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ACCA MOCK A
AUDIT AND ASSURANCE
Time allowed
3 hours and 15 minutes
All questions are compulsory and MUST be attempted
This paper is divided into two sections:
Section A: 3 objective test case questions
5 questions worth 2 marks per case
Section B: 2 × 20 mark questions (mainly scenario based)
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Section A
1B
The audit team have previously been offered a 15% discount on luxury home
appliances from BJ Electronics which will potentially have a high value. As only
goods with a trivial and inconsequential value can be received, if the same
discount is again offered, it will constitute a self-interest threat.
2D
As the audit senior is involved in prepration of financial statements so if he
performs the audit then he will review his own work, this is an example of self
review threat as a safe guard the audit senior should be removed from the
audit team.
3A
The fee income from BJ Electronics is 19% of Steve & Co's total fees. If, after
accounting for non-recurring fees such as the secondment, it remains at this
percentage of total fees on a recurring basis there is likely to be a self interest
threat because of undue dependence on this client. Where recurring fees
exceed 15% for listed companies, objectivity is impaired to such an extent that
mandatory safeguards are needed according to the ACCA Code of ethics and
conduct (ACCA Code).
4C
The partner and finance director of BJ have been on holiday together and
appear to have a longstanding close relationship. This results in a familiarity
and self interest threat.
5B
Outstanding fee is an example of intimidation threat in this case the audit firm
may not be robust enough when disagreement with management due to the
fear of recovery of the outstanding fee. In this case the audit firm should seek
a legal advice to know their rights in this particular situation.
6A
Every listed company should be headed by an effective board of directors
which should be comprised of equal number of exevutive and non executive
directors.
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7B
Two different individuals should be working as a CEO and Chairman of the company.
In this company Mr Griss should resign from one position and should refrain from
appointing his brother as CEO and Chairman of the company.
8B
Only the non executive directors can become the member of audit committee. It
should have thee non executive directors as members one of them should have
previous audit experience. Executive directors cannot become a part of this
committee.
9B
The auditors are appointed by shareholders of the company; the audit committees
will only recommend their reappointment as auditors to the board.
10 C
The audit committee will appoint the head of internal audit and also set the scope
of internal audit department but the other employees of the audit department are
appointed by the management of the company.
11 C
IAS 16 permits non-current assets to be revalued. However, if an item of property,
plant and equipment is revalued, the entire class of property, plant and equipment
to which that asset belongs
must be revalued. Xono Co is therefore entitled to revalue the restaurant, but they
will also need to revalue
all of them if it is to comply with IAS 16. The revaluation does constitute a change of
accounting policy, so disclosures do need to be reviewed. Under IAS 16, all noncurrent assets used by the entity should be depreciated, Repairs and maintenance
costs should be expensed as incurred, not capitalised.
12 B
Existence, classification and presentation are all assertions related to tangible noncurrent assets.
Completeness and accuracy, valuation and allocation are also relevant assertions.
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13 B
Physically inspecting assets listed in the non-current assets register tests for
existence. Recalculating
net book values tests for accuracy
14 A
Material items will require more evidence to support them than immaterial items,
which might be tested by comparative analytical review only. The size of the
account is considered in determining materiality (ie materiality may be determined
as 5% of profit before tax), but the auditor’s judgement regarding the sufficiency of
audit evidence depends on the level of audit risks associated with each account.
15 B
All the options are valid written representations, but only 2 and 4 are required in all
circumstances by ISA 580.
Section B
16 (A)(i) Audit risk is made up of the following components:
Audit Risk = Inherent Risk x Control Risk x Detection Risk
Inherent risk is the susceptibility of an assertion about a class of transaction,
account balance or disclosure to a misstatement that could be material either
individually or when aggregated with other misstatements, before consideration of
any related controls.
Control risk is the risk that a misstatement that could occur in an assertion about a
class of transaction, account balance or disclosure and that could be material,
either individually or when aggregated with other misstatements, will not be
prevented, or detected and corrected on a timely basis by the entity's internal
control.
Detection risk is the risk that the procedures performed by the auditor to reduce
audit risk to an acceptably low level will not detect a misstatement that exists and
that could be material, either individually or when aggregated with other
misstatements. Detection risk is affected by sampling and non-sampling risk.
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(A)(ii) Professional judgment
Professional judgment is the application of relevant training, knowledge and
experience in making informed decisions about the appropriate courses of action
in the circumstances of the audit engagement. The auditor must exercise
professional judgment when planning an audit of financial statements.
Professional judgment will be required in many areas when planning. For example
the determination of materiality for the financial statements as a whole and
performance materiality levels will require professional judgment.
Professional judgment will also be required when deciding on the nature, timing
and extent of audit procedures.
B (i)
Audit Risk
.
.
Response
Rio has recently been appointed as
auditor. There is a lack of cumulative
knowledge and understanding of the
business, which may result in a failure to
identify events and transactions which
impact on the financial statements
Adopt procedures to ensure opening
balances are properly brought forward
and corresponding amounts are
correctly classified and disclosed.
Review previous auditor's working
papers.
The directors only work part time at
Handy Car and there is no finance
director. This may promote a weak
control environment, resulting in
undetected errors or frauds
The controls will need to be
documented and evaluated. If these
are weak the level of substantive
testing will need to be increased
accordingly.
The requirement for customers to pay
50% on
Enquire of management the point at
which revenue is
ordering and the remainder following
delivery could result in revenue
recorded before it should be, if the
deposit is recorded as a sale and not
deferred until delivery. This would result
in revenue being overstated.
actually recognised, and review the
system of accounting for deposits to
ensure they are not included in
revenue until goods delivered and
signed for.
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The two year guarantee on the cars
gives rise to a provision, the
measurement of which involves a high
degree judgement, and therefore
carries a risk of misstatement.
Establish the basis of the amount
provided for and assumptions made by
the financial controller. Re-perform any
calculations and establish the level of
warranty costs in the year.
Contractors are required to invoice at
the end of each month but often there
is delay in receiving these. There is
therefore a risk the company will not
accrue for costs, resulting in incomplete
liabilities and understatement of
expenses.
Review invoices and payments to
contractors after the year end, and if
they relate to work undertaken before
the year end, ensure they are included
as accruals.
The current year raw materials costs for
materials also in inventory last year are
based on prices at least a year old. They
should be based on the actual cost or
reasonable average cost.
For a sample of materials to include the
cost of parts, compare material costs to
actual prices on invoices. Investigate
and resolve any significant differences
and evaluate the potential impact on
the inventory value in the financial
statements.1
The finished goods value is to be
estimated by Mr. Jones, who appears to
be basing his estimate on order value
rather that applying the IAS 2 rule that
goods should be valued at the lower of
cost and NRV. This could result in
inventory being overstated in the
financial statements.
For cars awaiting dispatch, establish the
lower of cost and NRV and compare
with the figures provided by Mr. Jones.
Investigate any differences evaluate the
potential impact on the inventory value
in the financial statements.
The new workshop is undergoing
refurbishment that could result in
inappropriate treatment of capital or
non capital items, potentially misstating
noncurrent assets, or repair costs in the
statement of profit or loss.
Obtain a breakdown of the related costs
and establish which are included as
noncurrent assets and which are
treated as repair costs. Review the
nature of items included in non-current
assets to ensure only capital items
included and review repairs to ensure
no capital items are included.
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(B)(ii)
ISA 501 Audit evidence – specific considerations for selected items sets out the
responsibilities of auditors in relation to the physical inventory count. It states that
where inventory is material, auditors shall obtain sufficient appropriate audit
evidence regarding its existence and condition by attending the physical inventory
count.
At the count attendance, Rio & Co will need to evaluate management's
instructions and procedures for recording and controlling the result of the
physical inventory count.
They must also observe the performance of the count procedures to assess
whether they are properly carried out.
In addition Rio & Co should inspect the inventory to verify that it exists and look
for evidence of damaged or obsolete inventory. They will also perform test counts
to assess the accuracy of the counts carried out by the company.
(C) Procedures in relation to property valuation and related disclosures
Obtain a copy of the valuer's report and consider the reliability of the valuation
after taking account of:
- Independence/objectivity
- The basis of valuation
- Qualifications
- Experience
- Reputation of the valuer.
Compare the valuation with the value of other similar properties in the locality
and investigate any significant difference.
Re perform the calculation of the revaluation adjustments and ensure the correct
accounting treatment has been applied.
Inspect notes to the financial statements to ensure appropriate disclosures have
been made in accordance with IFRSs.
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Q 17 The following significant accounting ratios are based on the accounts
provided in the question.
Ratio
Formula
20X2
20X3
20X4
20X5
20X6
Gross
profit (%)
Gross profit / Sales
23.52%
10.93%
14.18%
20.17%
19.72
%
Other
expenses:
sales (%)
Other expenses / Sales
14.08%
10.93%
14.36%
14.45%
15.31
%
Interest:
sales (%)
Interest / Sales
0.96%
1.14%
5.17%
5.42%
6.22%
Current
ratio
Current assets /
Current liabilities
1.39
0.91
0.73
0.73
0.76
Liquidity
or quick
ratio
(Current assets inventory) / Current
liabilities
0.80
0.59
0.46
0.37
0.34
Leverage
(%)
Total debt / (Total debt
+ Total equity)
N/A
N/A
82.42%
81.30%
89.82
%
Inventory
(months)
Inventory / Cost of
sales x 12
1.61
2.28
2.26
2.78
3.57
Receivabl
es
(months)
Receivables / Sales x 12
1.75
3.66
3.24
2.26
2.32
Payables
(months)
Payables / Cost of sales
x 12
2.26
5.43
4.43
4.43
5.09
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(a) The various factors in the accounts which may be indicative of going concern
problems are as follows.
I. Only losses or low profits are being made and the company is not generating
sufficient funds to finance the expansion required
II. There has been a dramatic increase in the level of overdraft over the last year
and there seems little prospect of the borrowing being reduced this shows that
company is facing cash flow problems.
III. There are signs of overtrading as the expansion has been financed by borrowings
and the increase in current assets is being financed by trade accounts payable.
IV. The leverage is low and decreasing, with very little security being available for
the loans.
V. There is a low current ratio and short-term funds are being used to finance longterm assets.
VI. The liquidity ratio is low and decreasing and the company's ability to meet its
liabilities on demand must be very questionable.
VII. Inventory levels are increasing, suggesting that one or more of the following
problems may exist: deteriorating sales, poor inventory control, obsolete or slowmoving inventories.
VIII. The value and age of trade accounts is increasing: some suppliers must be
having to wait a considerable time before being paid and it can only be a matter of
time before pressure is put on the company by one or more of its creditors.
IX. High and increasing interest charges make the company very vulnerable,
especially in a period of recession and high interest rates.
X. The fluctuating gross profit would suggest that the company's profit margins are
under pressure. The present level of gross profit does not seem sufficient given the
company's high level of expenses.
(b) The other important steps to be taken by the auditors in determining whether
or not the company may be properly regarded as a going concern at the year-end
would include:
I. Review carefully the cash and profit forecasts for the next year to see if they
suggested any improvement in the company's position
II. Seek some evidence that the company's bank is prepared to continue
supporting the company
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III. Review the level of post balance sheet trading to see if this supports the
forecasts and show any signs of improvement in the company's position
IV. Examine correspondence files for any evidence that suppliers might be putting
pressure on the company for repayment of monies owing
V. Consider how the company's position compares with similar companies in the
same business
VI. Discuss generally the situation with management and review any recovery plans
which they may have in mind
18
(a) Problems at BNH due to poor internal controls
I. The local decision making on purchasing may lead to BNH missing out on
discounts that would be available if goods were bought in large quantities. This will
also increase the bargaining power of BNH.
II. Due to the nature of the business the inventory may contain items with short
expiry dates and hazardous substances so good inventory control are very
important.
III. If the local managers are not making good decisions regarding purchasing there
could be stoke outs of certain lines of goods, losing potential sales and future
business if customers decide to shop at other stores with better stocks.
IV. There is a lack of centralization in accounting system. Any error arising on the
stand alone accounting system in each superstore may go undetected and the
management will not have good quality information for decision making.
V. There is no regular system of inventory counting any misappropriation of
inventory may go undetected. The goods are at high risk of being stolen by either
by staff or others.
VI. Management accounts are produced after every six months this reduces their
usefulness. Any fraudulent activity could go undetected for several months before
there is any chance of it being identified by management.
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(b) Recommendations to the board of BNH
I. A new computerized accounting system should be implemented integrating
sales, purchase and inventory accounting systems.
Advantage
This would give the board and senior management up to date information about
the inventory levels so that purchases orders can be places on time to avoid stock
outs.
This will also help the management to plan for purchasing in medium and long
term.
II. Management accounts should be prepared monthly and reviewed by senior
managers. The accounts should be prepared separately for each superstore.
Advantage
This will allow managers in the head office and the board to take prompt actions
if any superstore is not performing well. Lose making goods can also be identified
and dropped from the superstore range.
III. Sales pricing decisions should be taken centrally.
Advantage
This will help the business maximizing the profit by charging appropriate prices
for products.
IV. There should be regular inventory counts at superstore.
Advantage
Inventory counting is essential for good decisions regarding purchases and sales
prices. It is also important due to the nature of inventory of BNH. This should also
act as a deterrent against any staff pilferage of goods.
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