Inspect the board minutes to confirm the board agreed the amounts. Review the financial statements for disclosures relating to the bonus and assess with this is in compliance with local legislation requirements.

d) Impact on audit report

The $440k does not meet the requirements of IAS38 currently and therefore should not be shown as an intangible asset, and should be expensed. This leaves assets currently overstated by $440k and profit overstated by this amount also. This amounts to 6.9% of profit and 1.2% of net assets, which we can conclude is material to the users of the financial statements. If unresolved, the auditors would need to modify the audit report due to a material misstatement. The matter is material not pervasive and therefore the audit opinion should show a qualified except for opinion. The basis for opinion paragraph should then include details of the misstatement. This would be shown under the opinion paragraph.

Pearl Ltd - Answer a) Inspection - This can either be physical inspection or the inspection of a document. Observation - This is watching someone else do something, normally a member of the audit team will watch a member of the client staff carrying out some kind of procedure. Inquiry - This is when some kind of question is asked, usually a member of the member of the audit team asks a member of the client staff, but it can be an external enquiry. Confirmation - This usually means some kind of direct confirmation with a third party. It is normally requested in written form. Recalculation - As it sounds, this is when an auditor checks a computation that someone else produced. Re-performance - Instead of redoing a calculation, this is when a task is re-performed. Analytical Procedure - This is a comparison between two groups of data with a view to identifying either a consistency or inconsistency. Any unexpected relationship or inconsistency is then investigated. b) Inspection We could inspect a sample of non-current asset purchase invoices to confirm the dates of acquisition. We could inspect the plant register to confirm that all acquisitions of non-current assets are recorded promptly. Observation We could observe a member of the client's staff updating the plant register for a new asset that was acquired during the year. We could observe the non-current asset count (like an inventory count) that should be carried out periodically by the client's staff. Inquiry We could ask the client management to confirm the reasonableness of the chosen depreciation policy. We could ask the client management to confirm whether and company assets are held on the premises of any other companies. Confirmation A direct confirmation from the bank could be obtained in order to confirm whether any of the company assets have charges over them that relate directly to any bank loans. We could obtain direct confirmation form an independent, professional valuer to confirm the appropriateness of a valuation for any item of Property, Plant and Equipment - usually done for land or buildings, but can be done for any non-current asset. Recalculation

We could recalculate the amount of depreciation that has been charged on a sample of non-current assets to ensure that it is in accordance with the stated policy. We could recalculate the total for the plant register total for accuracy. Re-performance We could select a sample of items included in the non-current assets count that was carried out by the client staff, and then agree them to the physical asset, thus re-performing something already done by the client. We could re-perform an analysis of expenses that should already have been done by the client in order to make sure that no capital items have been missed. Analytical Procedure We could compare the replacement policy adopted by Pearl Ltd with other similar companies. We could carry out a global proof of depreciation. This involves recalculating the total amount of depreciation for one category of Property, Plant and Equipment and comparing it to the stated policy. This question is really good practice for applying the methods of obtaining evidence. More practice could be obtained by using b) as a basic template and just swapping Property, Plant and Equipment for any other area of the financial statements. c) We can obtain a management representation to confirm that the management of Pearl Ltd believe the policy to be a reasonable one. We can compare the policy that has been adopted by Pearl Ltd with other companies who use similar assets in a similar way to confirm some kind of consistency. We can inspect the plant register to establish the frequency with which items are replaced. If items are replaced every three years but depreciated over, for example, five years, then we know that the policy is not reasonable. We can review the levels of profits and losses that have been recognised in respect of any asset disposals. If they are large, then that will suggest that the depreciation rates are either too high or too low. We can look back at previous years to confirm that a consistent rate is being used. Too many changes can suggest profit manipulation by using very high, or low rates, depending upon what profit level the company wants to achieve. d) If a plant register is not maintained, then that means a lack of normal audit evidence that should really be available. The plant register is an accounting record and it is the duty of the client's management to maintain one. The audit report would be modified by including a qualified opinion on the grounds of a lack of evidence. It would not be serious enough to merit and adverse opinion because it is an isolated issue.

An explanation of the reason for the qualified opinion would be included in the basis of opinion which would be included immediately after the opinion itself.

Tickam Ltd - Answer a) Procedures for sales

Compare this year's sales with the previous year's figure and ensure that any significant fluctuation is explained.

Compare month by month sales figures for this year and last year and investigate any unusual trends.

Obtain a sample of telephone and e mail orders and ensure that they are sequentially numbered for completeness.

Observe the client's staff giving verbal confirmation of orders by telephone.

Select a sample of orders from the VMS and ensure that there are either email confirmations sent to customers or that there is a record of a telephone confirmation instead.

For a sample of orders recorded in the VMS, ensure that there is a sales invoice to accompany it. This will confirm that all orders have been invoiced.

Select a sample of sales invoices and confirm that they are sequentially numbered and that none are missing. This will help verify that sales are not understated.

Agree a sample of sales invoice prices to the standard price list to ensure that the sales valuation is correct.

Select a sample of sales invoices and perform any necessary recalculations on price, quantity, sales tax etc to confirm mathematical accuracy.

Consider using test data to interrogate the client's VMS system. We could try inputting some orders that we have generated to see if they are processed correctly. This will confirm that the VMS system is operating effectively.

Some of the orders that are input should be designed to be rejected (perhaps a negative quantity or an order for a 5- year hire) to see if the system will perform as expected.

We should select a sample of orders and trace them through to the receivables ledger to ensure that the receivables figure is complete.

We should carry out a cut off test. A sample of orders from just before the year- end should be selected and traced through to the sales invoices and the receivables ledger to ensure that they are recorded in the correct accounting period.

This should also be done with a sample of orders from immediately after the year end as well with the same objective.

We should inspect sales credit notes issued just after the year end to ensure that there is no “window dressing". This is when the sales for the year are inflated by creating dummy invoices at the end of the year and then reversing them with a series of credit notes at the beginning of the following year.

A large number of sales credit notes in the first month of next year could suggest that this is happening.

b) Procedures for Vehicles

Things like using an expert, management representations and looking at board minutes have been avoided here. They are valid IF they are used sparingly and a specific reason for each is given.

Compare the carried forward value for vehicles in last year's financial statements with the brought forward figure used this year to confirm a correct starting point.

The purchase invoices relating to new vehicles should be inspected to confirm the initial value of the items.

The dates on the invoices should also be confirmed to ensure that the items are recorded in the correct accounting period.

The figure for vehicles in the financial statements should be agreed back to the total for vehicles that is in the plane register.

A sample of vehicles should be physically inspected to confirm their condition. This helps with confirmation of valuation as well (useful economic life ).

A sample of vehicles should be physically inspected and traced back to the plant register. This will ensure completeness.

The same test should be done in reverse. A sample of vehicles should be selected from the plant register and then the physical asset should be identified. This helps to confirm existence.

A sample should be selected from the plant register and the depreciation calculation should be re-performed to ensure accuracy.

It should also be confirmed that these depreciation expenses are in line with the policy stated in the financial statements of Tickam Ltd.

A sample of sales invoices, relating to any disposals that occurred during the year, should be selected and then we should confirm that these items have been removed from the plant register. This will help verify that vehicles are not overstated.

We should confirm the existence and the details of vehicle registration documents (VRDs) for sample of vehicles. The VRDs will verify rights and obligations (ownership).

We should review any profits or losses on disposal for the year. If the profits or losses are large that may suggest valuation problems because the depreciation rate used is not reasonable.

Another rights and obligations test would be to inspect repair and maintenance records, as well as insurance documentation for all vehicles. Both should exist for all vehicles because they are normal ownership expenses.

We could compare the useful economic lives used by Tickam Ltd with other similar companies to ensure that they are reasonable.

We could inspect the plant register to identify how frequently the vehicles are being replaced and then agree this to the depreciation policy, to ensure that it is reasonable.

Mast Ltd - Answer a) It minimises the amount of disruption at the year-end by allowing inventory counting to be done all the way through the year instead. Due to the value of inventory being readily available all through the year, it will enable companies to maintain greater control over the inventory level and value. Any errors can be identified and corrected much quicker. Slow moving and obsolete items can be identified much more quickly so the risk of a loss in value will be minimised. It may reduce the amount of work that external auditors have to do because they can rely on the system instead of having to test it. This could cut the external audit fee. b)

Procedure

Reason

Review the results of the inventory checking that has been carried out during the year by the internal audit department.

To confirm that the work has been done to a decent level and can be relied upon by the external auditors.

Observe an inventory count in progress. To ensure that the count is done in accordance with the stated instructions.

Follow up on any errors and discrepancies that are identified by the count procedures.

To ensure that errors are corrected so that the process is effective.

Whilst observing a count, select a sample of items that are on the inventory system and agree the physical existence of that inventory.

This is helping to ensure existence of the inventory that is recorded.

Perform the same test in reverse. Select a sample of physical inventory and agree it to the inventory records.

This is helping to ensure the completeness of the inventory records.

Obtain a copy of the inventory count instructions.

To ensure that the process is well controlled and easy to follow for those carrying out the counts.

c) Integrity - All members should behave in an honest and straightforward manner in all of the professional and business relationships. Objectivity - Members should not allow bias or undue influence to affect their application of professional judgement to all situations. Professional Competence and Due Care - Members should ensure that their knowledge and skills are sufficient to be able to act diligently and in accordance with professional standards.

Confidentiality - Information relating to clients must not be used for personal gain or disclosed to a third party without the express consent of the client. Professional Behaviour - Members should comply with laws in order to avoid any act that would discredit the profession. d) The first thing to say here is that this is cause for concern and the auditor should ensure that they continue to act with a very strong sense of professional scepticism. We should remind the directors that we are bound by a code of ethical conduct that gives specific guidance on maintaining client confidentiality. Hopefully this will re assure them. We could confirm with them that we are used to dealing with this kind of situation, so our staff will use the utmost discretion in everything they do. If the directors still will not allow you access, then you will have no choice but to cease work. The letter of engagement is the legal contract of employment that sets out the responsibilities of directors and auditors. If one party is basically saying that they will not fulfil their duties, then the audit is not viable. If the letter had been signed and then we had discovered later that we did not have access to all records, then it is likely that we would have modified the audit opinion. Seeing as we know about it at the planning stage, it is highly unlikely that the audit would go ahead. We should remind the directors that they will not be any more successful if they ask another firm to do the audit - all audit firms should react in the same way.

Pizza Ltd - Answer a) This is currently an adverse opinion. This means that there is a misstatement in the financial statements that is not isolated to one or two specific areas. It is being claimed that the omission of the provision combined with the depreciation miscalculation is a pervasive issue. Because the opinion is based upon the fact that there is a misstatement, there is no missing evidence, so the opinion is not modified due to a lack of evidence. This is a very serious type of modification because it is claiming that ALL of the financial statements are wrong. b) I would agree that there is no missing evidence, so the audit report is correct not to modify on these grounds. I would also agree that no uncertainty exists, do there is no need for an emphasis of matter paragraph or a going concern uncertainty paragraph. However, an adverse opinion is too severe. There are two misstatements but apart from these two, the rest of the information in the financial statements is correct. It is possible to have two isolated misstatements and this is what we have here so a less extreme form of audit modification would be appropriate. I would go for a qualified opinion on the grounds of material misstatement with an explanation of the reasons for this to be included in the basis of opinion section. c) Examination and certification The word" certification" is not appropriate. This suggests that an auditor actually gives confirmation that the financial statements are 100% accurate when we do not do this. The word “certification" should be replaced with the phrase "independent expression of opinion”, which is the highest level of confidence that auditors can give. We will confirm that The word "confirm” here is wrong. We never confirm anything. As has been said already, we give an opinion which does give confidence but not as much as a confirmation would provide. The word "confirm"' should be replaced by “we will give an opinion ". The accuracy of the estimates Due to their very nature, estimates cannot be accurate. They can be more or less appropriate, so this the wrong use of language again. All we can do is assess the reasonableness of the estimates and judgements that have been made by the directors, so that is the wording that should be used.

No mention of materiality The basis opinion section would state that we are protected by the concept of materiality, that we are only expected to identify material misstatement and not all misstatement. This should be clarified as part of the basis of opinion section. Explanation There should be an explanation, in the basis of opinion section, of the reason for the adverse opinion. Currently, there is nothing. If the opinion ends up being qualified instead of being an adverse one, then an explanation of the reasons for this would be required instead. The basis of opinion is too short, lacks sufficient detail and uses misleading wording in its current format. d) A Key Audit Matter (KAM) is a new addition to the audit report format. It is designed to help narrow the expectation gap by providing a bit more explanation as to what auditors actually do. A KAM is an audit area that involves a lot of time and judgement in order to audit it effectively. All KAMs should be disclosed and explained in the audit report. We tell the users of the report how the matter was dealt with. A KAM is NOT a modification. We are not highlighting a problem; we are explaining how something important to the audit has been dealt with correctly.

Lesley and Co - Answer a) A hot review is a review of an audit file that takes place before the associated audit report has been signed. The main benefit is that any extra work that may be required as a result of the review can be undertaken without the disruption of having to change the audit opinion/report. A cold review is a review of an audit file that takes place after the audit report has been signed. The main benefit of this is that we can evaluate the relationship and consistency between the work carried out and the actual opinion provided, which is something a hot review is unable to do. Most audit firms will carry out both types of review on a regular basiS. b) Sapling Ltd The current modification is a disclaimer of opinion. This should be used when the evidence that is missing affects the entire view given by the financial statements. This is NOT the case here - it is only two months’ worth of sales records that are missing, so this is an isolated lack of evidence. We should suggest that a qualified “except for", opinion is used instead on the grounds of a lack of evidence. A full explanation of the reason for the qualified opinion should be included in the basis of opinion section of the audit report. This should go immediately below the opinion itself. Shrub Ltd The current modification is a qualified "except for" opinion due to a misstatement. There is no missing evidence and no uncertainty. The misstatement of $200,000 is only. 8% of total assets and is MOT material, so the modification used is not appropriate. An immaterial misstatement will not result in a modified opinion, so the report should be a normal "clean report” with no modification at all. The misstatement, along with any other uncorrected, immaterial misstatements, will be given to management in case they wish to adjust for them but it is not necessary for them to make any adjustment due to the size. Branch Ltd The current opinion is unmodified which suggests that there is no misstatement and no lack of evidence.

The claim is not settled and represents an uncertainty that will remain unresolved until after the date that the audit report is signed. This uncertainty will NOT require material uncertainty regarding going concern paragraph in this case. We can only include it if the uncertainty has been disclosed properly in the financial statements AND it does not affect the going concern status of Branch Ltd. The matter has not been disclosed, so we will need to use a qualified “except for opinion due to the omission of the disclosure, with an explanation of the qualified opinion in the basis of opinion section. There is no missing evidence and it is not serious enough to be a pervasive modification. Leaf Ltd An Emphasis of Matter Paragraph has been used here, but it is inappropriate to do so because there is no uncertainty at all. The actual audit opinion is currently unmodified which is also wrong. The directors have failed to supply us with normal, expected evidence so a modified opinion on the grounds of a lack of evidence is needed. This is a deliberate attempt to conceal on the part of the directors, so should be considered pervasive. A disclaimer of opinion should be used here, with a full explanation of the reason for it included in the basis of opinion section of the audit report. Twig Ltd The current modification is an adverse opinion, which should be used if there is a pervasive misstatement, one that affects the financial statements as a whole. In this case, there is no misstatement at all in the financial statements so the opinion is wrong. There is also no missing evidence so the opinion should remain unmodified. There is an inconsistency that exists, however, between some of the Other Information ( in this case, the environmental report ) and the financial statements. Seeing as it is the Other Information that is wrong, an Other Information Paragraph should be included in the audit report to draw attention to this. This is a modified report NOT a modified opinion.

Gavin Ltd - Answer a) Going concern is an assumption that a client is able to continue to trade for the foreseeable future. The foreseeable future is at least one further year from the current accounting year-end. An external auditor has to decide whether the true going concern status of a company had been reflected in its financial statements. If it is decided that this is not the case, then it is grounds for a modified audit report with various degrees of seriousness. b)

Inspection of any correspondence between Gavin Ltd and the legal advisers to try and confirm the most likely outcome of the court case and any cost that may be involved.

Analytical procedures should be carried out on sales revenue. A comparison between the levels of income before and after the court cases should enable us to confirm or deny any significant fluctuations.

An inspection of any correspondence between Gavin Ltd and the senior employee should be carried out to confirm the accuracy of the story.

An expert opinion may also be sought in order to confirm the claim that new techniques and materials are required in order to prosper, but are not being pursued.

Copies of the cash flow forecast and any other supporting documentation should be obtained and examined to confirm the viability of the proposal.

Discussion with the current and potential future, finance providers used by Gavin Ltd should take place to try and confirm the prospect of sufficient funding being available.

Discussion with the management of Gavin Ltd should take place in order to confirm that they believe that the future prospects of the company are good, that Gavin Ltd is actually a going concern.

An inspection of board minutes and cash paid/received records since the year-end should be undertaken to see if anything significant has occurred during the subsequent events period that may affect the going concern status of Gavin Ltd.

c) Uncertainty properly disclosed This will NOT result in a modification to the audit opinion. Instead the uncertainty will be highlighted by the inclusion of an extra paragraph in the audit report somewhere below the audit opinion. The paragraph will be called “Material Uncertainty relating to Going Concern" and should describe the circumstances surrounding the uncertainty. The paragraph will refer to a note in the financial statements that describes the uncertainty.

The paragraph will also state that the audit opinion is NOT modified as a result of the uncertainty. Uncertainty not disclosed An extra going concern uncertainty paragraph will NOT be used here. If the uncertainty is not disclosed in the financial statements, then the uncertainty paragraph in the audit report is NOT relevant. The audit opinion will be modified instead. The absence of a disclosure is a misstatement that would be considered material but not pervasive. Therefore, a qualified "except for "opinion will be given on the grounds of material misstatement due to the missing disclosure. Wrong basis of preparation The directors of Gavin Ltd claiming that the company will continue and the auditors saying that this is wrong means that the financial statements are misstated. There is no uncertainty so no going concern uncertainty paragraph will be relevant. There is also no lack of evidence. The misstatement would be pervasive because the wrong basis of preparation would mean that almost all areas of the financial statements are valued and classified incorrectly. This would require and adverse opinion. The financial statements do NOT give a true and fair view. d) Positive assurance is a high level of assurance and is usually associated with a normal audit of historic financial information. Negative assurance does NOT mean that something is wrong. It is a lower level of assurance that is given due to less work being carried out or more uncertainty involved with the particular assignment. A cash flow forecast is a predictive document so a lower, negative level of assurance would be given in this case.

Bullfinch - Answer Part (a) – Audit report elements and why included The following elements should be included within an auditor’s report along with why: Title – The auditor’s report shall have a title which clearly indicates that it is the report of an independent auditor, this distinguishes this report from any other. Addressee – The auditor’s report shall be addressed as required by the circumstances of the engagement, this is determined by law or regulation but is usually to the shareholders. This clarifies who may rely on the opinion and who may not, such as third parties. Introductory paragraph – The introductory paragraph in the auditor’s report shall identify the entity whose financial statements have been audited, state that the financial statements have been audited, identify the title of each statement which comprises the financial statements, refer to the summary of significant accounting policies and other explanatory information and specify the date or period covered by each financial statement. This paragraph aims to clarify what time period the audit covers and which pages of the financial statement have been audited, as not every page is audited. Management’s responsibility for the financial statements – This section of the auditor’s report describes the responsibilities of those in the organisation who are responsible for the preparation of the financial statements. This paragraph along with that of the auditor’s responsibilities looks to make clear what the role of management is, as well as what the role of the auditor is. It seeks to reduce the expectation gap. Auditor’s responsibility – The auditor’s report shall state that the responsibility of the auditor is to express an opinion on the financial statements based on the audit and that the audit was conducted in accordance with International Standards on Auditing and ethical requirements and that the auditor plans and performs the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. Along with the management’s responsibility paragraph, it seeks to make clear the role of the auditor and also what management’s role is. Also this paragraph seeks to explain what an audit involves and that only material misstatements are considered, as opposed to all errors. Opinion paragraph – When expressing an unmodified opinion, the auditor’s opinion shall either state that the financial statements ‘present fairly’ or ‘give a true and fair view’ in accordance with the applicable financial reporting framework. This paragraph details whether the financial statements are true and fair or not. Other reporting responsibilities – If the auditor addresses other reporting responsibilities in the auditor’s report, these shall be addressed in a separate section in the auditor’s report titled ‘Report on Other Legal and Regulatory Requirements’. This is important where there is local legislation which requires reporting on; this needs to be clearly identified in the report as this is in addition to the requirement of the ISAs. Signature of the auditor – The auditor’s report must be signed, this can be either the personal name of the auditor or, the signature is on behalf of the firm, depending on the jurisdiction in which the auditor is operating. This clarifies which firm or auditor has performed the audit engagement. Date of the auditor’s report – The auditor’s report shall be dated no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence on which to base the auditor’s opinion on the financial statements. The date of the audit report is important in the case of subsequent events which impact the financial statements; the auditor’s role is different depending on whether the audit report was signed or not when the subsequent event came to light. Auditor’s address – The auditor’s report shall name the location where the auditor practises. This is useful in case shareholders need to contact the auditors.

Part (b) – Subsequent event A key customer of Bullfinch.com has just notified the company that they are experiencing cash flow difficulties and are unlikely to make any payments for the foreseeable future. This information was received after the year end but provides further evidence of the recoverability of the receivable balance at the year-end. If the customer is experiencing cash flow difficulties just a few months after the year end, then it is highly unlikely that the year-end receivable was recoverable as at 31 October and hence is an adjusting event. The receivables balance is overstated and consideration should be given to adjusting this balance, if material, through the use of an allowance for receivables or by being written off. The total amount outstanding at the yearend was $283,000 and is material as it represents 7·4% (0·283/3·8m) of profit before tax and 2·5% (0·283/11·2m) of revenue. Hence, the directors should amend the 2014 financial statements by writing down or writing off the receivable balance. The following audit procedures should be applied to form a conclusion as to the level of the adjustment: – The correspondence with the customer should be reviewed to assess whether there is any likelihood of payment. – Discuss with management as to why they feel an adjustment is not required in the 2014 financial statements – Review the post year-end period to see if any payments have been received from the customer.