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FEEDBACK TUTORIAL LETTER
1ST SEMESTER 2017
ASSIGNMENT 2
Auditing 310 [AUD612S]
May 2017
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
1
Types of audit evidence Award 2 marks for each well explained point. Allow 1 mark for simply stating the appropriate area. Analytical procedures 1 Inquiry 1 Inspection 1 Observation 1 Re-calculation 1
Maximum marks 10
Examples of evidence Award 2 marks for each well explained point. Allow 1 mark for simply mentioning the appropriate test Analytical procedures 1 Inquiry 1 Inspection 1 Observation 1 Re-calculation 1
Maximum marks 10
Suitability of methods of gathering evidence
(b) Part (a) required candidates to state tests that could be carried out in (b) takes this
forward to actually considering whether each type of testing would be used in Mango .
Candidates should be able to identify that some methods of gathering evidence such
as enquiry are of more use than others. Note –also allow procedures as if used in
Mango limited by director – question could be read this way.
Types of audit evidence
Award one mark for explaining whether each technique is suitable for Mango Ltd and
one mark for explaining limitations in that technique to a maximum of 10
a) Analytical procedures
(i) Analytical procedures mean the study of trends and ratios in financial and non-
financial information. It is used within audit planning to identify risk areas and also as
a means of gathering substantive evidence, for example by calculating an estimate
of a particular figure based on knowledge of the business and comparing this to the
actual figure.
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
2
(ii) A comparison of gross profit percentages month by month for Mango could be
performed and any unusual fluctuations investigated as these could indicate errors
such as omission of sales, loss of inventory, or other errors.
Inquiry
(i) Inquiry means requesting information. This could be from individuals within the
company, either orally or in written representations, or in formal written requests to
third parties.
(ii) In Mango Ltd a relevant example would be to send a standard confirmation letter to
the company's bank (could be illustrated with an example of enquiry to client staff).
Inspection
(i) Inspection means looking at documentation, books and records or assets. This
could be done to confirm existence of an asset, to verify values or to provide evidence
that a control has taken place.
(ii) The inventory of cuddly toys at the year-end could be inspected as part of the
evidence relating to its value. The inspection would give evidence as to whether the
inventory was in good saleable condition (could be illustrated with an example of
inspection of documentation).
Observation
(i) Observation means watching a procedure being carried out. It is usually used as a
means of gathering evidence about the internal controls in a company.
(ii) In Mango Ltd it might be appropriate to observe the procedures that are carried out
when the post is opened to assess whether controls exist to prevent the
misappropriation of cash.
Recalculation
(i) Recalculation means the reperformance of an arithmetical process within the
accounting system.
(ii) This could involve re-checking a manual calculation or using a computer-assisted
audit technique to re-perform casts within the accounting records)
.
(b) The usefulness of analytical procedures depends on a number of factors
including the reliability of the underlying information. It seems that, as a small
business, Mango has little segregation of duties and formal controls. This casts doubt
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
3
on the reliability of the information and hence the conclusions that might be drawn
from the analytical procedures.
Inquiry evidence from third parties will be essential in the audit of Mango. As
well as the bank confirmation, it may be necessary to send confirmation letters
to suppliers to obtain third party evidence of the liabilities at the year-end.
Inquiry evidence from sources within Mango will be obtained mainly from
Mr Khata and its reliability will be very dependent on how the auditors assess his
integrity.
Inspection of documents will be a major part of the evidence gathered in the
audit of Mango. Supplier invoices will be inspected to verify values and to
confirm that purchases and expenses are genuinely business items. There may
be limits to the reliance that can be put on this as in a poor control environment
it may be difficult to confirm whether documentation is complete.
Observation may be the only way to gather evidence about controls such as
any that may exist over the opening of post. This type of evidence is limited in
its usefulness for two reasons:
– It only provides evidence that the control operated at the point in time that the
auditor carried out the test
– Client staff are likely to perform their duties exactly according to the company's
procedures manual when they are aware that the external auditor is observing them
whereas this may not be the case on any other day of the year
To place reliance on controls and reduce substantive testing the auditor needs
evidence that controls operated effectively over the whole of the accounting period so
the observation would be of limited usefulness. Observation of controls in operation
over the year-end inventory count might be more useful as this is a one-off, rather
than daily, procedure. If the auditor could see that the inventory count was being
carried out in a well-controlled way then it may be possible to reduce substantive
testing on the inventory sheets.
Re-calculation is a good check of the accuracy of invoices and control
accounts. However it only covers figures that that have been recorded in the
accounts, and will not identify omitted figures
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
4
QUESTION 2 (30 Marks) One mark per point (i) Sampling risk Explanation 1 Example 1 Non-sampling risk Explanation 1 Example 1 (ii) Sampling risk Controlled by 1 Non-sampling risk Controlled by 1 Allow other relevant points 1
Maximum marks 10 (b) One mark per point Audit manager comments Explanation of sampling method 1 Small population 1 Transactions material 1 Audit senior points Explanation of sampling method 1 Population homogenous – therefore use statistical sampling 1 Time to produce sample 1 Audit junior points Explanation of sampling method 1 Sample selection not random 1 Can't draw valid statistical conclusion 1 Allow other relevant points 1
Maximum marks 10
2 marks per point Definition Materiality – omission or misstatement 1 Materiality – size of the item 1 Important because: Financial statements incorrect 1 Directors/owners know of errors; auditor reporting to 1 Third parties rely on financial statements 1 Other relevant points 1
Maximum marks 10
(a) (i) 'Sampling risk' is the risk that the auditor's conclusion, based on a sample, may
be different from the conclusion reached if the entire population were subject to the
same audit procedure. There are two types of sampling risk. In the first type, the
auditor concludes in a test of controls, that controls are more effective than they
actually are, or in a test of details, that a material error does not exist when it actually
does. In the second type, the auditor concludes in a test of controls, that controls are
less effective than they actually are, or in a test of details, that a material error exists
when it actually does not.
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
5
'Non-sampling risk' arises from factors that cause the auditor to reach an incorrect
conclusion for any reason not related to the size of the sample. For example, the
auditor may rely on audit evidence that is persuasive rather than conclusive, the
auditor may use inappropriate audit procedures, or the auditor misinterprets audit
evidence and fails to recognise an error.
(ii) Sampling risk can be controlled by the audit firm by increasing sample size for
both tests of control and tests of detail.
Non-sampling risk can be controlled by the audit firm by proper engagement
planning, supervision and review.
(b) The audit manager wants to check all the invoices in the year. This would involve
checking around 500 invoices. This would be impractical in terms of time and cost for
the directors of Windhoek Plc. Although 500 is not a huge population, it is unlikely that
the firm would test 100% in practice.
The audit senior wants to select a sample using statistical sampling techniques. This
would involve calculating a sample size appropriate to the auditor's assessment of
factors such as risk, required confidence level, tolerable misstatement and expected
error. Such a sample can still produce valid conclusions and in this case, the
population consists of items showing similar characteristics. Where statistical sampling
is used all the items in the population must have an equal chance of being selected,
so the sample should be picked using a method such as random number tables or a
systematic basis. Provided that the sales invoices are sequentially numbered, this
should be easy to apply in the example.
The audit junior's suggestion is to use a 'random' method of selecting samples
manually and choosing a few important ones. This approach would not be appropriate
because the auditor is not choosing the sample randomly as there would be bias
involved and implies that 'haphazard' selection would be used. Valid
conclusions would not be able to be drawn because statistical sampling had not been
used to select the sample.
(c) Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of the financial statements. Materiality
depends on the size of the item or error judged in
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
6
the particular circumstances of its omission or misstatement. Materiality also has
qualitative, as well as quantitative, aspects which must be considered. The auditor
will determine materiality levels for the financial statements as a whole, but will also
set lower levels of performance materiality:
To reduce to an appropriately low level the risk that undetected or uncorrected
aggregate misstatements exceed materiality for the financial statements as a
whole.
For particular classes of transactions, account balances or disclosures
Materiality for the financial statements as a whole is often calculated as a percentage
of different items in the financial statements, such as revenue, profit before tax or net
assets. In the case of Windhoek Plc, materiality is likely to be based on 0.5 – 1% of
revenue, ie $350-700k.
The auditors of Tam Co must form an opinion on whether the financial statements are
free from material misstatement because there is a requirement for an audit under
local legislation for this company. Other users of the accounts may also be relying on
the outcome of the audit, such as the bank since the company has recently taken out
a five-year bank loan to finance an expansion. The bank would be very interested in
the accounts of Windhoek Plc as a basis for assessing whether the company will be
able to repay the loan. Users of the financial statements expect to receive reasonable
assurance that the information is ‘presented fairly in all material respects’ or is 'true
and fair'. This implies that there are no material misstatements or omissions
QUESTION 3 (30 marks)
Elements of audit report. 1 mark for each of the following (being 0.5 for the element and 0.5 for explanation for that element). Title of report Addressee of report Introductory paragraph Auditor’s responsibilities Management’s responsibilities Opinion Date of report Auditor's address Auditor's signature Up to Six marks
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
7
(b) Maximum 24 marks this section (14 for (1) and 10 for (2)) (i) Additional audit procedure
Issue one – up to 14 marks Additional audit work Discuss with directors Action against director Management letter Letter of representation Other relevant points (each)
Issue two – up to 10 marks Talk with director Asset transferred to director? Ask whether any payment made for yacht Check disclosure financial statements Check tax return Other relevant points (each) (ii) Effect on audit report
Issue one – up to 3 marks Amount is material 1 Modify opinion qualified 'except for' 1 Explain why modified 1
Issue two – up to 3 marks Modify opinion – qualified 'except for' Provide disclosure
Maximum marks 24
(a) Audit report
Title
The audit report should have a title which includes the wording 'independent auditor' to
distinguish this report from others that may be prepared internally by the company.
Addressee
The report should be appropriately addressed as required by the engagement and
local regulations. This is normally to the shareholders of the company or to those
charged with governance.
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
8
Introductory paragraph
This section identifies the financial statements being audited, including the date and
period covered. It also identifies the title of each statement that comprises the financial
statements being audited.
Management’s responsibility for the financial statements
This part of the report is included to describe the responsibilities of those who are
responsible for the preparation of the financial statements including those in respect of
internal control.
Auditor’s responsibility
This section describes the auditor’s responsibility for expressing an opinion, notifies
users that the audit was carried out in accordance with ISAs and explains what an
audit involves.
Opinion
This indicates the financial reporting framework used to prepare the accounts and
states the auditor's opinion as to whether the financial statements present fairly, in all
material respects (or show a true and fair view of) the financial position of the audited
entity in accordance with that framework.
Date
The audit report should be dated as at the completion of the audit, to show that the
auditor has considered any events after the reporting period date up to the date of
completion and how these might affect the financial statements. The report should not
be dated earlier than the date on which the accounts are signed or approved by
management.
Auditor's address
The audit report should name a specific location, which is normally the city or town
where the auditor maintains the office that has responsibility for the audit.
Auditor's signature
The audit report should be signed in the name of the audit firm, the personal name of
the auditor, or both, as appropriate. It is usually signed in the name of the firm
because the firm assumes responsibility for the
audit.
(Note. Only six were required.)
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
9
(b) Issue 1 – understatement of sales income
(i) Audit procedures
– Discuss the issue with the other directors of the company so that they are aware of
the matter and its seriousness
– Perform further substantive audit work, such as detailed analytical review, to confirm
the extent of the understatement
– Obtain a written management representation letter point of the estimate of the
amount of the fraud
(ii) Potential effect on audit report
As this issue is material, the understatement of sales income representing 5% of total
revenue for the year, it is likely to have a negative effect on the audit report. The report
should include a qualified opinion on the basis of an inability to obtain sufficient
appropriate audit evidence on sales for the year. The audit report should provide
details of this matter giving rise to the qualified opinion in a Basis for qualified opinion’
paragraph.
Issue 2 – personal use of boat
(i) Audit procedures
– Discuss the issue in more detail with the director concerned
– Through discussion, find out whether the director purchased the boat and if so,
agree the amount to the cash book and bank statements and non-current asset
register
– Review financial statements to ensure correct disclosure as a director's benefit
within directors' emoluments
(ii) Potential effect on audit report
Non-current assets on the statement of financial position will be overstated since they
include a boat that is used for personal use by one of the directors and not for the
purposes of the business. Given that, non-current assets are likely to be material to
the statement of financial position; this issue may result in a qualified audit opinion on
the basis that the overstatement of non-current assets has resulted in the accounts
being materially misstated. The value of the boat should be taken off the statement of
financial position and it should be reclassified as a benefit within the directors'
emoluments notes
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
10
QUESTION 4 (10 marks)
Duties re financial statements Allow 1 mark for director responsibilities, and 1 for auditor responsibilities Preparation of financial statements Fraud and error Disclosure Going concern Similar relevant points – each point
Maximum marks 4
(b) Auditors' reports Up to 1 mark per relevant point Use of term Auditing Standards Limitation on use of judgements and estimates Time limitation FS free from material error Directors' responsibilities Reference to annual report Allow other relevant points
Maximum marks 6
(a) Preparation of financial statements
The directors have a legal responsibility to prepare financial statements giving a true
and fair view. This implies that they have been prepared in accordance with the
relevant IASs and IFRSs.
The auditor's duty is to carry out an audit (according to the International Standards on
Auditing) and to give an opinion on whether a true and fair view is given (or whether
the financial statements present fairly, in all material respects, the financial position of
the entity). In doing this they will have to consider whether the relevant accounting
standards have been properly followed.
Estimates and judgements and accounting policies
The directors have the responsibility for making the estimates and judgements
underlying the financial statements and for selecting the appropriate accounting
policies.
The auditor's responsibility is to assess the appropriateness of the directors'
judgements and to modify the audit opinion in the case of any disagreement causing
the auditors to conclude the financial statements are not free from material
misstatement.
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
11
Fraud and error
The directors have a duty to prevent and detect fraud and error. This is a duty they
owe to the shareholders and there is no 'materiality' threshold attached to their duty.
The auditor is responsible (under ISA 240) for obtaining reasonable assurance that
the financial statements are free from material misstatement including material
misstatement caused by fraud.
The auditor is responsible for maintaining professional scepticism throughout the
audit, considering the possibility of management override of controls. The audit team
must discuss how and where the entity's financial statements may be susceptible to
material misstatement due to fraud, including how fraud might occur.
Disclosure
The directors are responsible for disclosing all information required by law and
accounting standards.
The auditor's responsibility is to review whether all the disclosure rules have been
followed and whether the overall disclosure is adequate. There are certain pieces of
information, which, if not disclosed by the directors, must be disclosed by the auditor in
his report. Examples of this are related party transactions and transactions with
directors.
Going concern
The directors are responsible for assessing whether it is appropriate to treat the
business as a going concern. In doing this, they should look at forecasts and
predictions for at least twelve months from the reporting date. They should also
disclose any significant uncertainties over the going concern status of the company
The auditors' responsibility is to consider whether there are any indicators of going
concern problems in the company, and assess the forecasts made by directors and
decide whether the correct accounting basis has been used and whether there is
adequate disclosure of significant uncertainties.
The auditor must consider modifying the audit opinion in the auditor’s report if:
(i) The directors have considered a period of less than twelve months from the
reporting date (this could result in a qualified opinion due to an inability to obtain
sufficient appropriate evidence)
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
12
(ii) The directors have used the going concern basis when the auditor believes that its
use is not appropriate (this will be a result in an adverse opinion)
(iii) The auditor agrees with the basis chosen by the directors but feels that the
disclosures are inadequate (this will probably result in a qualified 'except for' opinion)
(iv) The auditor agrees with the chosen basis, and that the disclosures are adequate
but there are uncertainties over the going concern status of the company. In this case,
the opinion will be unmodified but an emphasis of matter paragraph will be added.
(b) Errors in the report extract
'Presentation of information in the company's annual report'
The auditor's legal responsibilities relate to the financial statements, which comprise
the primary statements plus the supporting notes. They do not extend to any other
information, for example a chairman's statement, or 5-year summary. To make this
clear, this section should refer only to the financial statements.
Under ISA 720, the auditor’s responsibilities relating to other information in documents
containing audited financial statements the auditor has a responsibility to read the
other information to identify whether there are any inconsistencies with the financial
statements or anything that is misleading, but the primary opinions given on the
financial statements only.
'In accordance with Auditing Standards'
The report should specify exactly which auditing standards have been used so that
there is no risk that readers misunderstand how the audit has been done. It should
specify that the audit has been performed in accordance with International
Standards on Auditing.
'Evaluating ….the reasonableness of all accounting estimates'
It is inappropriate to imply that the auditor has considered every estimate made by
management. This is unlikely to be true because auditors do not look at every single
transaction and item in the financial statements; it is the duty of the auditor to give
assurance only on whether the financial statements are free from material
misstatement.
'As much audit evidence as possible in the time available'
This phrase is inappropriate because it implies that the auditor has not had time to
obtain all the evidence
TUTORIAL LETTER MEMO
SEMESTER 1/2017
"COURSE NAME" AUDITING 310
"COURSE CODE" AUD 612S
13
that is needed. The auditor is expected to obtain sufficient evidence on which to base
conclusions. The auditor should have planned the audit so as to obtain sufficient
evidence in the time available.
'Confirm'
This word should not be used because it implies a greater degree of certainty than is
possible based on normal audit procedures. The certainty implied by the word 'confirm'
may expose the auditor to negligence claims if it turns out that there are any material
errors in the financial statements. A more accurate
description of the level of assurance given by an audit is 'reasonable assurance'.
'No liability for errors can be accepted by the auditor'
This disclaimer at first might appear to be useful in protecting the auditor against
liability. However, the view of the ACCA is that general disclaimers should not be
included in audit reports, as their use would tend to devalue the audit opinion.
The directors are wholly responsible for the accuracy of the financial statements'
This statement should not appear in the auditor’s responsibility section of the report.
Details of management’s responsibilities is differently worded and should appear in an
earlier separate section of the report outlining the responsibility of management for the
preparation of the financial statements.