1
Shamsuddin a newly qualified chartered accountant has recently established his practice in the
name of Shamsuddin & Co., Chartered Accountants. He is continuously trying to expand his
practice and in this process he came across the following situations:
(i) One of his friends, who is the owner of an advertising agency, has offered to provide
significant discount for publicity of his new practice.
(ii) Fashion Limited, a private limited company, which has suffered heavily on account of
recent financial turmoil, has informed him that it is willing to appoint him in the forthcoming
annual general meeting (AGM) of the company in place of the existing auditors, if he can quote
a fee below the existing audit fee.
(iii) Design Limited has contacted Shamsuddin and informed him that they are willing to
appoint him as their external auditor in the next AGM at a fee of Rs. 200,000 if he completes
the audit in a month. However, in case of delay in the audit work the audit fee will be reduced
to Rs.150,000.
(iv) Shamsuddin receives an offer of appointment as auditors from Style Enterprises, a sole
proprietorship, who wants to remove the existing auditors before completion of their term of
office.
Required:
Shamsuddin is inclined to accept the above offers. Discuss the options available with him in
each of the
above situations.
Shamsuddin, as a newly qualified chartered accountant, should carefully consider the ethical
implications and professional responsibilities associated with each of the situations presented.
Here are the options available to him in each of the scenarios:
Situation (i): Friend Offering a Discount for Publicity:
Shamsuddin should exercise caution in accepting discounts from friends in exchange for
publicity, as it could raise ethical concerns and compromise his independence. The options
available to him are:
1. Decline the Offer: The most ethical option is to decline the offer from his friend.
Accepting significant discounts from friends could impair his independence,
objectivity, and professional skepticism.
2. Accept Publicity Without Discounts: If Shamsuddin still wishes to promote his
practice, he can accept the offer of publicity without accepting discounts. This
approach maintains his independence and integrity.
Situation (ii): Offer from Fashion Limited:
In this scenario, Shamsuddin should consider the ethical implications of quoting a fee below
the existing audit fee. His options include:
1. Quote an Ethical Fee: Shamsuddin should quote a fee that is reasonable and
commensurate with the expected workload. Quoting an unreasonably low fee to
secure an audit engagement could compromise audit quality and independence.
2. Discuss the Ethical Concerns: Shamsuddin should have a discussion with Fashion
Limited to express his concerns about quoting a fee below the existing audit fee. He
can explain the importance of maintaining audit quality and independence and work
with the company to arrive at a reasonable fee.
3. Decline the Engagement: If Fashion Limited insists on an unreasonably low fee,
Shamsuddin should consider declining the engagement, as it would be in violation of
ethical and professional standards.
Situation (iii): Offer from Design Limited:
The time frame and the fee arrangements for the audit engagement with Design Limited raise
ethical considerations. Shamsuddin's options include:
1. Negotiate a Realistic Time Frame: Shamsuddin can negotiate with Design Limited
to extend the audit time frame to ensure that the audit work is conducted thoroughly
and meets professional standards. Rushing the audit could compromise quality.
2. Reject the Offer: If Design Limited is unwilling to extend the time frame or maintain
a reasonable audit fee, Shamsuddin can consider rejecting the engagement. Rushing
the audit to meet a tight deadline and reduced fees can jeopardize audit quality and
independence.
Situation (iv): Offer from Style Enterprises:
Accepting an appointment as auditors to remove existing auditors before their term of office
raises ethical concerns. Shamsuddin's options include:
1. Decline the Offer: Shamsuddin can decline the offer from Style Enterprises as
removing existing auditors prematurely may not be in accordance with professional
and ethical standards.
2. Consult with the Existing Auditors: Shamsuddin can discuss the situation with the
existing auditors and seek their input on the matter. It may be possible to resolve any
issues without the need for a premature change in auditors.
In all of these situations, Shamsuddin should prioritize his ethical and professional
responsibilities. Maintaining independence, objectivity, and adherence to professional
standards is essential to ensuring the integrity and quality of his audit practice. If he is faced
with ethical dilemmas, seeking guidance from his professional accounting body or an
experienced mentor can be beneficial.
2
Comment on each of the following independent situations with reference to the applicable rules
and
regulations.
(a) Zaman is a partner in a firm of Chartered Accountants and holds 5,000 shares in Mardan
Limited (ML). His firm has received an offer for appointment as auditors of Khanewal Limited
(KL). ML and KL are subsidiaries of Dera Khan Limited (DKL).
(b) Bilal and Company has received an offer for appointment as auditors of IJK Limited. The
total paid up capital of the company is Rs. 990 million whereas its ordinary share capital is Rs.
130 million.
Faryal, the wife of a partner in Bilal and Company, is a director in LMN Limited which holds
50 million non-voting preference shares and 2 million ordinary shares in IJK Limited. Faryal
also holds 10,000 shares in LMN Limited. The par value of both types of shares is Rs. 10 each.
In both situations, the ethical and regulatory rules for auditors and audit firms must
be considered to ensure compliance with professional and ethical standards. Let's
analyze each situation separately:
Situation (a): Zaman's Firm and Auditors' Appointment for Khanewal Limited
(KL)
In this situation, there are potential conflicts of interest and independence concerns
related to the appointment of Zaman's firm as auditors for Khanewal Limited (KL),
especially considering that Mardan Limited (ML) and Khanewal Limited (KL) are
subsidiaries of Dera Khan Limited (DKL). Here are the key considerations:
1. Independence and Conflicts of Interest: Auditors are required to maintain
independence and avoid conflicts of interest when accepting audit
engagements. Holding 5,000 shares in Mardan Limited (ML), which is linked to
the same parent company (DKL) as Khanewal Limited (KL), could potentially
impair Zaman's independence.
2. Regulatory Compliance: Auditors are expected to comply with the applicable
laws and regulations, including ethical and independence standards set by the
regulatory authority. It's essential to assess whether the firm's acceptance of
the audit engagement for Khanewal Limited (KL) complies with these
standards.
3. Disclosure and Transparency: If any financial interests in ML or relationships
with DKL could compromise independence or create conflicts of interest,
these should be disclosed to the client (KL) and evaluated in accordance with
professional standards.
Situation (b): Bilal and Company's Appointment as Auditors for IJK Limited
In this scenario, there are potential independence and conflict of interest concerns
related to Faryal's relationships and shareholdings. Here are the key considerations:
1. Independence and Family Relationships: Auditors are expected to maintain
independence, which includes avoiding conflicts of interest, financial interests,
and family relationships that may impair independence.
2. Shareholdings: Faryal's shareholdings in LMN Limited, which holds shares in
IJK Limited, may raise concerns about independence, especially if these
holdings represent a substantial interest in IJK Limited's affairs.
3. Regulatory Compliance: Bilal and Company should assess whether the
acceptance of the audit engagement for IJK Limited complies with the ethical
and independence standards set by the regulatory authority.
4. Disclosure and Transparency: If Faryal's shareholdings in LMN Limited and
relationships with IJK Limited or its affiliates raise independence or conflict of
interest concerns, these matters should be disclosed to the client (IJK Limited)
and evaluated in accordance with professional standards.
In both situations, it is essential for the audit firms and their partners to carefully
evaluate the potential conflicts of interest, relationships, and financial interests that
could compromise their independence as auditors. If such concerns exist, they should
be disclosed, and the firms should assess their impact on their ability to serve as
independent auditors effectively. Compliance with regulatory and ethical standards is
of utmost importance to maintain the integrity and credibility of audit engagements.
3
Your firm is the external auditor to two companies. One is a hotel, Tahira, the other is a food
wholesaler, Parvez, which supplies the hotel. Both companies have the same year-end. Just
before the year end, a large number of guests became ill at a wedding reception at the hotel,
possibly as a result of food poisoning.
The guests have taken legal action against the hotel and the hotel has taken action against the
food wholesaler. Neither the hotel nor the food wholesaler has admitted liability. The hotel is
negotiating out-of-court settlements with the ill guests, the food wholesaler is negotiating an
out-of-court settlement with the hotel. At the year end, the public health authorities have not
completed their investigations.
Lawyers for both the hotel and the food wholesaler say informally that negotiations are „going
well‟ but
refuse to confirm this in writing. The amounts involved are material to the financial statements
of both
companies.
Required: Assuming that your firm continues with the audit of both companies, for each
company, describe the difficulties you foresee in obtaining sufficient audit evidence for
potential provisions, contingent liabilities and contingent assets.
In this scenario, the external auditor faces difficulties in obtaining sufficient audit
evidence for potential provisions, contingent liabilities, and contingent assets for
both the hotel (Tahira) and the food wholesaler (Parvez). Here are the challenges for
each company:
For Tahira (the Hotel):
1. Provisions:
 Lack of Confirmation: The hotel is in the process of negotiating outof-court settlements with the guests who fell ill. Since the lawyers
refuse to confirm the progress in writing, the auditor may struggle to
obtain confirmation of the terms and amounts of potential provisions
related to legal claims.
2. Contingent Liabilities:
 Uncertainty: The public health authorities have not completed their
investigations, making it uncertain whether there will be any contingent
liabilities arising from this incident. The auditor may find it challenging
to estimate the likelihood and amount of potential liabilities accurately.
3. Contingent Assets:
 Legal Action Against Parvez: The hotel has taken action against the
food wholesaler (Parvez) but has not yet received any settlement or
compensation. The outcome of this action is uncertain, making it
challenging to recognize any contingent assets on the hotel's financial
statements.
For Parvez (the Food Wholesaler):
1. Provisions:
 Lack of Confirmation: Similar to the hotel, Parvez is negotiating an
out-of-court settlement with the hotel, but there's no written
confirmation from lawyers about the progress. The auditor may
struggle to obtain confirmation of the terms and amounts of potential
provisions related to this dispute.
2. Contingent Liabilities:
 Uncertainty: The outcome of negotiations and potential legal actions
against the food wholesaler is uncertain. The auditor may face difficulty
in estimating the likelihood and amount of contingent liabilities
accurately, especially if Parvez has not yet recognized any potential
liabilities.
3. Contingent Assets:
 Outcome of Legal Action: If Parvez intends to take any legal action
against a third party, and the outcome of such action is uncertain, the
auditor may find it challenging to recognize any contingent assets
resulting from potential legal settlements.
Given the uncertainty surrounding both companies' legal disputes and the lack of
written confirmation regarding negotiations, the auditor may need to take the
following steps:
1. Gather Sufficient Information: The auditor should obtain as much
information as possible from the company's management, including the status
and progress of negotiations and legal actions, even if it's not provided in
writing.
2. Evaluate the Uncertainty: The auditor should assess the likelihood of
potential provisions, contingent liabilities, and contingent assets and may
need to disclose in the audit report the material uncertainties related to these
matters.
3. Consider Legal Advice: Consult with legal experts to gain insight into the
potential outcomes and legal implications, which can assist in estimating
contingent liabilities and assets.
4. Monitor Developments: Keep track of developments related to the legal
disputes and negotiations after the year-end to ensure the financial
statements are updated as needed.
The auditor's goal is to provide a fair and accurate representation of the financial
statements, taking into account the uncertainties and complexities surrounding these
legal matters.
4
Prime Super Markets Limited
Discuss the categories of threats and related safeguards in each of the following situations:
(a) Your firm is the auditor of Prime Super Markets Limited, a chain of super markets.
During a
promotional campaign, the management has distributed discount vouchers which have also
been
given to the audit team members.
(b) You are the manager on the audit of Abid Textile Mills Limited. The client has requested
you to
send two staff members on secondment for three months to assist the chief financial officer as
its
two senior accounting team members have resigned recently.
(c) Fine Petroleum Limited (FPL) is the audit client of your firm for five years. During the
year, the
engagement partner has been changed due to mandatory rotation as per Code of Corporate
Governance. However, the firm has decided to retain Atif, the audit manager, who has been
involved in the audit of FPL for the past five years.
In each of the situations presented, there are potential threats to the independence,
objectivity, and professionalism of auditors. The threats can be categorized as selfinterest threats, familiarity threats, and advocacy threats, among others. To address
these threats, safeguards should be put in place. Here are the categories of threats
and related safeguards for each situation:
Situation (a): Prime Super Markets Limited
Threats:
1. Self-Interest Threat: The audit team members receiving discount vouchers
from the client's management may create a self-interest threat if it impacts
their objectivity and independence.
Safeguards:
1. Independence and Objectivity Training: The audit team should receive
training on maintaining independence and objectivity and be reminded of the
importance of these principles.
2. Review and Approval: A review and approval process should be in place to
ensure that accepting vouchers or gifts does not compromise the
independence and objectivity of audit team members. The vouchers should be
reported and reviewed by a senior member of the firm.
Situation (b): Abid Textile Mills Limited
Threats:
1. Familiarity Threat: Sending staff members on secondment to the client may
create familiarity threats if they become too aligned with the client's interests,
potentially compromising their independence.
Safeguards:
1. Limiting Access: Limit the access of secondees to sensitive information and
client decision-making processes to reduce familiarity threats.
2. Supervision: Ensure that the secondees are properly supervised and
monitored by senior audit personnel to maintain objectivity.
3. Regular Reporting: Require regular reporting from the secondees to the
audit firm, providing updates on their work and any potential ethical concerns.
Situation (c): Fine Petroleum Limited (FPL)
Threats:
1. Self-Interest Threat: The audit manager, Atif, has been involved in the audit
of FPL for five years, creating a self-interest threat as he may want to retain
the client.
Safeguards:
1. Mandatory Rotation: The engagement partner has been rotated, which is a
safeguard to reduce self-interest threats. This ensures that a fresh perspective
is brought to the audit.
2. Senior Personnel Review: The work performed by the audit manager should
be subject to thorough review by senior personnel, providing an additional
layer of oversight.
3. Ethical Guidelines: Reiterate the importance of adhering to ethical guidelines,
independence, and objectivity principles to the audit manager.
In all cases, the application of safeguards is essential to address the threats to auditor
independence, objectivity, and professionalism. The choice of safeguards should be
tailored to the specific circumstances and risks associated with each situation.
Additionally, regular training and awareness of ethical and professional
responsibilities are vital for audit teams.
5
TAURUS TRADERS
As manager responsible for prospective new clients you have visited Taurus Traders, a limited
liability
company, which supplies a range of specialist materials to the building industry. The chief
executive and majority shareholder, Mr. Aquila, has asked your firm to make a proposal for
the company’s audit and provision of financial advice.
During your grown from $4 million to $7 million in the last two years and the company is
profitable.
Further growth is anticipated as Mr Aquila has plans:
(1) To increase the company’s customer base by making certain materials available to the
public
through builders’ merchants, and
(2) To expand the product base by setting up an overseas operation to manufacture silicon
carbide
components.
Mr Aquila negotiates prices directly with both suppliers and customers. A part-qualified
accountant was recruited earlier this year to help with credit control and to set up more formal
accounting systems and procedures. A desktop computer provides basic sales, receivables,
inventory and payroll information. The software was written to Mr Aquila’s requirement by
his wife’s brother. Most purchases require foreign currency translation and are recorded
manually. Each month-end there are varying, small and unreconciled differences on the
receivables and payables ledger control accounts.
The annual budget significantly understates actual revenue and expenses because of higher
than
expected growth. Management accounts are produced infrequently on an ad hoc basis.
For management accounting purposes, cost of sales is calculated as a percentage of sales value
of
different product categories. Historically, this method has proved reasonably reliable when
compared
to the year-end valuation of the annual physical inventory count. However, margins on product
lines
have recently become much more varied.
Taurus is currently experiencing a high level of returns of faulty materials. These are returned
to
inventory if they cannot be sold at a discount for cash.
Mr Aquila is negotiating a bank loan to finance the cost of planned new premises. Contracts
with the
builders have been signed and building work has commenced. The bank is waiting for a profit
forecast
before giving final approval to a $2 million loan.
Taurus Traders has increasingly tended to exceed its agreed overdraft facility. Mr Aquila has
indicated
that a large receipt from a major customer, expected at the end of next month, is to be used to
clear tax payment arrears and repay his loan of $52,000.
Mr Aquila is recently married and has purchased a luxury apartment and a new car. He is
dissatisfied
with the firm of accountants which currently prepares and audits the annual financial
statements. He
attributes this to the firm’s failure to reconcile the ledgers. He also claims that the firm has been
unable
to suggest how his remuneration package can be increased to meet his personal needs.
Required
Identify and describe the principal business risks relating to Taurus Traders.
Identifying and describing the principal business risks for Taurus Traders is essential
for the audit firm to understand the potential challenges and areas of concern in
providing audit and financial advice. Here are the principal business risks related to
Taurus Traders:
1. Rapid Growth and Budgeting Challenges:
 Taurus Traders has experienced rapid growth, with revenue increasing
from $4 million to $7 million in the last two years. The annual budget
significantly understates actual revenue and expenses due to higherthan-expected growth. This presents a risk of budgetary misalignment
and may lead to financial instability if not managed effectively.
2. Credit Control and Accounting Systems:
 Although a part-qualified accountant was recently hired to set up
formal accounting systems and procedures, the presence of small and
unreconciled differences on the receivables and payables ledger control
accounts indicates weaknesses in the credit control and accounting
systems. These discrepancies can affect the accuracy of financial
reporting.
3. Custom Software and Manual Processes:
 The use of custom-written software for accounting purposes and
manual foreign currency translation for purchases can pose a risk of
errors, data inconsistencies, and limited scalability as the business
grows. Relying on software developed by a family member may lack
proper documentation and support.
4. Management Accounting and Cost of Sales:
 The method of calculating cost of sales as a percentage of sales value
for different product categories may no longer be reliable, especially
with more varied product margins. This approach can lead to
inaccurate financial reporting and potentially misinformed decisionmaking.
5. High Level of Returns:
 Taurus Traders is experiencing a high level of returns of faulty materials.
The risk here is related to inventory management and the potential
financial impact of these returns, including whether they are
appropriately accounted for, disposed of, or returned to inventory.
6. Bank Loan and Overdraft:
 The company's reliance on bank loans and the tendency to exceed the
agreed overdraft facility present risks in terms of financial stability and
liquidity. The approval of a $2 million bank loan depends on a profit
forecast, which may be uncertain due to budgetary challenges.
7. Tax Payment Arrears and Loan Repayment:
 Mr. Aquila's plan to use a large customer receipt to clear tax payment
arrears and repay his personal loan of $52,000 raises questions about
the company's ability to meet financial obligations and the
appropriateness of using business funds for personal purposes.
8. Margin Variability and Product Expansion:
 The variability in product line margins and plans to expand into new
products through an overseas operation may result in pricing and
profitability challenges. Ensuring accurate product costing and pricing
strategies is essential.
9. Infrequent Management Accounts:
 The ad hoc production of management accounts rather than regular
and structured reporting can hinder effective decision-making and risk
management. Timely and accurate financial reporting is crucial for
informed business decisions.
10. Client Dissatisfaction and Remuneration Issues:
 Mr. Aquila's dissatisfaction with the current accounting firm's inability
to reconcile ledgers and suggest solutions for increasing his
remuneration package raises concerns about the effectiveness of the
current professional services and the company's remuneration strategy.
To address these business risks, Taurus Traders should focus on strengthening
financial reporting, internal controls, inventory management, and budgeting
processes. Auditors should assess the adequacy of these measures and provide
appropriate guidance and recommendations to mitigate these risks effectively
6
Required:
(a) Prepare briefing notes to be used at a planning meeting with your audit team, in which
you
evaluate the business risk facing Jolie Co to be considered when planning the final audit for
the
year ended 30 November 2010.
Professional marks will be awarded in part (a) for the format of the answer and the clarity of
the
evaluation.
(b) Using the information provided, identify and explain FIVE financial statement risk.
(c) Recommend the principal audit procedures to be performed in respect of the valuation of
the JLC
brand name.
7
All cheese is stored to maturity on wooden boards in GVF’s cool an air shed. However, recently
enacted health and safety legislation requires that the wooden boards be replaced with stainless
steel shelves with effect from 1 January 2009. The management of GVF has petitioned the
government health department that to comply with the legislation would interfere with the
maturing process and the production of medium and strong cheeses would have to cease.
In 2007, GVF applied for and received a substantial regional development grant for the
promotion of
tourism in the area. GVF’s management has deferred its plan to convert a discussed barn into
holiday
accommodation from 2008 until at least 2010.
Required
(a) Identify and explain the principal audit risks to be considered when planning the final audit
of GVF
for the year ending 31 March 2009.
When planning the final audit of GVF (assuming GVF refers to a cheese manufacturing
company) for the year ending 31 March 2009, there are several principal audit risks to
consider. These risks are related to various aspects of the business and regulatory changes.
Here are the principal audit risks and explanations for each:
1. Compliance with Health and Safety Legislation:
 Risk Explanation: The recently enacted health and safety legislation
requiring the replacement of wooden boards with stainless steel shelves for
cheese storage represents a significant compliance risk. The management's
claim that this change could affect the maturation process and production is a
concern.
 Audit Procedures: The auditor should assess the extent to which the
legislation will impact the production process, including potential effects on
product quality, production timelines, and costs. They should also examine the
progress made in implementing the required changes and management's plan
for compliance.
2. Regional Development Grant and Tourism Promotion:
 Risk Explanation: GVF received a substantial regional development grant for
promoting tourism in the area. The risk here is that the grant, its utilization,
and the deferral of plans for converting a barn into holiday accommodation
may have financial reporting and compliance implications.
 Audit Procedures: The auditor should assess the proper recognition and
accounting treatment of the grant, including any related commitments or
obligations. They should also review the reasons for the deferral of the
conversion plans and whether it aligns with the grant's conditions.
Additionally, the auditor should evaluate the potential impact of these changes
on the financial statements.
3. Inventory Valuation and Maturation Process:
 Risk Explanation: The cheese maturation process is a critical aspect of the
business. Changing the storage method from wooden boards to stainless steel
shelves may affect the maturation process, potentially impacting the valuation
of inventory, production costs, and product quality.
 Audit Procedures: The auditor should assess the impact of the storage
method change on the maturation process and inventory valuation. This may
involve evaluating the reasonableness of any adjustments made to inventory
values, the consistency of the valuation method, and the impact on the cost of
goods sold.
4. Revenue Recognition:
 Risk Explanation: Given the potential impact on production due to
compliance with health and safety legislation, there may be risks related to
revenue recognition. Changes in production, quality, or product availability
could affect sales and revenue recognition.
 Audit Procedures: The auditor should assess the recognition of revenue,
considering any changes in sales volumes or product mix. This may involve
analyzing sales records, reviewing sales contracts, and evaluating the potential
impact on revenue recognition policies.
5. Regulatory Compliance and Reporting:
 Risk Explanation: Compliance with regulatory changes and the reporting of
such compliance is essential. Failure to properly disclose changes in
production processes, maturation methods, or grant utilization could result in
financial statement misstatements or non-compliance with reporting
requirements.
 Audit Procedures: The auditor should review the company's disclosures in
the financial statements, including compliance with health and safety
legislation and the impact of regional development grants. They should verify
the accuracy and completeness of these disclosures.
In summary, the principal audit risks for GVF in the year ending 31 March 2009 include risks
related to regulatory compliance, financial reporting of grants, the impact of the maturation
process changes on inventory, revenue recognition, and overall financial statement accuracy.
The auditor should carefully assess these risks and tailor their audit procedures accordingly to
mitigate them effectively.
8
CHAUDHRY PACKAGING LIMITED
You are the manager responsible for the audit of Chaudhry Packaging Limited (CPL) a listed
company,
for the year ended 31 March 2015.
During the planning stage, the audit team has presented the following points for your
consideration:
(i) During the year, after the death of previous chief executive, his son was appointed as the
new chief
executive.
(ii) Sales of the company declined significantly during the first 10 months on account of general
economic downturn. However, sales in the last month showed improvement and were 20%
higher
than the average sales of the previous months.
(iii) Deferred tax recognised on losses amounted to Rs. 170 million.
(iv) Scrap sales showed significant increase during the year.
(v) CPL experienced significant turnover in its management team.
(vi) Initial test of controls reveal that list of approved suppliers is not maintained. The
management is of the view that in order to get the lowest quotes any supplier is allowed to
quote prices and therefore
a formal list of suppliers is not prepared.
Required:
In light of the above facts identify the audit risks and the key audit steps to address them. (15
Marks)
(Note: While describing the key audit steps, the answer should be restricted to a maximum of
3 major
points in case of each risk)
Identifying audit risks and planning appropriate audit steps is crucial for a thorough and
effective audit of Chaudhry Packaging Limited (CPL) for the year ended 31 March 2015.
Here are the audit risks associated with the provided facts, along with key audit steps to
address each risk:
Audit Risk 1: Change in CEO

Audit Steps:
1. Review the Appointment Process: Examine the process followed in
appointing the new Chief Executive Officer (CEO) after the death of the
previous CEO to ensure it was transparent, in accordance with corporate
governance standards, and not influenced by any undue external factors.
2. Assess CEO's Qualifications: Verify the qualifications and experience of the
new CEO to ensure that he possesses the necessary skills and expertise to lead
the company effectively.
3. Evaluate Any Related Party Transactions: Investigate whether any related
party transactions or conflicts of interest exist between the new CEO and the
company and ensure they are appropriately disclosed in the financial
statements.
Audit Risk 2: Sales Fluctuations

Audit Steps:
1. Analyze Sales Data: Review and analyze sales data to understand the reasons
behind the significant decline in sales for the first 10 months and the sudden
improvement in the last month.
2. Inquire About Sales Improvement: Inquire with management about the
factors contributing to the improvement in sales during the last month,
including any unusual or non-recurring events.
3. Assess the Adequacy of Sales Projections: Evaluate the reasonableness of
sales projections and forecasts to ensure they are in line with industry trends
and economic conditions.
Audit Risk 3: Deferred Tax on Losses

Audit Steps:
1. Review Deferred Tax Calculation: Examine the deferred tax calculation
related to recognized losses amounting to Rs. 170 million to ensure it complies
with relevant accounting standards.
2. Verify the Valuation Allowance: Assess the valuation allowance on deferred
tax assets, ensuring that it is appropriate and properly supported.
3. Examine Tax Planning Strategies: Investigate any tax planning strategies or
changes in tax policies that may have led to the recognition of deferred tax
assets and assess their compliance with tax laws and accounting standards.
Audit Risk 4: Increased Scrap Sales

Audit Steps:
1. Analyze Scrap Sales: Analyze the significant increase in scrap sales during
the year, focusing on the nature of the scrap, pricing, and whether it aligns
with industry norms.
2. Verify Scrap Sales Documentation: Examine supporting documentation for
scrap sales transactions to ensure they are properly authorized and recorded
accurately.
3. Assess Internal Controls: Evaluate internal controls related to scrap sales to
prevent potential misstatements or fraudulent activities.
Audit Risk 5: High Turnover in Management Team

Audit Steps:
1. Obtain Organizational Chart: Request an updated organizational chart to
understand the turnover in the management team and identify any potential
control weaknesses.
2. Review Personnel Records: Inspect personnel records to confirm the
qualifications and experience of new management team members.
3. Assess Impact on Internal Controls: Evaluate the impact of the management
team turnover on internal controls, risk management, and corporate
governance, ensuring that control procedures are still effective.
Audit Risk 6: Lack of Approved Suppliers List

Audit Steps:
1. Evaluate Procurement Process: Investigate the procurement process to
understand the reasons for not maintaining a list of approved suppliers.
2. Review Supplier Contracts: Examine supplier contracts and invoices to
ensure that the company is dealing with reputable and reliable suppliers.
3. Assess Procurement Controls: Evaluate the adequacy of controls in place to
mitigate the risk of dealing with unreliable or unapproved suppliers, focusing
on the verification of quality, pricing, and terms of supply.
By addressing these audit risks with the suggested audit steps, the audit team can enhance the
reliability of the audit and provide assurance on the financial statements of CPL for the year
ended March 31, 2015.
9
SHAHZAD LIMITED
Your firm is the auditor of Shahzad Limited (SL), a listed company, which is a wholesaler of
consumable
products. SL records its sale on delivery of goods and maintains up to date computerised
inventory
records.
A full inventory count was conducted at the year end. The senior who attended the physical
stocktaking at the central warehouse has observed the following matters:
(i) The inventory count took place on January 1, 20X3 under the supervision of the Inventory
Controller. No movement of inventory took place on that day.
(ii) Four counting teams were formed. Each team comprised of two persons. The floor area was
allocated by the teams among themselves.
(iii) Each team was instructed by the Inventory Controller to remember which inventory had
been
counted.
(iv) Pre-numbered count sheets were provided to the staff involved in the inventory count. The
count
sheets showed the inventory ledger balances, to facilitate reconciliation.
(v) Old, slow-moving or already sold inventories were highlighted on the count sheets at the
time of
counting.
(vi) Items not located on the pre-numbered inventory sheets were recorded on separate sheets
which
were numbered by the staff.
(vii) At the end of the count, all inventories against which advances from customers had been
received
were removed from the physical inventory on the instruction of the Inventory Controller.
Required:
Identify the weaknesses in the system of inventory count. Give appropriate explanations to
support
your point of view.
The observed practices during the inventory count at Shahzad Limited (SL) reveal several
weaknesses in the system of inventory count. These weaknesses can potentially impact the
accuracy of the inventory count and the reliability of financial statements. Here are the
identified weaknesses with explanations:
1. Inventory Count on January 1, 20X3:
 Weakness: Conducting the inventory count on January 1, the first day of the
year, may lead to inaccuracies, as it is unlikely that all inventory items would
be in the exact condition and location as recorded at year-end.
 Explanation: Inventory counts should ideally occur as close to the year-end as
possible to ensure the accuracy of inventory balances.
2. Allocation of Floor Area by Counting Teams:
 Weakness: Allowing counting teams to allocate floor area among themselves
can lead to potential biases and inconsistencies in counting practices. It may
result in certain areas being over- or under-counted.
 Explanation: The allocation of floor area should be carefully planned and
supervised to ensure that all areas are counted thoroughly and without bias.
3. Relying on Memory of Counting Teams:
 Weakness: Instructing counting teams to remember which inventory they have
counted may lead to errors or omissions, as human memory can be fallible.
 Explanation: A more reliable approach is to use physical labels or markers to
clearly indicate which items have been counted to prevent duplication or
omission.
4. Use of Pre-numbered Count Sheets Showing Ledger Balances:
 Weakness: Providing count sheets showing ledger balances can potentially
lead to confirmation bias, as counters may unconsciously verify inventory
quantities against ledger balances, rather than independently counting the
items.
 Explanation: Counters should ideally use blank count sheets without ledger
balances to promote independent counting. Reconciliation can be performed
later in the process.
5. Highlighting Old, Slow-moving, or Sold Inventories:
 Weakness: Highlighting certain inventory items can influence counters to pay
more attention to these items and may result in a failure to properly verify
other items.
 Explanation: All inventory items should be treated equally during the count
process to maintain accuracy and consistency.
6. Recording Items Not Located on Separate Sheets:
 Weakness: Allowing staff to record items not located on separate sheets may
lead to confusion and difficulties during the reconciliation process.
 Explanation: Any items not located on the pre-numbered inventory sheets
should be recorded on the same standardized count sheets to ensure consistent
tracking.
7. Removing Inventories with Customer Advances:
 Weakness: Removing inventories against which advances from customers had
been received from the physical inventory may not be appropriate. It may
result in discrepancies between physical and accounting records.
 Explanation: It's generally better to include all inventory items in the count
process and then separately identify those with customer advances for
appropriate accounting treatment.
In conclusion, the observed weaknesses in the inventory count system at Shahzad Limited
could compromise the accuracy and reliability of inventory records. Implementing stronger
controls and best practices, such as minimizing bias, ensuring proper allocation of work, and
maintaining consistency, can help improve the inventory count process and the financial
reporting accuracy.
10
RENTALS LIMITED
Rentals Limited (RL) is a real estate company engaged in the business of renting of office
buildings and
shopping centres across the country. The investment properties are carried at fair value. The
fair values are determined by an internal valuer at the end of each reporting period.
Required:
Considering the inherent complexities involved in the determination of fair values of
investment
properties, discuss the key controls that RL is expected to employ while carrying out the
valuation
internally.
Determining the fair values of investment properties is a crucial financial activity for a real
estate company like Rentals Limited (RL). The process of valuing investment properties is
complex, and it's important to have robust controls in place to ensure accuracy, consistency,
and compliance with accounting standards. Here are some key controls RL is expected to
employ while carrying out the valuation of investment properties internally:
1. Internal Valuation Policy:
 RL should establish a comprehensive internal valuation policy that outlines the
principles, methodologies, and standards to be followed in valuing investment
properties. This policy should align with international accounting standards
and local regulations.
2. Qualified Valuation Team:
 Ensure that the valuation team consists of qualified and experienced
professionals who are knowledgeable about the real estate market, property
valuation techniques, and accounting standards.
3. Independence and Objectivity:
 Emphasize independence and objectivity in the valuation process. The
valuation team should not have any personal or financial interest in the
properties they are valuing to avoid conflicts of interest.
4. Regular Training and Development:
 Provide ongoing training and professional development opportunities to keep
the valuation team up to date with changing market conditions, regulations,
and best practices.
5. Documentation and Record-Keeping:
 Maintain comprehensive documentation of the valuation process, including
data sources, assumptions, and methodologies used. This documentation
should be readily available for review and audit purposes.
6. Peer Review and Validation:
 Implement a system of peer review, where another qualified valuer or team
reviews the valuation reports for accuracy and consistency. This helps identify
errors or inconsistencies and ensures the reliability of valuations.
7. Market Research:
 RL should conduct thorough market research to gather information about the
local real estate market, including recent sales, rental rates, occupancy levels,
and market trends. This data is critical for making informed valuation
decisions.
8. Use of Independent External Valuers:
 In addition to internal valuations, RL may choose to engage independent
external valuers periodically to cross-verify the fair values. This can provide
an extra layer of assurance and transparency.
9. Segregation of Duties:
 Separate the roles of individuals involved in the valuation process to minimize
the risk of fraud or manipulation. For example, the team responsible for
property management should not be the same as the valuation team.
10. Review by Senior Management and Audit Committee:
 Have a process in place for senior management and the audit committee to
review and approve the valuation reports. This adds an additional layer of
oversight and governance.
11. Compliance with Accounting Standards:
 Ensure that the valuation process is in compliance with relevant accounting
standards and local regulatory requirements, such as IFRS (International
Financial Reporting Standards).
12. Quality Assurance Program:
 Establish a quality assurance program that periodically assesses the
effectiveness and adherence to the internal valuation policy and controls.
By implementing these controls, RL can enhance the accuracy, reliability, and transparency
of its investment property valuations, which is crucial for financial reporting and decisionmaking. It also helps build trust with stakeholders, including investors, auditors, and
regulatory bodies.