1 CAP2 AU S13 10/06/2012

CA Proficiency 2

PAPER 1 AUDITING & ASSURANCE

SUMMER 2013 (Wednesday 26th June 2013 - 9.30 a.m. to 1.20 p.m.)

INSTRUCTIONS TO CANDIDATES 1. The first 20 minutes of this examination is dedicated to reading time. During this time, candidates may refer

to their materials and make notes on this examination paper or in their own note book. Candidates are NOT permitted to open their answer books until instructed to do so. 2. Answer Question 1 in Section A. Answer ANY TWO of the THREE Questions in Section B. 3. Candidates should indicate clearly whether they are answering the paper in accordance with the law and

practice of Northern Ireland or the Republic of Ireland. 4. Candidates should deem each monetary amount shown with the / symbol to be stated in their relevant

currency. 5. All workings should be shown. 6. Answers should be illustrated with examples where appropriate. 7. Section A begins on Page 2 overleaf.

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SECTION A

CASE STUDY Answer Question 1

QUESTION 1 (Compulsory)

You are a newly appointed Audit Senior in BDL Chartered Accountants and you have just returned from a period of study leave and holidays. Upon your return your Manager has informed you that you will be working on the audit of Youserv Limited (YOUSERV) an indigenous Irish company that provides financial services and back office support to companies in Ireland. YOUSERV which was formed in 2008 has, unlike many other companies in Ireland, thrived though the recessionary period as a result of many companies in Ireland deciding to restructure their operations and outsource their finance function. YOUSERV has grown from servicing 5 small customers in 2008 to serving 21 customers in 2012 of which 3 are multinational companies. As a result of its continued growth, YOUSERV was successful in raising loan finance of / 7.5 million during the last quarter of 2010. This is repayable at various stages over a four year period. YOUSERV has a year end of 31 December 2012 for statutory audit purposes. It is now January 2013. Set out in Appendix 1 are the results of audit procedures conducted around revenue and receivables during the interim audit (for the 10 month period to 31 October 2012). The results of the final audit for revenue and receivables (for the year ended 31 December 2012) are set out below. Year-end audit - revenue and receivables December 2012 You have just commenced the year end statutory audit for YOUSERV. The assessed materiality for the 31 December 2012 amounts to / 180,000 on the basis of 5% of profit before tax. As a follow up procedure to the debtors confirmation process conducted during the interim audit, your Manager has requested that YOUSERV conduct an accounts receivable roll forward from the 31

st October 2012 to 31

st

December 2012. The Audit Manager also wishes to perform post year-end cash testing on certain debtor balances that did not respond to address the existence assertion. The Finance Manager of YOUSERV has left your Partner a voicemail indicating that he has prepared the roll forward but it took him a significant amount of time. Your Partner enquiries whether the work performed over debtors at the interim audit provides sufficient comfort over the existence of accounts receivables and whether post year-end cash testing is required. Details of the accounts receivable roll forward together with the work performed by your Audit Assistant is set out below. Your Audit Manager has requested that you review the work performed by the Audit Assistant and provide appropriate feedback.

/ Audit work performed Opening debtor balance 4,560,000 Agreed to debtors listing at 31 October 2012.

Sales in the period 1,657,000 This represents sales for the period 1 November 2012 to 31 December 2012. This includes / 40,000 of a loan to Mr Madden, a Director of YOUSERV, which was advanced in early November 2012 and which was due to be repaid in full by 31 December 2012. Sales occurred evenly throughout the two month period.

Cash receipts in the period (800,100) This amount was posted to bank in the general ledger. / 760,100 was received in respect of trade debtor payments and / 40,000 was received as a repayment of a loan from Mr Madden.

Credit notes (578,000) This figure represents credit notes issued in the two month period to 31 December 2012. Amounts are in line with prior years and generally credit notes arise 1 month after the initial sale and these credit notes arose evenly over the period no issues noted. As a result of recommendations provided by the audit team at the interim audit YOUSERV has now created a sales returns provision of / 290,000 as at 31 December 2012.

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QUESTION 1 (Contd)

/ Audit work performed

Transfer of debit balances in the creditors ledger to debtors

230,000 These represent debit balances that were on the creditors ledger as at 31 December 2012. YOUSERV was delayed in processing the invoices of these services from their suppliers but their suppliers were demanding payment so a journal entry of Dr Creditors and Cr Cash was posted. Confirmed that these invoices have been recorded post year end in line with YOUSERVs policy of recording liabilities when the related invoice is received.

Closing debtor balance 5,068,900 Mathematically accurate

Requirement:

Interim audit

(a) In respect of the debtors confirmation process conducted as part of the interim audit procedures (see Appendix 1) at 31 October 2012 set out:

(i) The factors that should be considered in determining a sample of debtors to circularise and the adequacy of the sample selected for YOUSERV debtors.

6 Marks

(ii) The audit procedures you will now conduct on each of the selected FIVE debtor balances. 15 Marks

(iii) Any journal adjustments you will propose as a result of your interim audit work. 6 Marks

(b) Draft an internal memorandum which briefly outlines your observations regarding YOUSERVs revenue and receivables, together with appropriate examples to support your discussion, as evidenced from your interim audit work.

6 Marks Year-end audit

(c) In respect of the follow up procedures conducted as part of the year-end audit of revenue and receivables

at 31 December 2012 set out:

(i) Your response to your Partners query as to whether the work performed over debtors at the interim audit provides sufficient comfort over the existence of accounts receivables and whether post year-end cash testing is required.

3 Marks

(ii) The additional audit procedures you would request your audit assistant to conduct on the accounts receivable roll forward.

16 Marks

(iii) The additional adjustments (if any) you would propose in respect of the debit balances on the creditors ledger as at 31

st December 2012 and how you would assess the sales returns

provision of / 290,000 as at 31st December 2012.

8 Marks

Total Marks: 60 Marks

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QUESTION 1 (Contd) Appendix 1 Interim audit - revenue and receivables October 2012 As part of the interim audit work debtor confirmations as at 31 October 2012 were sought as per the 5 balances below (selected at random from the listing of trade receivables):

Debtor Balance per debtors listing

Balance per the confirmation

Comments

STAR / 220,000 NZ$ 270,000 Note 1 APOLLO / 460,000 / 260,000 Note 2 EIGHT / 340,000 / 300,000 Note 3 ADAMA / 120,000 / 75,000 Note 4 TAURA / 360,000 - Note 5 The results of the confirmation process are set out in notes 1 to 5 below: Note 1 As part of the confirmation process it was noted that STAR is invoiced in NZ$ and the amount confirmed of NZ$ 270,000 includes invoices for services received to 31 October 2012 worth NZ$ 300,000 less payments made on the 29

th October 2012 of NZ$ 30,000. The payment of NZ$ 30,000 was received by YOUSERV on the 4

th

November 2012. The balance of / 220,000 represents the NZ$ 300,000 retranslated at the FX rate at 31 October 2012. Note 2 The difference relates to invoices raised by YOUSERV for / 200,000 in respect of services from 1 October 2012 to 30 November 2012. There was a delay in sending these invoices and consequently the invoices were recorded by APOLLO in November 2012. The / 200,000 was recognised by YOUSERV in revenue for the period to 31 October 2012. Note 3 Management has noted that this balance is being disputed by EIGHT. EIGHT believes it was overcharged for services when compared to contracted prices. There is a provision of / 40,000 in accruals to reflect this overcharge. Note 4 The date on ADAMAs confirmation was the 5

th November 2012 which showed credit notes received during the first

week of November for / 45,000. These credit notes of / 45,000 were recorded in the accounting records of YOUSERV at the end of November 2012 but relate to services provided in September 2012. Note 5 No confirmation was received by TAURA but the finance clerk has indicated to you that the debt definitely exists and will be fully repaid as TAURA is co-owned by a director of YOUSERV.

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QUESTION 2 APPEARS ON PAGE 6 OVERLEAF P.T.O.

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SECTION B

Answer ANY TWO of THREE Questions in this Section QUESTION 2

You are the Audit Senior working on the audit of Fishtanks Limited (FISHTANKS) for the year ended 31 December 2012. FISHTANKS manufactures and sells a wide number of products from small goldfish tanks to very

large commercial exotic fish aquariums.

Your Audit Manager received a call yesterday informing him that FISHTANKS annual stocktake is taking place today, the 2

nd of December 2012. Your Audit Manager has requested that you attend and has informed you that the

materiality for the audit has been set at / 50,000.

You arrive on site and are met by FISHTANKS Financial Controller, Brian McEvoy. Brian asks to speak to you about a couple of things pertaining to the audit before you carry out your counts. During the course of this meeting,

Brian asks if you would be able to prepare the books and records and the financial statements for FISHTANKS for

the current year as he will not have an opportunity to prepare them given his current workload. Brian notes that this

is a once-off request as FISHTANKS has recently employed an Accountant (who happened to be the Audit

Manager from the prior year) and, once this person settles in, they will be able to prepare the financial statements

going forward.

Brian then provides you with background information regarding inventory. FISHTANKS produces to order and

closes over Christmas, therefore, at year-end, FISHTANKS holds minimal work-in-progress and finished goods.

Brian tells you that FISHTANKS estimates the cost of each stock item at the beginning of the year and that this

estimate is entered into the system and used to value inventory included in the year-end statement of financial

position. Brian also notes that the inventory levels as counted at 2nd

of December 2012 (today) are not expected to

differ significantly to inventory levels at year end and, as such, the levels at 2nd

of December will be used for

recording physical inventory quantities as at 31 December 2012 as FISHTANKS does not intend to conduct a

further inventory count at 31 December 2012.

Brian tells you that, due to his workload, he wants to get the audit of inventory out of the way before the year end. He tells you that he remembers what information was requested for inventory in the prior year audit and has

provided the same information to you by email (see Appendix 1). Brian also tells you that FISHTANKS only has a

few small orders over the next couple of weeks highlighting again that inventory levels should not move

significantly after todays count.

Brian is confident he has given you everything you need for the audit of inventory and wont have time to provide any further information.

Following the meeting with Brian, you attend the count. You perform the number of counts agreed with your Audit

Manager. You note no issues with FISHTANKS count procedures and traced the items counted to the inventory listing without exception.

Requirement:

(a) Prepare a memo to your Audit Manager outlining any ethical issues you note from the information provided by

Brian McEvoy. 6 Marks

(b) Set out the additional work that needs to be conducted to gain sufficient audit evidence over inventory as at 31

December 2012.

4 Marks

(c) Indicate any initial adjustments that are required as a result of your review of the inventory information provided

by Brian McEvoy. 2 Marks

(d) For each item noted in (c), outline the potential effect on the audit report if not resolved. (Note: candidates are

not required to deal with the cumulative effect of these adjustments on the audit report.)

8 Marks

Total Marks: 20 Marks

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QUESTION 2 (Contd)

Appendix 1 Extract from Brian McEvoys email

Top 5 Inventory Items

Code Description Quantity Estimated cost per unit

(exclusive of VAT)

/

Total value per statement of

financial position as at 2 December 2012

/

A011 Rectangular Glass Panel 100x80 5,495 115.00 631,925

G049 Square Glass Panel 50x50 3,960 85.00 336,600

C123 Aluminium Sheeting 40,250 7.50 301,875

X555 Plastic black 95,739 2.50 239,348

T009 Electric cabling 21,460 11.00 236,060

Other inventory items 981,451

Total inventory 2,727,259

Most recent purchases prices of inventory items set out below by invoice date (note that the original invoices are being extracted from the files and will be scanned to you tomorrow)

Code Description Invoice date

Cost per unit (exclusive of

VAT)

/

A011 Rectangular Glass Panel 100x80 1 Dec 12 124.99

G049 Square Glass Panel 50x50 9 Nov 12 60.00

C123 Aluminium Sheeting 13 Oct 12 10.00

X555 Plastic black 12 Oct 12 3.75

T009 Electric cabling 6 Oct 12 13.33 Details of the current inventory provision The total inventory provision is / 34,782. As the amount is small, I expect this to be below the materiality set for the audit and so no further testing is required.

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QUESTION 3

You are the Audit Senior on Deluge Limited (DELUGE), a company that operates in the recycling and waste management industry in Ireland. DELUGE has been in operation for three years having successfully secured bank

funding in 2010 to commence operations. Extracted information from DELUGEs income statement and statement of financial position is set out below.

31/12/2013

Projected

/000

31/12/2012

Unaudited

/000

31/12/2011

Audited

/000

31/12/2010

Audited

/000

Revenue 35,780 25,420 20,156 10,546

Finance costs 210 290 210 115

Profit/(Loss) before taxation 3,560 (890) (1,790) 460

Net assets / (liabilities) 2,130 (1,430) (540) 1,250

Bank borrowings 3,250 5,450 5,750 5,750

Cash and cash equivalents 1,200 156 624 878

DELUGE has insignificant amounts of non-cash transactions and the cash and cash equivalents balance at the

year ends equates to cash generated from operations. Bank borrowings of / 5,750,000 were received in January 2010 and half of this loan was subject to a fixed interest rate of 4.5% and the remaining half subject to variable

rates which, during 2012, averaged at 5.2% for the first half of 2012 and 4.8% for the second half of 2012. An

amount of / 1,750,000 was repaid from the fixed rate loan at the end of June 2012 in accordance with the loan repayment agreement and this was funded by an additional drawdown on a new facility agreement of

/ 1,450,000 and the remaining / 300,000 from cash reserves. The new loan facility of / 1,450,000 carries increasing interest rates, whereby the first / 500,000 incurs interest at a rate of 6%, the next / 500,000 incurs a rate of 7% and for each / 200,000 increment thereafter the interest rate increases by 0.5%.

The loan funding is due for repayment in instalments of / 2,200,000 in June 2013, / 1,800,000 in July 2014 and the new facility of / 1,450,000 falls due for repayment in December 2014. No further loan facilities or funding is available to DELUGE at present.

Requirement: (a) Outline your initial assessment of the funding position of DELUGE and the associated going concern

considerations. Calculations are not required. 4 Marks (b) Prior to signing the financial statements for the year ended 31 December 2012 set out the audit inquiries you

would make regarding the going concern assessment of DELUGE and the audit report implications arising from this assessment.

8 Marks (c) Draft a working paper which assesses the reasonableness of the finance costs recognised for the year ended

31 December 2012. 8 Marks

Total Marks: 20 Marks

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QUESTION 4 You are the Audit Senior on Beany Limited (BEANY), a company that specialises in the manufacture and distribution of medical device equipment. It is now April 2013 and the audit for the year ended 31 December 2012 is nearing completion. The Audit Manager has requested that you finalise the audit work on the cash flow statement in advance of the Audit Committee meeting which is due to take place next week. Due to time constraints during the audit fieldwork, audit work on the cash flow statement, while commenced, is not complete. Set out below is an extract from the audit working paper that was pulled together in a hurry, and which details the work that has been completed on the net cash flows from operating activities in the cash flow statement. Your Manager has indicated that he is happy with the work that has been completed on the cash flows from investing activities and cash flows from the financing activities but wishes you to focus on the net cash flows from operating activities. Extract of cash flow statement for the year ended 31 December 2012

Cash flow from operating activities / 000 Audit work completed

Profit before taxation 22,689 Agreed to profit before tax per income statement

Adjustments for:

Depreciation 4,200

Investment income (1,340)

Interest expense 3,450

Working capital changes:

Increase in trade receivables (1,500) Recalculated agreed as difference between opening trade receivables as at 1/1/2012 and closing trade receivables as at 31/12/2012

Decrease in inventories (2,450)

Decrease in trade payables (1,890)

Cash generated from operations 23,159 Mathematical accuracy checked no errors noted

Interest paid (3,100)

Income tax paid (2,800)

Net cash flow from operating activities 17,259 Mathematical accuracy checked no errors noted

Requirement: (a) Set out your general understanding of the role of the Audit Committee in enhancing corporate governance practices. 10 Marks (b) Set out the audit procedures you would use to verify each of the line items on the above extract of the cash flow statement.

10 Marks Total Marks: 20 Marks