2025
AUDIT, ASSURANCE AND RELATED
SERVICES
A
ICAP ATTEMPTWISE PAST PAPERS
(Updated till Winter-2024 attempt)
By the Grace of Almighty Allah, I am pleased to present the attempt-wise past
papers of Audit, Assurance & Related Services for CFAP-6.
A
R
S
This volume contains;
✓ ICAP papers of last 47 attempts.
✓ Suggested Answers by ICAP (Summer08-Winter24)
✓ Examiner Comments (Summer07-Winter24)
✓ Marking plan (Winter15-Winter24)
INTRODUCTION
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ICAP
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ICAP
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
PROFESSIONAL EXAMINATIONS
SUMMER 2001
June 07, 2001
ADVANCED AUDITING
PE-1 (PAPER-2)
Q.1
(M ARKS 100)
(3 HOURS)
A friend of yours, Iqbal, is a qualified Chartered Accountant, practicing as a partner in a
firm of Chartered Accountants. Because of your relationship with him, you are aware that
he has invested a substantial amount of his savings in a company owned by one of his
clients. A common friend, who happens to be a broker by profession, recently took you into
confidence and informed you that Iqbal had passed on to him some confidential information
about this company where Iqbal had invested his savings. As a result of this information,
your broker friend was able to influence the price of the share of this company in the local
stock exchange due to which the price escalated, resulting in a considerable appreciation in
the value of shares owned by Iqbal.
Iqbal has indulged in such activities more than often and appears to have a reputation of not
being straight forward in his dealings with clients and have been careless in rendering
services thereto to the point that at times he shows up to work at the last minute to initial his
report , generally finalized by his staff.
Recently, he has been accused of being completely out of touch with the latest
developments in the profession and is least bothered about it. In fact, he has been found to
have openly carried out activities which you regard as highly objectionable.
Required:
Identify and discuss the Fundamental Principles which Iqbal has failed to observe in order
to achieve the objectives of the accountancy profession.
(10)
Q.2
You are currently in the process of preparing a presentation to your staff which deals with
Quality Control for audit work. You are expected to include in your presentation the
requirements of On-the-job training during the performance of the audits. Soon thereafter,
you are planning to carry out necessary Evaluation of audit personnel and intend to apprise
them of the objective of this evaluation.
Required:
Q.3
(a)
(b)
Discuss the requirements of On-the-job training in your presentation.
List the objectives of Evaluation of audit personnel in your presentation.
(a)
State the essential reporting differences with regard to Corresponding figures
and the Comparative financial statements.
(02)
What is included in the auditor’s assessment in deciding about the extent of audit
procedures with respect to the Corresponding figures ?
(04)
Discuss the reporting requirements for the auditor when his report on the prior
period is modified.
(04)
(b)
(c)
(04)
(06)
(2)
Q.4
Q.5
(a)
Identify the two aspects of the accounting and internal control systems about
which the auditor would obtain audit evidence.
(02)
(b)
When would the auditor regard audit evidence as more persuasive ?
(03)
(c)
How does the auditor deal with the situation when inventory is found under the
custody and control of a third party ? Include in your answer the considerations
which the auditor is likely to take into account in this regard.
(05)
Zohra, a semi-senior on the audit of Shah Alam Manufacturing Company Limited
overheard the Senior-in-charge of the audit saying that there has been an effective operation
of internal controls at the company during the current year. You were surprised to hear this
assessment as during the course of your interim audit, you had observed some deviations
from the prescribed controls and had felt that the system of internal controls was rather
ineffective as a result thereof. Zohra intends to discuss this matter with her Senior-incharge.
Required:
Please explain to Zohra:
(a)
(b)
(c)
Q.6
the meaning of “ effective operation of internal controls” and;
(03)
the important fact recognized by the concept thereof.
(04)
some procedures performed by you may not have been specifically planned by you
as tests of control but may serve as such. Give Zohra an example in this regard and
state when you may use that audit evidence.
(03)
Jabeen, being a recently promoted semi-senior on an audit engagement, has been instructed
by Afzal, the senior-in-charge, to design and carry out proper Cutoff tests. She is not too
sure about certain aspects of Cutoff procedures and has posed the following questions to
Afzal:
(a)
How Cutoff errors can occur and when do they take place ?
(02)
(b)
What is the objective of Cutoff tests?
(02)
(c)
How to perform Cutoffs in respect of (i) sales (ii) sales returns and allowances
and (iii) cash receipts?
(06)
Afzal has taken on him to sit down with Jabeen and remove her confusion about the Cutoff
tests and is, therefore, preparing his presentation for Jabeen.
Required:
Help Afzal in dealing with the above questions. Ensure that answers to each of the above
questions of Jabeen are brief and to the point.
Q.7
Discuss the course of action the auditor is expected to follow in a situation when facts are
discovered after the financial statements have been issued which if previously known to
him would have resulted in the modification of his report.
(10)
(3)
Q.8
Rana has just completed the necessary field work in respect of the audit of the financial
statements of Akbar Manufacturing Company (Private) Limited for the year ended June 30,
2000 and is currently going through the various issues that arose during the course of the
audit, before presenting her files to her Manager for his review. She noted that she was able
to successfully resolve all such issues with the exception of one issue which related to the
consolidation of the financial statements. Akbar Manufacturing Company (Private) Limited
ceased to consolidate the financial statements of its subsidiary companies because it
considered this basis to be inappropriate in view of substantial minority interests. Rana is
well aware of the fact that under International Accounting Standards, the existence of such
minority interests is not an acceptable reason for not consolidating the financial statements
of subsidiary companies with those of the parent. Rana has, therefore, concluded that
modification in the Auditor’s Report is necessary and, to impress her Manager, she has
decided to prepare a draft of the same.
Required:
Q.9
(a)
Identify the type of opinion which should be expressed and reasons thereof.
(04)
(b)
Assist Rana in drafting the required modification and its effect in the opinion
paragraph of the Auditor’s Report. You are expected to follow the requirements of
the relevant ISA in the drafting of the modification and its effects in the Auditor’s
Report.
(06)
Faraaz, one of your Manager deputed by you on the audit of the financial statements of
Quaid Manufacturing Company Limited for the year ended June 30, 2000, has assembled
the following facts in his Review Memorandum for your consideration:
“The recent introduction of a computerized accounts receivable system resulted in
errors and, although the system deficiencies causing these errors have now been
rectified, the management of the company is concerned about preserving customer
goodwill. As a result, I was instructed not to obtain confirmation of certain accounts
receivables amounting to Rs.123.98 million and was not able to satisfy myself
concerning the validity of these accounts by alternative means. Accordingly, I was not
able to determine whether any adjustments might be necessary to accounts receivable,
sales, income taxes and working capital”.
You immediately knew that your work was cut out for you and, therefore, decided to have
an urgent meeting with the top officials of the company. In the meantime, however, you
requested Faraaz to prepare the potential reservation in the Auditor’s report, assuming that a
qualification is the type of reservation required under the circumstances.
Q.10
Required:
Prepare a draft of the reservation in the Auditor’s Report together with the opinion
paragraph to be incorporated therein. Ensure that you follow the requirements of the
relevant ISA in the preparation of your draft.
(10)
(a)
What is your understanding of the concept of “Corporate Governance” ?
(04)
(b)
List the areas covered by the ICAP’s committee on Corporate Governance in its
recommendations for the code of Corporate Governance in Pakistan.
(06)
(THE END)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
PROFESSIONAL EXAMINATIONS
WINTER 2001
December 04, 2001
ADVANCED AUDITING
PE-1 (PAPER-2)
Q.1
(M ARKS 100)
(3 HOURS)
Zaid a fresh qualified chartered accountant has recently established his practice in the name
of Zaid & Co., chartered accountants. He is continuously trying to expand his practice and in
the process he came across the following situations:
(a)
One of the Zaid’s close friends, Ahmed, who is in retail business advises him that he
should take support of media for the purpose of publicity of his new practice to
attract clients. He gave him the example how he managed to increase his sales
through media advertisement.
(b)
Clever Ltd., an owner managed company asks Zaid that they are willing to appoint
him in the forthcoming annual general meeting (AGM) of the company in place of
the existing auditors, if he can quote fee which is 50% of the existing audit fee. Zaid
believes that keeping in view the estimated time required for audit and the fact that he
needs business, it will still be a profitable job.
(c)
Zaid receives an offer of appointment as auditors from Famous Limited, a listed
company who wants to remove the existing auditors before completion of their term
of office.
(02)
(02)
(02)
Keeping in view the sensitivities of the above matters, Zaid seeks your advice. Being a good
friend of Zaid, belonging to the same profession, advise him in each of the above keeping
professional ethics in view.
Q.2
(a)
Throughout the world, audit firms are placing more and more reliance on tests of control
instead of substantive procedures. This practice has changed the traditional approach
of audit. What do you consider are the reasons behind this approach? Can substantive
procedures be eliminated through this approach?
(05)
(b)
In respect of each of the following internal control techniques, state the underlying
Accounting Control Purpose:
i)
cancellation of processed documents
(01)
ii)
avoiding assignments of incompatible duties
(01)
iii)
periodic physical inventories
(01)
iv)
use of multiple-copy forms
(01)
v)
matching of documents
(01)
(2)
(c) You have noted the following Intentional Compliance Deviations during your audit:
i)
deliberate by-passing of the credit approval procedures
(01)
ii)
deliberate by-passing of preparation of shipping documents to accommodate
an emergency shipment of goods
(01)
deliberate failure to perform prescribed detailed physical quantity count on
incoming shipment of materials
(01)
deliberate failure of clerk to perform verification of pricing operations
previously performed on sales invoices
(01)
deliberate failure of treasury to control keys to cheque-writing machine in
accordance with prescribed policy
(01)
iii)
iv)
v)
State the possible motives underlying the above-referred deviations.
Q.3
Ahmed is the audit incharge of Family Limited – a listed company. During the course of audit
he realized that management is involved in significant associated company transactions. The
Company is purchasing raw materials from Relative (Private) Limited – an associated
company and is selling most of its products to Parents (Private) Limited – another associated
concern. Through extensive audit procedures, Ahmed comes to know that Family Limited is
selling goods to Parent Limited at a price which is much lower than the market price resulting
in a substantial loss to the company and payment of less sales tax to the government treasury.
The management has made disclosures in the accounts that the transactions with the
associated companies are at arm’s length. Ahmed views this as a serious non-compliance of
laws and regulations.
Required:
(a)
(b)
Q.4
Q.5
Q.6
(05)
What are the reporting responsibilities of the auditor viz-a-viz
management, shareholders and regulatory authorities in this respect?
(04)
Discuss ‘sampling risk’ and ‘tolerable error’ and correlation between ‘tolerable error’ and
‘sample size’ during the process of an audit.
(08)
(a)
Discuss the concepts of Materiality and Audit Risk in evaluating audit evidence.
(05)
(b)
If after planning for specific audit procedures, the auditor determines that the
acceptable Materiality level is lower, Audit Risk is increased. How does the auditor
compensate for this?
(05)
Identify the auditing procedures during which Computer Assisted Auditing
Techniques (CAATs) could be used.
(04)
List the major steps to be undertaken by the auditor in the application of a
Computer Assisted Auditing Techniques.
(04)
(a)
(b)
Q.7
Having discovered the aforesaid non-compliance, what procedures
Ahmed should perform? (You are not required to draft audit opinion).
(a)
Why the extent of working papers is regarded as a matter of Professional Judgement? (02)
(b)
What is the specific requirement of International Statement of Auditing in relation to
Documentation?
(02)
(3)
(c)
Q.8
What kind of Documentation you would consider for the working papers in support of
Computer Assisted Audit Techniques?
(05)
If adequate disclosure is made in the financial statements the auditor should ordinarily express
an unqualified opinion and modify the auditor’s report by adding on Emphasis of a Matter
paragraph.
(a)
What is the objective of adding a paragraph, as referred to above?
(01)
(b)
Prepare a draft of ‘Matter of Emphasis’ paragraph.
(04)
(c)
Would you modify your audit opinion by giving a ‘Matter of Emphasis’ paragraph
in case adequate disclosure is not made in the financial statements of the fact that the
company has been unable to renegotiate its significant borrowings? Discuss.
(04)
Q.9
Is an auditor responsible for detection of frauds in the financial statements? What an
auditor should do when he becomes aware about existence of fraud in the financial statements? (06)
Q.10
Your firm was engaged by ABC & Company to express an opinion on a Component, that is,
on a Schedule of Trade debts of the company. Necessary field work has just been completed
and as a result thereof, the Engagement Partner has requested you to prepare a draft of your
Report for his review.
Required:
Q.11
Prepare a draft of your Report on the trade debts of the company,
assuming that an unmodified report is warranted.
You have been assigned responsibility to handle a large size audit assignment. Outline
various steps that you would consider during various phases of the audit from inception
to conclusion. You are not expected to provide details as summary would suffice.
(THE END)
(10)
(10)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Professional Examinations
Summer 2002
June 04, 2002
ADVANCED AUDITING
PE-1 (PAPER-2)
Q.1
(MARKS 100)
(3 hours)
When planning an audit of the financial statements an auditor must understand
audit risk and its components.
Required:
a)
Define audit risk and its components.
(05)
b)
For each illustration given below, identify the component of audit risk which
is most directly related to the illustration.
(10)
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
c)
A client fails to discover employee fraud on a timely basis because
bank accounts are not reconciled monthly.
Cash is more susceptible to theft than an item of fixed assets.
Confirmation of receivable by an auditor fails to detect a
material misstatement.
Disbursements have occurred without proper approval.
Inadequate segregation of duties.
Omission of a necessary substantive audit procedure.
Susceptibility of loan receivable to material misstatement, assuming
there are no related controls.
Technological developments make a major product obsolete.
For stock-in-trade perpetual inventory count system has not
been established.
ABC company, a client, lacks sufficient working capital to continue
operations.
Based on the information given below, indicate whether each of the
following factors would most likely increase audit risk, decrease audit risk,
or have no effect on audit risk
(i)
This is the first year of profit since commencement of operations
five years ago.
(ii)
The chief executive officer is also a majority shareholder of the
company.
(ii)
The internal auditor reports to the finance director.
(iv)
The accounts department has experienced a high rate of turnover of
key personnel.
(v)
The auditor has been auditing the company for the past three years.
(05)
(2)
Q.2
For each error and fraud listed below, identify one internal control procedure which,
if properly designed and implemented, most likely could assist in preventing or
detecting the error and fraud.
(i)
(ii)
(iii)
(iv)
Q.3
a)
b)
Invoices for goods sold are posted to incorrect customers accounts.
Goods ordered by customers are shipped, but are not billed to anyone.
Invoices are sent for shipped goods but are not recorded in the sales journal.
Invoices are sent for shipped goods and are recorded in the sales journal but
are not posted to any customer account.
(v)
Credit sales are made to individuals with unsatisfactory ratings.
(vi)
Customers cheques are received for less than the customers full
account balances but the customers full account balances are credited.
(vii) Customers cheques are misappropriated before being forwarded to
the cashier for deposit.
(viii) Customers cheques are credited to incorrect customer account.
(ix)
Different customers accounts are each credited for the same cash receipt.
(x)
Customers cheques are misappropriated after being forwarded to the cashier
for deposit.
(10)
Describe the auditing procedures the auditor would perform to gather
evidence concerning subsequent events upto the date of auditors report
on the financial statements.
(05)
Sampling is essential in the audit of financial statements. In determining the
sample size the auditor should consider whether sampling risk is reduced to
an acceptably low level. Describe the factors which influence the sample size
for
i.
ii.
Q.4
Q.5
a test of control
a substantive test
In order to protect you as an auditor against claim of negligence, list down
what documentation would you devise in support of your audit work performed?
a)
b)
(05)
(05)
What are the circumstances which could lead to modification of audit report
on the financial statements i.e emphasis of matter, qualified opinion, disclaimer
of opinion, adverse opinion?
(05)
Items (i) to (xv) listed below present various situations an auditor might encounter
in conducting an audit of financial statements . For each situation describe the
type of opinion to be issued by the auditor i.e. unqualified opinion, emphasis
of matter, qualified opinion, disclaimer of opinion, adverse opinion.
Do not draft qualifications.
(i)
The financial statements of a listed company do not disclose significant
related party transactions.
(ii)
A client changes its accounting policy for valuation of inventories
from FIFO to Moving Average Cost Method. The auditor concurs with
the change although it has a material effect on the comparability of
the financial statements.
(3)
(iii)
An auditor is engaged to audit a client’s financial statements after the
annual physical inventory count. The accounting records are not
sufficiently reliable to enable the auditor to become satisfied as to the
year end inventory balances.
(iv)
A client has significant amount of deposit in a bank which is under
liquidation. Pending completion of liquidation proceedings of the bank,
no provision has been made in the accounts. This matter is adequately
disclosed in the financial statements.
(v)
A client has significant amount of receivable which is disputed by the
customer and the matter is under litigation. Pending adjudication in
court, no provision has been made in the accounts. This matter is
adequately disclosed in the financial statements.
(vi)
The financial statements of a listed company do not disclose
remuneration paid to chief executive, directors and executives of the
company.
(vii)
The financial statements of a listed company do not include a cash
flow statement.
(viii)
Due to losses and adverse key financial ratios, an auditor has substantial
doubt about a client’s ability to continue as a going concern for a
reasonable period of time. Despite the material uncertainty, the auditor
concludes that the use of going concern assumption is appropriate
based on management’s plans to deal with the events and conditions
that raise doubt about the going concern. The client has adequately
disclosed its financial difficulties in a note to its financial statements,
which do not include any adjustments that might result from the
outcome of this uncertainty.
(ix)
The chief executive officer refuses the auditor access to minutes of board
of directors’ meetings.
(x)
The auditor is unable to obtain audited financial statements of a
consolidated subsidiary.
(xi)
Previous year’s financial statements were audited by another firm of
chartered accountants who issued an unqualified audit opinion thereon.
(xii)
Certain material transactions cannot be tested because of management’s
retention policy related to records.
(xiii)
Management does not provide reasonable justification for a change in
accounting policy.
(xiv)
The client refuses to permit the auditor to confirm certain significant
accounts receivable or apply alternative procedures to verify these balances.
(xv)
The chief executive officer is unwilling to sign the
management representation letter.
(15)
(4)
Q.6
a)
b)
c)
d)
Q.7
Q.8
What is the difference in the objective and scope of internal and external
audit?
(03)
Will you rely on the work of an internal auditor who reports to the Finance
Manager of company who largely carries out certain pre-audit functions such
as checking of invoices prior to payments?
(03)
What recommendations can you make to enhance the effectiveness of internal
audit in a large listed financial institution ?
(06)
Chief Executive of a large listed company has approached you to assist them
in designing the terms of reference (TOR) of their newly formed Audit
Committee of the Board. You are requested to draft the TOR for the Audit
Committee in the light of good corporate governance practices.
(07)
Tina is auditing Kapadia & Sons, a small trading distribution agency. Kapadia
& Sons is using stand-alone PCs for accounting and related internal control
system. While planning the job, Tina asked the question to you being a job
incharge on the audit, that what is the effect of stand-alone PC environment on
audit procedures to be performed on this job?
(06)
You are audit manager at Khalid Surmawala & Co., Chartered Accountants. Your
firm has recently appointed a batch of twenty audit staff under a training contract.
Your partner advised you to conduct a training session for them on audit evidence.
You are required to present your lecture on the following:
a)
‘Sufficient appropriate’ audit evidence.
b)
Procedures to be performed by an auditor to obtain audit evidence.
(THE END)
(05)
(05)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Professional/Final Examinations
Winter 2002
December 12, 2002
ADVANCED AUDITING
[PE-1 Paper 2] & [Module “E” Paper E-14]
Q.1
Q.2
Q.3
(MARKS 100)
(3 hours)
(a)
List the type of information that may come to the auditor’s attention that may
indicate that Non-compliance with laws or regulations has occurred.
(05)
(b)
With reference to the Acceptance procedures in respect of prospective clients,
discuss the procedures, which you would include in your evaluation.
(05)
One of your clients is implementing an IT system for its cash management function.
List five key IT controls which you would suggest to include in the system.
(10)
During the course of the audit of the accounts of Zafar Corporation Limited for the
year ended June 30, 2002, you have decided to use the work of an Expert as audit
evidence. However, before proceeding with the same, you need to discuss this
matter with the management of the Corporation, and for that, you are expected to
make a small presentation thereto which should include such matters as:
(a)
circumstances under which you would consider the need to use the work of an
expert
(b)
consideration which you will have in determining the need to use the work of
an expert
(c)
consideration which you will have in assessing the professional competence
of the expert
Address these matters in your presentation.
(10)
Q.4
During your audit of the accounts of Imran Manufacturing Co. (Private) Limited for
the year ended June 30, 2002, you are in the process of briefing your staff about
transactions which might appear unusual in the circumstances and wish to give them
some examples that may indicate the existence of previously unidentified Related
Parties. What examples would you give them in this regard?
(05)
Q.5
Your firm has been appointed as an auditor of a commercial bank which has
recently commenced operations in Pakistan. The Audit Committee of the Bank has
also asked your firm to carryout a special review, in addition to the statutory audit,
to evaluate the bank control procedures for the prevention of money laundering.
Highlight significant anti-money laundering control procedures which you would (12)
expect.
(02)
Q.6
Q.7
Q.8
Q.9
(a)
At the conclusion of the audit of XYZ (Private) Limited for the year ended
June 30, 2002, you have decided to express a reservation in your report on the
accounts of the above-referred company as a result of your disagreement with
the management in respect of its failure to record depreciation on its building
and equipment, using annual rates of 5% and 20% respectively. You have
determined that a Qualified opinion would be issued. Draft your reservation,
along with the opinion paragraph, to be included in your report in accordance
with the requirements of related International Standard on Auditing. Do not
draft the entire report pursuant to the requirements of the Companies
Ordinance, 1984.
(04)
(b)
Usman, an Audit Manager, is toying up with the idea of expressing a
disclaimer of opinion in his report on the accounts of ABC Corporation for the
year ended June 30, 2002 due to his inability to observe physical inventories
and confirm trade debts on account of certain limitations placed by
management of the company. Assist him in drafting the Scope paragraph, a
paragraph discussing the scope limitation and the concluding paragraph of the
report. You are expected to follow the requirements of related International
Standard on Auditing in your drafting of the above.
(04)
(c)
State the basic elements and the lay out of the auditor’s report on a special
purpose audit engagement.
(05)
(a)
The work performed by each assistant needs to be reviewed by personnel of at
least equal competence. Why?
(05)
(b)
State the functions performed by personnel carrying out supervisory
responsibilities.
(05)
(a)
Identify the two categories in which fraud risk factors relating to
misstatements resulting from misappropriation of assets may be grouped.
(02)
(b)
For each of the above two categories, identified in (a) above, list examples of
fraud risk factors which relate to misstatements that results from
misappropriation of assets.
(08)
While reviewing the notes, prepared for you by your Audit Manager, before the
Closing meeting with the Chief Executive Officer of NY Corporation in respect of
the financial statements for the year then ended June 30, 2002, you noted the
following:
(a) The management of the Corporation is not willing to reverse an accrual of
Rs.350.00 million it made in the above-referred financial statements on
account of certain rebates, the Corporation claims, are due from a
Telecommunication company, as a result of a law suit filed by the corporation
against the Telecommunication company, in the local High Court. These
rebates relate to the period commencing July 1, 1998 to June 30, 2000. The
Telecommunication company, in turn, filed a counter lawsuit against the
Corporation. Legal proceedings in both cases are currently in the initial stages
of hearing. Realization of amount accrued by the Corporation, therefore,
appeared uncertain to you, as well as to the legal advisor of the Corporation.
All your efforts failed to persuade the management that the accrual in question
should be reversed.
(03)
(b)
The Corporation during the current year transferred a sum of Rs.575.00
million, representing the cost of a Project, from capital work-in-progress to
fixed assets and claimed depreciation and investment tax credit thereon, even
though the said project had not resulted in the production of intended products
in commercially feasible quantities by the end of the current year. Whilst your
Audit Manager agreed with the management that the said project commenced
production, he regards the production to be in trial run period and, as such, is
of the firm view that commencement of commercial production had not taken
place and, hence, is of the view that all expenditure of revenue nature should
continue to be capitalized up to the date of commencement of commercial
production. The management of the Corporation, however, is not willing to
listen to your Audit Manager who has determined that due to the abovereferred transfer, profit for the year is overstated by Rs.27.00 million.
(c)
The Corporation during the current year advanced a sum of Rs.287.00 million
to one of its associated undertakings. The above sum was extended with
complete disregard to the approval of the shareholders as a result of which
your Audit Manager noted that the advance in question had been given
without arranging for a Special resolution and that the said advance was, in
fact, in excess of thirty percent of the paid up capital and free reserves of the
Corporation at the time when the same was given. The management of the
Corporation had not made any disclosures in this regard in its financial
statements.
Required:
As Engagement Partner of the audit of NY Corporation, you are expected to:
•
Give a convincing reason to the CEO as to why the views of your Audit
(06)
Manager may be correct in respect of each of the above matters.
•
Identify the circumstances why it may not be possible for you to render an
unqualified opinion if the CEO insists on his point of view in each of the above
(02)
matters.
•
Assuming that it is not possible for you to render an unqualified opinion, draft
(12)
your reservations in respect of each of the above matters.
(THE END)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final/Professional Examination
Summer 2003
June 02, 2003
ADVANCED AUDITING
[Module ‘E’ Paper E-14] & [PE-1 Paper 2)
Q.1
(a)
(b)
Q.2
(a)
(b)
Q.3
(a)
(b)
Q.4
(a)
(b)
Q.5
(MARKS 100)
(3 hours)
The role of external auditors in recent corporate failures has been frequently
questioned. Discuss the impact of major audit failures such as “Enron” and
“World Com” on the audit profession. What in your opinion should be the
response of the profession to enhance public perception about the profession.
(10)
The Institute of Chartered Accountants of Pakistan has notified a list of
services which external auditors can perform for their listed external audit
(05)
clients. What are those services?
Your firm has recently won a new audit of a large manufacturing company.
However, you noted that prior period’s financial statements had not been
audited. You are of the view that for current assets and liabilities and noncurrent assets and liabilities, you could obtain some audit evidence as part of
the current period’s audit procedures.
As an audit manager, explain your point of view in detail, for the benefit of
your staff.
(06)
As a result of audit of the manufacturing company mentioned above, you
were unable to obtain sufficient appropriate audit evidence on the opening
balance of inventory. You were, however able to obtain sufficient appropriate
evidence with regard to the closing balance of the inventory. You are required
to draft your opinion, including the qualification, if any. Do not write the
whole report but just draft the qualification, if any and opinion paragraph.
(05)
When is the auditor’s assessment of materiality and audit risk expected to be
different? Include in your answer the reason for the same together with an
example in support thereof.
(06)
Why would the auditor in planning the audit work intentionally set the
acceptable materiality level at a lower level than is intended to be used to
evaluate the results of the audit?
(03)
What is the responsibility of the external auditor regarding assessment and
disclosure of a change in accounting policy made by his client.
(05)
It is often said that working papers should possess certain characteristics. List
some of these characteristics.
(05)
You are relaxed that the financial statements of MNOP Corporation have finally
been issued by its Board of Directors together with auditor’s report, when, all of a
sudden, the concerned Audit Manager barged in your room to inform you that he
has just become aware of a material fact related to the financial statements of the
MNOP Corporation, which existed at the date of your report and which if known to
you at that date may have caused you to modify your report.
You immediately got on your feet and started wondering about your course of
action.
Describe the course of action you will follow in the above referred situation.
(10)
(2)
Q.6
During your audit of the financial statements of Triple AAA Insurance Company
Limited for the year ended December 31, 2002, you noted that the company had not
complied with the requirements of S.R.O. 938, issued during the current year by the
Securities and Exchange Commission of Pakistan, insofar as the valuation of
“available for sale” investments in the financial statements was concerned. The
company had stated such investments at cost, as opposed to valuing these at the
lower of cost or market value (market value to be taken as lower if the fall is other
than temporary), as required in the above S.R.O. As a result, you noted that
provision amounting to Rs.131. 036 million required for valuing such investments
on this basis had not been made by the company in the financial statements of the
company.
Further, you noted that although the company had made a provision of Rs.28.929
million for claims “Incurred But Not Reported” (IBNR) in the above referred
financial statements, the same fell short by Rs.57.859 million, as a result of which
provision in the required amount of Rs.86.788 million was not made on this
account.
Given the materiality of the amounts involved and their effects on the financial
statements of the Company, you have decided to express qualifications with regard
to these matters in your report.
Draft qualifications in respect of the above matters in your Report on the financial
statements of the Triple AAA Insurance Company Limited, together with the
related appropriate wording in the opinion paragraph of your Report. Do not
attempt to write the whole report. Draft qualifications and the related wordings of
the opinion paragraph.
(10)
Q.7
(a)
(b)
State the obligations of Chartered Accountants with regard to the
Confidentiality of client’s information or employer’s affairs.
(03)
Is Confidentiality only a matter of disclosure of information?
(02)
Q.8
Discuss the role of audit committees in the light of the requirements laid down in
the Code of Corporate Governance.
(10)
Q.9
Sputnik Loan Company has 100 branch loan offices. Each office has a Manager
and four or five Subordinates, employed by the Manager. Branch Managers prepare
the weekly payroll, including their own salaries, and pay employees from cash on
hand. The employees signs the payroll sheet signifying receipt of his salary. Hours
worked by hourly personnel are inserted in the payroll sheet from time cards
prepared by the employees and approved by the Manager.
The weekly payroll sheets are sent to the Head Office along with other accounting
statements and reports. The Head Office compiles employees earnings records and
prepares all tax salary reports from the weekly payroll sheets.
Salaries are established by Head Office job evaluations schedules. Salary
adjustments, promotions and transfers of full time employees are approved by a
Head Office salary committee based upon the recommendations of Branch
Managers and Area Supervisors. Branch Managers advise the salary committee of
new full-time employees and terminations. Part-time and temporary employees are
hired without referral to the salary committee.
(a) Based upon your review of the above referred payroll system, how
might payroll funds be diverted?
(08)
(b) Prepare a payroll audit program to be used in the home office to audit
the branch office payrolls of the Sputnik loan company.
(12)
(THE END)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final and Professional Examinations Winter 2003
December 01, 2003
ADVANCED AUDITING
Module E and PE-1
(MARKS 100)
(3 hours)
Q.1
Related parties relationship and transactions with related parties have significant
impact on audits. As audit manager, you have been asked by your partner to brief
your staff about various types of relationships and unusual transactions which may
be carried out between such parties. Make a presentation to cover the above
issues?
(10)
Q.2
(a)
Describe what do you understand by the term “going concern”. Briefly
discuss how would you as an auditor, evaluate management’s assessment of
the entity’s ability to continue as a going concern.
(03)
(b)
List the factors which may indicate that a company is not a going concern
and briefly describe why each of these factors indicates going concern
problems?
(05)
Q.3
Recently, there have been a number of highly publicized cases of alleged or actual
management frauds involving misstatement in the financial statements that have
adversely affected the reputation of the accountancy profession. As a result, the
IFAC and other professional bodies have issued revised standards on “Auditors
Responsibilities” in respect of fraud in the financial statements.
Required:
Q.4
(a)
What are the responsibilities of an auditor and those charged with
governance with respect to fraudulent financial reporting?
(06)
(b)
What are the characteristics of management fraud that an auditor should
consider to fulfill the auditor’s responsibilities related to detecting
management fraud?
(02)
(c)
Three factors that heighten an auditor’s concern about the existence of
management fraud include (1) an intended public placement of securities in
the near future, (2) management remuneration dependent on operating
results, and (3) a weak internal control environment evidenced by lack of
concern for basic controls and disregard of the auditor’s recommendations.
What other factors should heighten an auditor’s concern about the existence
of management fraud?
(04)
You are required to certify the Statutory Report of Fresh Beverages Limited, a
listed company in terms of Section 157 of the Companies Ordinance, 1984. State
the audit procedures to be performed by you in this respect.
(10)
(2)
Q.5
The Board of Directors of a listed company are concerned about company’s
declining profitability and have appointed a new Managing Director. The new
Managing Director has approached your firm to carry out a forensic investigation
in certain areas where he believes that the company is loosing revenue. The areas
identified by him include:
(i)
(ii)
(iii)
Purchases of material from local sources.
Payments made for advertising and other expenses.
Payments for overtime and other staff related expenses.
Required:
(a)
Identify ways in which misappropriation of company’s funds may be taking
place in each of the above areas.
(05)
(b) Suggest appropriate internal controls to mitigate the risks of above
mentioned misappropriation possibilities.
(10)
Q.6
Nawab, a newly qualified chartered accountant has established an audit firm. In
order to increase its base he decided to induct you as a partner in the firm. Before
making any decision, you have carried out an assessment of the firm’s practice.
You have noted that Nawab does not care much of quality control in the firm. He
believes that job should be profitable even at the cost of quality. You are well
aware that such an attitude may expose the firm to severe penal action by the
regulatory authorities. You have decided to convince Nawab for implementation
of sound quality control policies in the firm as a precondition for joining as a
partner. For this purpose, you are required to develop a paper containing:
(a)
(b)
Salient features of the Quality Control Program of the ICAP.
(05)
Your recommendation for establishing the Quality Control Policies and
Procedures in the firm.
(05)
Q.7
One of the key responsibilities of an audit manager is to manage an effective client
relationship. Briefly explain what factors would be important in managing this
relationship and what steps should be taken by the audit manager to perform this
task effectively?
(10)
Q.8
Your firm has been approached by a large trading company to carry out a review
of its prospective financial information:
(a)
(b)
Q.9
What factors should be kept in mind while determining the extent of
examination procedures for such a review.
(05)
What will be the key contents of your report on this information?
(10)
Ahmed is an audit assistant at a large chain of shoe shop namely Fullstop. Fullstop
is using on-line computer systems for entering transactions, making inquiries,
updating master files and requiring reports. As Ahmed has no prior experience of
auditing an entity using on-line computer system, he asked you, being the
engagement manager of the audit, the following questions:
(a)
What is the effect of on-line computer system on audit procedures to be
performed on this job?
(04)
(b) What are the matters of particular importance while auditing through online computer systems?
(06)
Draft your replies to the questions raised by Ahmed.
(THE END)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations Summer 2004
June 10, 2004
ADVANCED AUDITING
Q.1
Q.2
(MARKS 100)
(3 hours)
You have been admitted as a partner in a recently established audit practice
comprising of 10 partners. The partners have asked you to draft the firm’s “Clients
acceptance and retention policies and procedures” that will ensure firm’s
independence and ability to serve clients properly. Draft such policies and
procedures.
(10)
M & B Limited is an unquoted public company engaged in the manufacture and
marketing of textile products. Its production facility and head office is located in
Karachi. Sales are made through a network of merchants across the country. The
audit of the company is in planning stage and you, in your capacity as audit senior,
have been assigned the task of evaluating the internal audit function of the
Company.
The Company has an adequately manned internal audit department (IAD). Scope
and objectives of the IAD are determined by the Audit Committee, which reports
directly to the Board of Directors of the Company.
Major functions of IAD include:
(i)
(ii)
(iii)
Systems review and compliance testing;
Review of monthly management accounts including variance, trends and
ratio analysis;
Substantive testing as per the overall internal audit plan. The internal
audit planning is performed by the head of internal audit department and
approved by the Audit Committee; and
The work and reports of the IAD are reviewed by the Audit Committee on a
quarterly basis.
Required:
(a)
(b)
(c)
Explain why an auditor should consider internal audit activities while planning
the audit.
Based on the above, perform preliminary assessment of internal audit. Also
state further information, if any, regarding the internal audit function that you
may require.
Assuming you have planned to rely on the work of the internal auditor,
describe what would you consider in evaluating specific work of the internal
auditor.
(02)
(05)
(03)
2
Q.3
You are engaged in the audit of a listed manufacturing concern as audit senior. The
audit field work has been completed and you have completed your review. The
following issues have remained unresolved after your final meeting with the Finance
Director of the client:
(a)
(b)
Company has incurred certain expenses on the launch of a new product. The
company has recognized only one third of the expenses in the profit and loss
account while the remaining expense are being deferred over a period of three
years. The amount of expense being deferred is Rs. 20 million which is
material in the context of the company’s financial statements.
(06)
The company has provided interest free loan amounting to Rs.25 million to its
associated company without obtaining the approval of its share holders. The
Finance Director has indicated to you that the company does not intend to
disclose this loan separately in the financial statements.
(06)
Required:
Prepare a Memorandum for your Audit Partner giving your opinion about these
issues, keeping in view the requirements of the relevant International Accounting
Standards and provisions of the Companies Ordinance, 1984.
Q.4
You have encountered following independent situations in conducting an audit of a
manufacturing company. For each situation select the type of opinion you consider
suitable and give reasons for your choice. Assume that each situation has a material
impact on the financial statements.
(a)
(b)
(c)
(d)
(e)
Q.5
You were appointed as auditor after the year end date and the accounting
records are not sufficiently reliable to ensure accuracy of the year end
inventory balances.
Gratuity and pension liabilities recorded on the basis of workings prepared by
client were reasonably close to the liability assessed by the actuary. Small
errors found in the data used by the actuary may have impact on actuarial
computation to a maximum of 5% of gratuity and pension liability.
A term deposit of Rs. 10 million with a bank has been carried in the financial
statements at cost. The bank has filed a voluntary liquidation petition
subsequent to the year-end date and the net realisable value of the deposit is
not more than 20% of cost.
The company changed its method of inventory valuation from FIFO to
average. You concur with the change although it has a material effect on the
comparability of the financial statements.
Financial statements do not disclose certain long-term obligations
Your client XYZ Limited, a listed company, has decided to recognize the deferred
tax asset arising from unassessed tax losses in its books. You are the audit manager
at this client and are faced with the dilemma whether to include the matter in the
Audit Report or not. Your audit partner of this engagement is of the view that
benefit of tax losses cannot be taken until and unless the tax losses are determined
by the tax authorities.
(02)
(02)
(02)
(02)
(02)
3
Last year, M/s. XYZ Limited suffered huge loss due to the golden handshake
expenses paid to around 200 employees whose services were terminated by the
company in view of its plans for restructuring in future.
Required:
Based on the financial and regulatory reporting framework currently prevailing in
Pakistan for listed companies, present your views as to who do you think is correct
– your client or your audit partner and why? Further, assuming that your partner
agrees with the client on recognition of deferred tax asset in respect of the
unassessed tax losses, state the related disclosures which are required to be made in
the financial statements of XYZ Limited keeping into consideration the
requirements of International Accounting Standard 12 “Income Taxes” (revised).
Further, also draft the modification in the Audit Report, if you consider it to be
(12)
necessary.
Q.6
Q.7
(a)
In terms of provisions of the Companies (issue of capital) Rules 1996, a listed
company is required to obtain a certificate from its auditors before issue of
bonus shares.
Draft the above-referred certificate to be issued by the auditors.
(04)
(b)
What is the definition of free reserve in the context of the issue of bonus
(04)
shares and right shares?
In the context of the code of ethics issued by the Institute of Chartered Accountants
of Pakistan (ICAP):
(a)
(b)
Define the term “Independence”, as it relates to a chartered accountant in
practice
(02)
Describe situations, which may raise doubts about the independence of a
chartered accountant in practice.
(10)
Q.8
Auditors are required to obtain appropriate written representations from
management on matters material to financial statements, when other sufficient audit
evidence cannot reasonably be expected to exist. Give examples of representations,
which can be so obtained related to derivative financial instruments in the context
of International Auditing Practices Statement 1012.
(06)
Q.9
The auditing profession world over has experienced expectation gap arising on
account of major corporate failures particularly in the western countries. These
corporate failures have also raised doubts about the reliability of audited financial
statements.
Required:
Identify some of the steps which have been taken by the Securities and Exchange
Commission of Pakistan and the Institute of Chartered Accountants of Pakistan to
enhance the reliability of audited financial statements and the quality of accounting
profession in Pakistan.
(10)
4
Q.10
You are senior in charge on the audit of Smart Cars Limited and following
information is available as to the overall business environment of the company.
Smart Cars Limited is a public limited company and is engaged in assembling,
progressive manufacturing and marketing of cars and vans. Sales are made against
100 percent advance payment and delivery is made after 3 months. If, however,
delivery is delayed, the company is required to pay interest on the advance at the
prevailing market rates.
Automobile industry is steadily growing locally and its demand is on the rising
trend. However, local manufacturers are facing difficulty in making prompt
deliveries, which usually takes around 3 to 8 months. Customers are demanding to
allow import of new/used cars to meet the rising demand in the country.
Although the company is operating at its maximum capacity, it is not able to meet
demand on timely basis. Working at maximum capacity has deteriorated the quality
of workmanship and has raised quality concerns. It is a normal industry practice to
offer one year after sales service warranty.
During the year, competitors have introduced 4 new models at very competitive
prices. However, the company has not introduced any new model.
Required:
You are required to identify and explain:
(a) the business risks faced by the company;
(b) financial statement risk in relation to business risks identified above;
(c) accounts affected by the above risks; and
(d) your plan to address the identified financial statement risks.
(THE END)
(2.5)
(2.5)
(2.5)
(2.5)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations Winter 2004
December 10, 2004
ADVANCED AUDITING
Q.1
(MARKS 100)
(3 hours)
Tips e-Shops Limited (TSL) is engaged in marketing and sales of books through its
web-based portal, making delivery within 48 hours. Its operations extend over all the
major cities of the country.
TSL offers books, magazines, journals, textbooks, etc., to its customers on wide
variety of subjects. It also sells advertising space on its website which it bills on the
basis of number of hits. All its business partners including suppliers and courier
companies are electronically linked by TSL’s business application system (software),
which automates virtually all the processes of supply chain. This means that
deliveries are automatically made by the suppliers when an order is received by TSL
on its system and related costs and revenue are recognized accordingly. To make all
this possible TSL has, over the years, made significant investment in internally
developed software and website development.
Required:
TSL has appointed Tom Jerry & Co., Chartered Accountants as its auditors for the
year ended June 30, 2004. You are audit supervisor in the Firm and your Manager
has asked you to start planning work on this engagement in line with applicable
auditing standards. Prepare relevant extracts of Audit Planning Memorandum
identifying and explaining the audit risks resulting from use of e-business specially
with reference to:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
Q.2
Internally developed software and website development cost
Fixed assets and depreciation (including impairment loss)
Stock ownership
Stock return and warranty claims
Data processing
Credit card transactions, and
Advertising costs.
Review each of the following situations in respect of an audit client which is
managed by you in the capacity of audit manager:
(i)
The company made investment amounting to Rs.10 million in an associated
company which has ceased operations. The auditors of the associated
company have qualified their report on the going concern issue. However, the
company has not made any provision in respect of this investment.
(ii)
The total liability of the company in respect of accumulated leaves of
employees is Rs. 150 million. However, the company has made a provision
of only Rs. 40 million representing the encashable portion of the leaves based
on the contention that the remaining portion of the liability is not required to
be paid.
(13)
(2)
Q.3
Q.4
(a)
Write a note to your partner explaining each of the above issue and your
contention on the same.
(04)
(b)
Draft qualifications in audit report on the above issues.
(06)
You are the audit partner responsible for audit of a large consumer goods company.
The chief executive is concerned that the controls over recording of sales in one of
the division of the company are not strong. He has informed you of the following:
• Sales are very heavy in the last fortnight of the year
• Distributors incentive is based on sales targets
• The divisional head is remunerated, based on profits of the division.
(a)
Identify audit risks based on the above information.
(06)
(b)
What components of financial statements will be affected by each of these
risks?
(03)
(c)
Describe the audit approach for each of the above risks.
(06)
You are the audit supervisor responsible for the audit of Universal Manufacturing
Limited (UML), a high-tech electronic goods manufacturing company. The draft
financial statements for the year ended June 30, 2004 shows the following data:
2004
2003
(Rupees in millions)
Revenue
Profit before tax
Total assets
804
20
678
734
64
619
The following audit issues have been highlighted by your audit team for your
attention:
(i)
During the year, UML has installed machinery on leasehold land. The
remaining term of the lease is 15 years. Under the terms of the lease, the
machinery must be dismantled and the site restored when the lease term
expires. The expected cost of restoration of land in the year 2019 is
Rs. 50 million and an annual provision of Rs.3.3 million is being made by
charging the cost to profit and loss account.
(ii)
The company has calculated the net deferred tax liability at the year-end
amounting to Rs.32 million, which has been duly recognized in the accounts.
Tara, a semi senior, has identified that the timing differences in respect of
assets acquired on finance lease and related liabilities have not been
considered, while calculating the above deferred tax liability. Based on her
working, Rs. 4 million should be recognized further as deferred tax liability.
Required:
For each of the above issues, comment on the matters that you should consider and
the audit evidence that you should expect to find, in undertaking your review of the
audit working papers.
(16)
(3)
Q.5
List procedures that may be performed in an engagement to review financial
statements in the context of investments in stock market.
(06)
Q.6
Kamal, a Chartered Accountant, is engaged to audit the financial statements of
Ahmed Wholesalers (AW) for the year ended June 30, 2004. Kamal obtained and
documented an understanding of AW’s internal controls relating to accounts
receivables and assessed control risk relating to accounts receivable as ‘high’.
Kamal requested and obtained from AW an aged accounts receivable schedule
listing the total amount owed by each customer as of the balance sheet date and sent
positive confirmation requests to a sample of customers. Subsequently, Kamal tested
the accuracy of the aged accounts receivables schedule. Kamal has asked Tariq, an
audit staff to follow-up on the three returned confirmations that are summarized
below. Assume each confirmation is material if the potential misstatement is
projected to the population.
Ref.
No.
Customer
Balance
Rupees
Customer’s comme nts
AW’s comments
/ Tariq’s notes
7
Amber &
Co.
885,000
Yes, we ordered Rs.885,000 worth of
goods from AW in May. However,
we mailed a cheque for Rs.885,000
on June 8, 2004.
The cheque was
received
and
deposited
but
posted to wrong
customer’s
account.
24
Babita
Trading
1,475,000
Sure we ordered Rs.1,475,000 worth
of goods on April 10, 2004, but AW
was out of stock until recently. They
back ordered the goods and we finally
received them on July 06, 2004.
We received Rs.1,416,000 worth of
goods on consignment from AW on
June 10, 2004, but they are not sold
yet.
30
Claire
Jones
1,888,000
-
-
Required:
(a)
(b)
Q.7
Describe the procedure(s), if any, that Kamal should perform to resolve each
of the three confirmations that were returned. Assume that AW will record
any necessary adjusting entries and that Kamal will verify that they are
appropriate.
Assume that Kamal sent second request for accounts receivables initially
selected for confirmation, for which no responses were received. Describe the
alternative procedures that Kamal should apply for such receivables.
(06)
(03)
After the financial statements of DEF Leasing Company Limited, a listed company,
for the year ended December 31, 2003, have been published, you, being the
statutory auditor of the company, become aware of the fact that the company had
recorded a total of three fake leases (which were material in nature) in its financial
statements for that year.
Required:
What action is required on your part, considering the requirements of International
Standard on Auditing 560 – Subsequent Events, assuming that the management does
not agree to revise and republish the financial statements and the Audit Report
thereon?
(10)
(4)
Q.8
Q.9
Describe the requirements of ISA-240 “The Auditor’s Responsibility to Consider
Fraud and Error in an Audit of Financial Statements” with regard to the following:
(a)
Professional Skepticism.
(02)
(b)
Planning Discussions.
(04)
(c)
Inquiries of Management that the auditor is required to make with regard to
Fraud.
(05)
Your client XYZ Limited, a listed company, has investments in three companies A,
B and C. XYZ Limited owns and holds 75% of the shares in company A, 65% of the
shares in company B and 50% of the shares in company C. However, XYZ Limited
has decided not to consolidate its three subsidiaries on the premise that it does not
have control over the same. The client insists that it is permitted to do this under the
requirements of International Accounting Standard (IAS) 27. You, being the
statutory auditor of the company, are in a fix whether to disagree with the client on
the accounting treatment accorded to the above.
Required:
In the light of the requirements of the Companies Ordinance, 1984 and IAS-27, give
your decision whether the treatment adopted by the client is correct. Give reasons in
support of your answer.
(10)
(THE END)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations
Summer 2005
June 10, 2005
ADVANCED AUDITING
Q.1
(MARKS 100)
(3 hours)
You are a senior member of the audit engagement team, auditing the financial statements of
XYZ Company Limited. Your job in charge is on leave and now you have to independently
plan the most appropriate methods of sampling for various accounts / areas and to identify
the areas where sampling need not be applied.
You are well aware of the fact that sampling is the key to an effective and efficient audit and
for all practical purposes without adequate application of sampling techniques an audit can
either become inefficient because of utilization of more time and wastage of efforts on
insignificant matters, or on the contrary, it may become ineffective as the results of audit
work may not be termed adequate.
With this perspective in mind, for each of the following, identify an appropriate method of
sampling or describe as to whether sampling would not be appropriate and some other
approach needs to be applied:
i)
Substantive testing for additions to fixed assets (Population size: 100 items / Rs. 70
million);
ii)
Compliance testing for revenue cycle – goods dispatch function (Population size:
100,000 dispatches / Rs. 550 million);
Substantive testing for payroll expenses (Population size: 102 employees / Rs. 85
million); and
Substantive testing for long term loans from commercial banks (Population size: 5
loans / Rs. 250 million).
iii)
iv)
Q.2
You are the audit engagement manager of Cargo Express Limited (CEL), a listed company
having cargo delivery business. CEL delivers cargo goods all over the country through a
fleet of heavy transport vehicles and has various wholly-owned subsidiaries formed to suit
its business requirements. The draft consolidated financial statements for the year ended
December 31, 2004 disclose turnover of Rs.260 million (2003: Rs.180 million), profit before
taxation of Rs.32 million (2003: Rs.25 million) and total assets of Rs.200 million (2003:
Rs.175 million).
The consolidated financial statements have been given to you by Sara, the senior on the job,
for your review together with a memo on the following issues:
(i)
The heavy transport vehicles have been consistently depreciated at 25 percent on a
straight-line basis according to the CEL’s financial policy manual. During the year,
the CEL has changed the basis of calculation and decided to charge depreciation at the
rate of 25 percent on reducing balance method to reflect the change in the expected
pattern of economic benefits. The CEL has calculated the current year charge on the
new basis as Rs.7.1 million (old basis : Rs.11.5 million) and accumulated depreciation
of Rs.14.3 million has been written back to opening balance of retained earnings in
the Statement of Changes in Equity.
(03)
(03)
(03)
(03)
(2)
(ii)
The financial statements of one of the principal subsidiary company, Montreal
Limited for the year ended December 31, 2004 are audited by another firm of
Chartered Accountants. In the draft consolidated financial statements of CEL,
Montreal’s profit before taxation of Rs.1 million and total assets of Rs.62 million have
been included. The contingency note to Montreal’s financial statements disclose a
contingent liability amounting to Rs.3 million on account of pending litigation relating
to claim lodged by one of the suppliers. Subsequent to the year end, the Court decided
the case against Montreal. However, the management of Montreal has decided not to
make a provision for the above amount as they have preferred an appeal against the
judgment.
Required:
Q.3
(a)
Your comments on each of the above issues to the audit engagement team.
(07)
(b)
State the audit evidence that you should expect to find in carrying out review of the
audit working papers and financial statements of CEL for the above issues.
(06)
Your firm has been the auditors of Signet Engineering Ltd., a large multinational having
diverse operations. Since the volume of transactions is large, it has been the practice of the
manager in-charge of the audit to complete all audit work by performing substantive
procedures in combination with tests of controls at an interim date that is September 30. The
manager responsible for the audit of Signet has resigned and your manager has been
assigned in his place.
(a)
(b)
on receiving the assignment, your manager has asked you to prepare a report
regarding conduct of audit at an interim date in the light of International Standards on
Auditing and to describe in it the extent of audit work that will need to be performed
at the end of the period to provide a reasonable basis for extending conclusion from
the interim audit to the period end.
(06)
When after the interim audit, your team goes for the final audit, you as senior in
charge observe that the sales figure is unusually high. Sales have increased from Rs.30
billion as at 30th September to Rs.50 billion at the year end (December 31st). Your
conclusion at the end of the interim audit had been satisfactory although you did
observe then that the revenues were well below the target. There were also pressures
from the parent company, to improve upon the revenue targets.
On immediate inquiry from management you were told that the increase in revenue
was due to a large order received at year end. In these circumstances, how would you
satisfy yourself that the financial statements are free from the material misstatements? (06)
Q.4
KIBOR & Co., a firm of Chartered Accountants, is engaged in the audit of City Cars
Limited. The financial statements of City Cars Limited are prepared in accordance with
International Accounting Standards and Interpretations issued by the International
Accounting Standards Board and the International Financial Reporting Interpretations
Committee respectively. You are the manager in charge of the audit and Zara, the senior in
charge has submitted to you, the draft auditor’s report and financial statements for review.
The draft financial statements for the year ended December 31, 2004 show the following:
Revenue
Profit before taxation
Total assets
(Rs. in million)
540
25
75
(3)
The draft auditor’s report on the financial statements shows the following extract of matter
reported:
“As stated in note 5 and 6 to the financial statements, lease rentals paid amounting
to Rs.18 million have not been reflected in the balance sheet but included in
administrative expenses and deferred tax debit amounting to Rs.5 million has not
been recognized in the accounts.
In our opinion, the financial statements give a true and fair view of the financial
position of the Company as of December 31, 2004 and of the results of its
operations and its cash flows for the year then ended in accordance with IASs as
applicable in Pakistan.”
The relevant notes as stated in the financial statements are as follows:
Note:
(5)
Rentals paid amounting to Rs.18 million in respect of assets acquired on lease are
charged to the profit and loss account. The fair value of fixed assets acquired on
leasing arrangement is Rs.40 million.
(6)
Provision for current taxation is based on taxable income determined in accordance
with taxation laws at the current rate of taxation. The company accounts for
deferred taxation using the balance sheet liability method on all temporary
differences. However, as a matter of prudence, the company does not recognize net
deferred tax debit balance which amounts to Rs.5 million as of the balance sheet
date.
Required:
Give your comments on the above for submission to the audit partner for his review.
Q.5
(12)
You are engaged in the audit of Fine Exports Limited – a listed company involved in export
of garments. Besides the export of garments, the company is also involved in certain local
businesses including dyeing on toll manufacturing basis and sale of left over or rejected
garments in the local market. During the interview of client’s staff at planning stage, you
have got hints that there might be certain undisclosed or un-recognized revenues.
Consequently the audit is now considered to be high risk.
The Partner in charge of audit has asked you to develop a specific audit program to address
the risk of completion of revenue. Based on the additional work performed on the basis of
such audit program you came across few instances of unrecorded revenues and revenues
recorded as fake liabilities. At this stage, you can not conclude with reasonable certainty
that these are the only unrecognized revenues and as to whether there are any corresponding
expenses that have not been recorded particularly keeping in view the fact that the goods
receipt and dispatch functions are not adequately documented and the costing and
production reporting systems are not adequate. At the audit concluding meeting the
management disagreed with all of your findings.
Required:
(a)
(b)
(c)
List at least six audit procedures to specifically address the enhanced risk of
completeness of revenue duly mentioning the risk addressed by each of such
procedures;
(06)
Describe which form of modified audit opinion would be most adequate in such
circumstances; and
(02)
Draft a report modification paragraph and audit opinion paragraph that should be
included in the auditors’ report.
(06)
(4)
Q.6
Q.7
To maintain the firm’s standards of quality, it is necessary that there is adequate direction,
supervision and review at all levels. What procedures should be implemented by the firm to
ensure that this criteria is satisfied?
You are the partner of Shahab & Co., Chartered Accountants. One of your audit clients,
Independence Limited, a listed company has approached you with the intention of engaging
your firm for some other assignments which are as follows:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
Q.8
Q.9
(10)
Rendering of accountancy services
Taxation services
Conducting agreed upon procedures
Financial due diligence for acquisition of a company
Actuarial valuation of employment benefits
Human resource consulting
Legal opinion on labour laws
Training of the Board of Directors
Outsourcing of internal audit function to your firm
Assistance in preparation of disaster recovery plan
Which of the assignments can be accepted by your firm in the light of restrictions placed
under the Code of Ethics for Chartered Accountants.
(05)
You are the manager supervising the audit of a large manufacturing company. Management
of the company claims that it has implemented a sound system of internal control. You are
required to briefly explain to the audit team the definition and components of internal
control to enhance their understanding of this subject in the light of International Standard
on Auditing - ISA 315 (Understanding The Entity And Its Environment And Assessing The
Risks of Material Misstatement).
(10)
The Code of Corporate Governance requires the directors of a listed company to establish
an Audit Committee. With reference to the code, answer the following:
(a) Who can be the members of the Audit Committee?
(b) What are the responsibilities of the Audit Committee with regard to internal and
external auditors, internal controls and review of interim and annual financial
statements of the listed company?
(THE END)
(02)
(10)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations Winter 2005
December 09, 2005
ADVANCED AUDITING
Q.1
(MARKS 100)
(3 hours)
Systems Limited is a listed company engaged in the business of software export all
over the world and to its holding company based in United Kingdom. Sanam is the
job incharge and Aftab is the manager on the audit of Systems Limied. Just before
the year end, they had a meeting with the Chief Financial Officer (CFO) of Systems
Limited to plan the audit of the financial statements for the year ended June 30,
2005. The CFO informed them that during the year Systems Limited has made
significant investment of Rs.250 million in acquiring various rights, brands and
licences from the holding company under an agreement.
When the audit engagement team came back to office they concluded that the above
transaction is prone to certain risks and accordingly Aftab has advised Sanam to
prepare a detailed substantive audit work program on intangible assets addressing
all such risks.
You are required to develop an audit work program for the verification of intangible
assets acquired by Systems Limited during the year stating audit objectives and at
least five substantive procedures.
Q.2
(06)
Tania is the manager in-charge for the audit of the financial statements of
International Cargo Limited. During the review of working paper file of this client,
Tania noted that the engagement team had identified the following issues in the
Audit Issue Control Document:
(a)
(b)
(c)
(d)
The Company has not carried out physical verification of fixed assets since
considerable period;
Purchases made by the employees on the Company’s behalf were not properly
supported by invoices and receipts. This has resulted in the misclassification
of certain expenses;
The Company does not reconcile its accounts with other group companies on
a regular basis. This resulted in significant delays in the preparation of the
financial statements as a number of disputes arose when reconciling the year
end balances;
The Company does not have a policy for the systematic review of its
inventory to identify slow moving and obsolete items;
Tania discussed the above matters with the respective team members and advised
them to include these issues in the final engagement memo for the engagement
Partner’s review. The Partner, after discussion with the team had determined that
the financial effect of the above matters was not material in relation to the financial
statements. However, these are considered significant enough to require
communication to those charged with governance. You, as audit senior, are required
to draft management letter points duly incorporating the observation, implication
and recommendation on each of the above matters.
(08)
(2)
Q.3
(a)
Iqbal & Company are engaged in the audit of Lasbella Tractors Limited for
the year ended June 30, 2005. Zeeshan is the audit supervisor at this client.
While performing the relevant audit procedures for taxation, he identified that
the Company had opted for tax assessment under Final Tax Regime (FTR) of
the Income Tax Ordinance, 2001 for the tax year 2005. However, during the
year the said scheme has been abolished by the taxation authorities
retrospectively and accordingly the Company has become liable for
assessment under normal tax. Upon discussion with the tax manager, he was
informed that the Company has made provision for taxation in the financial
statements for the current year on the basis of FTR, as the management
believes that it is unjust to withdraw the scheme retrospectively. The
Company has decided to make representations before the Central Board of
Revenue (CBR) seeking its administrative jurisdictions for removal of this
unjust action. Further the management asserts that if the CBR does not agree,
the company will file a writ petition before the High Court to contest the
retrospective amendment. The tax advisor however, in his opinion has stated
that the probability of the company’s success on the matter is low. Zeeshan is
faced with the dilemma whether to include the matter in the audit report or
not. The draft financial statements of the Company for the year ended June
30, 2005 show the following data :
(Rs. in million)
Revenue
500
Gross Profit
200
Income tax on FTR basis
27
Income tax on normal rates of taxation
48
Required:
(i) Explain the implication of the matter on the financial statements; and
(ii)
(b)
Q.4
Q.5
(04)
Discuss the type of audit report to be issued in the above situation and
draft a suitable modification, if any, in the light of relevant International
Standard on Auditing.
(04)
During the year the company has paid dividend amounting to Rs. 50 million
and deducted zakat thereon @ 2.5 percent of the par value of the shares where
applicable. The zakat has not been deposited till the board of directors
meeting in which financial statements have been approved. Draft suitable
opinion paragraph relating to zakat?
(03)
The management of a company is responsible for making accounting estimates
included in financial statements. However, the auditors should obtain sufficient
appropriate audit evidence as to whether an accounting estimate is reasonable in the
circumstances. You are required to:
(a)
Give brief comments on the nature of accounting estimates; and
(03)
(b)
Discuss the approach in the audit of accounting estimates.
(07)
Reliance Investment Limited, an investment company, placed its funds during the
year in developed stock exchanges such as New York and London stock exchanges
through fund manager, SC Bank. The SC Bank is responsible to invest the funds of
the company in profitable securities. It is expected to generate income of at least 10
percent of the amount invested and report to the company on monthly basis.
(3)
The Security Services Bank (SS Bank) based in New York has been appointed as
the trustee of this fund management scheme. The SS Bank is responsible to keep
investment securities and cash in its custody and act at the instructions of the SC
Bank. SS Bank also maintains the securities and cash position, carries out valuation,
maintains related records and reports to the company on monthly basis.
The chief accountant of the company receives the reports from both banks, updates
the investment position and records the returns on investments in the books of
account. Additionally, the chief accountant also receives report from the auditor of
SS Bank on the design and effectiveness of internal control of the bank.
The investment portfolio as at 30 June 2005 is Rs.21,500 million which represents
60 percent of the total assets of the company and return on investment for the year
ended 30 June 2005 is Rs. 1,200 million.
You are the auditor of Reliance Investment Limited. Describe your responsibilities
and work that you will perform in order to place reliance on internal control reports
of the auditor of SS Bank.
(08)
Q.6
Give your comments as senior in-charge of the audit engagement on the following
issues to the engagement partner.
(a)
XYZ limited has purchased further shares amounting to Rs. 100 million of
one of the associated companies without complying with the requirements of
section 208 “Investment in Associated companies and undertakings” of the
Companies Ordinance, 1984.
At the time of finalization of audit this matter came to your knowledge. You
discussed the matter immediately with the management and management
agreed to fulfill the compliance of the requirements of Section 208 in next
financial year.
(b)
(05)
Your firm has been appointed to carry out the audit of the trade debts as at
interim period i.e. 31 December 2004 in accordance with International
Standards on Auditing. It was agreed with the management that opinion on
the trade debts should be based on International Accounting Standards as
applicable in Pakistan.
During the start up meeting, the senior management restricted you from
sending request letter for balance confirmation to one of its major customers
because of some serious disputes. The amount receivable from such customer
is Rs. 280 million representing 25 percent of total trade debts. However, you
have been provided the agreements and memorandum of understanding made
with the customer and other relevant documents.
(05)
Q.7
(a)
Describe briefly the quality control review program established by the
Institute of Chartered Accountants of Pakistan.
(b)
What are the policies and procedures that an audit firm is expected to
establish with regard to maintaining high quality on individual audit
engagements?
(03)
(05)
(4)
Q.8
After the final closing of the books of account, your client invited you (engagement
partner) for audit and provided you final draft financial statements. After one week
the draft financial statements have been revised with the explanation by chief
accountant that certain adjustments were erroneously left from being recorded.
During the review of the first draft and revised draft of financial statements, you
noted that there are significant changes in the following components:
•
•
•
Sales increased from Rs.1 billion to Rs. 1.5 billion;
Provision against doubtful debts reduced from Rs.200 million to Rs.100
million; and,
The provisions made for staff retirement benefits decreased from Rs.75
million to Rs.30 million.
You are required to discuss the susceptibility of the company’s financial statements
to material misstatement due to fraud with the members of the engagement team
and explain the following:
Q.9
(a)
How fraud can be committed by management overriding controls using
certain techniques?
(03)
(b)
What could be the risk assessment procedures to identify risk of
misstatement due to fraud?
(02)
(c)
How to respond to the risk of management override of controls?
(d)
What audit strategy should be followed for journal entries and other
adjustments made through out the year or at year end?
(03)
(02)
Your firm has been approached by the management of Fox Limited, a listed
company for the year ending 31 December 2005 in the month of November 2005 to
fill the casual vacancy of the auditors. The audit fee fixed for outgoing auditors was
Rs. 1,000,000. You are willing to accept the engagement on the same remuneration.
In view of the lower expected profit of Rs. 5 million only for the year ended 31
December 2005, the management is of the view that the audit fee is too high
because it represents 20 percent of the expected profit. The management offers you
10 percent of the actual profit for the year ended 31 December 2005.
Would you accept the audit on the terms of remuneration offered by the
management? Please give reasons for your response.
(05)
Q.10
You are planning the audit of Marhaba Limited for the year ended June 30, 2005.
The principal activity of the company is the sale of bricks and paving products to
building companies and the general public. All products are purchased from three
major manufacturers in the country. Two years ago, the company diversified into
the manufacture and sale of fiberglass chimney stacks which are also sold to
building companies and its sales have grown steadily and now amount to 10% of
total turnover.
You have been provided with the following information from the financial
statements of Marhaba Limited in respect of the years ended June 30, 2004 and
2005:
(5)
Extracts from the profit and loss account
Revenue
Cost of sales
2005
2004
Rs. in ‘000’
24,863
22,659
(21,334)
(20,045)
Gross profit
Operating expenses
3,529
(3,220)
2,614
(2,469)
Operating profit
Financial charges
309
(114)
145
(27)
Profit on ordinary activities before taxation
195
118
384
429
1,760
6,101
26
2
7,889
8,273
1,899
5,092
23
4
7,018
7,447
Net Current Assets
2,464
3,816
316
216
6,812
1,461
1,702
3,926
305
217
6,150
1,297
Long term liabilities
Net Assets
(93)
1,368
(97)
1,200
Extracts from the balance sheet
Fixed assets – tangible
Current assets
Stocks
Trade debts
Prepayments and accrued income
Cash at bank and in hand
Total assets
Less: Current liabilities
Bank overdraft
Trade creditors
Other creditors
Accruals and deferred income
Required: (a)
Explain the usefulness of analytical review procedures in planning an audit.
(b)
Prepare planning notes on matters which you wish to discuss, in respect of
the information above, at the audit planning meeting with the Finance
Director of Marhaba Limited. Your notes should refer to analytical
procedures and other general procedures where relevant.
(09)
(03)
(6)
Q.11 Badar & Co. are the auditors of Smart Casuals (Private) Limited for the last five
years. The management of the Company has approached the firm for a special
assignment in respect of Accounts Receivables as at June 30, 2005. After the initial
discussions the firm has accepted the assignment to perform the following Agreed
Upon Procedures:
•
Obtain and check the addition of the trial balance of accounts receivable as at
June 30, 2005 prepared by the Company, and compare the total to the balance in
the related general ledger account.
•
Obtain and compare the list of all customers and the amounts owing at June 30,
2005 to the related names and amounts in the trial balance.
•
Obtain and check the details of Rs.30 Million received till August 31, 2005 from
the customers against the outstanding balances of Rs.50 Million as at June 30,
2005.
Badar & Co. has issued the engagement letter for an Agreed Upon Procedures
Engagement. The audit senior has completed the field work and performed the
above procedures. You are now required to prepare the report of factual findings in
connection with ‘Accounts Receivables’ as at June 30, 2005 assuming that there is
no exception noted, for the partner’s review containing all the necessary elements
applicable for the Agreed Upon Procedures Engagement.
(09)
Q.12 List ten examples of those situations, which indicate that non-compliance with laws
and regulations, may have occurred.
(03)
(THE END)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations
Summer 2006
June 09, 2006
ADVANCED AUDITING
Q.1
(MARKS 100)
(3 hours)
You are manager incharge on the audit of the financial statements of XYZ Pakistan
Limited, a large multinational FMCG company, which has appointed your firm as
auditors for the first time. During the course of finalization of audit you had various
meetings with the senior management of the Company. The management of the
company is really proud of their systems, business ethics and transparency in the
financial reporting systems. Nevertheless, during discussion you came across a
situation whereby the management has refused the request of signing the general
representation letter. The chief executive and chief financial officer of the company
are of the view that all their procedures and financial reporting systems are
transparent and you are given full liberty to check and verify any information and
there is no bar on providing you any information that you may require for the
purpose of your audit. Accordingly, they feel that through a representation letter,
you wish to transfer your responsibility to them. Therefore, they are not willing to
sign any sort of representations by whatever name called.
In this respect you are required to submit a memorandum to the management
highlighting the requirements of the International Standard on Auditing on
management’s representations. Accordingly, you are required to:
(a) List down the documents through which the auditor can ensure that the
management and those charged with governance acknowledge their
responsibility for the preparation of the financial statements;
(b) Identify who should sign the representation letter.
(c) Explain as to what should be the date of representation letter; and
(d) Describe what would be your action, if the management continues to refuse
providing a written representation letter.
Q.2
(03)
(02)
(02)
(03)
At planning stage of the audit of a new client, you, as an audit manager had a
meeting with the CEO and CFO of the company. Various matters such as
company’s performance, profitability, turnover of staff, import of plant and
machinery during the year, inventory turnover, collection from debtors, payment of
creditors, investment in marketable securities etc were discussed.
As a result of the discussion you were able to assess that a significant portion of the
company’s business is conducted with parties which are closely linked with the
company.
As the audit manager you are now required to explain the following to the members
of the audit team:
(a) Procedure as to how completeness of related party transaction could be
verified.
(b) Examples of transactions, which indicate the existence of related parties.
(c) Examination of identified related party transactions
(04)
(03)
(04)
(2)
Q.3
State Street Limited (SSL) is a public limited company. Their external auditors are
Mohammad Din & Co., Chartered Accountants. They are also providing taxation
services to SSL. You are working as Manager Audit on the above engagement. You
came to know that your firm’s tax services department has agreed with the
management of SSL to represent the Company before the taxation authorities in
respect of an appeal filed by them involving substantial amount of tax demand. In
consideration thereof, the tax department will charge ten percent of the amount of
tax relief that may be allowed.
As an audit engagement manager you are not comfortable with the above
arrangement as it may impair independence of the Firm. You are required to put
forward a note before the audit engagement partner highlighting the guidance
provided in the Code of Ethics as issued by the Institute of Chartered Accountants
of Pakistan in respect of contingent fees charged to clients for assurance and nonassurance services.
Q.4
(06)
You are a manager on the audit engagement of Afghan Automobiles Limited.
Yasin, the incharge of audit engagement, while reviewing the draft financial
statements noticed that the current assets include an asset described as Derivative
Financial Instruments. Upon his inquiry, the Chief Financial Officer explained that
there are certain open foreign exchange forward contracts that are recognized at
their fair value in accordance with the International Accounting Standards. He
further explained that these contracts were entered into in order to manage the
company’s risk exposure relating to fluctuations in the foreign currency exchange
rates.
Yasin has no prior experience of auditing the derivatives and the audit plan
approved by the manager did not cover the procedures for auditing derivatives.
Therefore, she consulted you being the engagement manager for seeking guidance
on planning and performing auditing procedures for financial statement assertions
related to derivative financial instruments. You are required to answer the
following questions raised by him:
(a) Describe briefly what are ‘Derivative Financial Instruments’
(b) What are the key substantive procedures related to valuation and measurement
assertions about derivatives?
Q.5
Q.6
Discuss ‘Audit Matters of Governance Interest’ that arise from the audit of
financial statements and are required to be communicated to those charged with
governance?
You are currently working as Audit Senior in a medium sized audit firm. Your firm
does not have any international affiliation and all the working standards and
practices of the firm have been developed locally in the light of the International
Standards on Auditing and the pronouncements of the Institute of Chartered
Accountants of Pakistan.
The firm has commenced an exercise to further strengthen the working procedures
of the firm in general and to improve the quality control process in particular, in
line with the revised ISA on Quality Control for Audits of Historical Financial
Statements. In this respect, the managing partner of the firm advised you to prepare
memorandum describing the following:
(04)
(05)
(05)
(3)
(a) The term “Engagement Partner”; and
(b) Responsibilities of an engagement partner.
Q.7
(03)
(06)
(a) The financial position of Sonia Limited as at 31 December 2005, is as follows:
•
•
•
Current liabilities over current assets are Rs. 200 million.
Carrying value of property, plant and equipment is Rs. 600 million.
Long term borrowing is Rs. 750 million.
You are the senior incharge of the audit engagement for this client and have
expressed your concern on the company’s ability to continue as a going
concern. The management shared with you its five-year plan. You are
satisfied that the assumptions used in preparation of the plan are appropriate
and reasonable but the ability to obtain further borrowing is uncertain.
However, management is confident that the company would be able to obtain
borrowing. Management is willing to give disclosures of its five-year plan in
the financial statements.
Q.8
Explain and discuss the above situation to your partner along with your
suggestions with regard to type of audit report that should be issued?
(05)
(b) Discuss those factors, which should be considered by the management in
assessment of going concern assumption?
(04)
A company was incorporated on 1 January 2005 and started its commercial
operations accordingly. While reviewing the financial position of the company as
at 30 June 2005, it comes to the knowledge of the management that there are
certain cases of non-compliance of laws and regulations such as Companies
Ordinance 1984, Sales Tax Act, 1990 and Income tax Ordinance, 2001. The
management has serious concerns on this situation and seeks your advice in this
respect.
Advise the management regarding policies and procedures that may assist the
management in the prevention and detection of non-compliance with laws and
regulations.
Q.9
A private limited company with paid up capital of Rs. 25 million has outsourced its
internal audit department for a period of 3 years to a professional firm of chartered
accountants, Shams Qamer & Co., during the year ended 31 December 2005.
According to the ‘Outsourcing Agreement’, if the management changes the internal
auditor before expiry of 3 years, the management would pay a compensation of Rs.
1.00 million to Shams Qamer & Co.
Before holding an annual general meeting for the year, the company received a
notice from a member of the company for change of external auditors and also
proposed the name of Shams Qamer & Co. for the same.
The management is confused whether internal auditor can also be appointed as
external auditor of the company. Therefore, management contacted you for seeking
your opinion in this respect.
(05)
(4)
Advise the management with reference to ISA on the subject and the Code of
Ethics issued by Institute of Chartered Accountants of Pakistan as to whether
Shams Qamer & Co. engaged as internal auditors can also be appointed as external
auditors of the company simultaneously.
Q.10
(07)
During the audit of financial statements of an investment advisory company, for the
year ended 31 December 2005, you noted the following:
(a) The company has accumulated losses at the close of financial year amounting
to Rs. 50 million which have eroded the company’s capital of Rs. 30 million.
(b) During the financial year, the company provided loan of Rs. 250 million to its
directors for their personal business. The receivable from directors at year-end
is NIL.
Explain how would you deal with the above matters while finalizing the audit of
the company. Suggest a suitable modification in audit report if the same is
considered necessary.
Q.11
(08)
A listed company situated in Pakistan has two independent branches in other
countries. At the planning stage of audit for the year ended June 30, 2005 you sent
appropriate instructions to the auditors of both branches and requested them to
perform the work in accordance with the International Standards on Auditing and
send audit opinion on the financial statements accordingly.
One of the reports you received from the auditors states that audit work has been
carried out in accordance with the local auditing standards. The other auditor has
completed his work according to your satisfaction.
How would you handle the above situation?
Q.12
(06)
You are the engagement manager of National Commercial Bank Limited. As part
of the audit planning you are evaluating the risk factors that may indicate the
possibility of fraudulent financial reporting or misappropriation of assets.
Considering the significance of this aspect of audit, the Audit Committee of the
Bank has requested you to give them a presentation as to how the audit team has
planned to address the risk of fraud in the upcoming audit of the Bank.
Prepare the key points that you will include in your presentation for the Audit
Committee of the Bank on the following:
(a) “Fraud is more likely to be perpetrated at banks that have serious deficiencies
in corporate governance and internal control”.
(b) Fraud risk factors in respect of the following banking operations:
(i)
Deposit taking
(ii) Lending
Q.13
(05)
(03)
(03)
While reviewing the published financial statements of a listed company audited by
you, it was found that a note to the financial statements as contained in the signed
copy available in your working paper is missing. The amount involved in the note
was not material.
Discuss auditor's responsibility in such case?
(THE END)
(04)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations Winter 2006
December 8, 2006
ADVANCED AUDITING
Module F
Q.1
(MARKS 100)
(3 hours)
ABC & Co. Chartered Accountants have been offered an appointment as the auditor of
prospective financial statements of Alif Limited, which have been prepared in the form
of a projection. These prospective financial statements are prepared to help the
directors of the company to make certain strategic decisions for the expansion of the
company. The volume of sale projected in the said financial statements had never been
achieved by the company in the past.
ABC & Co., Chartered Accountants are also the external auditors of the company.
You, as audit manger, of the firm, are required to prepare a memorandum for the
partner in-charge containing the following:
(a)
(b)
Q.2
The matters that need to be considered before accepting this engagement.
The information to be contained in an unmodified audit report on the prospective
financial statements.
(02)
(08)
While reviewing the directors’ report of Bay Limited, at the conclusion stage of your
audit, you noted that;
- Contingent liabilities reported in directors’ report were Rs. 250 million, whereas
the directors have previously agreed to report it in the financial statements as Rs.
525 million. On inquiry, the CFO informed that the directors had agreed with the
view of the auditors to avoid qualification although they still believe that
contingent liabilities should be reported at Rs. 250 million.
- A new plant was reported to be operative only for the half year while you have
sufficient appropriate evidence that the said plant remained in operation for almost
the whole year. However, financial statements do not contain any information
about duration of plant’s operation as it was not required under the law.
What course of action would you take to resolve the issues?
Q.3
(06)
Jeem Limited has accumulated tax losses amounting to Rs. 250 million. The
management has recognized a deferred tax asset amounting to Rs. 87.50 million
assuming that there will be sufficient taxable profit in the future. Tax computation of
the company is very complex and involves application of various rules and regulations
which are subject to frequent changes by the government.
Briefly describe the steps that you would take as an auditor in the audit of deferred tax
asset recognized by the management in the above case.
(06)
(2)
Q.4
You are the member of an audit team formed to conduct audit of Safe General
Insurance Limited, a listed company. The engagement partner of your firm has asked
you to prepare a note containing the following;
(a)
(b)
Q.5
Threats that potentially affect independence.
Measures to be taken by the engagement partner to form a conclusion on
compliance with independence requirements.
(04)
(04)
Ahmad & Co. Chartered Accountants have been appointed as auditors of Noon
Limited for the first time. Prior years’ financial statements have been audited by an
affiliated firm.
As audit in-charge of the company, you noticed that last year’s audit report had been
qualified by the previous auditors on the following matters:
-
Disagreement on capitalization of borrowing costs amounting to Rs. 15 million.
Inadequacy of records maintained for recording sales, causing non-identification
of related party transactions.
You are planning to carry out certain specific procedures in respect of opening
balances. Your team members consider these procedures unnecessary as previous
years’ audits were done by your affiliated firm. They feel that, this audit should not be
considered as an initial audit engagement.
You are required to brief your audit team on the following:
(a)
(b)
Q.6
Reasons for considering this audit an initial audit engagement and the evidence
you will obtain from applying procedures on opening balances.
Audit approach in respect of matters that caused modification of last year’s audit
report.
(04)
(06)
At the planning phase of the audit of Prudent Limited, a listed company, senior auditor
of your team submitted the following information;
-
-
-
-
(a)
The Board of Directors of the company has recently appointed Mr. Smart as new
chief executive whose remuneration is mostly based on efficiency bonus and
stock options.
Mr. Smart is reputed as a seasoned business executive and has been a very good
friend of the Chairman of the audit committee.
Since his joining he has proved to be the main decision maker and the Board
appears to be relying considerably on Mr. Smart and less interested in day to day
operations of the company.
Board’s main concern is now the growth in net earnings estimated for the next
year, which Mr. Smart strongly believes, will be 30% at the minimum.
There are a number of instances of lack of segregation of duties and Mr. Smart
being cost conscious, has allowed the situation to continue.
There is a big lay off plan in place and employees are expecting such plan
although it has been kept as top secret. This lay off will help the company to
achieve higher growth in earnings.
Mr. Smart has introduced an employees’ skill development scheme only for top
management personnels.
Describe the fraud risk factors, if any, that are indicated in the above information.
(07)
(3)
(b)
“Management is in a unique position to perpetrate fraud because of
management’s ability to directly or indirectly manipulate accounting records and
prepare fraudulent financial statements by overriding controls that otherwise
appear to be operating effectively. While the level of risk of management
override of controls will vary from entity to entity, the risk is nevertheless present
in all entities and is a significant risk of material misstatement due to fraud”.
What are the procedures that an auditor should design and perform to address the
risk of management’s override of controls?
Q.7
(06)
Mr. Kay, the audit partner of JKL & Co. Chartered Accountants, came across the
following matters relating to the trainee students of the firm;
-
They freely discuss information of one client with other clients unless client
specifically requests for confidentiality.
One trainee disclosed some key information of an ex-client to his friends outside
the firm, which probably were used by them for their personal benefit. However,
the trainee himself had not used such information in any way.
Another trainee supplied certain information to one of the lawyers of the client.
However, he had obtained prior written permission from the said client.
-
-
To address the issues relating to confidentiality Mr. Kay decided to hold a training
session for trainee students. As the audit manager, you are required to make a
presentation covering the following points;
(a)
(b)
(c)
Q.8
Principles of confidentiality.
Any breach of such principles with relation to given instances.
Examples of circumstances when disclosure of information of a client is
considered to be in order.
(03)
After the completion of field work of the audit of Ray Limited you, as audit in-charge,
have noted the following:
-
-
-
The provision of a material amount against a pending legal suit remained
unresolved between the auditor and Chief Financial Officer (CFO) until a second
opinion from a lawyer was received. Thereafter, liability was booked
appropriately.
This year, auditors performed extensive audit procedures on revenue account.
There were a number of minor errors which were corrected on the auditor’s
intimation. However, there were many other similar errors, which remained
uncorrected by the management, being considered immaterial, in aggregate.
There exists a disagreement between the auditors and the CFO relating to
provision for bad debts of material amount.
Internal audit department was found efficient and effective.
Chief Executive by-passes the credit committee frequently and approves credit
sales to some customers.
Which of the above matters may be included in your communication with the
management and audit committee of the company? Explain.
Q.9
(04)
(03)
While conducting initial meeting with members of your audit team, you have noticed
that they are confused about use of tests of controls in the presence of risk assessment
procedures related to internal controls. They are of the opinion that auditor is not
required to perform tests of operating effectiveness of internal controls in each audit
(09)
(4)
period. They also believe that auditor can save much time and energy by omitting
substantive tests when tests of controls give sufficient and appropriate evidence that
efficient and reliable controls were in effect through out the period under audit.
(a)
(b)
(c)
Q.10
Briefly discuss why tests of controls are required to be performed when risk
assessment procedures have already been performed.
How does an auditor rely on operating effectiveness of internal controls tested
during previous audits?
Give your comments on the team’s understanding about omitting substantive
procedures?
(04)
(04)
(02)
Zay (Pvt.) Limited engaged in construction of industrial buildings has been asked by a
prospective customer to attach summarized financial statements of the company duly
certified by a practicing chartered accountant, with the tender documents.
The Chief Financial Officer (CFO) contacted Abdul Qadir & Company, Chartered
Accountants, who had recently been appointed by the company in place of another
firm of chartered accountants and requested them to issue the required certificate. For
the said purpose, CFO also sent a set of summarized financial statements extracted
from audited financial statements on which previous auditor had issued his audit
report.
(a)
(b)
Q.11
Explain whether the firm can accept the engagement.
Briefly describe the main elements of auditor’s report on summarized financial
statements?
(03)
(07)
Briefly explain the following components of Internal Control System:
(a) Entity’s risk assessment process.
(b) Information and Communication.
(THE END)
(04)
(04)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations
Summer 2007
June 8, 2007
ADVANCED AUDITING
Q.1
(MARKS 100)
(3 hours)
The Credit Manager of one of your audit clients has left without giving any notice. His
responsibilities included maintenance and distribution of management information
reports and participation as a member of credit committee.
The said client has requested your firm to allocate one of your staff members, for a
period of two months, to take up the responsibilities of Credit Manager. Your firm deals
in such kind of assignments for non-audit clients.
Mr. RMP, the Risk Management Partner, has been requested to advise the firm on the
above stated engagement.
Required:
Draft a memo on behalf of Mr. RMP clearly indicating whether and under what
conditions the firm can accept the above assignment under each of the following
situations:
(a) the client is an unlisted company;
(b) the client is a listed company.
Q.2
(10)
The Management of Fine (Pvt) Limited sent a letter to the statutory auditor of the
company along with following statement and notes:
Statement of Receipts and Payments
For the year ended 31 December 2006
Bank balance as 1 January 2006
Add: receipts from customers and shareholders
Less: - Payment against purchases
- Salaries paid
- Other expenses paid
Bank balance as 31 December 2006
Rs. in million
50
150
200
90
50
20
160
40
Notes to the Statement of Receipts and Payments:
1.
2.
3.
During the year company issued further shares of Rs. 100 million.
Payments against purchases and other expenses are made through cheques and
nothing was outstanding at the end of the year.
All goods purchased have been sold and all debts have been collected before the
year end.
(2)
The audit firm has appointed you as job in-charge to audit the financial statements of the
company. Following information has also been made available to you:
(i)
There are only five shareholders in the company having close family relationship
with each other and they are supervising the entire business activity themselves.
(ii) The company is engaged in sales and after sale services of a large number of
products.
(iii) Payments against purchases and other expenses are made through cheques except
the payments of some insignificant amounts.
(iv) The system of accounting and management information is reasonably
sophisticated. However, the management does not apply some of the important
internal controls due to its direct involvement in business operations.
The chief executive of the company has requested that since management lacks
accounting knowledge, the receipt and payment statement may be treated as the financial
statements or alternatively, a summary balance sheet and profit and loss account may be
prepared by the auditor. He has justified his request on the ground that user group is
extremely limited and is itself involved in the management of the company.
Required:
Discuss the following with appropriate explanations:
(a)
(b)
(c)
Q.3
What should be the response to the Chief Executive’s request;
Essential matters to be dealt at engagement stage; and
Internal controls of the company.
(12)
During the audit of financial statements of Shine Limited, a member of audit team has
developed the following differences of opinion with her job in-charge:
(i)
She believes that an incorrect working of obsolete stock provided by the client,
which was superseded by a revised working given subsequently, should be kept in
the working paper file as there was material difference between the earlier and
final workings. Job in-charge wishes to discard the working since it was revised by
the client management themselves after discovering the error. An explanatory note
describing the error and how it was corrected has already been included in the file.
(ii)
She performed risk assessment procedures related to sales and concluded that the
risk of material misstatement is high. While making such an assessment she tested
the risk of material misstatement due to error but did not consider material
misstatement due to fraud as she relied on the assessment and documentation made
by the job in-charge at financial statement level. Job in-charge does not agree with
her approach but he is not sure as to how she should have approached the issue.
(iii) She noted that a sales officer of the company had sold many products at exorbitant
prices to a customer and earned handsome commission thereon. She suspects
possibility of fraudulent collusion between sales officer of the company and
employees of the customer. However, the difference between normal and
abnormal prices is of below material amount. Job in-charge identifies it as a
significant risk of fraud and wants to communicate the same to those charged with
governance. She does not agree with the job in-charge.
Required:
(a) Resolve the above differences arising between the team member and job in-charge,
giving proper explanation in each case.
(b) Draft a policy statement and narrate the guidelines relating to difference of opinion
within the engagement team.
(09)
(05)
(3)
Q.4
While going through the newspaper, Mr. Akram came to know that the Ministry of
Health had issued show-cause notices to those pharmaceutical companies which had not
yet started their own manufacturing within a period of two years from the issuance of
permission of toll manufacturing, as the said permission was subject to this condition.
Akram is involved in the audit of Dine Pharma Limited (DPL) as engagement partner.
The audit is expected to be finalized within one month. DPL’s products are
manufactured under toll manufacturing arrangements and it has three to five years noncancelable agreements with five manufacturing units. Akram has approached you as the
firm’s Technical Director for consultation on the above matter.
Required:
Briefly advise Akram about impact of the above matter on the financial statements
disclosure as well as auditors’ report.
Q.5
(10)
Mr. Dar is the Chief Financial Officer (CFO) of a medium sized limited company
engaged in sale of consumer goods through a number of distributors. These distributors
collect and deposit the sale proceeds in collection accounts opened in more than 100
branches of a commercial bank situated in urban and rural areas all over Pakistan. These
accounts are non-checking accounts (i.e. the company cannot issue cheque or transfer
the amount to any account other than the designated sales collection control account).
Under an agreement with the bank, the branches transfer the amounts collected on next
working day to the designated sales collection control account.
The auditor of the company intends to obtain direct confirmations from all branches and
intends to use positive as well as negative confirmations. Considering that such audit
procedures would take considerable time and may delay the finalization of accounts, the
Chief Executive Officer (CEO) is of the opinion that Mr. Dar should ask the auditor to
omit this procedure. CEO believes that according to International Standards on Auditing
management has a right to ask the auditor not to send direct confirmations.
Required:
Prepare an explanation for CEO on behalf of CFO explaining him the guidelines laid
down in International Standards on Auditing in respect of external confirmation in the
above case.
Q.6
You are an Audit Manager in a large firm of chartered accountants which is also a
member of a global firm. You have recently completed the audit of one of your clients.
Your firm has already been appointed as auditors of the company for the following year.
Soon after the appointment, you came to know that the chief executive of the company
was involved in some illegal practices and he is about to face some investigation.
Required:
Discuss the various possibilities arising out of the above situation and what action would
you take in each case.
Q.7
(09)
(10)
You are the statutory auditor of Critical Limited. The company has asked you to submit
a special purpose audit report for onward submission to a regulatory authority. The
report has to be submitted on a format prescribed by the regulatory authority, the
substance and wording of which does not conform to the requirements of International
Standards on Auditing.
Required:
(a) Describe the essential contents of a special purpose audit report as required by the
International Standards on Auditing.
(b) Explain how you would respond to the above situation.
(08)
(4)
Q.8
Mr. Ali has recently joined as Audit Partner of ABC & Co., Chartered Accountants. On
assuming the responsibility he discovered that the firm does not have comprehensive
guidelines for “Engagement Quality Control Review”. He wants to bring this issue to the
notice of Managing Partner.
Required:
Prepare discussion points for Mr. Ali explaining the following:
(a)
(b)
(c)
Q.9
The basis of selecting engagements for review;
Nature and timing of review; and
Criteria for eligibility of engagement quality control reviewer.
SK is the engagement senior on the audit of PK Limited. One of his team members has
been assigned the task of verifying the fair values of various assets in the financial
statements. He is perplexed by the fact that out of various valuation methods available
under the company’s financial reporting framework, the management has used a
particular method, except in one case where the management has changed the valuation
method in the current year. The team member is confused and has approached SK for
guidance.
Required:
Describe the procedures that should be performed in the above situation.
Q.10
(11)
(05)
You are the job in-charge on the audit of Globe Industries Limited (GIL) which is the
holding company of a large group of companies engaged in production and marketing of
consumer items, food products and textiles. The net worth of the group is approximately
Rs. 89 billion whereas profit for the year ended December 31, 2006 is Rs. 6.4 billion
(2005 : Rs. 4.8 billion).
During the planning phase of the audit, you have gathered the following information:
(i)
GIL holds 25% shares in Multan Industries Limited (MIL), at the beginning of the
year. GIL purchased further 30% shareholding in MIL on April, 2006. MIL is
audited by a large firm having international affiliation.
(ii) One of the group companies i.e. Karachi Industries Limited has incurred serious
losses during the year. Company had to discontinue two of its main products after
facing litigations on a copy right issue. The auditor of the company has expressed
serious doubts about the status of the company as a going concern and has issued
a disclaimer of opinion.
Required:
Describe the important aspects that you would consider at the planning stage.
(THE END)
(11)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS – FINAL EXAMINATIONS
SUBJECT
Advanced Auditing
Q.1
SESSION
Summer 2007
The question was based on the requirements of code of ethics. A situation was
given and the examinees were required to advise whether the auditor could accept
the assignment if the client was an unlisted company and if it was a listed
company.
The part related to listed company was simple and most examinees were able to
answer correctly in the light of ICAP’s Council’s directive 4.16 which was
applicable to listed companies only.
However, for the benefit of the students we would like to inform that the directive
4.16 was withdrawn by ICAP on June 07, 2007 and for future examinations they
should refer to a negative list of services which now from part of the listing
regulations of stock exchanges in Pakistan.
The response to the point related to unlisted company was average. The students
were expected to cover the question under three heads:
•
•
•
Permissibility (It is permissible under the Code of Ethics).
Identification of the threats to independence mainly the self review threats.
The safeguards that should be applied in such situations as described in
para 9.186 of the Code of Ethics.
Some of the students thought it enough to say that the same is permissible without
stating the conditions under which the assignment may be accepted. Some of the
students were also of the view that directive 4.16 will also be applicable on
unlisted companies which obviously led to a totally incorrect answer.
Q.2
The question related to a small, family owned company with annual receipts of
only Rs. 150 million. The question consisted of three parts as discussed below:
(a)
In this part almost all the students were able to declare correctly that since
the company is a private limited company, it has to prepare its accounts in
accordance with the Fifth Schedule and the alternatives suggested by the
CEO were not acceptable.
However, very few were able to mention the other two important points i.e.
while preparing the accounts as requested by the CEO, the auditor should
evaluate the existence of self review threat and take appropriate safeguards
and should also avoid taking management decisions.
Examiners’ Comments on
Advanced Auditing – Summer 2007
(b)
Most of the students restricted themselves to describing the matters that are
generally contained in an engagement letter without reference to the
environment in which the company was operating.
It was evident from the given scenario and was also mentioned in the
question that the management has compromised on some of the important
controls. It was therefore expected that students at this level will highlight
this issue and then mention the important matters to be considered at the
engagement stage and not just the matters that are generally contained in the
engagement letter. However, very few students could approach the question
as described above.
Q.3
(c)
The examinees were required to comment on the internal controls of the
company. Most of them, restricted their answers to matters such as lack of
segregation of duties and supervisory controls by the owners. Very few were
able to mention an important point that the totally dominant role of the
owner management increases the risk of management override of controls.
(a)
In this part of the question, three situations were given as discussed below:
(i)
This was a simple situation. Most of the students correctly advised
that since proper explanatory note about the error has already been
provided in the working papers, there was no need to keep the
superseded schedules in the working papers file.
(ii)
Most of the answers to this part were sketchy. The students were
generally able to emphasis correctly that there was a need to assess
the risk of fraud at the assertion level. Similarly, they were also able
to conclude that in case such a risk was material, the auditor should
evaluate the design of the entity’s related controls, control activities
and their implementation. However, better answers were those which
mentioned the fact that according to the International Standard on
Auditing, in case of revenue, the auditor should ordinarily presume
that there is a risk of material mis-statement due to fraud and where
the auditor concludes that such risk is not applicable, he should
document the reasons for such conclusion.
(iii)
In this case also most of the students were able to conclude correctly
that possibility of collusion between the employees of the customers
and the sales officer of the client does not cause any material misstatement in the financial statements and that it was below material
level. Some of the good students also pointed out that there may be a
possibility of future claims by the customer although it did not change
the ultimate conclusion on the issue.
Page 2 of 6
Examiners’ Comments on
Advanced Auditing – Summer 2007
(b)
In this part, most of the students were able to give the guidelines relating to
difference of opinion between the members of engagement team, which
included matters related to identification, resolution, consultation and
documentation of the differences of opinion.
While giving policy statement most students were confused and wrote
lengthy answers covering various aspects, mostly those which were also
covered in the guidelines. What was required was a short statement
emphasizing the timely resolution of any difference of opinion at the
appropriate level.
Q.4
This was a practical question. According to the given scenario the audit client, a
pharmaceutical company expected the issuance of a show cause notice from the
concerned authorities, on account of its failure to commence its own
manufacturing. Presently its products were being manufactured under noncancellable toll manufacturing agreements.
Two aspects of the situation were examined i.e.
• Effect on financial statements
• Effect on audit report
The issues that were relevant in the above situation mainly included the following:
•
•
•
•
possibility of imposition of fines
incurrence of damages that may become payable due to discontinuation of
contracts
threat of forced discontinuation of operations
concerns related to validity of going concern assumption
Most of the candidates were able to identify the above issues and assessed their
impact on the financial statements and on the audit report based on the guidance
available in the auditing standards.
Q.5
This was a straightforward question and most of the students were able to give
correct answers based on ISA 505. The main points which the examinees were
expected to cover in their answers were as follows:
•
The auditor has to use his judgment in evaluating the management’s request
and consider the alternate procedures that may be available.
•
External confirmation is considered more reliable for audit purposes.
•
The auditor has the sole authority whether or not to adopt the external
confirmation procedure, according to the circumstances.
•
The auditor may use negative or positive confirmations or a combination
thereof, depending upon the circumstances.
Page 3 of 6
Examiners’ Comments on
Advanced Auditing – Summer 2007
Q.6
•
In case management does not authorize the auditor to use external
confirmations and the auditor deems it necessary, he may modify the audit
report on the basis of scope limitation.
•
The auditor may use other procedures to verify the balances before reaching
any conclusion.
According to the scenario given in the question, the auditor had discovered, after
the audit has been completed, that the Chief Executive Officer of the company was
involved in some illegal practices. The various possibilities arising out of the
situation were required to be discussed.
The part related to continuation of audit was well covered by most examinees as
they discussed the relevant issues such as:
•
•
•
the quality control policies of the firm.
quality control policies of the international firm of which the auditor was a
member.
the impact the concerned practice of the Chief Executive Officer will have
or may have, on the financial statements of the company.
However, they were also required to consider the impact which the activities of the
Chief Executive Officer may have had on the financial statements which were
recently audited and give their opinions based on the guidance provided by the
auditing standards in respect of subsequent events. This part was mostly ignored by
a large number of candidates.
Q.7
(a)
This was an easy question and most of the students mentioned almost all the
contents of the special purpose audit report as recommended by the
International Standards on Auditing-ISA 800. However, many students gave
the contents related to the independent auditors report on General Purpose
Financial Statements as given in ISA-700, and lost easy marks.
(b)
In this part the examinees were required to explain how the auditor will react
if a report is to be submitted to a regulatory authority on a format other than
the one advised by the International Standards on Auditing.
The Standards suggest three ways of dealing with the situation as follows:
•
•
•
Reword the format according to the Standard (if possible)
Attach a separate report; or
Use the prescribed format without mentioning that ISA’s have been
complied with.
Only about 20% of the students could mention all the three points.
Page 4 of 6
Examiners’ Comments on
Advanced Auditing – Summer 2007
Q.8
(a)
This part was done well by most of the examinees. They were able to state
clearly that quality control review should be carried out in case of audit of
financial statement of all listed companies whereas other entities shall be
selected on the basis of specified criteria.
Most of them were also able to specify that such criteria should be based on
matters such as involvement of public interest, presence of unusual
circumstances and legal requirements etc.
(b) This part was poorly attempted. It was based on two issues i.e. nature of
quality control review and timings of such a review. Very few of the
examinees could answer in a concise manner. Lengthy answers were
generally given based on the general knowledge of the candidates but the
issues involved were not appropriately dealt with.
As far as the nature of review is concerned, the person carrying out the
quality control review is required to use his judgment in selecting the areas
for review. He usually reviews the selected working papers related to
significant judgments and conclusions reached during the audit. Whenever
necessary, he discusses the issues with the engagement partner.
As far as the timing is concerned, such review is carried out at appropriate
stages during the audit. Most of the students were of the view that the quality
control review is only carried out at the end of the audit.
(c)
Q.9
While describing the criteria for eligibility of engagement quality control
reviewer, most of the examinees stressed on the qualification and experience
of the reviewer. Very few stressed on the position of authority which such a
reviewer should hold in the firm. Similarly, the requirement of maintaining
objectivity, by selecting such a person, (as the reviewer) who has not been
participating in the engagement etc. was mentioned by few students only.
The question relating to valuation methods was rather easy for final level
students yet the performance was not very encouraging. The examinees at
this level are those who have sufficient experience of auditing and they
should easily have identified the following, in their responses:
•
•
•
The auditor should obtain an understanding of the management’s
rationale in selecting a particular method of valuation.
He should assess whether the valuation method is appropriate, given
the nature of assets and norms of the business and industry.
In the case where valuation method was changed, the auditor should
evaluate whether the new valuation method is a more appropriate
basis of measurement or is supported by a change in the
circumstances etc.
Page 5 of 6
Examiners’ Comments on
Advanced Auditing – Summer 2007
Q.10
The question pertained to the planning stage of an audit of consolidated accounts.
The students were generally able to answer the points related to the company
Multan Industries Limited (MIL) which had been converted into a subsidiary,
during the year under review. However, most of the students failed to give a
proper response as regards Karachi Industries Limited (KIL). KIL was a group
company whose status as a going concern was doubtful and its auditor had issued
a disclaimer of opinion. Usually, in such a situation, the auditor of the holding
company assesses the materiality of the investment and its possible impact on the
consolidated accounts and draws up a strategy based on such assessment. Most of
the students could not understand the question. They failed to realize that the audit
has already been carried out by KIL’s auditor and wrote details about the
procedures an auditor should follow when the going concern status becomes
doubtful.
(THE END)
Page 6 of 6
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations Winter 2007
December 7, 2007
ADVANCED AUDITING
(MARKS 100)
(3 hours)
Q.1 Sukoon Limited is engaged in manufacturing and sale of office equipments. It has appointed
you in place of XYZ & Company for the audit of financial statements for the year ended
June 30, 2007.
During the audit you noted the following:
° An employee of the company, responsible for after-sales-services, misappropriated cash
which he recovered from the customers without raising proper invoices. The amounts
were small and much below the materiality level.
° During the last year (ended on June 30, 2006), the middle management in connivance
with lower staff booked a sale of material amount which actually pertained to the current
year. The higher management has issued warning letters to the concerned employees but
is reluctant to take any further action as the company has not suffered any losses. XYZ
& Company has given an unmodified report on the previous year’s financial statements.
Required:
(a) Describe how each of the above situations will impact the following:
(i) Assessment of risk and audit procedures;
(ii) Communication with management and with those charged with governance.
(b)
(c)
(03)
(04)
As a result of material misstatement in sales of previous year, management has agreed
on restatement of the corresponding figures in current year’s financial statements.
What would be the impact on the auditors’ report in this case?
(03)
Explain the difference between corresponding figures and comparative financial
statements.
(04)
Q.2 As the senior in-charge of audit of a listed company, you noted the following matters:
(i) Some of the outstanding balances are in excess of the credit limits.
(ii) Certain sales tax invoices were not signed by the preparer and the reviewer.
(iii) IT Steering committee has not been constituted. However, major decisions regarding
IT are discussed in the Management Committee as well as the Board meetings.
(iv) The company does not have an approved Disaster Recovery Plan.
Required:
Prepare a note for inclusion in the Management Letter, covering your observations in respect
of the above, the implications thereof and your recommendations.
(10)
Q.3 Maria Khan, an audit supervisor, has been deputed on an audit client as audit senior of the
team attending stock taking exercise. The value of stock at year end is Rs. 250 million and
total assets are worth Rs. 400 million. During the stock taking she has come across an item
of raw material packed in sealed containers. The containers were few in number but of high
value; the total cost being Rs. 24.0 million. She has been informed that the raw material will
be used in the production of a very specialized product which the client has recently
developed. The raw material needs specialized storage facilities and the containers are
required to be opened in specialized conditions.
(2)
Management has refused to open the sealed pack containers for physical verification. The
field staff has counted the containers and satisfied themselves that raw material as per
records was physically available. Maria has approached you, as audit manager, for advice as
to what needs to be done.
Required:
What would be your advice to Maria about the procedures that may be undertaken to reduce
the audit risk to an acceptably low level.
(08)
Q.4
Your firm is a member of an internationally recognized network of accountancy firms and
provides wide range of professional services. A large multinational company South Union
wishes to have a business presence in Pakistan. Having completed the necessary regulatory
formalities, the management of the company has approached your firm for appointment as
auditors. The management has also requested you to provide the following services in the
current year:
(i)
Carry out market search to identify the parties engaged in distribution business. The
fee will be dependent on the eventual appointment of the distributor by the
management;
(ii) Recruit professionals in the position of Head of finance and Internal Audit;
(iii) Provide a general ledger package that has been developed by your firm.
Your firm has decided to accept the appointment as auditor but has refused to carry out the
other services.
Required:
Write a letter to the management, briefly explaining the reasons for refusal to accept the
other assignments.
(07)
Q.5 Rufi, a practicing member of the Institute of Chartered Accountants of Pakistan, is engaged
in compilation of financial statements of Peshawar Branch of Gamma Limited, a furniture
manufacturer and supplier. These will be incorporated in the consolidated financial
statements of the company. The fact that the financial statements of the branch have been
compiled by Rufi will be mentioned in the annual report of the company.
During the assignment he noticed the following:
(i)
The management had ignored an expert’s opinion indicating impairment in value of
tangible fixed assets and these have been stated at cost less depreciation;
(ii) It was not possible to verify sales made to related parties, as management had not
provided the relevant details;
(iii) The management has given a representation that all spares are in good condition.
However, during discussion with one of the employees it was revealed that some
spares of material amount were damaged and were of no value at the balance sheet
date.
Rufi is about to finish the assignment and intends to issue a report on the compiled financial
statements. Management wishes to present above financial statements to their auditors
without any adjustment.
Required:
(a) How should Rufi deal with the issues referred to in para (i), (ii) and (iii) as given
above?
(05)
(b) Why do you think Rufi is inclined to issue a report? Assuming that Rufi is able to
resolve the above issues appropriately, prepare a draft report that Rufi may submit to
the management.
(08)
(3)
Q.6 You are a member of the audit team engaged in the audit of a listed company. At the
planning stage the audit in-charge paid little attention to the internal auditing activity on the
pretext that internal auditor generally lacks independence in performing its duties.
The department is headed by a professional and experienced individual who is a close friend
of the Chief Executive Officer and the General Manager of the company. He utilizes such
relations very effectively and applies surprise physical checks, unplanned investigations and
takes on-the-spot corrective measures on detection of errors or flaws in controls. This
approach has reduced the lengthy paper work that is normally seen in internal auditing
departments of other companies.
Required:
(a) Assess the internal audit function of the company and its relevance for the external
auditors;
(07)
(b) Comment on the present approach of the audit in-charge and how it would affect the
overall audit performance.
(03)
Q.7 In the audit of Silver Limited you have been provided with a list of related parties alongwith
the transactions made with them. Upon comparison of this list with that of the previous year,
you are surprised that the number of related parties and values of such transactions have
reduced significantly.
Required:
How would you obtain sufficient appropriate audit evidence in respect of the completeness
of the information pertaining to related parties?
(09)
Q.8 When designing audit procedures, the auditor sometimes selects specific items from the
population for testing instead of using audit sampling techniques.
Required:
(a) What factors does an auditor take into account while using specific selections?
(b) What audit risk emerges in such selection and how is it dealt with by the auditor?
Q.9 Gold Blocks Limited a family owned company was formed in 1990 to run a concrete block
manufacturing facility. It remained a medium sized and equity based concern for some time
and then in 1993, Saleem an enthusiastic family member, took control as its Chief Executive
Officer (CEO). He started aggressively by acquiring other manufacturing units through bank
financing. In 1997 the name was changed to Gold Limited to align it with the long term
plans of diversification. The company’s revenues grew at an average of 62% annually during
1993-2000. Besides acquisitions, the CEO also made disinvestments which produced very
high capital gains. The company went public in 2001 and generated huge funds.
Consequently, three directors representing the other shareholders were appointed on the
Board. Equity inflow and high leverage allowed the company to buy-out many established
businesses engaged in marble tiles, ceramics and sewerage pipelines. However, the growth
rate declined to 28% per annum during 2001 to 2003.
The company used various innovative methods of business promotion, such as:
°
°
Attracting material suppliers to enter into long term contracts at low prices paid
upfront or in flexible pattern suitable to the suppliers. Similar kind of schemes were
offered to the company’s distributors also;
Shared common sales promotion costs with distributors, established own distribution
set ups in untapped areas and transferred own distribution set ups to distributors at
different payment plans.
(03)
(02)
(4)
By the mid of 2004 the company started facing many problems such as intense competition,
mismanagements and labour unrest, which resulted in sharp decline in revenue growth and
severe liquidity crunch.
Since incorporation, IIG Chartered Accountants had been the external auditors of the
company. In 2002, IIG merged with SAW and formed SIG Chartered Accountants.
Accordingly, Gold Limited appointed SIG as its auditors in 2002. Gold Limited was among
the most committed clients of the firm. One of the reasons was that many executives of
finance department were ex-SIG people.
In 2007, on the recommendation of the reconstituted Audit Committee, AAQ Chartered
Accountants were appointed in place of SIG. The new auditors expressed a disclaimer of
opinion in their audit report to the members. They stated that quantification of effects of
misstatements in previous years’ financial statements was not possible and that the following
types of misstatements have occurred:
°
°
°
Material errors were made in revenue recognitions;
Certain business disposals in 2000 and 2005 were made to entities which were
indirectly sponsored by the company itself and a large portion of the amounts were
still outstanding;
Many receivables from distributors were in fact adjustable from their un-booked
claims regarding common advertisements
Apparently, SIG’s Quality Control Partner understood the increased audit risk in 2004 and
rated the company as ‘high risk’. However, the engagement partner, who had been in the
position since 1999, claimed that since there was no history of intentional misstatement,
there was no need to alter the audit procedures. The audits of last five years have also been
reviewed by a senior partner who was also responsible for business promotion of the firm.
The Reviewer sent various complicated revenue recognition issues to Research Department
of the firm during 2004, 2005 and 2006. Based on the advice of the Research Department,
the engagement team suggested certain adjustments, which were refused by the
management. The engagement partner and the reviewer considered the amounts immaterial
and agreed to issue unqualified reports.
The Board of Directors was extremely upset on the issuance of disclaimer by the new
auditors. Besides seeking clarification from the CEO, it wrote a letter to the regulator
complaining about the performance of the previous auditors. The letter, among other things,
contained the observation that the auditors:
°
°
failed to report/identify errors in revenue recognitions, weaknesses in internal controls,
understatement of advertisement expenses, financial losses due to labour unrest and the
fact that many business promotion schemes were not beneficial for the company.
refused to accept certain assignments during their tenure such as designing of internal
controls, bad debt estimations, etc. which otherwise could have given them better idea
of the company’s affairs.
Required:
The regulator has appointed you as the investigation officer. You are required to submit a
brief appraisal report discussing the following:
▪
▪
▪
▪
Corporate governance Issues.
Quality controls at SIG, Chartered Accountants.
Audit approach of engagement partner
Expectation gap between the prescribed standards of an audit and the understanding of
the Board of Directors.
(24)
(THE END)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination - Winter 2007
Overall observation
The overall performance of the students in the paper could be termed below average. The
questions were based on practical scenarios and students could have performed well had
they read the Auditing standards in reasonable detail and applied their practical
knowledge which they gain during the course of audit. However, the majority could not
approach the questions logically and provided irrelevant details which were not asked for.
Besides knowledge and practical application of the standards, the students also suffered
from lack of presentation and communication skills.
Question-wise comments are as under:
Q.1
Q.2
(a)
This question was aimed to test the knowledge of the students as regards the
impact of instances of fraud and error which come to the knowledge of the
auditor, on assessment of risk and audit procedures and its eventual
reporting to the management and to those charged with governance. Many
students poorly approached this question and instead of discussing the
matters identified above they wasted their time in stating detailed
substantive procedures to overcome the situation. Barring few exceptions,
students did not distinguish clearly as to what was the appropriate forum to
communicate the matter.
(b)
In this part the majority was able to identify that the auditor will give an
emphasis of the matter paragraph in which he shall describe the
circumstances that required the change in corresponding figures alongwith
reference to appropriate disclosure in the financial statements.
(c)
In this part the majority was able to differentiate correctly that
corresponding figures form an integral part of the financial statements
whereas prior year’s figures contained in comparative financial statements
do not form part of the current period financial statements.
Generally the candidates were able to perform well in part (i) and (ii) of this
question. They could appreciate clearly the risk carried in exceeding credit
limits and when the invoices were not signed. However, it was noticed that
students appeared to have little knowledge about the role of IT steering
committee and effectiveness of DRP and its relevance to an organization.
Page 1 of 5
Examiners’ Comments on Advanced Auditing Winter 2007 examinations
Q.3
This question was set to test the practical approach of the candidates. They were
required to assess as to how an auditor can satisfy himself about stock balances in
special circumstance and when it is impracticable to attend the stock check.
Majority of the students declared that the situation created a scope limitation and
accordingly recommended the issuance of a modified audit report. Only about
25% of the students could suggest alternative procedures to verify the stock such
as:
•
•
•
•
Q.4
This question was designed to test the knowledge of students about the non audit
services which an auditor can provide to its audit clients and the related potential
independence issues. Although it was an easy question but the response was not
that good. The following errors were commonly seen:
•
•
•
•
Q.5
Identifying the packets at random and verifying their contents/use by
observing the production process subsequent to year-end.
Studying the literature supplied by the supplier to verify the managements
claim.
Verifying the standard quality by using independent experts/laboratory tests.
Discussing the procedure adopted by the management to ensure the existence
of material in packed containers and assessing the reliability of the
managements procedures.
(a)
Surprisingly very few students could highlight the issue of contingent fee in
the context of Chartered Accountants Ordinance which declares such practice
as professional misconduct.
Some of the students declared that under ICAP’s Code of Ethics an auditor
cannot render any non audit service to its audit clients.
A large number of students did not provide any reason for not accepting the
non-audit services. Threats such as self interest, self review, impairment of
independence and objectivity etc. were discussed by some of the good
students only.
Quiet often the reason for refusing a particular assignment were incorrect.
The question was based on ISRS 4410 “Related Services”. The examinees
were required to give their opinion as to how an accountant should react if
faced with certain situations, while carrying out an assignment for
complication of financial statements. Most of the examinees were not
familiar with the requirement of ISRS 4410. The answers were mostly on
either side of the two extremes i.e. some examinees narrated all the steps i.e.
even those which are only relevant in case of audit assignments, whereas
others gave a blanket permission to the accountant to use the information as
provided by the management. Very few of the examinees were able to form
balanced opinions as recommended by ISRS 4410. The students are advised
to go through para 11 to 16 of the ISRS to become aware of the
responsibilities of an accountant, while carrying out an assignment to
compile financial statements.
Page 2 of 5
Examiners’ Comments on Advanced Auditing Winter 2007 examinations
Q.6
(b)
Very few of the examinees were able to point out that an accountant must
issue a report on such assignment if his name is associated with the
financial information compiled by him (para 6 of ISRS 4410). Many
students gave the standard form of audit report instead of giving the report
on Compilation Engagement. The contents of such a report are listed in the
above standard and examples of such reports are also available in the
appendix to the Standard.
(a)
A large number of students answered this question in a general manner i.e.
without giving due consideration to the situation which was presented in the
question. Consequently, they simply listed the various factors that are
considered by the auditor while assessing the internal audit function and
consequently secured very few marks. They were expected to highlight the
following issues in their assessment of the Internal Audit Function:
(b)
•
The Head of Internal Audit (HIA) enjoyed a good position but his close
relationship with the top management could impair his objectivity.
•
The scope of his functions is wide and his recommendations are given
due consideration.
•
HIA seems competent but competence of his staff need to be evaluated.
•
His actions lack due professional care as his work is not properly
planned and documented.
•
An overall view as to whether the internal audit function should be
taken into account to modify nature, timing and extent of audit
procedures.
Surprisingly at this level also many students fully agreed with the approach
of the audit incharge and declared that since internal audit function lacks
independence it cannot be relied upon altogether. Making such a decision
even before making any assessment of the relevance thereof is not justified.
It is generally true that internal audit lacks independence yet some of its
objectives are similar to those of external audit and hence it may be useful.
Q.7
This was one of the easiest and simple question set by the examiner and
candidates performed well and generally secured good marks as they quoted the
relevant points based on ISA 550 ‘Related Parties’.
Q.8
(a)
Most of the students were able to identify the factors which the auditor,
considers while using specific selection. The factors include, auditors
understanding of the entity, the assessed risk and characteristics of the
population to be tested.
However, some of the students kept on discussing the materiality issues and
how the decision to select high value items may improve the efficiency of
the audit.
Page 3 of 5
Examiners’ Comments on Advanced Auditing Winter 2007 examinations
(b)
Q.9
In this part the students were generally able to identify that specific
selection is subject to non-sampling risk and that the auditor has to obtain
evidence regarding the rest of the population, as in case of specific
selection, the results cannot be projected to the entire population.
This question was based on a short case. At this level of their training, students
were expected to grasp the situation well. However, most of them seemed
overawed by the situation and could not identify the key issues as required by the
question.
Four aspects of the situation were required to be discussed. The expectation of the
examiner and the performance of the students, is discussed below:
Corporate Governance Issues
The following deficiencies of the directors of the entity were very much apparent
from the case:
•
•
Failure to establish sound internal controls.
Maintaining significant business policies like those related to business
acquisitions/disposals recovery of debts, complex transactions etc.
The conduct of the Audit Committee was also found deficient in many ways
including the follows:
•
•
Did not rotate the auditors for so long
Did not give due importance to the appointment of SIGs and the threats
related thereto.
The students were generally able to point out the above points. However, they
included a number of irrelevant points also which were not required.
Quality Control at SIG
Most of the students pointed out that Quality Control at SIG was good. To
support their view they mentioned that SIG had policies in place for risk
evaluation, review of audit by a senior partner, presence of a Research
Department for handling complex issues etc. However, very few could point out
that on the implementation side there were serious issues which were evident
from the following instances:
•
When QC partner rated the client ‘high risk’, appropriate measures were not
taken.
•
The person responsible for review of audit was also responsible for business
development.
•
Engagement partner was not rotated for eight years.
•
No safeguards were adopted in view of the presence of ex SIGs in the
executive team.
Page 4 of 5
Examiners’ Comments on Advanced Auditing Winter 2007 examinations
Audit Approach of Engagement Partner
Here again the response of the students left much to be desired. Most of the
replies were not specific and mentioned general points like failure to detect errors
and fraud; failure to qualify the report etc. At this level, the examiner expected
the students to include specific issues in their answers such as:
•
Failure to carry out proper risk assessment procedures in view of the presence
of high risk factors such as pressure on management to show high
performance, opportunity available to CEO for material mis-statement and the
involvement of highly complex transactions.
•
Failure of the engagement partner to adopt proper audit approach in view of
the presence of ex SIG employees.
•
When QC partner rated the client ‘high risk’ the response of the engagement
partner was not according to the principles of professional skepticism.
Expectation gap between Prescribed Audit Standards and Understanding of
the Directors.
This area proved easy and many of the students were able to clarify the following
simple points to remove the expectation gap:
(i)
The auditor is not responsible to identify errors unless material.
(ii)
Labour unrest and issues of management inefficiency do not affect fair
presentation.
(iii) Assignments related to designing of internal controls and estimation of bad
debts create self review threat on the independence of the auditor and
therefore the auditor’s refusal to accept such assignments was in
accordance with the recommendations of International Standards on
Auditing.
(THE END)
Page 5 of 5
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations
Summer 2008
June 6, 2008
ADVANCED AUDITING
(MARKS 100)
(3 hours)
Q.1
Wood Limited (WL) is a listed company. SMSF Chartered Accountants have been the
auditors of the company for the last three years. In November 2007, with substantial change
in shareholding a new Board of Directors was elected. The new Board made significant
changes in the senior management within a week of taking charge.
On February 10, 2008, after completing the field work, the auditors sent the financial
statements alongwith initialed draft audit report, to WL’s board for its approval. On the same
date, a senior partner was assigned to carry out an engagement quality control review.
During the review he noted the following:
(i)
Management representation letter contains a paragraph that “We have taken charge
from the previous management on 28 November 2007 and after taking charge, we
commenced valuation exercise in respect of plant and machinery in various factories
owned by WL. To date, thirty percent of plant and machinery has been valued. The
exercise carried out so far shows that fair value of the assets is 20% less than the
carrying value, for which an impairment loss has been accounted for. In view of this
situation, we are not confident about the fair value of the plant and machinery as
presented in the financial statements.”
(ii)
The valuation is being carried out by the production manager who is a qualified
engineer. He had been responsible for year-end valuation review for many years. This
is the first time when he has reported an impairment.
(iii)
The issue of impairment loss, which is of material amount, was a contentious matter
between a team member and the job in charge. On inquiry Mr. Manzoor Nazar, the
engagement partner, informed that he had accepted the job in charge’s view point.
(iv)
This matter was also reported to the stock exchanges on December 5, 2007 resulting
in a sharp decline in share prices of WL, which otherwise had a good price-growth
history.
(v)
Subsequent to year end, WL has been awarded a very profitable long-term supply
contract by Timber Limited (TL), a reputable industrial undertaking. No direct
confirmation was obtained from TL.
(vi)
WL announced a 100% right issue in December 2007 at market price. Because of
discouraging response from the minority shareholders, the directors and their
associates purchased a large number of right letters from the open market.
(vii)
The firm’s record reveals that Mr. Manzoor had applied twice for a job in WL during
last one and half years. However, there is no current information about his intention.
Required:
Write a review report on behalf of the reviewer indicating the deficiencies noted in the audit
as well as the policies of the firm and submit your recommendations.
(16)
(2)
Q.2
You are the engagement partner of a listed company. After completing audit field work, you
have provided the draft audit report alongwith the draft financial statements prepared by
management to the Board of Directors with a cover letter stating that the firm will issue its
audit report after the Board has approved the financial statements.
Your manager has brought to your knowledge that last week the client has published its
annual report including Financial Statements and audit report (which had not been signed by
the firm). Notice of Annual General Meeting (AGM) has also been published in the
newspapers.
Required:
Explain what course of action should the firm take in the above situation.
Q.3
(06)
On reviewing the published financial statements of RRK Limited, their auditors, Ahmad
Mobeen and Company, Chartered Accountants, noted the following:
(i)
(ii)
(iii)
(iv)
It has been mentioned in the directors’ report that a material amount which was
provided as a bad debt had been recovered after year end.
Director’s report states that decline in sales, was due to general economic conditions.
However, the auditors’ feel that it was due to inappropriate strategies adopted by the
management.
A graph in the published report depicted the value of last year’s inventory at Rs. 326
million, which according to the corresponding figures given in audited financial
statements amounted to Rs. 250 million.
Directors’ report stated that negotiations for expansion of production facilities by
acquiring a sick unit had been finalized, whereas the auditors have definite
information that the company could not strike the deal.
Required:
Explain how the auditor should resolve each of the above issues. What steps would the
auditor need to take in case the client does not agree with his recommendations?
(10)
Q.4
You are the audit engagement partner of a listed company, Steel Limited (SL). The firm is
currently in the process of completing limited scope review of SL’s interim financial
statements for the half year ended December 31, 2007. The audit team has recently
concluded their work with following findings for your decision:
(i)
Inventory is a significant item of the balance sheet but the auditor was not asked to
attend the stock count at the end of the period. Consequently, the audit team relied on
the count communicated by the management.
(ii)
SL has executed many contracts with its customers for long term future deliveries at
different prices, amounting to Rs. 1,200 million. To avoid loss on account of price
fluctuation, short term futures had been bought in international market against future
deliveries valuing Rs. 300 million only. Such futures are carried-over on maturity.
Remaining deliveries have been left open.
(iii)
A set up of the company in Lahore having carrying value of Rs. 235 million has been
sold to an associated undertaking for Rs. 240 million. The minutes of the Board of
Directors show that the transaction was carried out at an arm’s length price. No
explanatory note has been given in the financial statements in this regard.
(iv)
As a percentage of total debts the provision for bad debts are in accordance with the
previous history of the company. However, due to time constraints the practice of
using age-analysis of debtors has not been used this time.
(v)
Due to time constraints the review of subsequent event was not carried out by the
audit team.
Required:
Discuss the above issues and their implications on your report.
(11)
(3)
Q.5
Trade Limited has been engaged in sales of product X for a long time. In January 2007, it
started trading of product Y which was sold with money-back guarantee being exercisable
within 120 days of sale. Consequently, the sale of Y far exceeded the company’s expectation
and eventually constituted 40% of the total sales of the company in the year 2007. An extract
from the Trading Account of product Y for the year ended December 31, 2007 is as under:
Particulars
Gross Sales
Sales returns and allowance
Provision for sales returns-Gross
Cost of sales
Rs. (in million)
650
130
18
400
On account of money-back guarantee a provision has been made, for sales return subsequent
to year end. The provision is three times the actual sales returns during the first 15 days of
January 2008.
As the time available for presenting financial statements is limited, the management has
decided to adopt it as a consistent accounting policy to be followed each year.
The audit is to be finalized by February 15, 2008. The team member who was assigned to
verify the provisions believes that in such situation the auditor is compelled to rely on
management’s estimate. Therefore, a simple procedure of recalculation will be appropriate.
Required:
Explain the appropriate audit procedures to verify the provision for sales returns in the light
of relevant International Standard on Auditing.
(08)
Q.6
To ensure the continuity in supply of cement required for development projects in far flung
areas, the Provincial Government sought application from cement producers for a three years
supply contract. Cement Limited (CL), a relatively new cement producer, was also interested
in filing the said application, as it could bring provincial government as a secured and
committed customer. CL also has a similar contract with the Local Government for the last
two years.
One of the requirements of the Provincial Government is that CL should submit a report by
their independent auditors on CL’s compliance with certain covenants of their agreement
with the Local Government i.e. those related to capital adequacy, price computation,
minimum level of inventory and any other matter directly related to financial reporting.
SSZ Chartered Accountants have been the statutory auditors of CL for the last three years.
They were appointed to carry out the engagement at a fee of Rs. 100,000. Mr. Sharif,
engagement partner of the last annual audit, discussed the scope of work with the
management. The discussion revealed the following matters:
(i)
(ii)
(iii)
(iv)
The report is supposed to cover the period November 03, 2004 to December 31,
2007.
The agreement (Referred to as XYZ/2004 dated November 03, 2004) consisted of
voluminous annexures and attachments; and contained references to a number of
rules and regulations contained in various legislations.
Certain disputes have erupted over the period, some of which still remain unsettled.
Mr. Sharif assessed that the assignment would take around twenty working days. The
management felt the estimate unreasonable, as the said agreement had already been
reviewed by the auditors during the annual audits.
(4)
The firm accepted the offer and Mr. Sharif performed the engagement in fifteen working
days. He is now preparing the required compliance report with the following information in
hand:
(i)
Two significant disputes were raised by the Local Government relating to capital
adequacy and price computation of ‘Quick-set Cement’. Both were resolved through
negotiations as confirmed by the officials of the Local Government verbally, however
a written confirmation was refused. The records show that CL convinced the Local
Government authorities by producing the opinion of a legal expert, based on
Regulation JKL of 1961.
The management is confident that this compliance report will also support their view
point in their dealing with the Local Government, although the engagement letter
does not contain such an understanding.
Minimum level of inventory was actually kept by three distributors of CL under
binding contracts clearly citing the purpose of the arrangement. The management is
of the view that this practice is in conformity with the interpretation given in
Regulation referred to above.
CL was also required to provide a performance guarantee of Rs. 24 million issued by
a scheduled bank. However, this facility was not renewed after the first year. As a
result, CL is exposed to a general penalty as provided in the agreement.
(ii)
(iii)
(iv)
Required:
Based on International Standards on Auditing and ICAP’s Code of Conduct:
(a) Explain how the above issues should be dealt with in the compliance report.
(b) Draft a Report on Compliance with the Agreement.
(c) Explain your view point in response to the management’s comments regarding
assignment completion time.
(d) Comment on the firm’s decision to appoint Mr. Sharif, for carrying out this
engagement.
(20)
Q.7
In 2005 the management of Fiber Limited presented before the Board of Directors, the plan
of a new business segment, quite different from existing business of FL. The approval was
granted in the same year.
In December 2007, even after over two years of operation, the bottom line of cash flow was
negative. Some of the Board members are convinced with the management’s explanation
that the initial projections were correct, nevertheless, the periodic pattern of cash flows is not
according to the expectations. Others, who are in majority, feel that the initial projections
were materially misstated. The Board has therefore directed the management to submit
prospective financial statements relating to the segment for next five years.
The management submitted the projection with the following assumptions:
(i)
(ii)
(iii)
(iv)
The company will be able to sell a large piece of land in the heart of the city, in
2008, to set up a factory in a different city on hired premises.
The factory will attain 70% capacity within six months of its establishment.
Whole production will conveniently be sold in that city and FL will not have to
incur any transportation cost.
The transportation cost, which is one of the main contributors of negative cash
flow, will be reduced substantially by using cargo train in place of trucks.
Negotiations with railway authorities are in final stage.
Administrative expenses will grow at 5% per annum.
After examination by an independent auditor, the board intends to publish the abridged form
of such financial statements in the news letter of the company which is circulated to
shareholders each month.
(5)
ABUK Chartered Accountants have been contacted by the Board to examine the prospective
financial statements and submit their report within ten days.
Mr. Umer is a partner in the firm and has expertise in such assignments. When asked by the
firm to take up the offer as engagement partner, he informed that his wife is the daughter of
the Chief Financial Officer of FL and also holds 75,000 shares of the company.
Required:
(a) Discuss the points which the firm should consider while accepting the engagement and
assigning the job to Mr. Umer.
(04)
(b) Assuming that the engagement is accepted, draft an appropriate audit report.
(04)
(c) Explain how the historical financial statements can be used by the auditor in
performing the engagement.
(04)
Q.8
You have recently joined a medium size chartered accountants firm as their audit manager.
While reviewing the firm’s audit methodology you have observed that the firm follows a
standard set of audit work programs. These work programs have been used by the firm for
the last many years and rely extensively on traditional judgment sampling. You are of the
opinion that by following the statistical sampling techniques, you would be able to carry out
a more effective and efficient audit.
Required:
Briefly narrate the advantages and disadvantages of judgmental and statistical sampling.
Q.9
(07)
The financial statements of Modern Equipment (Pvt) Limited reveal that the company has
paid a donation of Rs. 15 million to a charitable organization where one of the directors of
the company is a trustee. The company has earned a gross profit of Rs. 40 million. The
selling and administration expenses including the donation amount to Rs. 60 million and as a
result the company has incurred a net loss of Rs. 20 million.
Required:
(a) Discuss the significance of the above donation, to the auditor and design appropriate
audit procedures to address the issue.
(06)
(b) Discuss the possible impact of the above issue on the auditor’s report.
(04)
(THE END)
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2008
Ans.1
(a)
Quality Control Issues:
 While assigning the audit work to Mr. Manzoor Nazar, the firm ignored the threat
which existed due to his earlier intention to join WL as an employee.
 Mr. Manzoor also failed to update the firm about this matter, due to which firm
could not ascertain the self-interest threat to independence and objectivity of the
engagement partner.
 Engagement partner did not ensure the engagement reviewer had been appointed.
As a result, significant matters arising during the audit could not be discussed or
resolved.
 No consultation was undertaken on impairment loss issue, which was contentious
and material.
 It appears that engagement partner resolved the difference of opinion between the
team member and the job in charge by imposing his decision without satisfying the
team member. No avenue was available to the team member to assert his opinion.
The following Risk Factors do not seem to have been considered:
 Change in Board of Directors and significant change in Management.
 Valuation of plant and machinery was being done by an employee who may have
been an expert but his independence was questionable.
 Sudden change of assessment in the valuation creates doubts on the reliability of
the work done.
 Informing stock exchanges about impairment loss, uncertainty on fair value of
plant and machinery, issue of right shares at declined market price and acquisition
of right shares by directors and their associates point to an apparent motive of the
Board of directors to accumulate WL’s shares at low price.
`
Deficiencies in Audit Approach:
 In view of the management’s perceived motive of presenting poor financial
position to affect the market price, the representation by the management as
regards impairment of plant and machinery is not a reliable evidence.
 Opinion of the internal expert seems to have been influenced by the directors and
the management. Thus, it should not have been considered as appropriate
evidence.
 Due consideration was not given to the auditor’s previous knowledge and
evidences that were already available in previous year’s working paper files.
 Audit opinion on a significant matter was formed without corroborating other
evidences.
Recommendation:
An independent valuation expert be appointed to form an opinion on valuation of plant
and machinery.
If independent valuation supports the opinion of the internal expert,
 ascertain whether or not valuation done in previous year was erroneous.
 In case of error in previous years, comparative financial statements be amended
after completion of valuation exercise.
 In case valuation exercise cannot be completed, the audit report should contain an
emphasis of matter paragraph on significant uncertainty.
If independent valuation does not support the opinion of the internal expert, the auditor
should
 Re-assess the risk of fraudulent misstatement by management and those charged
with governance.
 Consider whether misstatement due to fraud involves higher management and those
charged with governance, in which case the firm may consider withdrawal from the
engagement.
Page 1 of 7
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2008
Ans.2
As soon as we come to know about the above stated facts, we should immediately contact the
client and inform them that unless the auditors have signed their report on the financial
statements, such financial statements will remain and be deemed unaudited.
SECP should be informed about the situation
Legal opinion should be taken.
The auditor may take necessary steps to inform the shareholders either immediately or in the
AGM about the possible impact on the financial statements.
Ans. 3
(i)




Ans.4
Evidence of subsequent recovery of long outstanding debt will be evaluated.
If the evidence of recovery is sufficient and appropriate, the financial
statements will be revised and issued to the shareholders along with a fresh
auditors’ report.
In case of disagreement with the management on this issue, the auditor will
issue a qualified opinion; and will also take necessary actions to prevent
reliance on the previous report.
If the evidence is not sufficient or appropriate, the management will be asked
to change the director’s report.
(ii)
Reason for decline in sales is a matter of opinion and will have no impact on audit.
(iii)
The figure presented on graph may be due to typographical mistake, correction of
which should be communicated to the users. In case of disagreement with the
management an emphasis of matter paragraph will have to be included in the audit
report. However, if the figure is correct on the graph, the error in previous period will
have to be rectified retrospectively. In case of disagreement opinion will be
appropriately qualified.
(iv)
The matter of acquisition of a sick unit will be discussed with the management, as it is a
material misstatement of fact (although not affecting the financial statements). In case
of disagreement, auditor will seek legal opinion.
The implications of the various issues referred to in the question, on the auditor report, are
discussed hereunder:
(i) Failure to observe stock count:

Ordinarily the auditor is not required to perform the procedure of observation for
obtaining evidence in a review engagement.

Analytical procedure will be sufficient in this case.

There will be no implication on auditor’s review report.
(ii) Exposure to significant exchange rate risk:

Auditor is not supposed to give any assurance on the adequacy of the
management’s risk management activities.

Auditor is responsible to assess whether the derivatives, as discussed, have been
accounted for and presented according to the requirement of the International
Financial Reporting Standards.

However, if open position casts a significant threat to the viability of the
company’s business, the auditor may draw the attention of the reader of
conclusion report by adding an emphasis of matter paragraph in the report.
Page 2 of 7
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2008
(iii) Sale of one of the company’s set-up to an associated undertaking:

The information about the sale of the business segment to a related party is
necessary for understanding the changes in financial position. Therefore, an
explanatory note should be included in the condensed financial statements.

Ordinarily the auditor is not required to corroborate the evidence provided by the
management.

In case management refuses to disclose this information, suitable modification
will be considered.
(iv) Discontinuation of the practice of using Age Analysis for bad debts estimation:

Apparently, bad debt provision is following the historical trend. The auditor is
required to persue inquiry and analytically review procedures in a review
engagement.
(v)

If the results of such procedures are satisfactory, then no further procedures are
required. Accordingly age analysis for estimating bad debts is not mandatory in
this situation.

There will be no implication on audit report.
Failure to carry out review of subsequent events:

In a review engagement auditor is not responsible to review subsequent events.
Management is inquired about the procedure it has followed to identify
subsequent adjusting event.

There will be no implication on audit report.
Ans.5
Audit procedure to verify Provision for sales return:
 Apparently, the provision made by the company has no plausible basis.
 The actual returns during the year are Rs. 130 million as against the total sales of Rs. 650
million. If the sales and sales returns are made evenly throughout the year, a plain
application of return percentage suggests that the provision should be nearly Rs. 32.5
million.
 In the above circumstances the auditor should obtain an understanding of the entity’s
assumptions on which estimate is based.
 If the basis is considered inappropriate, the auditor should make a revised estimate either
on his own or by using expert opinion. The estimate should be based on:
- industry practice and trend of sales return;
- comparison of industry and company’s terms of sale;
- Trend of sales return in the company i.e. sales return with-in first 15 days;
between 16 to 30 days; between 31 – 45 and so on.
 Own estimate prepared on the above assumptions will be compared with management’s
estimates. If the difference is material, the management will be asked to explain.
 Subsequent sales returns up to the date of authorization will also provide an evidence
about the reasonableness or otherwise of the management’s estimate.
Ans.6
(a)


Verbal confirmation from Local Government as regards the resolution of dispute
on capital adequacy and price computation of cement, will not be considered as
appropriate/sufficient audit evidence.
Refusal of written confirmation is a scope limitation and unless other appropriate
evidence is available the report will need to be modified.
Page 3 of 7
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2008




Management’s intention to use the auditor’s report for the purpose of dealing with
the local government is beyond the scope of the engagement. Therefore, the
auditor’s report should specify the agreed intended use thereof.
Interpretations given in Regulation JKL, 1961 were used to form the opinion on
compliance relating to minimum inventory level and price computation.
Therefore, the Regulation should also be referred to in the report for better
understanding of the assurance.
Not renewing performance guarantee is a clear non-compliance which needs to be
reported as qualification.
Decision to keep the inventory with distributors could not be considered as a noncompliance because these are covered under binding contracts and the purpose of
the arrangement is also mentioned in the contract.
(b)
We have audited Cement Limited’s compliance with certain covenants of cement
supply agreement No. XYZ/2004 dated November 03, 2004 read with Local
Regulation JKL 1961, executed between the company and the Local Government. The
purpose of the report is to fulfill the condition attached to an application to be filed
with the Provincial Government to obtain a cement supply contract.
We conducted our audit in accordance with International Standards on Auditing-800
“The Independent Auditor’s Report on Special Purpose Audit Engagement” applicable
to compliance auditing.
The Standard requires that we plan and perform the audit to obtain reasonable
assurance as to whether Cement Limited has complied with the agreement referred to
in preceding paragraph. An audit includes examining appropriate evidence on a test
basis. We believe that our audit provides a reasonable basis for our opinion . We report
that:
(a)
(b)
We could not directly confirm, from the Local Government, the status of noncompliance of capital adequacy and price computation of ‘quick-set cement’.
The company failed to maintain a performance guarantee with a scheduled bank,
which is a violation of the agreement.
In our opinion, except for the effect on the overall compliance, if any, as might have
been determined, had we been able to obtain the confirmation from the Local
Government in respect of capital adequacy and price computation of quick-set cement
and the non-compliance stated in paragraph (b) above, as of December 31, 2007, the
Company was, in all material respects, in compliance with the covenants of price
computation, minimum inventory level and other matters related to financial reporting
of the agreement referred to in the preceding paragraphs.
AUDITOR
Date
Address
C
Views of the management on job time:
It is true that auditors have already reviewed the subject agreement during the audit of
the financial statements. However, the review was different in nature as discussed
below:
Page 4 of 7
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2008
Materiality was set on the basis of certain Materiality was set on the basis of
values of financial statements.
principles agreed at the time of
engagement.
During the audit only those clauses of the
agreement would have been studied
which could impact the revenue and
expenditure and risk of loss.
In the given engagement the auditors
were required to obtain assurance about
the management’s claim of compliance
with all the clauses which may or may not
have significant financial impact on the
company.
The agreement was among one Since only this agreement was the subject
of the very large number of documents of the auditor’s report, it required far
that could have required auditors’ extensive examination.
attention. Hence only a general review of
the same was required.
Due to these differences the nature and extent of examination of agreement was much
larger in this engagement than in audit. Accordingly, considerable time was required to
complete the engagement.
Ans.7
(d)
Appointment of Mr. Sharif
Since Mr. Sharif was also the engagement partner on the audit of Cement Ltd., his
appointment for this assignment may result in self review threat.
(a)
The matters which should be considered while accepting the assignment and assigning
the job to Mr. Umer are as follows:
Acceptance of engagement:
 Client acceptance consideration, such as, integrity of management, expertise
available in firm etc will be given.
 Whether the assumptions being used are clearly realistic.
 Whether the time limit prescribed by the Board of Directors is sufficient.
 Whether the projected financial statements and auditor’s report will be
appropriate for the intended use.
 Although the firm is legally allowed to accept the assignment, adequate
safeguards should be considered in view of the fact that one of the partners
wife had financial interest in the entity and close family relations with the
CFO of the company.
 There should be an agreement with the management that abridged projections
must contain a caution for shareholders that for better understanding complete
set of prospective financial statements be referred.
 Firm should also consider whether it will be able to carry out the engagement
with due professional competence even if Mr. Umer is unable to be the
engagement partner.
Assigning the job to Mr. Umer:
Since the wife of Mr. Umer has financial interest in the company as a shareholder,
Mr. Umer is not expected to carry out the assignment with the level of objectivity
required for the engagement. Therefore, he should not be appointed as engagement
partner.
Page 5 of 7
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2008
(b)
We have examined the projection of XYZ Business Segment of Fiber Limited in
accordance with the International Standard on Assurance Engagements applicable to
the examination of prospective financial information. Management is responsible for
the projections including the assumptions set out in Note X on which it is based.
This projection has been prepared for assuring the viability of the segment referred to
in preceding paragraph. As the segment is in development phase the projection has
been prepared using a set of assumptions that include hypothetical assumptions about
future events and management’s action that are not necessarily expected to occur.
Consequently, the users are cautioned that the projection may not be appropriate for
purposes other than those described above.
Based on our examination of the evidence supporting the assumptions, nothing has
come to our attention which causes us to believe that these assumptions do not provide
a reasonable basis for the projection. Further, in our opinion the projection is properly
prepared on the basis of the assumptions and is presented in accordance with the
International Financial Reporting Standards.
Even if the events anticipated under the hypothetical assumptions described above
occur, actual results are still likely to be different from the projection since other
anticipated events frequently do not occur as expected and the variation may be
material.
(c)
The historical financial statements provide the auditors with
 the knowledge of company’s business and trends and relation that would exist
among the elements of financial statements; and
 a yardstick for considering management’s assumptions.
The auditors also uses historical financial statements to assess whether the prospective
financial statements have been prepared on the basis consistent with them.
Ans.8
(i)
Judgmental Sampling
Advantages
 As the approach is being used for
many years so its well understood
and refined by experience.
 The auditor can bring his judgment
and experience into play.
 No special knowledge of statistics is
required.
 Time saved form non deployment of
statistical methods may be spent on
carrying out further audit procedures
on different areas.
 Saving of extra resources such as
computer soft wares.
 Selecting samples with large amounts
facilitates greater coverage.





Disadvantages
It is not based on any scientific
technique.
No quantitative results are obtained.
Personal bias in the selection of
sample is unavoidable.
There is no real logic behind the
selection of the sample or its size
The conclusion reached is usually
vague.
Page 6 of 7
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2008
(ii)
Ans.9
Statistical Sampling
Advantages
 It is based on scientific techniques
 Special software is available to help
efficient execution
 The method is impartial and can be
defended easily
 It provides precise mathematical
statements about probabilities of
being correct
 The method is efficient as the same
level of confidence can be achieved
with a relatively smaller sample.
Overlarge sample size are not taken
 The system in different audit firms
tend to become standardized
 It can be used by staff at all levels




Disadvantages
It lacks flexibility
Often
several
attributes
of
transactions or documents are tested
at the same time
Lacks human judgement and more
reliance is placed on statistical
conclusion
As the technique is not always
understood, false conclusions may
also be drawn.
(a) The following issues are significant in respect of the donation of Rs. 15 million:


Donations represent 25% of the total selling and administration expenses.
Such a huge amount of donation by a company which has already incurred a loss
casts serious doubts about the motive behind such donation.
Audit procedures to address the issue may involve the following:
(i) Obtain information about the charitable institution i.e. its name, nature,
registration and reputation.
(ii) Scrutinize possibility of any relationship between the two organizations, their
directors/trustees and their spouses and relatives etc.
(iii) Verify mode of payment i.e. cash, bearer cheque, crossed cheque etc.
(iv) Verify approval and authorization.
(v) Assess the relevance of the donation to the nature of business of the company.
(b)
Since appropriate business consideration does not seem to be involved, mere
approval by the Board would not confirm that the expenditure has been incurred for
the purpose of the company’s business.
If the auditor is unable to satisfy himself on the above issue he will have to qualify the
report by:
(i)
stating the brief facts of the case.
(ii)
using the “except for” type of qualification, while certifying that the business
has been conducted in accordance with the objects of the company.
(THE END)
Page 7 of 7
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
Q.1
SESSION
Final Examination - Summer 2008
The question contained a situation where a new management has recently taken
over. It has authorized the production manager to conduct a fixed asset valuation
exercise which was in progress. However, the results of valuation carried out so far
were different from those carried out in previous years and showed significant
impairment. Certain other issues relating to quality control and audit approach were
also mentioned and the students were required to write a report on the firms
policies along with appropriate recommendations.
The students rightly emphasized on the appointment of independent valuer.
However, most of them simply recommended that the figure determined by the
independent valuer should be depicted in the financial statements. They failed to
realize that if the results of the independent valuation were significantly different
from those shown by the management, the auditor will need to re-assess the risk of
fraudulent mis-statement and risk of involvement of higher manager and of those
charged with the governance.
On the other hand, if the independent valuation agreed with the valuation carried
out by the management, it will cast a doubt as regards the valuation procedure
followed in previous years and the auditor will need to assess whether the figures
reported in prior years were erroneous.
As regards the other issues, the students were generally able to cover apparent
weaknesses and gave appropriate recommendations. However the following
important points were not covered by most of the students:
Q.2
•
Informing stock exchanges about impairment loss, uncertainty on fair value of
plant and machinery, issue of right shares at reduced price and acquisition of
right shares by directors and their associates point to an apparent motive of the
Board of directors to accumulate WL’s shares at low price.
•
In view of the management’s perceived motive of presenting poor financial
position to affect the market price, the representation by the management as
regards impairment of plant and machinery could not be considered a reliable
evidence.
This was an easy question. A situation was given in which the client had issued the
financial statements before the issuance of audit report. Most of the students were
able to list the actions that a firm will usually take in such a situation, such as
taking legal opinion, informing SECP and ICAP and taking steps to prevent
reliance on the financial statements. However, very few of the students could point
out that the auditor should also communicate with the client to ascertain their point
of view. The discussion with the client was all the more important because as given
in the question, the financial statements were sent to the client, for approval of the
Board of Directors which was an indication that the auditor was to a great extent
satisfied with the information depicted in the financial statements.
Page 1 of 6
Examiners’ Comments on Advanced Auditing - Summer 2008 Examination
Q.3
In this question the students were required to discuss four different situations and
explain how an auditor should resolve them.
A large number of students replied without considering the fact that the given
matters have arisen after the publication of financial statements and the auditors’s
report. Consequently in many cases they suggested totally irrelevant procedures.
The performance of students other than those referred to in the preceding
paragraph, is discussed below:
(i)
Most of the students answered this sub-part in accordance with the
recommendations contained in ISA 560 “Subsequent Events”.
(ii)
Very few of the students could explain that the reason for decline in sales is a
matter of opinion and will have no impact on the audit.
(iii) The error referred to in this sub-part could have been on account of
•
•
Typographical error; or
error in last years financial statements
In the case of a typographical error the auditor should ask the management to
convey the correction to the users. On the other hand, in case of error in the
previous years financial statements, the error needed to be rectified
retrospectively.
In case of disagreement with the management the auditor needed to take
necessary steps to re-communicate the audit report after adding:
•
•
emphasis of the matter paragraph, in the former case; and
appropriate qualification, in the latter case.
Very few of the students were able to produce comprehensive replies as
suggested above.
(iv) The mis-statement regarding acquisition of a sick unit, in the director’s
report, is a material mis-statement of fact although it may not have any affect
on the financial statements. The auditor need to discuss it with the
management and in case of disagreement, should seek legal opinion.
Most of the replies revolved around the above points and secured reasonable
marks.
Q.4
In this question the students were supposed to give their views on various situations
arising during a limited scope review of interim financial statements. Only about
10% of the students produced good answers. Most others did not seem to be aware
of the differences between a limited scope review and a full scope audit and
consequently gave inappropriate recommendations.
The mistakes noted in majority of the answers are discussed hereunder:
(i)
Failure to observe stock count:
A large majority did not know that the auditor is not required to observe the
stock count in a review engagement and declared that the auditor should
qualify his report or give a disclaimer.
Page 2 of 6
Examiners’ Comments on Advanced Auditing - Summer 2008 Examination
(ii)
Management decision regarding forward exchange contracts:
While discussing the client’s exposure to exchange rate risk, very few of
the students could identify the fact that the auditor is not supposed to give
assurance on the adequacy of the management’s risk assessment
procedures.
Most of them strongly recommended that the auditor should carry out
detailed procedures to assess the impact of the management’s decision of
not covering foreign currency liabilities through forward contracts, on the
financial results of the company. Normally the auditor is not supposed to
carry out such procedures. Only when the open position casts significant
doubt as regards the overall viability of the company’s business, the auditor
may decide to draw the attention of the readers by adding an emphasis of
matter paragraph.
(iii)
Sale of the company’s set-up to an associated undertaking:
Most of the answers were focused on the requirements of IAS-24 on related
parties. The importance of an explanatory note for understanding the
changes in financial position of the company, was highlighted by very few
of the candidates.
(iv)
Discontinuation of the practice of using Age Analysis for bad debts
estimation:
A large majority was able to answer correctly that age analysis was not
compulsory if there are other means of assessing the adequacy of bad debt
provision. Still, about 20% of the students declared otherwise.
(v)
Failure to carry out review of subsequent events:
Only about 50% of the students knew that the auditor is not responsible to
consider subsequent events, in a review of interim financial statements.
Q.5
Generally students failed to demonstrate their practical knowledge and could not
explain appropriate audit procedures to verify the provision for sales returns. Many
of them failed to realize that it was the first year of trading of Product “Y” and
therefore some of the audit procedures were not relevant. The examiner expected
the students to focus on the following:
•
•
•
•
•
•
Obtaining an understanding of the management’s assumptions on which the
estimate was based.
Making revised estimates.
Using experts opinion.
Industry practice
Trend/Pattern of sales returns.
Sales returns subsequent to year end and as close as possible to the date of
signing of audit report.
Page 3 of 6
Examiners’ Comments on Advanced Auditing - Summer 2008 Examination
Q.6
The question was based on a situation according to which the auditor was required
to report on the clients compliance with certain covenants of an agreement with the
local government. The question consisted of four parts as discussed below:
(a)
The students were supposed to consider different issues and their
implications on the compliance report. The responses are discussed
hereunder:
(i)
Majority of the students considered the refusal of local government to
provide a written confirmation as acceptable, particularly if supported
by legal opinion. They failed to realize that under the circumstances
the failure to provide written confirmation was a scope limitation.
(ii)
Very few of the students could identify the fact that it shall not be
appropriate for the management to use the report for the purpose of
dealing with the local government because it was beyond the scope of
the engagement. Consequently it was necessary that the audit report
should specify the agreed intended use thereof.
(iii) Majority of the students were able to explain that keeping inventory
with the distributor was not a non-compliance as these were covered
under binding contracts and the purpose of the arrangement was also
mentioned in the contract.
However, many students misinterpreted the situation also, and
declared that it should be mentioned in the report as a qualification.
(b)
(iv) The matter regarding failure to review performance guarantee was
quiet straightforward and almost all the students were able to suggest
correctly that it should be reported as a qualification.
Draft Report
Majority of the students were able to draft the report correctly as they
adopted the format specified in IAS-800. However, as discussed above, a
large majority was not sure as to which of the matters required qualification
and consequently lost the related marks. Moreover, some of the students did
not write the complete report and deliberately left some parts of the report
using expressions such as:
“We conducted our audit………………”
Consequently, they lost the marks allocated to these parts of the report.
(c)
Very few of the students could answer this part in an appropriate manner.
Some of the students supported the management’s point of view whereas a
large majority did oppose the management’s comments but did not give any
explanation to support the auditor’s point of view.
Page 4 of 6
Examiners’ Comments on Advanced Auditing - Summer 2008 Examination
The students were expected to highlight the following issues:
(d)
Q.7
•
The agreement was among one of the very large number of documents
which attract the auditors attention in an audit of financial statements
and hence did not warrant such a close scrutiny during the annual audit,
as was required in the given assignment.
•
In a full audit, only such clauses of the agreement which had material
effect on revenue/expenditure and risk of loss, were relevant whereas in
the given assignment each and every clause was important and the
auditor was required to perform various procedures to assess the
compliance thereof.
This part was attempted well by most of the students as they identified that
appointment of Mr. Sharif on this assignment may involve self review
threat.
The question pertained to an assignment related to review of prospective financial
statements. It consisted of three parts, each of which are discussed below:
(a)
The performance was generally good as students were able to cover most of
the points referred to in ISQC 1 (Para 28) and ISAE-3400 (Para 10)
However, a large number of students mixed up the two different aspects of
the question i.e.
•
•
Acceptance of the audit assignment by the firm; and
Appointment of Mr. Umer as the engagement partner.
Very few of the students could cover the above by explaining as under:
•
The firm is legally allowed to accept the assignment but needs to take
adequate safeguards in view of the fact that the wife of a partner (Mr.
Umer) was the CFO of the client.
•
Mr. Umer should not be appointed as engagement partner because he is
not expected to carry out the assignment with the desired level of
objectivity.
(b)
Most of the students were able to do well as they used the format given in
ISAE 3400 related to Prospective Financial Statements. However, in this
question also, some of the students tried to produce short form of the report
as discussed in Question 6 (b) and lost easy marks.
(c)
The performance in this part was quiet poor as most of the students were
unable to highlight the significance of historical financial statements for the
auditor, while reporting on the prospective financial statements. Some of
the important matters for which the auditor may rely on the Historical
Financial Statements are as follows:
• Knowledge of Company’s business and trends.
• Relationship between various components of the financial statements.
• For assessing whether the prospective financial statements have been
prepared on a basis which is consistent with those used for historical
financial statements.
Page 5 of 6
Examiners’ Comments on Advanced Auditing - Summer 2008 Examination
Q.8
This was an easy question and most of the students were able to list down the
advantages and disadvantages of Statistical Sampling and Judgmental Sampling.
Q.9
(a)
Students were required to discuss the significance of a major donation made
by a company which had incurred a loss. Instead of discussing the specific
situation, a large number of students listed down the routine audit steps
which the auditor carries out in a normal situation i.e. when the amount of
donation is not material enough to have a significant impact on the results
of the company.
Very few of the students considered the point that such a huge amount of
donation, by a company, which has already incurred losses, casts serious
doubts about the motive behind such donation and the audit procedures
designed by them did not seem to address this important aspect.
(b)
In this part however, a large number of students discussed the importance of
evaluating whether the donation can be classified as an expenditure incurred
for the purpose of the company’s business and how to qualify the report if
the answer to the above was in the negative.
(THE END)
Page 6 of 6
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations Winter 2008
December 5, 2008
ADVANCED AUDITING
Q.1
(MARKS 100)
(3 hours)
Sea view Limited is a manufacturing company. Behroze & Co., Chartered Accountants are
their auditors. The audit of financial statements of the Company for the year ended
November 30, 2008 is in progress. Sami, the senior in charge on the audit has received the
first draft of the financial statements from Kamil, the CFO of the Company. The abridged
financial information of the Company for the year ended November 30, 2008 is as follows:
Property, plant and equipment
Intangible assets
Inventories
Trade debts
Sales
Cost of sales
Gross Profit
2008
2007
Rs. in ‘000’
2,325
1,210
100
50
650
460
210
80
4,300
6,700
3,800
5,100
600
1,600
Sami had a meeting with the CFO of the Company which revealed the following matters:
(i)
The Company’s sales have suffered on account of depressed economic conditions in
the country;
(ii) The Company has introduced a new product ‘Cherry’ during the year in place of
‘Merry’ and incurred substantial cost in the acquisition of property, plant and
equipment; and
(iii) This year’s physical verification of stocks had not been carried out on November 30
on the plea that the relevant staff was on leave. The stock check will now be carried
out on December 15, 2008.
Required:
Given the above data and circumstances, identify the following:
(a) the risks that may result in material misstatements in the financial statements; and
(b) the implications of the risks identified along with audit procedures that would be
most suitable to mitigate those risks.
(15)
Q.2
During the audit of a manufacturing company, you have noted certain conditions that cast
significant doubt on the company’s ability to continue as a going concern. You had a
meeting with the CEO of the Company to discuss the issue and communicated your
decision that at least an emphasis of matter paragraph in the Audit Report is inevitable.
The CEO disagreed with your opinion and shared with you the management’s plan to deal
with the potential going-concern uncertainty. The plan mainly constitutes the following
measures:
(i)
(ii)
(iii)
the Company is guaranteed a continuous financial support by the parent company;
it has recently rescheduled its borrowing facilities;
the management has plans to reduce overheads and administrative expenses;
(2)
(iv)
(v)
(vi)
the management has decided to discontinue a segment with non-profitable
operations;
the management has plans to increase equity; and
the management is expecting profitable operations in the next year.
Required:
Describe the audit procedures that should be performed to gather sufficient appropriate
audit evidence to support the validity of the CEO’s claims and assess the viability of the
above measures being taken by the management.
(16)
Q.3
Your firm has been appointed as the auditors of Star Limited, a well established consumer
goods manufacturing company. During the audit you were provided with various oral
representations during meetings and discussions. While finalizing the audit you requested
the management to provide such representations in writing. The management has however
informed you that they are not accustomed to providing any representations to the external
auditor in writing.
The management is of the view that it has provided full access to whatever records,
documents and evidences were available with it without any exception and that now it is
the auditor’s responsibility to correlate the same with the oral representations.
The management has further informed that the only signed documents which it will be
providing to you would be the signed copy of the financial statements and the certified
true copy of the resolution of the BOD approving the financial statements and other
significant matters, in line with the requirements of the corporate law.
Required:
You are required to explain the following:
(a) Is there any relevance of oral representations for the External Auditors?
(b) What are the situations in which written representation from the management is
mandatory?
(c) What course of action would you like to take in the above circumstances?
(12)
Q.4
The financial statements of Walter Limited (WL) a public unlisted company, for the year
ended 30 June 2007 were significantly delayed and were finalized in April 2008. After
finalization of financial statements, a meeting of the board of directors (BOD) of WL was
held in May 2008 and Annual General Meeting (AGM) was held on June 18, 2008. Due to
delay in holding the AGM, the Securities and Exchange Commission of Pakistan (SECP)
has imposed a penalty and has advised WL that no such delay shall be entertained in
future.
In the AGM, the shareholders of WL appointed your firm as the statutory auditors and the
fact has been communicated to you by the Company Secretary through his letter dated
June 22, 2008 which was faxed to you on the same date.
The company’s financial year is closing on June 30, 2008 and the management wants to
commence the audit immediately in order to ensure timely financial reporting and holding
of AGM.
Required:
(a) Explain the client acceptance procedures that you would like to perform in the above
situation.
(b) What other steps would you like to take before commencement of the audit?
Q.5
Your firm has completed the audit of financial statements of Flora Limited (FL), a public
listed company, as of June 30, 2008 and has issued the audit report on September 30,
2008. While preparing to attend the Annual General Meeting (AGM), you noted that a
particular sub-note was altogether missing from the published financial statements.
(12)
(3)
On scrutiny, you found that the original signed copy of the financial statements available
in your records did contain the note.
Required:
(a) Explain the auditor’s responsibility in such a situation if the amount involved is
considered material.
(b) What difference would it make if the amount is immaterial?
(06)
Q.6
You are the audit engagement partner for Mubarak Limited (ML), a listed company which
is the subsidiary of a company registered in USA. You have received an email from your
firm’s tax partner based in Lahore. He has informed you that in a recent meeting with the
Chairman of ML in Lahore, he discussed an opportunity to pursue major assignments for
the Company. He strongly urged you to have an urgent meeting with the CEO of ML as
the company is in discussion with other firms also and is due to take a final decision soon.
The services include Internal Audit Outsourcing and Corporate Finance Services (CFS).
CFS mainly involve negotiating the terms of restructuring / re profiling of long-term
borrowings obtained by ML from one of its lenders. However, as the audit engagement
Partner of Mubarak Limited you are of the opinion that it would not be possible for you to
provide the above services.
Required:
Write a comprehensive letter to the client explaining your point of view, giving
appropriate reasons and references to the relevant standards and regulations.
(10)
Q.7
You were the engagement partner on the audit of a commercial bank which has a network
of more than 200 branches, across the country. During a recent meeting, a member of the
audit committee referred to an instance of irregularity in a branch, whereby the Branch
Manager had extended credit to a close relative without following the bank’s credit
disbursement procedures. The member criticized the auditors for their failure to highlight
such instances.
Required:
As an engagement partner, write a letter to the audit committee explaining your point of
view in detail with specific references to the International Standards on Auditing,
wherever applicable.
(09)
Q.8
You are employed as the Chief Internal Auditor of MNQ Commercial Bank Limited.
Recently the Central Bank has taken serious action against some of the banks for their
failure to detect money laundering activities.
Required:
For the guidance of the management and staff, develop a list of situations which may
indicate the involvement of money laundering activities.
(10)
Q.9
Your firm has been appointed as the auditors of Antarctica Limited for the year ended
June 30, 2008. The Company was incorporated in the year 2000. Since then, its financial
statements have been prepared in accordance with the approved accounting standards as
applicable in Pakistan and have been audited by a highly reputable professional auditing
firm. Since the previous auditors had never expressed a modified audit opinion, the audit
team feels that there is no risk in respect of comparatives and accordingly did not perform
any work in this respect.
Required:
Describe the auditor’s responsibility as regards the verification of opening balances and
the steps that may be needed in the above situation.
(THE END)
(10)
ADVANCED AUDITING
Final Examinations – Winter 2008
Suggested Answers
Ans.1
The following are the risks that may result in material misstatement in the financial statements and the
procedures that may be performed to mitigate those risks:
Risk
i)
Overstatement of sales /
Sales cut off may not be
proper.
Implication
Although, the sales have
decreased from Rs. 6,700
million in 2007 to Rs. 4,300
million in 2008, resulting in a
net decrease of Rs. 2,400
million, still there is a
significant risk that even this
sales may have been
overstated because, the
Company was facing earning
pressure and physical
inventory observation has
been delayed by 15 days.
(correlate with point iv)
Audit procedures to mitigate
risks
Noting of last document as on
30 June 2008 such as invoices,
gate passes, delivery challans
etc.
Sales cut off procedures
should be performed.
Revenue expenses may have
been capitalized.
During the year, PPE has
almost doubled to Rs. 2,325
million. There is a significant
risk that revenue expenses
may have been capitalized
with the cost of PPE for new
product “Cherry”.
Detailed test of transaction
should be performed on
additions of PPE. This may
include vouching and
verification of source
documents and physical
verification of PPE acquired
during the year.
Impairment of items of
property, plant and equipment
With the introduction of new
product, impairment of PPE
items that belong to the old
product may not have been
provided for.
Identify items of PPE acquired
for “merry” in prior years
from Fixed Asset Register,
ascertain their carrying values
and assesses the amount of
unrecorded impairment loss if
any.
iii) Existence/ validity of trade
receivable.
Trade debts have more than
doubled in spite of the
decrease in sales. There is a
risk that these receivables may
have been overstated as of the
balance sheet date. The sales
relating to next year may have
been recorded in the year
under audit.
Circularization of independent
confirmation requests to the
debtors.
Indication of doubtful/
uncollectable accounts.
In spite of lower sales, trade
receivables have increased
significantly by Rs. 130
million. There might be old
outstanding debts.
Analysis of Debtors aging
schedule, Company’s credit
policy and provision for
doubtful debts.
ii)
Scrutinize the amount of sales
recorded in the last week to
identify undue increase if any.
Page 1 of 7
ADVANCED AUDITING
Final Examinations – Winter 2008
Suggested Answers
iv)
Understatement of inventory/
Inventory cut off may not be
proper/Inventory valuation
may not be correct.
This year, the management has
requested to carry out physical
verification of inventories 15
days after the balance sheet
date.
There is a risk of
understatement of inventory
and overstatement of sales as
the Company might have tried
to recognize sales of
subsequent period in the
period under audit.
At the time of stock take, roll
back working should be
prepared and verified and
cross matched with the cut off
documents to ensure that
inventory movements are
recorded in correct accounting
period.
Cut off procedures should be
performed.
NRV of the old product
“Merry” need to be
considered.
v)
Ans.2
Impairment of intangible
assets
The Company has abandoned
the product “merry”. The
intangible assets might include
unamortized cost of
intangibles related to “merry”
which should have been
charged off.
Detailed verification of
intangible assets to identify
those costs from which future
economic benefits are no more
expected to flow to the
Company.
Following Audit Procedures should be performed in the given circumstances:
(i)
Financial Support from parent company
In support of parent company’s guarantee to provide continuing financial support to the
Company, we should obtain
ƒ A copy of legally binding agreement between the parties / Board Resolution, and
ƒ Ensure that the parent company is financially capable of supporting the Company (e.g.
historical financial statements, forecasted information).
(ii)
Rescheduling of borrowing facilities
We should obtain a
ƒ copy of written agreement or
ƒ Communication in respect of debts rescheduled by the Company with banks or financial
institutions. / Confirmation from financial Institutions.
(iii)
Reduction of overheads and Administrative expenses.
ƒ Assess whether it would be feasible to reduce overhead and administrative costs. For
example such reduction may have serious negative impact on the company’s ability to
provide quality services to the customers.
ƒ Such plans might be evidenced by an approval of board of directors.
(iv)
Discontinuance of non-profitable segment
The auditor should consider the
ƒ marketability of the segment assets,
ƒ restrictions on their disposal (such as loan agreements or encumbrances),
ƒ possible direct and indirect effects of disposal,
ƒ the Company’s ability to discontinue operations of the segment without any negative impact
on the other operations,
ƒ sale agreement, letter of intent or an appraisal report in respect of the above,
ƒ approval of the board of directors and the shareholders.
Page 2 of 7
ADVANCED AUDITING
Final Examinations – Winter 2008
Suggested Answers
(v)
Increasing the Equity
ƒ Evaluate management’s feasibility plan to inject further capital or issue of further capital.
ƒ Examine related documentation and the steps taken so far( Board minutes, Permission from
regulator)
(vi)
Profitable operation in next year
ƒ Discuss with the management, the basis of estimating the increase in profits such as new
products, customers, markets, etc., that may result in profitable operation as supported by a
detailed marketing plans.
ƒ analyze and discuss the entity’s latest available interim financial statements;
ƒ Consider whether the assumptions underlying the forecast appear appropriate in the
circumstances.
ƒ Compare the prospective data for the current period with results achieved to date.
ƒ Analyze and discuss the profit and other relevant forcaste.
General Procedures
We would obtain sufficient appropriate audit evidence that the above plans are likely to be
implemented and that the outcome of these plans will improve the situation.
We would seek written representation from management regarding the above plans.
Ans.3
(a)
Relevance of Oral representation:
An auditors should document the oral representations made by the management during the
course of audit and make them part of audit working papers. However oral representation is less
reliable then written representation.
(b)
The following types of representations should mandatorily be in writing:
(i) Relating to a matter material to the financial statements when other sufficient appropriate
audit evidence cannot reasonably be expected to exist.
(ii) Management’s acknowledgement of its responsibility for the design and implementation
of internal controls to prevent and detect error; and
(iii) Management’s acknowledgment that (according to its belief) the effects of uncorrected
errors aggregated by the auditor during the audit are immaterial, both individually and in
the aggregate, to the financial statements taken as a whole. A summary of such items
should be included in or attached to the written representations.
(iv) Management’s acknowledgement of its responsibility for the design and implementation
of internal controls to prevent and detect fraud;
(v) That the management has disclosed to the auditor the results of its assessment of the risk
that the financial statements may be materially mis-stated as a result of fraud;
(vi) That the management has disclosed to the auditor its knowledge of fraud or suspected
fraud affecting the entity involving:
ƒ Management;
ƒ Employees who have significant roles in internal control; or
ƒ Others, where the fraud could have a material effect on the financial statements; and
(vii) That the management has disclosed to the auditor its knowledge of any allegations of
fraud, or suspected fraud, affecting the entity’s financial statements as may have been
communicated by employees, former employees, analysts, regulators or others.
(c)
An auditor may accept the oral representation provided by the management of Star limited but
these need to be documented in the working papers.
Moreover, since oral representations are less reliable, the auditor should reassess whether it
needs to perform additional procedures in view of the above situation.
However, where written representation is mandatory the auditor should obtain written
representations and in case of management’s refusal, it shall consider appropriate modification of
the auditor’s report.
Page 3 of 7
ADVANCED AUDITING
Final Examinations – Winter 2008
Suggested Answers
Ans.4
(a)
CLIENT ACCEPTANCE PROCEDURES
The firm should perform procedures designed to provide it with reasonable assurance that the
firm:
(i)
(ii)
(iii)
has considered the integrity of the client and does not have information that would lead it
to conclude that the client lacks integrity;
is competent to perform the engagement and has the capabilities, time and resources to do
so; and
can comply with ethical requirements.
With regard to the integrity of a client, the firm should consider the following matters:
(i)
The identity and business reputation of the client’s principle owners, key management,
related parties and those charged with its governance.
(ii) The nature of the client’s operations, including its business practices.
(iii) Information concerning the attitude of the client’s principal owners, key management and
those charged with its governance towards such matters as aggressive interpretation of
accounting standards and the internal control environment.
(iv) Whether the client is aggressively concerned with maintaining the firm’s fees as low as
possible.
(v) Indications that the client might be involved in money laundering or other criminal
activities.
(vi) The reasons for the proposed appointment of the firm and non-reappointment of the
previous firm. In this situation, the firm should ascertain the reasons for delay in
finalization of the previous financial statements.
Information on the matters that the firm obtains may come from, for example:
(i)
Communications with existing or previous providers of professional accountancy services
to the client in accordance with the IFAC Code, and discussions with other third parties.
(ii) Inquiry of other firm personnel or third parties such as bankers, legal counsel and industry
peers.
In considering whether the firm has the capabilities, competence, time and resources to
undertake a new engagement, it should assess:
ƒ the staff profiles at all relevant levels,
ƒ special capabilities if any, required to audit the client
ƒ Ability to perform work at all relevant locations
The firm also considers whether accepting an engagement from a new client may give rise to an
actual or perceived conflict or interest. Where a potential conflict is identified, the firm considers
whether it is appropriate to accept the engagement.
(b)
OTHER STEPS
Professional Clearance Letter we need to refer to the Code of Ethics for Chartered
Accountants which requires that the proposed chartered accountant in practice should:
(i)
Ascertain if the prospective client has advised the existing auditors of the proposed change
and has given them the permission, preferably in writing, to discuss the client’s affairs
fully and freely with the new auditors i.e. our firm.
(ii) After getting satisfactory reply from prospective client, request permission to communicate
with the existing chartered accountant. If such permission is refused or the permission
referred to in (a) above is not given, the proposed chartered accountant in practice should,
barring some judgmental exception, decline the appointment.
(iii) On receipt of permission, we shall ask the existing auditors, preferably in writing:
(a) To provide information on any professional reasons if any, on account of which our
firm may decide not to accept the appointment and,
(b) If there are any such matters, to provide all the necessary details to enable us to come
to a decision.
Page 4 of 7
ADVANCED AUDITING
Final Examinations – Winter 2008
Suggested Answers
Particularly in view of the fact that it is the first audit, we should send an engagement letter, preferably
before the commencement of the engagement, to help in avoiding misunderstanding with respect to the
engagement.
Ans.5
(a)
ƒ
ƒ
ƒ
ƒ
(b)
Ans.6
The auditor should communicate with the client and inform them about the omission.
The auditor should also advise the client to inform the Securities and Exchange
Commission of Pakistan the relevant stock exchanges, and other regulatory bodies
wherever the accounts have been submitted.
The auditor should ensure that the management sends a corrigendum to all the shareholders
before the AGM. If due to time constraint or any other reason it is not possible, the auditor
should see that the management, in addition to sending the corrigendum, shall also inform
the shareholders about the omission at the AGM.
Under the Companies Ordinance, 1984, the auditors are entitled to attend the Annual
General Meeting therefore they should inform the shareholders themselves if management
fails to do so.
The auditor should ensure the same actions as mentioned in(a) even if the amount involved is not
material
Response to the client conveying the inability to carry out certain assignments.
Under the listing regulations of the stock exchange of Pakistan, the external auditors of listed
companies are prohibited to provide internal audit services to the listed companies, which are being
audited by them.
Further, the Code of Corporate Governance has also placed certain restrictions on the external auditors
and restricts the listed companies from appointing their auditors to provide services in addition to audit
except in accordance with the listing regulations and requires the auditor to observe applicable IFAC
guidelines in this regard and to ensure that the auditors do not perform management functions or make
management decisions, responsibility for which remains with the Board of Directors and management
of the listed company.
Also according to the Code of Ethics (para 9.198), provision of CFS to an audit client may create
advocacy and self-review threats. In case of the proposed CFS, the independence could be impaired
and there are no safeguards that could reduce the threat to an acceptable level. A self review threat may
be created when a firm provides internal audit services to an audit client.
The negotiation with the Company’s banker is purely a management function and cannot be
undertaken by us as it will be a violation of the listing regulations and the CCG as disclosed above.
Further, as ML is a subsidiary of a company based in US which is subject to US SEC Rules, we will
also need to refer to the SEC to see as to what other types of services are the external auditors allowed
to provide.
Ans.7
Views expressed by the Audit Committee Member were not correct due to following reasons:
The objective of an audit of financial statements carried out in accordance with ISA is to obtain
reasonable assurance that the financial statements taken as a whole are free from material
misstatements.
For this purpose, the auditor considers internal control relevant for the preparation and fair presentation
of the financial statements but is not required to express an opinion on the effectiveness of the entity’s
internal control system.
Page 5 of 7
ADVANCED AUDITING
Final Examinations – Winter 2008
Suggested Answers
An audit opinion does not assure the future viability of the entity nor the efficiency or effectiveness
with which management has conducted the affairs of the entity.
The audit process is subject to certain limitations which are also recognized by ISA. Such limitations
includes:
ƒ use of sampling,
ƒ reliance on internal controls which itself is subject to limitations (for example: possibility of
management override or collusion) and the
ƒ fact that most audit evidence is persuasive rather than conclusive.
Moreover, in the context of the specific instance referred by the Audit Committee Member, it may be
possible that the subject branch may not have been selected for the purposes of audit due to its relative
insignificance in relation to the overall financial statements.
Moreover, the fact that credit was granted to close relative of branch manager without following
normal lending procedures, may not necessarily result in material misstatement in the financial
statements.
Ans.8
Possible indications of money laundering activities in which the Bank and its customers might have
been involved include the following:
When the source of funds is difficult to pinpoint or appears inconsistent with the customer’s means or
expected behaviour;
Transactions that seem to be inconsistent with a customer’s known legitimate business or personal
activities or means; unusual deviations from normal account and transaction patterns;
Situations in which it is difficult to confirm the identity of a person;
Unauthorized or improperly recorded transactions; inadequate audit trails;
Unusually large currency transactions, particularly in exchange for negotiable instruments or for the
direct purchase of funds transfer services;
Apparent structuring of currency transactions to avoid regulatory record keeping and reporting
thresholds; like carrying out many transactions below the specified limits.
Uncharacteristically premature redemption of investment vehicles, particularly with requests to remit
proceeds to apparently unrelated third parties;
The purchase of large cash value investments, soon followed by heavy borrowing against them;
Large lump-sum receipts from abroad;
Insurance policies with values that appear to be inconsistent with the buyer’s insurance needs or
apparent means;
Purchases of goods and currency at prices significantly below or above market;
Use of many different firms of auditors and advisers for associated entities and businesses;
Forming too many companies or trusts that appear to have no business purpose;
Page 6 of 7
ADVANCED AUDITING
Final Examinations – Winter 2008
Suggested Answers
Ans.9
Auditor’s Responsibility
I do not agree with the understanding of the audit team.
The auditor should obtain sufficient appropriate audit evidence that:
(i) The opening balances do not contain misstatements that materially affect the current period’s
financial statements;
(ii) The prior period’s closing balances have been correctly brought forward to the current period or,
when appropriate, have been restated; and
(iii) Appropriate accounting policies are consistently applied or changes in accounting policies have
been properly accounted for and adequately presented and disclosed.
Steps needed to be performed by auditor
When the prior period’s financial statements were audited by another auditor, the current auditor may
be able to obtain sufficient appropriate audit evidence regarding opening balances by reviewing the
predecessor auditor’s working papers. In these circumstances, the current auditor would also consider
the professional competence and independence of the predecessor auditors.
When the auditor is not satisfied by above step, the auditor will need to perform other audit procedures
such as:
(i)
Current assets and liabilities
Some audit evidence can ordinarily be obtained as part of the current period’s audit procedures.
For example:
ƒ the collection (payment) of opening accounts receivable (accounts payable) during the
current period will provide some audit evidence of their existence, rights and obligations,
completeness and valuation at the beginning of the period.
ƒ Observing a current physical inventory taking and reconciling it back to the opening
inventory items.
ƒ Performing audit procedures on the valuation of the opening inventory items.
(ii) Non-current assets and liabilities
ƒ In respect of fixed assets, investments and long-term debt etc., the auditor will ordinarily
examine the accounting records and other information underlying the opening balances.
ƒ In certain cases, the auditor may be able to obtain confirmation of opening balances with third
parties, for example, for long-term debt and investments. In other cases, the auditor may need
to carry out additional audit procedures.
A combination of the above audit procedures may provide sufficient appropriate audit evidence.
(THE END)
Page 7 of 7
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations
Summer 2009
June 5, 2009
ADVANCED AUDITING
Q.1
(MARKS 100)
(3 hours)
You are the senior in charge on the external audit of Brown Limited (BL), a company
dealing in consumer products. The draft financial statements for the year ended December
31, 2008 show profit before tax of Rs. 30.1 million and total assets of Rs. 242.4 million.
The following issues have been identified during the course of the audit:
(i)
On January 10, 2009, a liquidator has been appointed at Express Pakistan Limited
(EPL), a major customer of the company. Sales to EPL during the year under review
amounted to 35% of BL’s revenue and the balance due from EPL at December 31,
2008 was Rs. 5.89 million.
(ii)
On January 25, 2009, a direct confirmation was received from BL’s lawyers. He had
informed that because of the complexity of the issues involved in one of the
litigation faced by the company, which was initiated in October 2008, it is not
possible to forecast its outcome. However, he has advised that the possible impact of
an unfavorable decision (if any), ranges between zero to Rs. 10 million. The draft
financial statements do not contain any disclosure in respect of this uncertainty.
(iii)
During the year the company incurred costs of Rs. 1.1 million in respect of repairs
and maintenance of its machinery. These costs have been capitalized and included in
the carrying value of property, plant and equipment. The management has refused to
make any adjustments in the financial statement in respect of this matter.
(iv)
During the year, the company has commercially imported certain branded products
amounting to Rs. 200 million, which are subject to FTR at import stage. The final
tax paid at import stage amounted to Rs. 4 million and the entire amount has been
recognized as expense, in the current period. However, goods costing Rs. 50 million
remained unsold and are included in the stock-in-trade.
Required:
Explain the possible effects of the situations described above, on BL’s financial statements
for the year ended December 31, 2008 and discuss the implications thereof, if any, on the
audit report.
(10)
Q.2
You are the manager in charge on the audit of financial statements of Haroon Private
Limited. During the course of audit you noticed certain conditions which created
significant doubts about the validity of the going concern assumptions.
You have discussed the issue with the client which further revealed that the management
has developed certain plans to cope with the situation but on the basis of your assessment
of their plans, you concluded that the going concern assumption is no more appropriate.
Required:
(a) Advise the client as to what should be done in the above circumstances.
(b) What procedures would you perform if the management agrees to your proposals?
(c) If the management does not agree, draft appropriate modifications for inclusion in
the audit report. (You may assume necessary details)
(10)
(2)
Q.3
Narrow Street Limited is an auto parts manufacturing company. The Company offers
product warranty to its customers. You are senior incharge on the audit of the Company for
the financial year ended December 31, 2008. While reviewing the draft balance sheet, you
have noted that the provision for product warranties has increased to Rs. 150 million as
compared to Rs. 85 million in the previous year. The Company’s profit after taxation as
appearing in the draft profit and loss account is Rs. 50 million. Considering the
significance of this change, you have decided to carry out a detailed test to verify the
amount.
Required:
(a) Describe the matters that should be discussed with the senior management while
carrying out the above verification.
(05)
(b) State the audit procedures to be performed in order to conclude that product warranty
liabilities are fairly stated in the financial statements of the Company.
(10)
Q.4
You are involved as a senior in auditing the financial statements of Blue Limited (BL), a
listed company, for the year ended December 31, 2008. While reviewing draft financial
statements you have noted that BL has material investments in two local private limited
companies and a joint venture company operating in the UAE. You have identified the
following risk indicators:
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
the investee companies have different year end than the investor company;
one of the investee is a foreign operation;
significant transactions between the investee and investor companies;
poor operating results and financial condition of one of the investee company;
the investor has guaranteed the debts of one of the investee company;
one of the investee’s financial statements are audited by another firm.
Required:
In view of the above Risk Indicators, identify the possible implications that might be of
significance to the audit team in assessing the risk of misstatements affecting the
investments made by the company.
(09)
Q.5
You have recently completed the audit of Rubi Limited (RL), a multinational company, for
the year ended December 31, 2008. The Chief Financial Officer (CFO) of the company has
now approached you for a report on book value per share, as of December 31, 2008 for
submission to the regulatory authorities.
Following is an extract from the audited balance sheet of RL as at December 31, 2008:
Issued, subscribed and paid-up share capital
(400,000 ordinary shares of Rs. 10 each)
Accumulated profits
Unrealized gain on revaluation of investments
Surplus on revaluation of fixed assets – net of tax
Rupees
4,000,000
2,000,000
500,000
600,000
The auditor’s opinion on the financial statements for the year ended December 31, 2008
was qualified as deferred tax asset amounting to Rs. 5 million was not recognized in the
financial statements.
Required:
Draft a report for submission to the client. Show necessary calculations related to the
figures disclosed in the report.
(15)
(3)
Q.6
You have worked as a job in charge on the audit of financial statements of a multinational
listed company, engaged in pharmaceutical business. During the course of your audit, you
became aware of various facts and details about the company.
It was a long engagement for which you had to move out of the city of your residence.
Consequently, a number of people around you, including family, friends and colleagues,
are aware of the fact that you were job in charge on the said audit. Some of them are
interested in having certain information as discussed below:
(a)
(b)
(c)
(d)
(e)
(f)
One of your close relative has got an offer for appointment as director marketing of
the said client. He wants to be aware of the levels of remuneration at comparable
positions in order to negotiate his remuneration properly.
A manager in your firm (other than the engagement manager for the said client) has
inquired about the internal controls in place, in respect of a specific process.
Assuming that the same would be effective, he intends to recommend the same as
best practice to a local pharmaceutical client.
Your sister has asked you about the ingredients of a specialized nutritional product
for children, being marketed by the company, which she is using for her child. You
are aware of all the details about the said product, as you got the opportunity to
perform tests on the costing of that product.
One of your friends is working in the Ministry of Health, Government of Pakistan.
He has asked you as to whether the company has complied with certain statutory
requirements. You are aware of the fact that the company is not complying with the
same and you have already included the matter in the management letter. With
reference to specific provisions of law, he has convinced you that it is his duty to
enquire about the same, and you are responsible to disclose the relevant information
to the Ministry. He has also informed you that in case of no response, you may be
served with a legal notice.
Your younger brother intends to commence distribution business. He has asked you
about the rate of commission and volume rebates being allowed by the said client to
its distributors, as he wants to work out the feasibility of business.
Your father invests his surplus funds in the capital market. Being aware of the fact
that companies like that always have a five to ten year’s plan in place. He has asked
you about the trend of earnings per share of the said company for the last five years,
and the expected growth in the net profits for the next five years.
Required:
Discuss each situation to conclude as to whether or not you can provide the requisite
information and the extent to which the same can be disclosed without compromising the
professional ethics. Support your conclusions, with appropriate arguments.
(10)
Q.7
You are employed as audit manager in Saleem and Company, Chartered Accountants, who
have been appointed by Indigo Private Limited to prepare certain financial information.
The management has informed that the information would be submitted to prospective
private investors in a foreign country and the fact that the information has been prepared by
your firm shall also be disclosed therein.
While preparing the financial information you identified that current maturity of a long
term loan amounting to Rs. 100 million has been shown as a long term liability, in the
books of account. The management disagrees with your observations and believes that the
amount should be disclosed as a long term liability. To support their point of view they
have informed you that their negotiations with the lenders are at the advanced stages and
the agreement for restructuring will be signed soon after the date on which the information
is due for submission.
Required:
Draft a suitable report to address the above situation.
(07)
(4)
Q.8
You are the partner in charge of your Firm’s risk management department and in the said
capacity your responsibilities interalia include advising the firm’s engagement partners /
managers on different aspects of the assurance and non assurance services, in accordance
with the applicable regulatory and independence framework. You have been requested for
guidance on the following issues:
(i)
(ii)
(iii)
Olive Limited has approached your firm to act as their advisors to the first public
issue of the company which shall be used to finance a new project. Your
responsibilities would include drafting the prospectus, assistance in completing
listing formalities and negotiations with and appointment of Bankers to the issue.
Previously you have also carried out a due diligence exercise in respect of the said
project. Olive limited has suggested different fee levels corresponding to the amount
of eventual subscription received.
Crimson Limited, an unlisted audit client has engaged a software company to
automate its accounting and finance functions. The company wants to engage your
firm to help in the implementation of the system.
Your firm has availed credit facility from Rose Bank Limited. You have a long
association with the bank and it has also been providing various other services to
your firm and its partners. The amount of loan to the firm is approximately one
percent of the firm’s total assets. The management of the bank has approached the
firm for appointment as statutory auditors.
Required:
(a) Advise the concerned partners/managers as regards the acceptance of the above
assignments.
(b) Suggest possible modification in the scope or terms of engagement or possible
safeguards, if any, to avail the opportunities within permissible limits.
(12)
Q.9
Develop audit work programs in respect of dividend to shareholders stating therein the
related assertions, audit objectives and substantive audit procedures.
(THE END)
(12)
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2009
Ans.1
(i)
Effect on Financial Statement
The amount due from Express represents
19.5% of profit before tax and is therefore
material by size. Consequently,
• provision should be made for the
outstanding amount to the extent
that it is not recoverable. Or
• Disclosure should be made if there
is an uncertainty as to the outcome
of the liquidation.
Effect on Audit Report
If the management fails to provide for the
outstanding debt or disclose the facts, the opinion
would be qualified on grounds of disagreement as
the amount is material.
Express is a major customer of BL as 35% The audit report will be modified in the form of
of its revenue is earned from it. Its inclusion of an “emphasis of matter” paragraph.
liquidation may caste significant doubt on
BL’s ability to continue as going concern.
In that case a disclosure should be made.
The amount involved is potentially
material as Rs. 10 million is 4% of total
assets and around 33% of profit before tax.
A disclosure should be given describing
the situation in the financial statements as
the circumstances give rise to a significant
uncertainty which could have an impact on
the financial statements.
ƒ If the management agrees to include a note
explaining the issue, the report will be
modified by including an emphasis of matter
paragraph.
ƒ If the directors refuse to include a note in the
financial statements or the note is inadequate,
the opinion should be qualified due to
disagreement.
(iii) Repair and maintenance cost is a revenue
expenditure and should be charged to the
profit and loss account.
ƒ Although there is disagreement over the
accounting treatment of the repairs and
maintenance costs, the amount is not material
as it is only 3.6% of profit before tax and
0.45% of total assets.
ƒ There is no need to modify the audit report as
long as any unadjusted errors in aggregate do
not exceed the materiality threshold.
ƒ Matter should be reported in Management
letter.
(ii)
(iv)
Any tax paid at import stage under FTR
should be recognized as a tax expense in
the period in which the related goods are
sold.
Accordingly, the portion of the tax paid
that pertains to the unsold inventory should
be carried forward in the balance sheet as
prepaid tax, subject to the following
conditions:
ƒ
Amount involved is 3.3% of profit before
tax and 0.4% of total assets and therefore is
not material.
ƒ
There is no need to modify the audit report
as long as any unadjusted errors in aggregate
do not exceed the materiality threshold.
ƒ
Matter should be reported in Management
Letter unless the error is rectified.
ƒ It is probable that the sale of imported
goods would result in sufficient future
taxable profits;
Page 1 of 8
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2009
ƒ The carry forward of tax shall not relate
to the inventories written down to net
realizable value in accordance with IAS
2 “Inventories”;
ƒ The tax to be carried forward as
explained above shall not constitute
value of inventories;
Ans.2
(a)
(b)
Ans.3
If it is finally concluded that Haroon Private Limited is not a going concern, advise the client that
the financial statements should be prepared on the alternative authoritative base as follows:
ƒ
ƒ
ƒ
ƒ
assets to be valued at recoverable amounts;
all assets and liabilities to be classified as current assets; and
a note in the financial statements disclosing that HPL is not a going concern.
recording of additional liabilities such as redundancy cost etc
ƒ
Auditors will ensure that alternative approach as discussed in (a) above has been properly
applied and adequate disclosures are made accordingly.
ƒ
If auditors are satisfied by the alternative approach and disclosures, they can issue
unqualified opinion. An emphasis of matter paragraph referring to the note in the financial
statements, describing the going concern situation may be included.
(c)
Adverse opinion:
In our opinion, because of the effects of the matters discussed in the preceding paragraph(s), the
financial statements do not give a true and fair view of the financial position of Haroon Private
Limited as of December 31, 2008, and of its financial performance and its cash flows for the
year then ended, in accordance with International Financial Reporting Standards”.
(a)
The following matters should be discussed with the management:
ƒ Change in operating policies and procedures that would affect warranties;
ƒ The types of warranty coverage offered by the Company; (General, special, extended etc.);
ƒ The factors that affect warranty coverage, such as volume purchased, type of installation,
change in warranty period, alterations to basic product, etc.;
ƒ Any production problems or possible changes in operations that are resulting in increased
warranty costs. Also, consider if the problems are isolated or generic; and
ƒ Any implicit/ implied warranty obligations that exist based on common industry practice.
ƒ Involvement of any expert.
ƒ Procedures used to calculate estimated costs of warranty repairs;
ƒ Whether there is change in sales volume from last year that affected the warranty
ƒ Other reasons for major variations.
(b)
Audit Procedures
¾ Review contracts, sale agreements and/or sales catalogs to verify the terms and provisions of
warranty coverage;
¾ Review contract files, correspondence files, and/or production reports that may indicate
potential warranty problems;
¾ Test estimated costs to complete warranty repairs by:
ƒ Reviewing current estimates of warranty repair cost and compare it with the actual costs
incurred after the balance sheet date;
ƒ Comparison of estimate made for prior periods with actual results for those periods.
ƒ Compare current estimates of warranty repair cost for selected items with their prior
warranty actual cost
ƒ Reviewing supports of estimated warranty repair cost by component (material, labor and
overhead).
Page 2 of 8
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2009
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
ƒ
Ans.4
(i)
(ii)
Consider the appropriateness of the Company’s model (cost estimation method) and test
the accuracy of its application to the relevant date;
Develop an alternative model to test the reasonableness of the provision;
Obtain direct confirmations from the customers;
Review confirmations from legal advisors to identify major disputes with any of the
customers;
Review a summary of items included in the provision for completeness and unusual
items;
Consider penalties and/or other costs associated with warranty or other performance
guarantees in determining the provision.
For new products, determine whether the Company has developed a reasonable basis for
providing warranty costs;
Review activity in the provision and the related expense accounts;
Risk Indicator
Significance/ possible Implication
The investee companies have different Failure to account for or disclose significant
year end than the investor company;
transactions occurring between the investees’ and
investor’s year end.
One of the investee is a foreign operations;
ƒ
ƒ
ƒ
ƒ
(iii)
Significant transactions between
investees and investor companies;
the
ƒ
improper elimination of intercompany
profits, (in case of consolidation)
ƒ
increased risk of inadequate disclosure of
related-party transactions
Risk of non arms length transactions
ƒ
Ans.5
due to Foreign currency fluctuations,
translations may not have been done
accurately
potential expropriation of assets
potential lack of reliable information
regarding the investee’s operations
different basis of accounting
(iv)
Poor operating results and financial Uncertainty regarding the
condition of one of the investee company; investment in such company.
(v)
The investor has guaranteed the debts of
one of the investee company;
(vi)
The investees’ financial statements are Misstatement due to the audit team’s reliance on
audited by another firm.
these financial statements and failure of the other
auditor to follow the appropriate standards.
The Board of Directors
RL Limited (the Company)
Karachi
ƒ
ƒ
realizibility
of
Inadequate disclosure of guarantees.
Failure to disclose or provide for any
liability that may have been due under the
guarantee agreement.
08 March 2009
Dear Sirs
BOOK VALUE PER SHARE BASED ON THE AUDITED BALANCE SHEET AS AT 31
DECEMBER 2008
Page 3 of 8
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2009
We have examined the annexed Statement of Book Value Per Share (the Statement) of the company as
at 31 December 2008 duly initialed by us for identification purposes. The book value per share has
been determined on the basis of audited balance sheet of the company as at December 31, 2008 in
accordance with the directives of the Institute of Chartered Accountants of Pakistan contained in
Technical Release 22 “Book Value Per Share” (TR-22) and we report that
The Statement is the responsibility of the Management of the Company. Our responsibility is to
examine the Statement and report thereon.
In our opinion, the Statement is presented fairly in all material respects in accordance with TR-22 of
the Institute of Chartered Accountants of Pakistan.
The book value per share of the face value of Rs. 10 each, taking into consideration, surplus on
revaluation of fixed assets, works out to Rs. 30.25 per share.
The book value per share of the face value of Rs. 10 each without taking into consideration surplus on
revaluation of fixed assets works out to Rs. 28.75 per share.
This report is being issued at the specific request of the company to meet the regulatory requirements
and it should not be used for any other purpose or circulated to any one else without our prior written
consent.
Yours faithfully
ALTERNATE REPORT BASED ON AGREED UPON PROCEDURES ENGAGEMENT
REPORT OF FACTUAL FINDINGS
The Board of Directors
RL limited ( the Company)
Karachi
Dear Sirs
We have performed the procedures agreed with you and enumerated below with respect to the book
value per share as of December 31, 2008, as set forth in the accompanying statement. Our engagement
was undertaken in accordance with the International Standard on Related Services applicable to
agreed-upon procedures engagements. The procedures were performed solely to assist you in
evaluating the validity of the book value per share and its submission to regulatory authorities and are
summarized as follows:
1. We obtained the statement of book value per share as prepared by management and compared
the information with the audited financial statements as at December 31, 2008.
2. We checked that the calculation of the book value per share is in accordance with the
directives of the Institute of Chartered Accountants of Pakistan contained in Technical Release
22 “Book Value Per Share”
We report our findings below:
(a)
The book value per share of the face value of Rs. 10 each, taking into consideration, surplus
Page 4 of 8
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2009
on revaluation of fixed assets, works out to Rs. 30.25 per share.
(b)
The book value per share of the face value of Rs. 10 each without taking into consideration
surplus on revaluation of fixed assets works out to Rs. 28.75 per share.
Because the above procedures do not constitute either an audit or a review made in accordance with
International Standards on Auditing or International Standards on Review Engagements (or relevant
national standards or practices), we do not express any assurance on the book value per share as of
December 31, 2008.
Had we performed additional procedures in accordance with International Standards on Auditing or
International Standards on Review Engagements (or relevant national standards or practices), other
matters might have come to our attention that would have been reported to you.
Our report is solely for the purpose set forth in the first paragraph of this report and for your
information and is not to be used for any other purpose or to be distributed to any other parties. This
report relates only to the item specified above and does not extend to any financial statements of RL
Limited (the Company), taken as a whole.
AUDITOR
Date Address
RUBY LIMITED
BOOK VALUE PER SHARE
(With and without surplus on revaluation of fixed assets)
As at December 31, 2008
Issued, subscribed and paid-up capital
Accumulated profit
Unrealized gain on revaluation of investments
Surplus on revaluation of fixed assets
*Deferred tax asset (not recognized in the financial statements)
Number of ordinary shares of Rs. 10 each, issued for cash
Book value per ordinary share of Rs. 10 each
With
Without
surplus
surplus
------ Rupees -----4,000,000
4,000,000
2,000,000
2,000,000
500,000
500,000
600,000
5,000,000
5,000,000
12,100,000
11,500,000
400,000
400,000
30.25
28.75
(*Included in the computation because the audit report was qualified on this issue and the qualification
was quantified)
Ans.6
(a)
Information requested can be disclosed, to the extent of the remuneration of the chief executive,
because in case of a public listed entity, it is public information.
The information related to executive directors is disclosed in the financial statements on
aggregate basis, hence it is not public and it would not be appropriate to disclose the same.
(b)
You cannot provide him the information directly about his question, as according to the code of
ethics, the confidentiality is applicable even in case of colleagues within the firm.
Page 5 of 8
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2009
However, code of ethics does not restrict the professional accountant to use his/her prior
knowledge and experience, even on a new job. Accordingly, you can use your knowledge as
benchmarks, if you form your independent view that these are appropriate for consideration as
benchmarks.
(c)
Information can be disclosed to the extent to which the details are made public by the company,
which is a common practice and requirement of law in the nutrition sector.
(d)
According to the Code of Ethics, a professional accountant may be required to disclose
confidential information when:
ƒ disclosure is permitted by law and is authorized by the client or the employer.
ƒ disclosure is required by law. (For example in the course of legal proceedings or disclosure to
appropriate public authorities if infringement of law is discovered.)
In case a written notice is received from the Ministry of Health, the relevant information may be
provided after ensuring that it is actually required by law. However, even in such case, the client
should at least be informed before sending the information.
Ans.7
(e)
You cannot provide any information.
(f)
Past information of earnings per share may be disclosed, as the same is public information but
future projections should not be disclosed as it is a confidential information of the entity.
COMPILATION REPORT TO BOARD OF DIRECTOR
On the basis of information provided by management we have compiled, in accordance with the
International Standard on Related Services applicable to compilation engagements, the balance sheet
of Indigo (Private) Limited as of December 31, 2008 and statements of income and cash flows for the
year then ended in accordance with the approved accounting standards as applicable in Pakistan.
Management is responsible for these financial statements. We have not audited or reviewed these
financial statements and accordingly express no assurance thereon.
We draw attention to Note X to the financial statements because the management has disclosed the
current maturity of loan amounting to Rs. 100 million as a long term liability which is a departure
from the requirement of international accounting standard.
ACCOUNTANT
Date
Address
Ans.8
(i)
(a) ƒ Since Olive Limited is not an audit client, therefore the requested services may be
provided.
ƒ In term of the Chartered Accountants Ordinance, 1961 and the code of ethics a member
should not enter into any contingent or conditional fee arrangement and the member is
guilty of professional misconduct if he/she enters into such arrangement. Hence, fee
based on amount of subscription received should not be agreed upon.
(b) An appropriate caveat should be built in the engagement letter wherein we should describe
the management’s responsibility and disassociate the firm from the responsibility of taking
management decisions on behalf of the client. The fee arrangement should be reconsidered
and brought in line with permissible mode like fixed fee or hours charged basis.
Page 6 of 8
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2009
(ii) (a) Since the company is unlisted, therefore accepting such an assignment is not altogether
restricted by ICAP’s code of ethics. However, provision of such services may create self
review threat.
(b) In order to address the issue of self review threat the auditor should apply appropriate
safeguards i.e. ensure that:
ƒ The client acknowledges its responsibility for establishing and monitoring the system of
internal controls.
ƒ The client makes all management decisions with respect to the design and
implementation process.
ƒ The client evaluates the adequacy and results of the design and implementation of the
system.
ƒ The client is responsible for the operation of the system (hardware or software) and the
data used or generated by the system.
ƒ The team engaged on the assignment should be different from the team employed on the
audit engagement.
(iii) (a) In terms of the provisions of the Companies Ordinance, 1984 a person who is indebted to the
company is disqualified to be appointed as the auditor of that company. Therefore
appointment will not be lawful. However IFAC code of ethics allows entering business
relationship with audit clients provided the terms should not be softer than those offered to
other customers.
(b) If the firm is interested in appointment as auditors then it would have to discharge all
amounts owed to Rose Bank Limited, to become eligible for appointment.
Ans.9
(A)
AUDIT OBJECTIVES
To determine whether:
(a)
All liabilities on account of unclaimed/unpaid dividends are properly recorded and represent
valid liabilities of the entity at the balance sheet date.
(b)
These are properly described and classified and adequate disclosures with respect to these
amounts have been made.
(c)
Zakat has been adequately deducted and deposited in the Central Zakat Fund according to the
requirements of Zakat and Ushr Ordinance, 1980 and Rules made there under.
(d)
Dividends have been paid within stipulated time.
(B) ASSERTIONS AND SUBSTANTIVE PROCEDURES
1. Recording of liability / dividend declared
Assertions addressed
(i)
Rights and obligations
(ii)
Completeness
(iii)
Existence
(iv)
Valuation and allocation
Procedures
(i)
See authority of Board and / or general meeting for all dividends declared.
(ii)
Agree capital on which dividend is paid with issued capital.
(iii)
Ensure that any unpaid / unclaimed amount of dividends is adequately disclosed.
(iv)
Ensure that dividends are paid out of profits only.
(v)
Ensure that no dividend is paid out of profits from sale or disposal of any
Page 7 of 8
ADVANCED AUDITING
Suggested Answer
Final Examinations – Summer 2009
(vi)
2.
immovable property / asset of capital nature.
In case of stock dividend the following steps would be performed:
ƒ Ensure that Companies Issue of Capital Rules, 1996 have been complied
properly.
ƒ Ensure that free reserve and surplus retained after the issue of bonus shares will
not be less than 25% of the increased capital.
ƒ Obtain confirmation from CDC to check issue of bonus shares.
Payments
Assertions addressed
(i)
Occurrence
(ii)
Completeness
(iii)
Accuracy
(iv)
Cut-off
Procedures
(i)
Ensure that dividend warrants are issued in the name of registered shareholders or
to their order.
(ii)
Ensure that dividend is paid within 45 days of declaration thereof (or 30 days in
case of a private company by such)/by such time as specified by commissioner.
(iii)
Ensure that withholding tax has been properly deducted from cash dividend.
(iv)
Ensure compliance with Foreign Exchange Act, 1947 including nomination of
authorized dealer and permission from SBP in respect of for remittance of dividend
to foreign shareholders.
(v)
Obtain reconciliations in respect of dividends related to prior years and check the
movement on test basis.
Zakat
(i)
Check the cases where Zakat has not been deducted to ensure that those are not in
violation of Zakat and Ushr Ordinance, 1980 and relevant Rules.
(ii)
Check Zakat exemption declarations on test basis, where applicable.
(iii)
Check deposit challan for payment of Zakat in the Central Zakat Fund.
3. Disclosure
Assertions addressed
(i)
Occurrence & rights and obligation
(ii)
Classification and understandability
(iii)
Completeness
Procedures
(i)
Ensure appropriate disclosure have been made in accordance with the reporting
framework.
(ii)
Fill relevant portion of Financial Statement Disclosure Checklist (FSDCL).
(THE END)
Page 8 of 8
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations Winter 2009
December 11, 2009
ADVANCED AUDITING
(MARKS 100)
(3 hours)
Q.1 Mr. Ansari who represents ABC & Company, Chartered Accountants, is the manager
responsible for the first year audit of Stello Limited (SL) for the year ending December 31,
2009. Previously the financial statements were audited by a very well reputed audit firm.
ABC & Company has now been appointed as the auditors, in pursuance of SL’s policy
according to which the statutory auditors are to be rotated after every five years.
While reviewing the working papers at the planning stage, Mr. Ansari became aware of the
following facts:
Background
The main business of the company is the operation of smelting plants that produce steel from
iron ore. The company was founded almost five years ago by a group of entrepreneurs. Its
managing director is Mr. Sami who has vast experience of working in reputed national and
international companies. Since inception, the company has experienced exceptional growth.
To generate funds for some of its future plans, the management is considering to get the
company listed before December 2010. The management expects to raise Rs. 700 million by
issuing 50 million ordinary shares at a premium of Rs. 4 per share.
Management Policies
The company has developed a sound system of Corporate Governance. Most of the executive
heads are experienced professionals. The company believes in employing a satisfied
workforce. In addition to competitive market based salaries, it also offers performance based
bonuses at all levels, including the senior management.
System of Accounting and Controls
The review of working papers indicates that the company has developed a sound accounting
and reporting system. The company has recently installed a state of the art accounting
software. However, as regards the system of disposal of scrap, the concerned engagement
team member had made the following observations:



The sale and disposal of scrap is managed by Mr. Sultan who is an Assistant Manager
and reports to the Senior Manager Marketing.
The scrap generated is collected by a local merchant on a daily basis. The rate is
negotiated by Mr. Sultan once every three months.
Only Mr. Sultan is authorised to sign the gate pass but quite often, in his absence, it is
signed by the delivery clerk.
Operating Results and Projections
The compound annual growth in company’s earnings over the last three years has exceeded
20% per annum and the projected earnings growth for the year ending December 31, 2009 is
in excess of 35%. The growth is mainly on account of profitable contracts which the
company has secured with two local manufacturers.
(2)
Some of the important events that have taken place during the current year are as follows:
Acquisition of Neptune Enterprise
On July 1, 2009 Stello Limited acquired 80% shares of Neptune Limited, a company based
in Argentina. This company manufactures steel products that are sold in its local markets.
The purchase was financed by means of a foreign currency loan. The loan is repayable in
five equal annual installments, commencing on July 1, 2010. The financial year-end of
Neptune Limited is June 30.
Major Capital Expenditure
The company has increased the production capacity of one of its plant. Land was acquired
for the purpose from a company in which a friend of Mr. Sami is the majority shareholder.
Plant and machinery was supplied by Big Manufacturer (Pvt.) Ltd. (BMPL). Although a
lower quote was received from another supplier, the Board decided in favour of BMPL as it
had a long standing business relationship with Stello whereas the other supplier was
considered to be too inexperienced.
Required:
(a) Evaluate the above situation and briefly discuss the key risk areas that Mr. Ansari
should consider while planning the audit.
(b)
Q.2 (a)
List three key audit procedures which the auditors may like to undertake, in the
above circumstances, in respect of each of the following:
(i)
Foreign currency loan
(ii) Capital expenditure
(06)
Red Sea Company Limited (RSCL) builds ships and constructs oil rigs for the offshore
oil industry. Under one of the contracts with Black Oil Company Limited, RSCL was
required to construct a rig for drilling oil, off the coast of Makran. The oil rig should
have been completed by April 30, 2009 but on account of delays and technical
problems, it is not expected to be completed until February 28, 2010. Consequently
Black Oil Company Limited has cancelled the contract and lodged a claim for damages
amounting to Rs. 150 million. This claim for damages was lodged by Black Oil
Company Limited on August 29, 2009 and it has been disclosed as a contingency, in
RSCL’s financial statements for the year ended September 30, 2009.
Required:
Describe the work that the auditor should carry out in the above situation, to determine
whether the accounting treatment and related disclosures, if any, in the financial
statements of Red Sea Company Limited for the year ended September 30, 2009 are
appropriate.
(b)
(19)
(12)
You are the senior responsible for the audit of Iqra Industries Limited (IIL). During the
course of the audit you became aware that a legal action has been instituted against IIL
by some of its customers, on account of disputes related to performance of its products.
In response to your request for an opinion the company’s lawyer has simply stated that
“We are totally unable to give any estimate”.
No provision was made in the financial statements for the possible loss as a result of
the claims (which are considered to be material) or for the related legal expenses,
although details of those legal claims were fully disclosed in the notes.
Required:
Comment on the implication of the above matter on the auditors’ report and the
financial statements of IIL.
(04)
(3)
Q.3 Mr. Omar is incharge of the quality control department of an audit firm. While reviewing the
working papers relating to some audit engagements of the firm he came across the following
situations:
(i)
The spouse of a partner in the firm is a legal consultant and is assisting an audit client
of that firm in filing its tax return.
(ii) The audit manager engaged on the audit of a company has been offered a job by that
company. He has been asked to join on March 1, 2010 when the current CFO would
retire. The audit is expected to be completed on December 15, 2009.
(iii) A meeting of the CEO of ABC & Company Limited and the audit engagement partner
was held to discuss the draft financial statements of the company for the year ended
September 30, 2009. Serious difference emerged between the two sides on the
accounting treatment and the disclosures of certain items and consequently the CEO
informed the engagement partner that unless the auditors agree to the company’s point
of view, they would not be reappointed for the next year.
(iv) The engagement partner on the audit of XYZ Limited has been its engagement partner
for the past six years.
Required:
Identify the category of threat involved in each of the situations described above and explain
how would it affect the objectivity and independence of the auditor. Also explain the
responsibility (if any) of the firm and the concerned member of the audit team.
Q.4
(11)
You are the manager incharge responsible for the audit of Day Pharma Limited, a subsidiary
of a multinational pharmaceutical company. One of the drugs being imported/marketed by
the company is VITABE. It was introduced a few months back but contributes significantly
to the company’s revenues. While the audit was in progress, you came across a news item in
a well known publication, according to which the authorities in many countries have banned
the use of VITABE as some of its ingredients were considered dangerous for human health
and required further testing. While going through some files you have discovered that the
parent company had informed Day Pharma Limited about the harmful effects of the drug.
However, it had not given any further instruction in this regard.
You have discussed this matter with the CEO who has informed you that the company had
not called off the medicine nor has it provided any information in this regard to the users of
the drug or the general public as the management is of the view that there is very limited risk
of any harm being caused by the drug. However, you had discussed this matter with a senior
physician who believes that these types of products are also banned in Pakistan.
Required:
Assess the above situation and describe what measures the auditor should take in such
circumstances.
(14)
Q.5 Raza & Company, Chartered Accountants is an old and well reputed audit firm. It has been
growing at a rapid pace with the result that the partners of the firm had been unable to devote
much time to various important issues. In view of your experience, they have inducted you as
a partner, with the primary responsibility of improving the firm’s systems and procedures.
The major issues that have attracted your immediate attention relate to human resources,
audit documentation and client acceptance and retention procedures.
Required:
(a) How would you evaluate the firm’s HR requirements and what steps would you take to
ensure that adequate human resources are available within the firm?
(b) Identify the situations under which you would recommend declining an assurance
engagement or consider resigning from the current engagement.
(c) Recommend how an engagement team member should evaluate as to what type of audit
documentation is required to be prepared in a particular situation.
(05)
(03)
(03)
(4)
Q.6 While reviewing the working papers to assess compliance with the Code of Corporate
Governance, the auditors of Fair Limited (FL), a listed company, came across the following
information:
(i)
The Board of Directors of FL comprises of ten directors. Mr. Muneer and Mr. Sualah
are the only non-executive directors on the Board. The chairman of the Board is Mr.
Saleem, who is also the chief executive of the company.
(ii) During the year, the board met four times. Due to his preoccupation, Mr. Kamal who is
the chief financial officer of the company could not attend an important board meeting
in which the half yearly accounts were approved.
(iii) One of the directors purchased 16% of FL’s shares on March 17, 2009. He
communicated this information to the Board of Directors in the meeting held on March
26, 2009.
(iv) FL has an audit committee which comprises of three members, including its chairman,
Mr. Waqar. The company’s internal audit department is headed by a Chartered
Accountant who reports to the audit committee.
Required:
(a) Draft the concluding paragraph of the review report to the members on the company’s
Statement of Compliance with the Best Practices of the Code of Corporate
Governance, including qualifications (if any). A full report is not required.
(b) Give brief reasons to support your point of view, in respect of matters which have not
been considered for reporting as a qualification.
(08)
(04)
Q.7 You are the auditor of Blue Sky Limited (BSL). The draft consolidated financial statements
of BSL and its subsidiary Sea Green Limited (SGL) for the year ended September 30, 2009
show a profit before taxation of Rs. 10.5 million (2008 : Rs. 9.4 million) and net assets of Rs.
55.2 million (2008 : Rs. 50.7 million). You have performed the audit procedures you
considered necessary for the year ended September 30, 2009 and are satisfied with the results
of those procedures.
However, your firm is also the auditor of Sea Green Limited (SGL). You were appointed as
SGL’s auditors for the year ended September 30, 2009 after BSL acquired 90% shares of
SGL on June 30, 2008. SGL’s draft financial statements for the year ended September 30,
2009 show profit before taxation of Rs. 0.7 million (2008: Rs. 1.7 million) and net assets of
Rs. 16.1 million (2008: Rs. 16.6 million). Both the companies are exempt from tax.
The previous auditors’ report on SGL’s financial statements, for the year ended September
30, 2008 was unmodified. However, during the audit of SGL it was discovered that due to an
error, the inventory as appearing in the audited financial statements for the year ended
September 30, 2007 was overvalued by Rs. 5.7 million. This amount is now being adjusted
by SGL over a period of three years i.e. over the years ended September 2008 to 2010.
You have approached the management advising them to adjust the full amount in the current
year. However, the management is not willing to accept your point of view.
Required:
Draft the modification paragraph of the report which you would issue on the consolidated
financial statements, in the above situation. (A full report is not required)
(THE END)
(11)
Ans.1
(a)
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2009
Key Risk Areas
(i)
Since it is the first year of audit there is a risk of misstatement of opening balances. The
auditor will also have to make arrangements for communication with the predecessor
auditor.
(ii)
To generate funds to support exceptional growth, the management is planning to get the
company listed and wants to issue shares on premium. This aspect might create risk that
assets and profits figures could be manipulated as the company has to fulfill the conditions
of SECP according to which ( besides other conditions) company shall have profitable
operational records of at least one year and full justification for premium need to be
disclosed in the prospectus.
(iii)
Company offers performance based bonuses at all levels, including the senior
management. This aspect might create risk that revenue/ profits figures could be
manipulated to show the desired performance by the management.
(iv)
The company has recently installed a state of the art accounting software. New system
could lead to errors in reports / statement derived from it.
(v)
lack of segregation of duties in the scrap sales process.
(vi)
Significant sales of the company are to few major customers with whom the company
seems to have close relationship. There is a risk of manipulation in revenue, since the
close relationship with the customers might lead to fraudulent connivance.
(vii)
Accounting and taxation implications of the acquisition of the foreign subsidiary,
complexity of which may cause misstatement due to error .
These include:
 Consolidation as per Companies Ordinance, 1984.
 Different year-end of the Argentinean subsidiary.
 Foreign currency translation
 Non-compliance with (IAS 21)
 Impairment of Goodwill.
(viii) The purchase of a foreign subsidiary was financed by means of a foreign currency loan.
Related implications are.
 Initial recognition as per IAS 39.
 Prevailing exchange rate application for conversion
(b)
(ix)
Land was acquired from a company in which a friend of Mr. Sami is the majority
shareholder. Hence, there is a risk that this relationship may have resulted in a non arms
length transaction.
(x)
Risk of inappropriate valuation of land.
Foreign Currency Loan
 Check the conversion of the foreign currency loan into presentation currency.
 Obtain direct confirmation from the lender.
 Review the foreign currency agreement to ensure that the loan has been appropriately disclosed
in the financial statements.
 Review compliance with foreign exchange regulation/registration with SBP.
Capital Expenditure
 Assess the value of land and plant and machinery using available resources/data or consider
hiring an expert.
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2009
 Review the necessary documentation including minutes of meetings of the directors, to assess
that each of them is an arm’s length transaction.
 Check title deeds and other related documents.
 Check physical existences
 Check whether feasibility of the plant has been made.
Ans.2
(a)
Suggested audit work:
 Examine the contract paying specific attention to the following:
 Clauses relating to delays or breaches of contract and consequential provision for
damages relating to the above.
 Under what circumstances a contract can be cancelled. Can it be cancelled only on
account of delay?
 Examine all correspondence relating to the alleged breach of contract. This would include
correspondence between Red Sea Company Limited and Black Oil Company Limited and
between their legal advisors.
 Obtain confirmation from Black Oil Company.
 Review subsequent events.
 With the permission of the client, approach the company’ solicitors and ask their opinion on
the likelihood of the success of the action and an estimate of the likely damages.
 Assuming that the amount involved is material enough, the auditor would also have to
consider obtaining legal advice from an independent source.
 Consider the impact of the situation on revenue recognition, based on the terms of the
contract.
 Evaluate the appropriateness of the assumptions used by the management in determining the
financial consequences of the claim and whether it includes all the information that was
relevant and existed at the time the estimate was made.
 Consider whether the management has appropriately disclosed the contingency with respect to
the nature and potential financial consequences in the respective notes to the financial
statements.
 If the contract with Black Oil Company Limited was material for the profitability and
sustainability of the Red Sea Company Limited consider whether there is a doubt as to the
Company’s ability to continue as a going concern, in such a case the auditor would consider
performing related audit procedures.
 Obtain specific representation from management regarding the existence, completeness and
disclosure of contingencies in the financial statements.
 If the matter is properly accounted for and disclosed, consider giving an emphasis of the
matter paragraph otherwise consider a qualified or an adverse opinion. The materiality of the
amount will have to be taken into account.
(b)
Significant uncertainty regarding litigation
The ultimate outcome of the matter cannot presently be determined and therefore there is a
significant uncertainty the resolution of which is dependent upon future events.
Since it is not possible to reliably estimate the amount of loss accounting treatment of not
recognizing the provision and giving of disclosure is correct.
The auditor should consider modifying the auditor’s report by adding an emphasis of matter
paragraph referring to the detailed note in the financial statements.
Ans.3
(i)
This situation does not contain any threat.
(ii)
Self-Interest Threat
Subsequent employment with the assurance client is of personal interest to the audit manager
which will impair the independences and objectivity of the audit manager in the professional
matter.
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2009
Moreover, if the company is listed, then as per Code of Corporate Governance (CCG) it shall not
appoint any member of the audit engagement team or his close relative as its CEO/CFO/Internal
auditor/director at any time during the next 2 years of his/her involvement in the audit. In case its
not a listed company, manager shall immediately inform the engagement partner about his
intentions and the firm should arrange proper replacements.
(iii) Intimidation Threat
The CEO of the client has actually threatened of replacement in case there is a disagreement by
the auditor over the issues.
Partner should discuss the issue with the other partners in the firm. Disclose to the audit
committee or other charged with governance and may decide to withdraw from the current year
engagement.
(iv) Familiarity Threat
The prolonged period of time during which partner has been the engagement partner could lead to
a close relationship with the company. This could affect his objectivity as he may decide not to
discuss contentious matters with the management, to maintain good relationship.
If the company is listed the firm is required by CCG to rotate the partner incharge after 5 years. If
it is a non-listed company this approach may be followed as best practice to avoid familiarity
threat.
Ans.4
Auditor should perform audit procedures to further confirm this noncompliance of health/safety
regulation. That is
 Inquiring from the original manufacturer of the product.
 Requesting assistance from the audit firm’s branches or associates in the countries where authorities
have banned the product.
If it is probable that the product is harmful or there is potential noncompliance with health and safety
regulations, the auditors should consider the following actions:
(i)
Communicate with those charged with governance/ audit committee/ supervisory board about the
potential noncompliance with the safety regulations.
(ii)
With the permission of client, seek legal opinion from company’s lawyer.
(iii)
Encourage the management of Day Pharma Limited to announce the problem publicly. There
will obviously be reluctance to do this. However, the auditors should try to explain and hopefully
convince the management that this would be the ethically correct way to proceed.
(iv)
Consider the impact of the above situation on the financial statements related audit procedures
and on the auditor’s report specially with respect to the following:
 Any hazardous inventory that would need to be written off.
 Provisions that may become necessary for refund of returned products, when the matter
becomes known.
 Disclosures relating to contingent liabilities that may need to be recognized in respect of
damages that may be claimed by the customers.
(v)
If the auditor concludes that the noncompliance has a material effect on the financial statements,
which has not been properly reflected in the financial statements, the auditor should express a
qualified or an adverse opinion.
(vi)
If the company refuses to disclose the matter itself the auditor should consider whether it need to
communicate with regulatory and enforcement authorities. While making such a decision, the
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2009
(vii)
auditor should consider the requirements of the code of ethics according to which information
discovered while performing a professional engagement must not be disclosed without proper
and specific authority to do so, or unless there is a legal or professional right or duty to disclose.
The auditor may need to seek legal advice in such circumstances, giving due consideration to the
auditor’s responsibility to the public interest.
(viii) Obtain clarification on view of parent company.
(ix)
The auditor may conclude that withdrawal from the engagement is necessary if the entity does
not take the remedial action that the auditor considers necessary in the circumstances. Factors
that would affect the auditor’s decision in this regard, include the following:
 implications on the integrity of the highest authority within the entity which may affect the
reliability of management representations;
 the effects on the auditor, of continuing association with the entity.
If the firm finally decides to resign, it may circularize a ‘statement of circumstances’ which
would describe the reason for the resignation. However, in reaching such a conclusion, the
auditor would ordinarily seek legal advice.
Ans.5
(a)
To evaluate the firm’s HR requirements, we should keep in view the number, nature and size of
the assignments which the firm has to complete.
On the basis of the above, we should evaluate whether the firm has sufficient staff with the
required capabilities; competence; and commitment to ethical principles; to complete these
assignments in accordance with the required standards.
In order to ensure that adequate human resources are available within the firm, the firm shall have
to make and implement appropriate policies to ensure that:
(i) competent and capable staff is hired;
(ii) adequate on the job training and education is provided to them;
(iii) they are properly coached by senior members of the engagement team and staff;
(iv) compensation and promotions are based on merit and the quality of performance.
(b) The auditor should consider declining an assurance engagement or resigning there from, in one or
more of the following situations:
(i) Where client’s integrity is in doubt.
(ii) If the firm does not possess the skills or lacks resources to complete such assignment.
(iii) It is not possible for the firm to comply with ethical requirements.
(iv) When there is a perceived conflict of interest and the issue cannot be resolved.
(v) When for any other reason, the auditor is unable to obtain evidence which is necessary to
form an opinion.
(c)
For evaluating as to what type of audit documentation would be performed in a particular
situation, the engagement team member should consider the following:
(i) the nature of the audit procedures to be performed;
(ii) the identified risks of material misstatement;
(iii) the extent of judgment required in performing the work and evaluating the results;
(iv) the significance of the audit evidence obtained;
(v) the nature and extent of exceptions identified;
(vi) the need to document a conclusion or the basis for a conclusion not readily determinable
from the documentation of the work performed or audit evidence obtained; and
(vii) the audit methodology and tools used.
Ans.6
(a)
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2009
We report that:
(i) The chief financial officer of the company could not attend one of the board meetings where
as the Code requires that CFO should attend all meetings of the Board.
(ii) A director purchased 16% of FL’s shares on March 17, 2009. He communicated the
information to the Board of Directors in their meeting held on March 26, 2009. According to
the code, he should have communicated the information immediately to the company
secretary in writing and that a written record of price, number of shares, form of share
certificate and nature of transactions should have been delivered to the company secretary
within 4 days of affecting the transactions.
Based on our review, except for the matters stated in paragraphs (i) and (ii) above, nothing has
come to our attention which causes us to believe that the Statement of Compliance does not
appropriately reflect the Company’s compliance, in all material respects, with the best practices
contained in the Code of Corporate Governance, effective for the year ended 30 June 20XX.
(b) Situations which have not been considered for reporting as a qualification
(i)
Board comprised only 2 non-executive directors. It means that executive directors are 80%.
The Code encourages that executive directors should not be more than 75% of the elected
directors including the chief executive. But it is not mandatory.
(ii) Mr. Saleem is the chief executive officer and chairman. The Code requires that the chairman
should preferably be an independent non-executive director but the requirement is not
mandatory.
(iii)
Ans.7
Audit committee’s chairman is Mr. Waqar who is an executive director. According to the
Code of Corporate Governance, Chairman should preferably be a non- executive director
but the provision is not mandatory.
On September 30, 2007, the inventory of a subsidiary was overvalued by Rs. 5.7 million. The
overvaluation was adjusted to the extent of Rs. 1.9 million during each of the years ended September
30, 2008 and 2009. Consequently the inventory as appearing in the consolidated financial statements for
the year ended September 30, 2009 has been overstated by Rs. 1.9 million. In our opinion, the above
adjustment is not in accordance with the International Accounting Standards which requires that the
overstatement should be rectified retrospectively. Accordingly, the inventory should be reduced by Rs.
1.9 million in the year 2009 and by Rs. 3.8 million in the year 2008, profit for the year should be
increased by Rs. 1.9 million in the year 2009 and by Rs. 0.475 million in 2008, accumulated retained
earnings should be increased by Rs. 2.1375 million in the year 2009 and by Rs. 0.4275 million in the
year 2008, goodwill should be increased by Rs. 3.8475 million in both the years i.e. 2009 and 2008 and
minority interest should be reduced by Rs. 0.19 million in the year 2009 and by Rs. 0.38 million in the
year 2008.
In our opinion, except for the effect on the consolidated financial statements of the matter referred to in
the preceding paragraph, the consolidated financial statements present fairly the financial position of
Blue Sky Limited and its subsidiary as at September 30, 2009 and the result of their operation for the
year then ended.
(THE END)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations
Summer 2010
June 11, 2010
ADVANCED AUDITING
Q.1
(MARKS 100)
(3 hours)
You are the manager in-charge on the annual audit of Decimal World Limited (DWL) for the
year ended December 31, 2009. DWL is a leading manufacturer of electrical appliances.
35% of its shares are held by Binary Pakistan Limited (BPL). However, with the help of
some consenting shareholders, BPL has been able to nominate 5 out of 8 directors on the
Board.
During the planning phase of the audit you became aware of the following matters:
(a) A foreign investor has made a public offer to purchase 51% shares of DWL at a price
of Rs. 13 per share. The share price has ranged between Rs. 12 to Rs. 14 per share
during the past six months.
(b) The company’s statement of financial position includes a deferred tax asset of Rs. 30
million on account of unutilised tax losses which have accumulated during the loss
making period 1999-2004. The management is of the view that future taxable profits
would be sufficient to utilise the available tax losses.
(c) DWL has established an e-commerce division to sell its products through internet. This
new division is administered centrally by the head office. This step has been quite
successful as the online sales have risen to 20% of the total sales during the year.
Required:
Identify and explain the audit risks which the auditor should consider while planning the
audit of DWL. Also highlight the key areas on which the auditor should place emphasis
upon, to address the above risks.
(12)
Q.2
You are a chartered accountant in practice. The following situations have arisen in
connection with two of your clients:
(a) A multinational company (MNC) which is planning to establish a place of business in
Pakistan by forming a public limited company under the Companies Ordinance, 1984,
has requested your firm to provide the following services:
(i)
(ii)
Receive the funds remitted by the MNC.
Make disbursements in accordance with the instructions of the MNC.
Required:
Explain how you would meet your professional obligations and responsibilities while
carrying out the above assignment.
(07)
(b) Your firm is the external auditor of a listed company. Recently the management of the
company has requested your firm to provide the following services:
(i) Reconciling the creditors’ ledger with the statements submitted by the suppliers.
(ii) Estimating the compensation payable to the employees who were seriously injured
while carrying out the trial run of the plant.
Required:
Explain the threats involved in accepting the above assignments and identify the steps
the firm should take to fulfill its professional responsibilities and obligations.
(10)
(2)
Q.3
You are the manager in charge on the audit of Hexa Garments Limited (HGL). The company
is listed on the Karachi Stock Exchange and has nine directors. It is engaged in the
manufacture and sale of fancy garments through its own retail outlets. You are considering
the following matters in respect of the audit for the year ended December 31, 2009:
(a)
The diluted earnings per share of Rs. 36.60 has been calculated without taking into
account the share options held by three directors. To justify the above calculations,
these directors have confirmed in writing that they do not intend to exercise the share
option. Had the share options been considered, the diluted earnings per share would
have been Rs. 35.60. The review of subsequent events revealed that four of the
remaining directors had exercised their share options following the balance sheet date.
The share options are available upto December 31, 2010.
(b)
According to the draft financial statements the total assets of the company are valued at
Rs. 375 million. These include value of ten retail outlets amounting to Rs. 175 million.
The valuation is based on historical cost less accumulated depreciation. During the
year ended December 31, 2009, the management had decided to revalue all the retail
outlets. The valuer appointed by the management has not been able to complete the
assignment to date. However, he has submitted two interim reports as described below:
Date of report
Number of shops revalued
Book value as on 31/12/2009 (Rs. in million)
Revalued amount (Rs. in million)
(c)
Interim Report
First
Second
31/12/09
20/02/10
3
4
40
60
70
100
During the year HGL has developed two new brands “Deebal” and “Kalachi” and has
launched an aggressive marketing campaign for their promotion. The company has
recognised the cost incurred on the campaign amounting to Rs. 10 million as an
intangible asset. It is being written off over the estimated useful life of the brands i.e.
four years.
Required:
Discuss the matters that may be of significance to you as an auditor, in respect of the above
issues. Also explain their implications on the audit report.
(16)
Q.4
You are the quality control partner in a medium size audit firm and have been asked to give
your views on the following situations:
(a) Pentagon Limited, an unlisted assurance client, has requested your firm to assist them in
the recruitment of the Chief Financial Officer (CFO) of the company. While short
listing the candidates, it was found that the applicants include CFOs of two of your
existing assurance clients.
(b) One of your firm’s large clients, a listed company, has requested that the current year’s
audit should be carried out by the same team which audited the last year’s financial
statements. The request has been justified on the grounds that the accounts department
is extremely busy on a special assignment and a new team would take a lot of their
time. You have also been informed that Mr. Shams has been the manager in charge of
that audit during the last three years.
Required:
Discuss the category of threat involved in each of the above situations. Also explain the
safeguards available with the firm which may eliminate or reduce the threat to an acceptable
level.
(14)
(3)
Q.5
Sigma Pakistan (Pvt.) Limited (SPPL) manufactures telecommunication accessories. The
management of SPPL is negotiating with one of its competitors to acquire a factory, at an
estimated purchase price of Rs. 350 million. SPPL intends to obtain financing from a venture
capital company (VCC) for the proposed acquisition.
Your firm, Gamma & Co., has been approached by SPPL to provide a report on the
following cash flow forecast, which would be provided to VCC:
Quarter ending
Jun. 2010 Sep. 2010 Dec. 2010 Mar. 2011
--------------Rupees in million------------Cash inflows
Cash sales
Receipts from credit sales
Cash outflows
Operating
Payments to vendors
Salaries
Factory overheads
Others
Purchase of fixed assets
Dividend
Royalty
Advance income tax
Purchase of factory
(i)
(ii)
188
870
1,058
203
900
1,103
210
938
1,148
251
1,249
1,500
(iii)
600
140
263
18
1,021
37
150
187
635
140
263
120
18
1,176
(73)
187
114
655
140
263
45
20
350
1,473
(325)
114
(211)
803
140
263
54
53
29
1,342
158
(211)
(53)
(iv)
(v)
Cash flow for the quarter
Opening cash balance
Closing cash balance
The following information is available:
(i)
(ii)
(iii)
(iv)
(v)
Cash customers are allowed discount @ 3% when they purchase goods worth Rs.
100,000 or more.
60% of the amount billed is collected within one month, 25% by the end of the
second month and 13% by the end of the third month. Bad debts are estimated at 2%.
Payment against purchase of raw material is made within 30 days, in order to avail
cash discount @ 5%. Payments for other materials are made within 45 days.
Factory overheads include property rentals, utility bills, insurance premium and
general office expenses.
Royalty is paid to a foreign company, for availing the right to manufacture certain
accessories.
Required:
(a)
Outline the key procedures that your firm should undertake in order to provide a
report on the cash flow forecast.
(b)
Draft an unmodified report for submission to the Board of Directors.
Q.6
Beta Construction Company Limited (BCCL) is involved in the construction of large
buildings and shopping plazas. The company commenced its business in 2004 by
establishing an office in Karachi and has grown rapidly. It currently has offices in five
major cities of the country and as many as 25 projects are in various stages of execution.
(16)
(06)
(4)
A substantial portion of the work is done through sub-contractors. Payment to subcontractors is based on certificate of work completion which is issued by the supervisor in
charge of each project. The certificate is sent through email to the finance department. The
payment is credited directly into the bank accounts of the sub-contractors.
Recently, the management has discovered that the project supervisor of a large project had
issued a fraudulent work completion certificate. The preliminary investigation indicated that
some other sub-contractors have also been paid fraudulently in the past and the practice was
ongoing for the past two years.
The management of BCCL has asked your audit firm to conduct an investigation into the
matter. Your initial discussion with the client has revealed the following:
(i) For the past four years the external auditors of the company are Alpha & Co.,
Chartered Accountants. They had issued unqualified audit reports for all those years
and had not reported any internal control weakness in their management letters.
(ii) Prior to approaching your firm, BCCL wanted to give this assignment to Alpha & Co.
However, they expressed their inability to undertake the investigation work.
Required:
(a) State the matters your firm should consider and the procedures that should be followed
prior to the acceptance of this assignment.
(07)
(b) State the basic objectives of the above investigation.
(03)
(c) Recommend the controls which the management should put in place, to avoid such
frauds in future.
(09)
(THE END)
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2010
A.1
(a) Audit risk: Pressure to maintain the earnings
(i) The management of DWL is under pressure to maintain the earnings of the company in order to
keep the share price of the company over Rs. 12.5 so that the offer of foreign investor will not
attract the small investors.
(ii) The areas requiring the auditors attention are as follows:
 revenues are recorded correctly as to amount and period.
 inventories are properly valued and recorded in the correct period.
 all expenses and provisions are recorded correctly as to amount and period.
(b) Audit risk: Recoverability of deferred tax assets
(i) Under IAS-12, deferred tax assets can only be recognized when it is probable that taxable profits will
be available against which the deductible temporary differences can be utilized. The company will
therefore need to show that future profits will be generated for the unutilized tax losses to be
offset against. If this is not possible, the deferred tax asset should be limited to the amount of
profits that can be measured with reasonable certainty.
(ii) The main areas which require auditors attention are as follows:
 The income tax provisions related to carry forward of tax losses and their adjustment against
future profits.
 Amount of future profits and reasonableness of such forecast.
(c) Audit risk: Issues relating to e-commerce sales
(i) Risk of non-compliance with taxation, legal and other regulatory issues
(ii) Risk of technological failure resulting in business interruption
(iii) Loss of transaction integrity
(iv) Risk of frauds by customers and employees
(v) Risk of application of improper accounting policies in respect of capitalization of costs such as
website development, translation of foreign currencies, allowances for returns, revenue
recognition., etc.
(vi) The main areas which require auditors attention are as follows:
 The effect of e-commerce model on the existing accounting policies
 The adequacy of internal controls in place.
 Process alignment. It refers to the way various IT systems are integrated with one another
and thus operate, in effect, as one system.
 Key security issues and how the management intends to address them
 Legal issues and opinion of the legal advisors.
A.2
(a) (i)
While taking up the assignment, we should keep in mind the following:
 A chartered accountant in practice should not assume custody of client’s monies unless
permitted to do so by law.
 It creates a self interest threat to professional behavior and may be a self interest threat to
objectivity.
 To safeguard against such threats, we would:
 keep such monies separately from firm’s assets.
 use such money only for the purpose for which they are intended;
 at all times, be ready to account for these assets, and any income, dividends or gains
generated, to any persons entitled to such accounting.
 comply with all relevant laws and regulations relevant to the holding of and accounting
for such assets.
Page 1 of 6
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2010

We should be aware of threats to compliance with the fundamental principles through
association of such assets. For example, money derived from illegal activities. In order to
safeguard against these threats, we should:
 make appropriate inquires about the source of such assets;
 consider their legal and regulatory obligations.
 seek legal advice.
(ii) There is no bar to accepting this business as MNC is not our financial statements audit client.
(b) (i)

Preparation of such reconciliations may be used by the client as base document of
accounting entries. Therefore, it may create a self-review threat when the financial
statements are subsequently audited by the firm.

While providing such assistance, the auditor should not involve in making management
decision which include:
 Determining or changing journal entries, or the classifications for accounts or
transaction or other accounting records.
 Authorizing or approving transactions; and
 Preparing source documents or originating data or making changes to such documents
or data.
 The significance of any threat created should be evaluated and, if the threat is other than
clearly insignificant, safeguards should be considered and applied as necessary to reduce the
threat to an acceptable level. Such safeguards might include:
 Making arrangements so such services are not performed by a member of the assurance
team;
 Implementing policies and procedures to prohibit the individual providing such services
from assisting in preparation of accounting records and making any managerial
decisions on behalf of the audit client;
(ii)
 The estimation of compensation may be used by the client as a basis for making provisions
in the accounts. Therefore, it may create a self-review threat. The significance of threat will
depend upon the following factors:
 The materiality of the amounts involved;
 The degree of subjectivity inherent in the matter concerned; and
 The nature of the engagement i.e. the purpose and objective of estimation.
 The firm should evaluate the significance of threat and if it is significant then apply the
necessary procedures to eliminate the threat or reduce it to an acceptable level. Such
safeguards may include:
 Policies and procedures to prohibit individuals assisting the audit client from making
managerial decisions on behalf of the client.
 Using professional who are not members of the assurance team to perform the service;
 The involvement of others such as independent experts.
Page 2 of 6
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2010
A.3
(a) Matters significant to the Auditor
(i) According to IAS-33, for the purpose of calculating diluted earnings per share, an entity shall
assume the exercise of dilutive options of the entity. The IAS does not allow any exception to
this rule.
(ii) Whether the share options given to the directors have been properly disclosed in the financial
statements.
(iii) The exercise of share options after the close of year needs disclosure as a non-adjusting event.
Implications on the audit report
(i) If the directors do not agree to amend the diluted earnings per share, the audit report should be
modified in this respect on the ground of disagreement.
(ii) If proper disclosure relating to exercise of share option has not been made, the audit report
should be modified due to non-disclosure of material information.
(b) Matters significant to the Auditor
(i) According to IAS-16 Property, Plant and equipment, if an item of property, plant and equipment is
revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued.
(ii) The increase due to revaluation of 7 of the 10 retail shops amounts to Rs. 70 million, which
represents 18.67% of total assets and is therefore material to the statement of financial position.
A disclosure will be required.
(iii) The auditor should ask the management either to defer the revaluation to a period when all
information related to all the shops is available from the valuer or revalue all the shops by
requesting the valuer to submit his final report prior to audit completion.
Implication on the Audit Report:
If the management refuses to disclose the information about the outcome of valuation exercise, the
audit report should be modified on the ground of disagreement with qualified” opinion.
(c) Matters significance to the Auditor
According to IAS-38 , internally generated brands shall not be recognized as intangible assets.
(i)
Hence, the capitalization of internally generated brands is a contravention to the requirement of
IAS-38 .
(ii) The intangible asset is material as it represents 2.7% of total assets.
Implications on the Auditor’s Report
If the financial statements are not revised in accordance with IAS, the audit report should be qualified
on the ground of disagreement with qualified opinion due to material misstatement.
A.4
(a) (i)
Recruitment of senior management may create current or future self interest, familiarity and
intimidation threats.
(ii)
Applications from CFOs of existing assurance clients has also created a threat to objectivity,
as we performs services for these clients whose interests will be in conflict with Pentagon in
respect of appointment of CFO.
(iii) The significance of the threat created should be evaluated and, if the threat is other than
clearly insignificant, safeguards should be considered and applied as necessary to reduce the
threat to an acceptable level.
(iv) The safeguards available to the engagement partner are the following:
 The firm should not make management decisions and engagement should be restricted to
advising suitable qualification and making a list of suitable candidates. The decision as to
whom to hire should be left to the client.
 The use of separate engagement team
 Procedures to prevent access to information (e.g., strict physical separation of such teams,
confidential and secure data filing);
 Clear guidelines for members of the engagement team on issues of security and
confidentiality.
Page 3 of 6
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2010
(b) Client’s request for certain staffs
The audit firm should assess whether the reason given by the client is valid under the circumstances
because if there is any other reason, it may affect the independence of the audit. Moreover, as a matter
of principle, the audit firm should not encourage such requests from the client.
Long association of Mr. Shams
Using the same senior personnel on an assurance engagement over a long period of time may
create a familiarity threat.
(ii) The significance of the threat should be evaluated and, if the threat is other than clearly
insignificant, safeguards should be considered and applied to reduce the threat to an acceptable
level.
(i)
Such safeguards might include:
 Rotating the senior personnel (other than the audit team)
 Involving an additional chartered accountant who was not a member of the assurance team to
review the work done by the senior personnel or otherwise advise as necessary;
 Independent internal quality reviews.
A.5
(a) Cash receipts:
(i)
Assess whether the assumption related to total sales and its bifurcation between cash and credit
sales is reasonable by considering whether it is in line with the known norms of the business.
Historical data of the company may also provide some useful information.
(ii)
Assess the reasonableness of the pattern of receipts from credit customers by applying the
credit terms allowed to different categories of customers.
(iii)
Review the latest age analysis of the receivables to assess the reasonableness of the pattern of
payment by credit customers.
(iv)
Check whether the 3% discount on sales allowed to cash customers is in accordance with the
market norms.
Check whether the increase in sales in 3rd quarter is in accordance with the production capacity
of the new factory.
(v)
Payment to vendors
(i) Review norms of business and historical data to assess the reasonableness of the pattern of
payments forecasted.
(ii) Check whether the 5% discount on raw material purchases is in accordance with terms and
conditions prevailing in the market.
Other operating cash outflows:
(i) Discuss with the management why operating expenses and salaries are not increasing in line
with sales.
(ii) Compare forecasted outflows on account of salary with latest available payroll.
(iii) Obtain a breakdown of the outflow on account of overheads and ensure that:
 All expense categories have been included.
 Non cash items such as depreciation, amortization, provisions, etc have been excluded.
(iv) For cash flows in respect of each main component of the overheads, review existing actual
documentation such as invoices and utility bills etc to ascertain the reasonableness of the pattern
of payments included in the forecast.
Page 4 of 6
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2010
Non-recurring cash flows:
(i) Review the capital budget to assess requirement related to capital expenditure.
(ii) Review the pattern of dividend payment and obtain representation letter if necessary.
(iii) Check amount of royalty and payment schedule as per agreement.
(iv) Check calculation of advance tax with profit forecast, working submitted by the client and
relevant tax laws.
(v) Review the documents relating to purchase of factory and ensure that cash outflow given in the
forecast is reasonable.
General:
(i) Enquire as to the competence and experience of the preparer of the forecast.
(ii) Ascertain why financial cost is not included.
(iii) Are there any other costs to be incurred in relation to the new factory in the period of cash flow
forecast? e.g. recruitment costs of new staff, any additional working capital requirements,
installation of plant and fixtures to the new factory etc.
(iv) Ensure that timing of outflows for purchase of factory is correct by carrying out discussion with
management and review of minutes of Board of Directors etc.
(v) Compare the forecast with actual cash flows of prior period and investigate unusual variations, if
any
(vi) Compare assumptions made with general industry data and trends and investigate any unusual
variations.
(b) AUDITOR’S REPORT TO THE BOARD OF DIRECTORS
We have examined the quarterly cash flow forecast of Sigma Pakistan (Pvt.) Limited for the year
ending March 31, 2011 in accordance with the International Standards on Assurance Engagements
applicable to the examination of prospective financial information. Management is responsible for the
forecast including the assumptions set out in Note A on which it is based.
Based on our examination of the evidence supporting the assumptions, nothing has come to our
attention which causes us to believe that these assumptions do not provide a reasonable basis for the
forecast. Further, in our opinion the forecast is properly prepared on the basis of the assumptions and
is presented in accordance with IFRS / applicable financial reporting framework.
Actual results are likely to be different from the forecast since anticipated events frequently do not
occur as expected and the variation may be material.
Gamma & Co.
Chartered Accountants
Karachi
June 11, 2010
A.6
(a) Before accepting the assignment, your firm should consider the following factors:
Whether the firm possesses technical competence to perform such services.
(i)
(ii) Whether required resources would be available to carry out the engagement.
(iii) Could there be any threats to compliance with the fundamental principles?
(iv) Are there any professional reasons for not accepting the engagement?
Procedures to be followed by the Audit Firm
The non acceptance by the existing auditor to carry out the assignment may represent a threat to the
fundamental principles. The necessary procedures to avoid this treat may be as follows:
Page 5 of 6
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2010
After informing the client approach to the existing auditor to ascertain any professional reason
for not accepting their assignment.
(ii) Acquire an appropriate understanding of the nature of the BCCL’s business, the complexity of
its operation and the relevant industries.
(iii) Understand the specific requirements of the engagement and the purpose, nature and scope of the
work to be performed.
(iv) Possess or obtain experience with relevant regulatory or reporting requirements.
(i)
(b) Basic Objectives of the above investigation
To ascertain a deliberate fraud has actually taken place.
(i)
(ii) To discover the perpetrator(s) of the fraud, and ultimately to assist in their prosecution.
(iii) To quantify the financial loss suffered by the company as a result of fraud.
(c) Control measure for dealing with sub-contractors
An authentic list of approved sub-contractors should be maintained.
(i)
(ii) All sub-contracting work should be awarded only to the approved sub-contractor.
(iii) There should be a proper procedure for inclusion / deletion from the list of approved subcontractors.
(iv) A company senior official visit to the sites and monitoring the performance of the sub-contractors
on a regular interval.
(v) Compliance of above procedures should be monitored regularly.
Control procedure for payments to sub-contractors
Work completion certificates should be issued on specific pre-printed forms (SPP) which should
(i)
be controlled sequentially.
(ii) Books of SPPs should be supplied only to authorized supervisors with instructions for their
safekeeping.
(iii) The stock of unused SPPs should be kept in the custody of an authorized senior management
official.
(iv) Original SPPs should be sent directly to Finance Department. Copies may however be sent earlier
(by fax or e-mail) to save processing time. The actual SPPs must be sent by courier immediately
after sending fax/scanned copy.
(v) All alterations on SPPs should be authenticated by the concerned supervisor.
(vi) Strict budgetary control should be exercised in respect of each project. Variances between the
actual and budgeted expenditure should be analyzed and explained. Monthly cash outflow forecast
of each project should be prepared and monitored.
(THE END)
Page 6 of 6
The Institute of Chartered Accountants of Pakistan
Advanced Auditing
Final Examinations – Winter 2010
Module F
December 10, 2010
100 marks - 3 hours
Q.1 You are the manager responsible for the statutory audit of Parrot Limited (PL), a listed company
engaged in the business of manufacture and sale of sports goods. It has three factories located at
Karachi, Lahore and Sialkot.
Summarized statement of financial position as of September 30, 2010 (unaudited) and 2009
(audited) are as follows:
2010
2009
Rupees in million
Assets
Property, plant and equipment
Investment in a subsidiary
Stocks
Debtors
Other current assets
Total assets
Equity and liabilities
Paid-up capital
Accumulated losses
Long-term bank borrowings
Creditors and other payables
Total equity and liabilities
1, 960
520
2,480
720
530
280
1,530
4,010
2,130
590
2,720
510
330
210
1,050
3,770
1,800
(1,650)
150
2,350
1,510
4,010
1,800
(1,350)
450
2,310
1,010
3,770
Following further information is available:
(i)
PL acquired a subsidiary in 2005 which is engaged in the business of manufacture and export
of sportswear. The investment is recorded in PL’s financial statements under the equity
method. The last dividend was paid by the subsidiary in 2007.
(ii)
During the physical count of stocks at Karachi on September 30, 2010 it has been observed
that stocks worth Rs. 100 million is obsolete and would require a provision of 20% to 30% of
the carrying value.
(iii)
During the year, PL and its bank agreed to reschedule the loan on the following terms:
ƒ Repayment date was extended from 3 years to 6 years.
ƒ Rate of interest was increased from 1-year KIBOR + 3% to 1-year KIBOR + 4%.
ƒ PL shall be required to maintain a current ratio of 1:1. In the event of non compliance of
this requirement, the loan would become immediately payable. However, on October 25,
2010, the bank agreed to waive this requirement.
Required:
(a) Identify the risks that may result in material misstatements in PL’s financial statements.
(b) Discuss the key areas on which you should place emphasis upon, to address the risks identified
in (a) above.
(20 marks)
Advanced Auditing
Page 2 of 3
Q.2 Quail & Company, Chartered Accountants has recently been appointed as the external auditor of
Penguins Limited (Penguin) for the year ending December 31, 2010. Penguin uses a fully
automated integrated accounting system which meets all its operational and financial reporting
requirements. Quail & Company is considering to hire a firm of consultants to assist it in evaluating
the IT related controls and procedures in order to attain a level of comfort over the IT controls
employed by Penguin.
Required:
(a) List any five important matters which Quail & Company should consider while deciding upon
the need to hire a firm of IT consultants.
(b) Specify the important matters which should be clarified in the agreement with the consultants.
(16 marks)
Q.3 The draft accounts of Kingfisher Pharmaceutical Limited (KPL) for the year ended September 30,
2010 show a profit before taxation of Rs. 115 million and total assets of Rs. 450 million.
Being the audit manager you are currently reviewing the following matters:
(i) The basis of preparation of financial statements states that these have been prepared in
accordance with the International Financial Reporting Standards. However, the accounting
policy note for borrowing costs states that all borrowing costs are expensed as incurred.
Results of audit tests show that borrowing costs expensed during the year include Rs. 15
million which relate to qualifying assets.
(ii) On October 17, 2010 the Income Tax Department issued amended assessment orders for the
tax years 2006 to 2009 in which an aggregate tax of Rs. 40 million has been demanded. KPL
has filed appeals against the orders before the Income Tax Appellate Tribunal. KPL’s tax
consultant has advised that it is not possible at this stage to give a reasonably accurate estimate
of the amount of tax that the company may ultimately be required to pay but it would range
between Rs. 10-35 million. There is no reference of this matter in the draft financial
statements.
(iii) The directors’ report contains a statement that “current year’s increase in profit before taxation
by over 10% is primarily due to the improved operating performance of the company”.
However, the income statement shows that KPL’s profit before taxation includes a gain on
sale of a factory amounting to Rs. 30 million. In the absence of this gain, the company would
have reported a reduction in operating profit by 19%.
Required:
In respect of each of the above matters:
(a) State with reasons what action you would take; and
(b) discuss the implications on the audit report, if any.
(13 marks)
Q.4 Vulture Limited (VL) is planning to acquire 100% shares in Sparrow (Private) Limited (SPL) which
is a small company and is not required to have a statutory audit. In order to satisfy VL about the
company’s financial statements, the directors of SPL have appointed your firm, Pigeon &
Company, Chartered Accountants, to undertake a review engagement. According to the terms of
engagement, your firm is required to review SPL’s financial statements for the year ended
September 30, 2010 and provide a report to the directors.
While performing the review you have observed that SPL has not carried out a physical inventory
count as at September 30, 2010. SPL’s inventory records were last updated on August 31, 2010. The
valuation of inventory was based on quantities determined by the store manager using the goods
receipt and despatch notes that he had kept since the last count. However, he is not confident that
all goods receipt and despatch notes have been recorded. Your firm has not been able to verify the
quantity of inventory through any other means. The carrying amount of inventory is material to
SPL’s financial statements.
Required:
Draft a review report on the financial statements, for submission to the directors of SPL. (11 marks)
Advanced Auditing
Page 3 of 3
Q.5 Develop audit programmes in respect of contingent liabilities and taxation (including deferred
taxation) stating therein the audit objectives and substantive audit procedures.
(20 marks)
Q.6 Eagle Limited (EL) is an unlisted company and operates a chain of 30 restaurants. The
management has established effective internal controls especially over cash receipts and payments
to employees and suppliers. The internal audit department of EL has been playing an important role
in continuous evaluation and monitoring of these internal controls. However, the chief internal
auditor (CIA) has recently resigned alongwith his two assistants.
Your firm has been the auditor of Eagle Limited (EL) for the last many years. The CEO of EL has
approached your firm for help in resolving the situation and has proposed the following alternatives:
(i) EL would outsource its internal audit department to your firm.
(ii) Your firm would recruit an individual for the position of CIA to fill the vacancy. In
consideration, EL would pay a fee equivalent to two months’ gross salary of the CIA.
(iii) EL would recruit the CIA and your firm would provide audit staff on secondment for six
months to assist the CIA in understanding and accomplishing the tasks. The CEO has showed
his inclination to hire Mr. Kiwi, the manager responsible for the audit of EL.
Required:
Comment on each of the above alternatives as follows:
(a) Discuss the threat involved and explain the safeguards, if any, available to the firm which may
eliminate or reduce the threat to an acceptable level.
(b) In the light of the Code of Corporate Governance, explain whether you would have accepted
the proposals, had EL been a listed company.
(20 marks)
(THE END)
A.1
(a)
(i)
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2010
Audit Risk
Investment in subsidiary: As the
carrying value of the subsidiary is
declining, there is a risk that value
of investment appearing in the
books may be impaired.
(ii)
Debtors: There is a significant
increase in the debtors. Therefore,
there is a risk of material
misstatement in case the company
fails to make appropriate provision
against doubtful debts.
(iii)
Stocks in trade: The valuation of
stocks at its NRV creates a risk that
the company may not be able to
determine the degree of
obsolescence on a reasonably
accurate basis resulting in
misstatement.
(iv)
(v)
Bank borrowings: The bank has
rescheduled the loans after
imposing tough conditions. There
is a likelihood that FL will not be
able to comply with the term of
borrowings related to current ratio
and loan may become payable
immediately.
Going concern issue: The financial
position and erosion of significant
equity creates the doubt that FL
may not be able to continue in
business for foreseeable future.
(b)
Key Areas on which emphasis to be placed
 The management should be asked to carry out
impairment testing by comparing recoverable
amount of the subsidiary with the carrying amount
of investment.
 The assumptions used in the impairment testing
specially for determining the value-in-use needs to
be analyzed for reasonableness.
 The management should also be asked to state the
investment in subsidiary in its Financial Statements
at cost or as per requirement of IAS-39.
 The ageing of the debtors needs to be carefully
analyzed and long outstanding debtors needs to be
inquired with the management.
 Circularize confirmations to the debtors and
evaluate the response.
 Check subsequent payments received from debtors.
 Review the basis of provision against doubtful and
assess its reasonableness.
 The need to employ an independent valuer may be
considered.
 Check subsequent sale of obsolete stock in order to
assess the amount of provision required.
 Discuss the reasons of obsolescence of stock at
Karachi and assess whether similar situation may
be prevailing at other locations also.
 Review movement in stocks of material items.
 All current assets and current liabilities should be
analyzed for their completeness.
 In case any adjustment is required which resultantly
(e.g. recording the stocks at NRV) reduce the current
ratio from 1: 1, the loan should be classified as
current liability.
 Reviewing outstanding creditors and assess:
 the company’s dependence on such creditor
 risk of litigation
 Ensure that management performs an assessment of
the entity’s ability to continue as a going concern.
 Evaluate management’s plans for future actions in
relation to its going concern assessment.
 If the entity has prepared a cash flow forecast, and
analysis of the forecast is a significant factor in
considering the future outcome of events or
conditions in the evaluation of management’s plans
for future action:
 Evaluate the reliability of the underlying data
generated to prepare the forecast; and
 Determine whether there is adequate support for
the assumptions underlying the forecast.
 Request written representations from management
and, where appropriate, those charged with
governance, regarding their plans for future action
and feasibility of these plans.
 Consider whether any additional facts or
information have become available since the date
Page 1 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2010
A.2
(a)
(b)
A.3
(i)
(ii)
on which management made its assessment.
While employing an IT Consultant, Quail & Co. should consider the following:
(i)
The degree of complexity of the client’s system
(ii) Determine how much audit evidence is available through electronic form
(iii) Ascertain the extent to which the data is shared among different applications
(iv) Determine the changes that the client has made to existing systems and whether any
new systems have been put into operation
(v) Ascertain client’s plans to use emerging technologies
The following terms would need to be clarified with the IT Consultant:
(i)
The scope and objective of the work of the IT Consultant
(ii) The auditor’s intended use of the Consultant’s work
(iii) Nature of information that would be required by the Consultant
(iv) The assumptions, methods and procedures that the Consultant would use
(v) The extent of the Consultant’s access to client files and record
(vi) The nature and extent of the firm’s review of the Consultants work
(vii) Ownership and control of working papers during and after the engagement including
any file retention requirement
(viii) Reporting time lines
(ix) An outline of contents of the reports of IT Consultant including form and content of
findings
(x) Compliance of the IT Consultant with the firm’s ethical requirement including
independence
(xi) Maintenance of client confidentiality
(xii) The Consultant’s relationship with the client
Action/reasons
 In order to comply with IAS 23, borrowing costs which meet its criteria should be
capitalized.
 The company’s policy of expensing out the borrowing costs in spite of meeting the criteria
for capitalisation is not in accordance with IAS 23 and needs to be changed.
 Costs of Rs. 15 million are material to the income statement, as reducing the expenses
would increase profit by 13%.
Report implications / modification
 If management agrees to change the accounting policy, the firm should mention the
concurrence statement in audit report that accounting policies have been consistently
applied except for the changes as stated in the relevant notes with which the auditor
concurs.
 If management refuses to capitalize the borrowing costs or to change the accounting
policies, the firm should give a qualified opinion (except for). Reason for the qualified
opinion i:e material disagreement between management and auditors regarding
accounting for borrowing costs, will be explained in “ Basis for Qualified Opinion”
paragraph placed before opinion paragraph.
Action/reasons
 The amount involved is material as Rs. 35 million is 30% of profit before tax and 8% of
total assets.
 The firm should request the management to:
 provide an amount which is the best estimate of the tax liability.
 include a note describing the situation in the financial statements, as the circumstances
give rise to a significant uncertainty which could have an impact on the financial
statements.
Report implications / modification
 If the management agree to provide for the amount and to include a note explaining the
issue, the report will be modified, but unqualified. An emphasis of matter paragraph
Page 2 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2010
should be added to the report after the opinion section drawing the user’s attention to the
note in the financial statements. There should be a specific statement that the opinion is
not qualified and a brief description of the circumstances.
 If the management do not agree to make a provision and include a note explaining the
issue, the firm should give a qualified opinion (except for). Reason for the qualified
opinion i.e. material disagreement between management and auditors , will be explained
in “ Basis for Qualified Opinion” paragraph placed before opinion paragraph.
(iii) Action/reasons
 The inconsistency between the Directors’ Report and the financial statements is material
to the financial statements.
 The firm should ask the directors to amend the report in line with the financial statements.
A.4
Report implications / modification
If directors refuse to amend their report, then an unqualified opinion on the financial
statements can be issued but other matter paragraph should be included to highlight this
inconsistency.
The firm may withhold its report in such case after obtaining legal advice.
Review Report to the Directors
We have reviewed the accompanying balance sheet of Sparrow (Private) Limited at September 30,
2010, and the income statement, statement of changes in equity and cash flow statement for the
year then ended. These financial statements are the responsibility of the Company’s management.
Our responsibility is to issue a report on these financial statements based on our review.
We conducted our review in accordance with the International Standard on Review Engagements
2400. This standard requires that we plan and perform the review to obtain moderate assurance as
to whether the financial statements are free of material misstatement. A review is limited primarily
to inquiries of company personnel and analytical procedures applied to financial data and thus
provides less assurance than an audit. We have not performed an audit, and, accordingly, we do not
express an audit opinion.
The Management did not carry out a physical stock taking of inventories which are valued at Rs. ____
in the accompanying financial statements, as of September 30, 2010. We were unable to satisfy
ourselves regarding inventory quantities by means of other review procedures.
The financial statement of Parrot (Private) Limited for the year ended September 31, 2009 was
unaudited.
Based on our review, except for the financial effects of any adjustments that might have been
determined to be necessary had the management carried out physical stock taking as of September
30, 2009 or applied appropriate alternate procedures to account for inventory value in the financial
statements, nothing has come to our attention that causes us to believe that the accompanying
financial statements are not presented fairly, in all material respects in accordance with the
International Financial Reporting Standards.
City
Date of Report
Pigeon & Co.
Chartered Accountants
Page 3 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2010
A.5
AUDIT PROGRAM FOR CONTINGENT LIABILITIES
Audit objectives
To determine whether:
(a) The contingent liabilities disclosed by the management include all contingencies.
(b) Contingent liabilities do not include:
(i) any obligation which should be provided for in the books of account of the Company as
the probabilities of its outcome against the Company are on the higher side and the
quantum and timing of payment may be estimated;
(ii) any obligation for which the possibility of outflow of resources embodying economic
benefits is remote.
Substantive procedures
(a) (i)
Discuss with management the client’s policies and procedures for determining the
estimated financial effect of contingencies, including those resulting from litigation,
claims, and unasserted claims.
(ii)
Examine the policies and procedures that the client has in place to monitor
compliance with laws and regulations, including those procedures designed to
prevent the occurrence of illegal acts.
(iii)
Obtain confirmation from the legal advisors including tax consultants and
banks/financial institutions.
(iv)
Review the schedule of contingencies provided by the client and carry out the
following steps:
1
 Compare current year’s position with the previous years and check the items
which have not been reported this year.
 Examine documents, files and correspondence related to each material
contingency reported in the schedule.
 Discuss the latest status in each case with the appropriate management
personnel.
 Check the basis of measurement of the contingencies.
 Check that the contingencies do not include items the probability of which is
remote.
 Ensure that provision has been made against all items that meet the relevant
criteria as mentioned in IAS 37.
 Refer the confirmation received from the legal advisors, tax consultants, banks
and financial institutions, with the schedule of contingencies.
 Where some or all of the expenditure required settling a contingent liability is
expected to be reimbursed by another party, ensure that the reimbursement
should be disclosed when, and only when, it is virtually certain that the
reimbursement will be received if the enterprise settles the potential obligation.
(v)
Perform the following steps to ensure that all contingencies have been disclosed.
 Review the minutes of board of directors and of other important meetings.
 Review important agreements and contracts and ensure that the company is in
compliance thereof.
 Review schedule of legal charges to ascertain the names of all legal advisors to ensure
that all the cases being defended have been identified.
 Review the results of audit procedures performed in other heads of accounts to
identify any contingency which may not be recorded.
(vi) Obtain representation from client that all known contingencies have been disclosed.
Page 4 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2010
(vii) Ensure that all contingencies have been appropriately disclosed in the financial
statements.
AUDIT PROGRAM FOR TAXATION
Audit objectives
To determine whether:
(a) Tax exposure, tax liability/receivable and deferred tax have been correctly calculated.
(b) All disclosures in respect of the above have been properly made in accordance with the
relevant standards.
Substantive procedures
(a) Current Taxation
(i) Overall Analytical Procedures

Compare amounts and ratios (e.g., effective tax rates) for the current period with
the prior year. Investigate significant fluctuations.

Perform detailed comparative analysis of trading and operating results with causes
and reason for variation duly supported with justification.
(ii)
Tax Expense

For the current year
 Review the computation of taxable income and ensure that all
additions/deductions are computed in accordance with the provisions of the
Income Tax Ordinance, 2001
 Compare balances as per computation schedule given by client with the general
ledger. Investigate any differences.
 Obtain and test the client's support for significant add backs/ deductions
appearing in the schedule.
 Compare the amounts of significant permanent and temporary differences for
the current period with comparable amounts for the preceding period.
 Ensure that tax in respect of income covered under FTR (if any) has been
correctly computed and accounted for.

Prior period tax provision
 Check tax charge / reversal in current year with respect to previous year with
appropriate documents, i.e. assessment order issued during the year, amended
returns filed by the company (if any), notices received from tax department and
related correspondence, etc.
 Where the client has decided to file an appeal against an order of the taxation
authorities and have not made full provision there against, discuss the issue with
the client and review the tax consultants advise thereon.
(iii) Tax Payable / Refundable

Obtain a schedule showing movement in tax payable / refundable and check as
follows:
 Check opening balances with the last year’s working papers
 Test check advance payment of tax and tax deducted at source from payment
challan, bill of entries, certificate of deduction of tax issued by the customers, etc.
 Check any adjustments (reduction in tax liability) with the refund orders /
revised assessment orders issued by the tax authorities.
(iv) Correspondence and confirmation from Tax Advisor(s)

Obtain and study correspondence with tax advisor(s).

Circularize confirmation to tax advisors and examine the response.
(v)
Tax Contingencies
Evaluate tax contingencies and ensure that these have been appropriately accounted for
and disclosed in the financial statements.
Page 5 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2010
(vi) Obtain representation from the management that all information has been disclosed.
(b) Deferred Taxation
(i)  Obtain a deferred tax working schedule from the client along with related
disclosures for current and prior periods.
 Check the calculation of major timing differences specially in respect of:
 Depreciation and amortization
 Provisions
 Revaluation of fixed assets, etc.
 Ensure that correct rate of tax has been applied to arrive at the deferred tax liability
/ asset.
 Ensure that the difference between the tax effect of opening and closing balance of
timing difference has been debited / credited, as appropriate, in deferred tax
expense / reversal account.
 In case of carry forward of tax losses/ minimum tax, ensure that deferred tax has
only been provided where the losses/ minimum tax are expected to be reversed in
the foreseeable future.
 Ensure that loss carry forwards utilized to offset current year taxable income have
not expired.
(c) Disclosure
Ensure appropriate disclosure have been made in accordance with the relevant standards
which include the reconciliation of tax charge for the year.
A.6
(a) Alternative 1: Outsourcing of Internal Audit Department
A self-review threat may be created when a firm provides internal audit services to a financial
statement audit client.
When the firm undertakes the outsourcing of internal audit activities, any self-review threat
created may be reduced to an acceptable level by ensuring that there is a clear separation
between the management and control of the internal audit by client management and the
internal audit activities themselves.
The firm may accept this alternative if appropriate safeguards are put in place to reduce the
threat to an acceptable level. The safeguard may include the following:
(i)
The audit client is responsible for internal audit activities and acknowledges its
responsibility for establishing, maintaining and monitoring the system of internal
controls;
(ii) The audit client designates a competent employee, preferably within senior
management, to be responsible for internal audit activities;
(iii) The audit client, the audit committee or supervisory body approves the scope, risk and
frequency of internal audit work;
(iv) The audit client is responsible for evaluating and determining which recommendations
of the firm should be implemented;
(v) The audit client evaluates the adequacy of the internal audit procedures performed and
the findings resulting from the performance of those procedures by, among other things,
obtaining and acting on reports from the firm; and
(vi) The findings and recommendations resulting from the internal audit activities are
reported appropriately to the audit committee or supervisory body.
(vii) Internal audit services should be provided only by personnel not involved in the
financial statement audit engagement and with different reporting lines within the firm.
Page 6 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Winter 2010
Alternative 2: Recruitment of CIA on EL’s behalf
The recruitment of senior management for an assurance client, such as those in a position to
affect the subject matter information of the assurance engagement, may create current or
future self interest, familiarity, and intimidation threats.
In any case, the firm should not make management decisions and the decision as to whom to
hire should be left to the client.
However, the firm could provide such services as:
(i) reviewing the professional qualifications of a number of applicants and providing advice
on their suitability for the post.
(ii) producing a short-list of candidates for interview, provided it has been drawn up using
criteria specified by the assurance client.
However, a contingent fee charged by a firm creates self-interest and advocacy threats that
cannot be reduced to an acceptable level by the application of any safeguard. Accordingly, the
firm should not enter into any such fee arrangement.
Alternative 3: Providing audit staff on secondment to assist CIA
A self-review threat may be created when a firm provides internal audit services to a financial
statement audit client. The firm can provide its staff on secondment to the client subject to the
application of safeguards given in alternative 1.
(b) Alternative 1: Outsourcing of Internal Audit Department
The firm of external auditors cannot provide internal audit services related to internal
accounting controls, financial systems or financial statements to its external listed audit
clients.
Alternative 2: Recruitment of CIA on EL’s behalf
The firm of external auditors cannot provide human resource related to executive recruitment
to its external listed audit clients.
Alternative 3: Providing audit staff on secondment to assist CIA
The firm of external auditors of a listed company cannot provide any service other than audit
including services on secondments basis except in accordance with the regulation and under
the IFAC guidelines. The firm may accept the engagement after ensuring that the terms of the
engagement specify that firm’s deputed staff will not be involved in management functions and
decisions.
However, Mr. Kiwi cannot be appointed as Chief Internal Auditor of the company because no
listed company can appoint a person as the Internal Auditor who was a partner of the firm of
its external auditors or an employee involved in the audit of the listed company at any time
during the two years preceding such appointment.
(THE END)
Page 7 of 7
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination - Winter 2010
General
The performance in this paper was average. The problem with majority of the students
was that they were unable to organize their answers in a logical order which would have
allowed them to cover all the relevant points. For example, in question 3, the majority
only covered the situations in which there is a disagreement between the auditor and the
client. The implications on the auditors report when client agrees with the auditor were
seldom mentioned. Similarly, while drafting audit program on taxation, the steps related to
current and deferred taxation and those related to payment of tax were all mixed up and as
a result quiet a few steps were ignored.
Question-wise comments are given below:
Q.1
Q.2
(a)
This part of the question was fairly well answered by majority of the
students.
(b)
Most of the students failed to clearly describe the key areas on which
emphasis is required to be placed which included impairment testing of
subsidiary, analysis of current assets and current liabilities, need to employ a
valuer for valuation of stocks and evaluation of going concern assumption.
At this stage of their career, such a response was really alarming.
(a)
This was an easy question. However, a large number of students were unable
to specify the matters which Quail & Company should consider while
deciding upon the need to hire a firm of IT consultants. The students were
expected to highlight the following matters:
•
•
•
•
•
(b)
The degree of complexity of the client’s system
How much audit evidence is available through electronic form
The extent to which the data is shared among different applications
The changes that have been made to the existing systems and new
systems that have been put into operation, if any
Client’s plans to use emerging technologies
This was the easiest of questions and almost all students did well.
Page 1 of 3
Examiners’ Comments on Advanced Auditing – Winter 2010 Examination
Q.3
In this question the students were supposed to give their views on three situations.
The mistakes noted in majority of the answers are discussed hereunder:
Situation 1
Generally the students demonstrated reasonable knowledge about the action to be
taken by the auditor and the implications on the audit report. However, a vast
majority missed an important point that if management agrees to change the
accounting policy, the auditor should give a concurrence statement in audit report.
Situation 2
Majority of the students could not mention that the auditor should ask the
management to make a provision of Rs. 10 million as it is the minimum amount of
payment which the company would be required to pay. Further, very few could
identify that even if a provision is made and the matter is appropriately disclosed
by way of a note, the auditor may add an emphasis of matter paragraph to the
report.
Situation 3
The situation was quiet simple and a large majority was able to answer correctly.
Q.4
Majority of the students were able to draft the report correctly as they adopted the
format specified in ISRE 2400. However, a large majority was not able to
adequately draft the qualifications. Some of the students did not write the complete
report i.e. left some parts of the report such as title, date, place etc. and lost the
related marks.
A large number of students did not mention in the review report that the financial
statements of Sparrow (Private) Limited for the year ended September 31, 2009
were unaudited.
Q.5
In the shape of this question there was an opportunity for the students to secure
good marks. Surprisingly, the students failed to demonstrate their practical
knowledge and missed some of the very important procedures as noted below:
Contingent Liabilities
•
Discuss with management the clients policies and procedures for determining
the estimated financial effect of contingencies.
•
Examine the policies and procedures that the client has in place to monitor
compliance with laws and regulations.
•
Check the basis of measurement of the contingencies.
•
Ensure that provision has been made against all items that meet the relevant
criteria as mentioned in IAS 37.
Page 2 of 3
Examiners’ Comments on Advanced Auditing – Winter 2010 Examination
Taxation
Q.6
•
Compare balances represented as being ‘per book’ with the general ledger.
Investigate any differences.
•
Test the significant add backs/ deductions appearing in the computation.
•
Study correspondence with tax advisor(s).
•
Evaluate tax contingencies and ensure that these have been appropriately
accounted for and disclosed in the financial statements.
•
In respect of deferred taxation, check the calculation of major timing
differences especially in respect of depreciation and amortization, provisions,
revaluation of fixed assets etc.
•
Review and check prior year’s tax charge, if any.
This was an easy question and a large number of students were able to correctly
demonstrate their knowledge relating to Code of Ethics for Chartered Accountants
and Code of Corporate Governance.
(THE END)
Page 3 of 3
The Institute of Chartered Accountants of Pakistan
Advanced Auditing
Final Examinations
Module F – Summer 2011
Q.1
Reading time – 15 minutes
June 6, 2011
100 marks – 3 hours
You are the engagement partner responsible for the audit of Saleem Auto Parts Limited (SAPL), a listed
company. SAPL supplies auto parts to three large motor car assemblers which are listed on the Karachi
Stock Exchange. Your review of the working paper files has disclosed that the company has been facing
liquidity issues for the last few months. You have also been informed that subsequent to the year-end,
SAPL has defaulted on one of its long term loan instalments.
SAPL’s directors have assured that this liquidity crunch is for a short span of time. To substantiate their
assertion they have provided cash flow projections for the next four years. An important assumption in
the cash flow projections is that agreements with all the motor car assemblers would continue for the
foreseeable future. However, during the year, one of the motor car assemblers, Pannu Motors Limited
(PML), has incurred substantial losses and has announced to close down one of its plants.
Required:
(a) State the audit procedures which your firm should perform in the above situation.
(b) Identify and explain the implications of the above issues on the audit report.
Q.2
(05 marks)
(09 marks)
You are the audit manager responsible for the audit of Laila Pharmaceuticals Limited (LPL), a listed
company, for the year ended March 31, 2011. During your initial meeting with the chief executive
officer and the chief financial officer of the company the following issues have been brought to your
attention:
(i)
At the year end, the net assets of LPL have reduced to Rs. 270 million (2010: Rs. 310 million). A
comparison of the draft income statement with the declared results for the nine months ended
December 31, 2010 is as follows:
Revenue
Cost of sales
Gross profit
Operating expenses
Financial charges
Operating profit / (loss)
Gain on sale of property
Net profit/(loss) before tax
(ii)
Nine months ended
Year ended
December 31, 2010
March 31, 2011
-------------- Rupees in million --------------500
530
(400)
(477)
100
53
(70)
(90)
(15)
(20)
15
(57)
20
15
(37)
On April 1, 2010 LPL had acquired 45% shareholdings in Sohni (Private) Limited (SPL). The
spouse of a director of LPL is a director in SPL.
(iii) On May 1, 2010 LPL purchased new office premises from SPL for Rs. 40 million. In January 2011
these premises were sold to Anarkali Limited (AL), an associated undertaking of LPL, for Rs. 60
million. Subsequent to the sale, LPL signed a five years’ agreement with AL to acquire the office
premises on a rent of Rs. 12 million per annum.
Required:
Assess the above matters and discuss how you would address the related implications during the course
of the audit.
(20 marks)
Advanced Auditing
Q.3
Page 2 of 3
Your firm has been appointed as the auditor of Jugnu Limited (JL), which is a manufacturer of
consumer products. The auditor’s report on the preceding year’s financial statements was unmodified.
The draft financial statements for the year ended April 30, 2011 disclose a profit before taxation of Rs.
75 million (2010: Rs. 155 million) and total assets of Rs. 2,100 million (2010: Rs. 1,910 million).
You are the audit manager at JL. The following issues arose during the audit and now require your
attention:
(i)
JL incurred an expenditure of Rs. 25 million on the development of five new products. It is
expected that these new products would generate future economic benefits.
(ii)
On July 1, 2008 JL had acquired four high-tech machines for Rs. 200 million which are being
depreciated over a period of 10 years on the straight line method. JL did not have the expertise to
operate the machines and had entered into an agreement with Umer Limited to operate the
machines. The contract is expiring on June 30, 2011 and Umer Limited has shown its inability to
continue after the expiry of the contract.
Required:
(a) Describe the principal audit procedures to be carried out for verifying the opening balances of the
financial statements of Jugnu Limited for the year ended April 30, 2011.
(04 marks)
(b) For each of the above issues, comment on the matters that you should consider and state the audit
evidence that you expect to be available.
(12 marks)
Q.4
Ranjha Limited (RL), a listed company, is engaged in the manufacture of fast moving consumer goods.
The draft financial statements for the year ended March 31, 2011 show a profit before taxation of Rs. 12
million and total assets of Rs. 300 million.
As the audit manager, you are reviewing the following issues which were brought to your notice by the
audit team :
(i)
On June 1, 2010 RL acquired a plant at a cost of Rs. 50 million. The plant has a useful life of 10
years with no residual value. RL follows the policy to depreciate the plant on the straight line
method. On January 1, 2011 the plant suffered physical damage due to a fire in the factory. The
technician from the manufacturer has inspected the plant and reported that the damage has
affected its production capacity which has now been reduced by 30%.
(ii)
During the year a petition has been filed against RL by one of its customers for recovery of Rs. 20
million, alongwith mark-up, damages and compensation, on the ground that materials supplied by
RL were defective. RL has filed a written statement in the Court denying the allegations.
RL’s legal advisor is of the view that the final liability of the company may range from 0% to 50%.
However, at this point of time, it is not possible to determine the amount with reasonable degree
of accuracy. No provision in this regard has been made in the draft financial statements.
(iii) In April 2007, RL acquired a high-tech production management software for Rs. 10 million. The
useful life of the software is 10 years. During the year it was discovered that in the past the
software was erroneously amortised assuming a useful life of 20 years.
The management has decided to adjust the amount short provided, over the remaining useful life
of the software.
Required:
Discuss the matters that may be of significance to you as an auditor in respect of each of the above
issues. Also explain their implication on the audit report.
(12 marks)
Advanced Auditing
Q.5
Page 3 of 3
You are planning the statutory audit of the financial statements of Mahiwal Limited (ML) for the year
ending June 30, 2011. ML sells and distributes networking equipment and accessories to corporate and
retail customers. Since January 1, 2009 ML has exclusive country-wide distribution rights of ‘Bisco’ and
‘Portel’, which are the leading international brands of networking equipment.
Your review of the prior year’s working papers has disclosed that ML has expanded its operations
significantly after securing the distribution rights of ‘Bisco’ and ‘Portel’. By June 30, 2010 there had
been a 60% increase in its customer base whereas the number of its branches had increased from 3 to 10
and the number of employees had risen from 30 to 115. The latest available draft financial statements
show that the sales of ‘Bisco’ and ‘Portel’ represent 90% of its total sales.
During a recent meeting with the finance director, you have been informed as follows:
(i)
ML has shifted its warehouse and customer service centre to larger premises in order to handle the
increased inventory level and the rising level of after sales warranty claims.
(ii)
ML has witnessed a slight fall in sales of ‘Bisco’ and ‘Portel’ because of tough competition from
other low priced brands.
A review of the draft financial statements has also disclosed that ML had revalued a property in
accordance with the requirements of the International Financial Reporting Standards. The property was
acquired many years ago to earn rental income.
Required:
(a) Identify and evaluate the audit risks in the above situation.
(12 marks)
(b) Discuss an audit strategy to take into account the identified risks in the overall audit plan.
(03 marks)
(c) Enumerate the key audit procedures to be conducted to assess the appropriateness of the
revaluation of property and the accounting treatment thereof.
(08 marks)
Q.6
You are the audit manager in Farhad and Company, Chartered Accountants. You have specific
responsibility for assessing the risks associated with the firm’s existing and proposed listed clients.
Presently the following matters are under your consideration:
(i)
Romeo Supermarket Limited (RSL), a large chain of super markets, has approached your firm to
perform financial due diligence of one of your audit client, Juliet Limited (JL), which is a listed
company. RSL intends to acquire 80% shareholding in JL.
(ii)
Sherbano Limited (SL) has requested your firm to provide a consent letter for acting as its auditors.
The wife of a partner in your firm is the Director Marketing in SL.
(iii) One of your assurance clients has requested your firm to provide consultancy services in relation to
a proposed transaction with a company based in Singapore. As your firm does not have the
expertise to undertake that assignment, it is considering to refer the assignment to Marvi &
Company, Chartered Accountants. It is expected that your firm would receive a commission of
15% of the assignment fee from Marvi & Company.
Required:
Discuss the categories of threats involved in each of the above situations and advise the partners as
regards the possible course of action that may be followed.
(15 marks)
(THE END)
A.1
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2011
(a) Cash flow problems, default in loan installment and possibility of the use of inaccurate
assumptions in projecting the cash flows indicate a need to review the appropriateness of
the going concern assumption. Therefore, the auditor should carry out the following audit
procedures:
(i)
Evaluate the reliability of the underlying data and assumptions used in cash flow
projections.
(ii) Ascertain the amount of sale to PML and its factory that was closed down and assess
its significance for the business operations of SAPL.
(iii) Review the last published financial statements and corporate announcements of PML
to assess future viability of its business operations. In case there are indications that
PML may need to close down or significantly curtail its business operations the
auditor should require the management to revise its cash flow projections.
(iv) Consider subsequent events to assess whether any additional fact or information
have become available since the date of management’s assessment. Discuss the
impact thereof, with the management, if required.
(v) Seek written representation from management regarding its plans for future actions.
(vi) After performing the above procedures, if there is a doubt about the appropriateness
of the going concern assumption, auditor will need to carryout additional audit
procedures depending upon the circumstances.
(b) Implications on audit report:
(i) If it is concluded that going concern assumption is appropriate and no material
uncertainty exists, we shall express an unmodified opinion.
(ii) If it is concluded that going concern assumptions is appropriate but a material
uncertainty exists which is adequately disclosed in the financial statements, we shall
express:
 an unqualified opinion

include an emphasis of matter paragraph in the auditor’s report to:
 highlight the existence of material uncertainty relating to the event or
condition that may cast significant doubt on the entity’s ability to continue as
a going concern and
 draw attention to the note in the financial statement which contains the
disclosure.
(iii) If it is concluded that going concern assumptions is appropriate but a material
uncertainty exists which is not adequately disclosed in the financial statements, we
shall express a qualified opinion or adverse opinion as appropriate.
A.2
(iv) If it is concluded that the going concern assumption is not appropriate, in the
preparation of the financial statements we should advise SAPL to revise the accounts
appropriately. In the case of disagreement, we shall express an adverse opinion.
Following are the important matters that the auditor would have to deal with:
(a) Drastic reduction in sales:
Drastic reduction in sales indicates that the management may have misstated the
operating results disclosed in the financial statements for the nine months ended
December 31, 2010.
The auditor should evaluate the situation and if a misstatement is confirmed, the auditor
would need to reassess his initial risk assessment and revise the audit procedures
accordingly.
Page 1 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2011
(b) Inability of the company to generate operating cash flows:
Following are the factors that may indicate the inability of the company to generate
adequate cash flows from its operations:
(i) Decline in net assets value by 13% because of net loss for the year;
(ii) Selling of property to the associated undertaking under sale and leaseback
arrangement in order to generate cash inflows.
(c)
The auditor would discuss the matter with the management and those charged with
governance about their future course of action regarding the cash flows issues. If the
matter is not resolved or remains uncertain, the auditor should perform the additional
procedures to evaluate the appropriateness of going concern assumption.
Sale and leaseback transaction:
This transaction raises the following issues:
(i) Whether it is an arm’s length transaction, especially in view of the fact that it
involves a related party.
(ii) Whether the accounting treatment is in accordance with IAS-17
The above issues are discussed hereunder:
(i) It seems that the transaction has not been entered in the ordinary course of business
as it is evident that:
 LPL earns 50% profit in a short period.
 Annual rental amount represents 20% of the sale proceeds.
The auditor would need to assess whether any undue favour has been allowed to the
associated company in order to book profit or to resolve the immediate liquidity
issue. If the answer is in the affirmative, the auditor would need to reassess his initial
risk assessment and consider revising the audit procedures accordingly.
(ii) In view of the given information it seems that LPL has recorded the transaction as an
operating lease. If this is the case, the decision to book the entire profit in the current
year may have been justified. However, the auditor needs to assess whether the sale
proceeds represent the fair value of the premises, on the date of transaction. In case
this is not true, the auditor should advise the management to record the sale and
profit, based on fair value and defer the remaining amount and amortize it over the
lease period .
In case, the auditor believe that the transaction should be recorded as a finance lease
the entire difference of Rs. 20 million should be amortized over the lease period.
(d) Consolidation of Sohni (Private) Limited:
The auditor should be mindful of the fact that LPL may be exercising control over more
than 50% of voting power in SL through the spouse of the LPL’s director.
The auditor should discuss the above possibility with the management. If it is established
that the control exists either through the spouse of the director or due to any other
similar situation, he should advise the management to present consolidated accounts.
(e) Impairment testing of Investments in Sohni (Private) Limited:
Purchase of 45% investment in Sohni (Pvt.) Ltd. where spouse of a director of LPL is also
a director creates the doubt that transaction had not been made in the ordinary course of
business and its value may have been impaired.
Page 2 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2011
(f)
The auditor should ask the management to perform test of impairment and make
appropriate provision, if required.
Investment in associated undertaking:
The auditor should also verify whether all the requirements of the Companies Ordinance,
1984 relating to investment in associated undertaking have been complied with.
In this regard he should discuss the matter with the management and corroborate the
discussion with the relevant documents (e.g. minutes of the shareholder’s meetings).
A.3
(a) The following audit procedures should be carried out on opening balances:
(i) Determine whether the prior year’s closing balances have been correctly brought
forward to the current period or, where appropriate have been restated.
(ii) Review accounting policies applied in the previous year and the current year to
ensure consistency and appropriateness of the policies applied.
(iii) If working papers of previous auditors are available, review them to obtain evidence
regarding the opening balances.
(iv) If working papers are not available, carry out appropriate audit procedures
regarding the opening balances.
(v) Evaluate whether the audit procedures performed in the current year provide
evidence relevant to the opening balances.
(vi) Perform additional procedures as are appropriate in the circumstances, if the above
procedures provide audit evidence that the opening balance contain material
misstatement that could materially affect the current period’s financial statements.
(vii) If it is concluded that such misstatement exists in the current period’s financial
statements, the auditor shall communicate the misstatements with the appropriate
level of management and those charged with governance and consider their impact
on the audit report, if any.
(b) (i)
(ii)
Matters to be considered:
 Although IAS-38 allows the recognition of internally generated intangible assets,
the auditor should ensure that all the requirements of IAS-38 would be complied
with, while capitalizing the development expenditures.
 Assess the basis of management’s expectation to ensure that future economic
benefits will flow to the enterprise.
 Rs. 25 million, the proposed intangible asset is not material to the financial
statement, but if it were written off as an expense for the year it would have been
material to the income statement as it would have reduced profit by 33.33%.
Audit Evidence:
 A breakdown of amount of Rs. 25 million.
 An assessment of various elements of the cost to assess whether any part thereof
can be classified as expense (e.g. research).
 Supporting invoices and other documents related to the cost of asset.
 Workings showing determination of the value in use, based on projections of
revenue from new products, to evaluate impairment, if any.
Matters to be considered:
 The auditors need to discover what management’s future intentions for the assets
are. Whether they want to dispose off or want to continue to use.
 If management intends to dispose off the machine then an impairment review
under IAS 36 must be carried out.
 If management intends to continue to use these machines, find out whether JL:
 would be able to find another service provider to operate these machines; or
 has developed internal expertise to operate the machines.
Page 3 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2011
If the answer to each of the above questions is in the negative, an impairment
review may need to be carried out.
 The carrying amount of the machines as of April 30, 2011 is approximately Rs.
143 million. This represents 6.8% of total assets and is therefore material to the
balance sheet.
Audit Evidence:
 Documentation of the discussion with the management and written
representation as regards future use of the machines.
 Evidence supporting the test of impairment e.g. draft sales agreements, cash flow
projections relating to value in use, any contract relating to new uses of machines
in the company.
 Working showing computations related to impairment review (if required) as
discussed in preceding paragraphs.
A.4
(a) (i)
Significant matter
 In view of the decline in production capacity, it has become necessary to
recalculate the value in use and recoverable amount in order to assess the
impairment in the value of plant.
 The value of plant is material to the financial statements in terms of total assets as
well as profit before tax of the company.
Impact on audit report
 If the impairment test indicates a decline in the value of plant, the management
should be advised to make appropriate adjustments.
 In case of disagreement with the management, the auditor should give a qualified
opinion.
(ii) Significant matter
 Amount claimed by the customer is material to the financial statements in terms
of total assets as well as profit before tax of the company.
Impact on audit report
 If management agrees to explain the issue in the note on contingent liabilities, the
report will not be qualified but in view of the material uncertainty an emphasis of
matter paragraph would have to be added to the auditor’s report to draw the
user’s attention to the note in the financial statements.
 In case of disagreement on making appropriate disclosure, the auditor should
give a qualified opinion.
(iii) Significant matter
 It is a fundamental error within the meaning of IAS-8 and its effect should be
taken into account retrospectively. All comparatives figures should be restated
accordingly.
 The management’s decision to adjust the short amortization in the future years is
in contravention to the requirements of IAS-8.
Impact on audit report
 Since the error is material in terms of profit after tax, it should be discussed with
the management. They should be advised to make appropriate adjustment and
disclosure in accordance with the requirements of IAS-8.
 In case of disagreement, the auditor should give a qualified opinion.
Page 4 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2011
Q. 5
(a) Audit Risks
(i)
Excessive reliance on two products
Sales of Bisco and Portel constitute 90% of its turnover. If ML is not able to sell any of
its product due to any reason (e.g. withdrawn of distribution right, launching of new
product by the competitor, etc), it would be difficult for ML to continue as a going
concern entity.
(ii) Rapid Growth
ML has experienced rapid growth over the period. This raises the following audit
risks
 Effectiveness of internal control
ML increased its customer base significantly, increased its branch network, taken
on significantly more staff and moved its warehouse and customer service centre
to new premises. All these factors require appropriate changes in the control. If
control and systems have not grown with the company or internal control has
been inadequate there is a significant risk of errors and even fraud in the financial
statements;
 Cash flow considerations
 Because of the rapid expansion ML may have been overtrading, creating a risk
that it may not be able to generate enough working capital to finance its
operations.
 The situation will be further deteriorated by the additional fixed costs that ML
has committed while carrying out the expansion.
(iii) Inventory
 Obsolescence
 Increase in rising level of after sales warranty claims may be on account of
increased sales however it may also be indicative of manufacturing fault in the
quality of equipment. This may affect the value of inventory in-hand
particularly if the drop in sales experienced recently is indicative of the defect
being publicized.
 If the main products or products are ultimately found to be defective, it may
result in following issues:
 Impact on valuation of inventories
 decline in sales which may result in accumulation of slow moving items
 high level of sales returns
 The risk of obsolescence will be considered “High” if ML does not have
recourse to the manufacturer in respect of defective inventory.
(iv) Provision for Warranty Claim
There has been an increase in sales warranty claim which may require significant
material provisions in the financial statements.
(v) Valuation of Investment Property
Revaluation generally involves making estimates based on a number of assumptions.
Because of this reason, there is the chance that:
 professional valuer/ management may not be sufficiently experienced to make the
assumption.
 assumptions may be manipulated by the Management to obtain the most
favorable fair value in the financial statements
Page 5 of 7
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2011
(b) Audit Strategy
(i) The auditor should not seek to place heavy reliance on controls, and instead
undertake more substantive testing.
(ii) A major audit risk in the income statement is the cost of wages and salaries,
particularly if controls have not been strong. There has been a high number of new
staff and if controls are weak, there is scope for errors and even fraud to have been
perpetrated.
(iii) Risk related to cash flows as discussed above may have raised the going concern
issues. The auditors should carry out extensive going concern procedures.
(c) Principal audit procedures – valuation of Investment property
(i) To ensure the reliability of Valuation report by the Valuer:
 Assess the nature and complexity of the matter of valuation of the investment
property.
 Ensure the reliability of the information provided by the Expert from alternative
sources of information.
 Assess the nature, scope and objectives of the valuer’s work.
 Enquire whether the Management can exercise control or influence over the work
of the valuer.
 Enquire whether the valuer valuation work is subject to technical performance
standards or other professional or industry requirement.
(ii) To ensure the Competence, Capability and Objectivity of the valuer:
 Enquire the professional certification of the valuer
 Enquire whether he is a member of any professional body.
 Enquire whether any professional or legal standard are applicable to them
 What assumptions and methods are used by the expert and are they generally
accepted with that expert’s field and appropriate for financial reporting purposes.
 The nature of internal and external information that the expert uses.
 Enquire whether he has any experience in the valuation of investment property
and their recognition at fair value.
(iii) To determine the objectivity of the valuer so that the independence of the valuation
can be judged:
 Enquire whether valuer is related to the entity. (e.g., close family member of the
director)
 Enquire whether the valuer has any financial interest in the ML (e.g., shareholder)
 Enquire whether the fee received by the valuer is reasonable and at market price?
(iv) To ensure that revaluation has been properly accounted for in the books and the
financial statements
 Ensure that revaluation has been done in accordance with the ML’s accounting
policy for recording the investment property.
 Ensure that the entire class of investment property should be revalued.
 Ensure that gain or loss arises due to revaluation should be recognized in profit or
loss for the year.
 Ensure appropriate disclosures have been in accordance with IAS-40
Page 6 of 7
A.6
ADVANCED AUDITING
Suggested Answers
Final Examinations – Summer 2011
(i) Romeo Supermarket Limited:
Providing due diligence services to the client (RSL) whose interests are in conflict with
your other assurance client (Juliet Limited) in relation to the transaction in question may
create a self review threat or threat to objectivity or confidentiality or professional
behavior.
However, the firm can provide such services provided it notifies JL of the firm’s business
interest or activities that may represent a conflict of interest, and obtains its consent for
accepting the assignment. In such case the following safeguards should also be considered:





The use of separate engagement teams;
Additional procedures to restrict access to confidential information to concerned
personnel only.
Clear guidelines to members of the engagement team on issues of security and
confidentiality;
The use of confidentiality agreements signed by employees and partners of the firm;
and;
Regular review of the application of safeguards by a senior individual not involved in
relevant client engagements.
(ii) Sher Bano Limited:

Family and personal relationships between a member of the assurance team and SBL
Director Marketing may create:
 threat to independence;
 self interest threat;
 familiarity threat; or
 intimidation threat

(iii) 

The significance of the above threat should be evaluated and the following safeguards
should be considered to reduce the threat to an acceptable level:
 Removing the individual from the assurance team;
 Where possible, structuring the responsibilities of the assurance team so that the
professional does not deal with matters that are within the responsibility of the
immediate family member;
 Policies and procedures to empower staff to communicate to senior levels within
the firm any issue of independence and objectivity that concerns them
The payment of such referral fee create a:
 self interest threat to objectivity; and
 self interest threat to professional competence and due care.
Before referring the assignment, your firm should disclose to the client about the
arrangement to receive a referral fee from Marvi & Company.
(THE END)
Page 7 of 7
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination - Summer 2011
General:
Generally the performance of students was not upto the desired level of expectation.
Almost all the questions were based on practical situations and students of final stage are
supposed to have the ability to deal with these situations. Lack of knowledge and poor
presentation skills were evident. Quality responses are expected from the students of final
stage particularly for advanced auditing as most of the students are associated with audit
function for a reasonable period of time. As this was an open book examination, student
must have been able to analyze the situation and mold the information/guidance provided
in the book, according to the given situations. However, they often failed to focus on the
issues presented in the questions. Many candidates changed the structure of questions by
inserting unwarranted assumptions or preferred to write all that they knew about a topic
without appreciating the specific requirement.
Q.1
(a)
This question required analysis of going concern assumption in the light of
the given situation and a list of audit procedures to be carried out. Most of the
students were able to identify going concern issue but copied audit
procedures from the book without considering the fact that they were dealing
with a practical situation. As a result, they missed some very relevant points
such as
•
Assessing the significance of the revenues generated from the loss making
customer, for the business of the client.
•
Assessing the viability of that customer and its implications on
Company’s future cash flow projections.
•
Consideration of subsequent events in assessing the company’s status as a
going concern.
Majority of the students spent too much time on going round vetting the
loan agreement with the bank and discussing alternate financing
arrangement that the company may have in place. Moreover, very few
could mention an important point that after performing above procedures,
if there is a doubt about the appropriateness of the going concern
assumption, auditor will need to carry out additional audit procedures.
Page 1 of 3
Examiners’ Comments on Advanced Auditing - Summer 2011 Examination
(b)
Q.2
Q.3
This part of the question carried 09 marks and yet many students simply
wrote that since the going concern assumption was no more valid, the auditor
should express an adverse opinion. All such students missed the following
important points:
•
There was no clear indication in the given scenario on the basis of which
they could have concluded firmly that the going concern assumption was
invalid. Consequently, they should have discussed all the various
possibilities.
•
It is not necessary that if the going concern assumption is not valid, the
auditor would express an adverse opinion i.e. if the client agrees with the
auditor and revises the financial statement in an appropriate manner, an
adverse opinion may not be required.
In this question, a practical scenario was given. The students were required to
identify the important issues that they as an auditor, would need to consider and to
elaborate as to how could they address these issues during the course of audit. The
performance was poor mainly on account of the following:
•
Interim figures for the nine months were given alongwith the figures pertaining
to the year-end. Many students failed to read the question carefully. They
produced the whole answer on the presumption that these were comparative
figures for two different years.
•
Many students restricted their answers to issues pertaining to related party
transactions. Other issues were ignored.
•
The fact that the sale for the last quarter, as depicted by the information
provided, was only 6% of the annual sales, was seldom identified.
•
Most of the students were able to pick the very obvious issues only. Very few
candidates seemed to have the ability to explore those issues which were not
very apparent.
(a)
This part of the question relating to verification of opening balances carried
easy marks and was well attempted probably because the steps were readily
available in the Auditing Standards.
(b)
In this part, students were required to give their views on two simple
situations and identify audit evidences that were expected to be available.
The response was above average as most of the students were able to discuss
all significant issues related to capitalization of development expenditure and
impairment review. The weaknesses identified were as under:
•
Materiality of the amount of development expenditure was not discussed.
•
Obtaining representation from the management on the intended use of the
machines was not mentioned.
Page 2 of 3
Examiners’ Comments on Advanced Auditing - Summer 2011 Examination
Q.4
In this question the students were supposed to give their views on three issues faced
by them as auditors of a consumer goods manufacturing company and to discuss
the impact thereof on the audit report. The response on each issue is discussed
below:
(i)
The given situation was that a plant has been damaged resulting in a decline
in its production capacity. The performance was good as most of the students
were able to identify the issue of impairment in the value of plant and the
impact on audit report in case there was a disagreement with the client, on its
reporting, in the financial statements.
(ii)
Majority of the students only mentioned that the contingent liabilities would
need to be disclosed and in view of the fact that a material uncertainty has
arisen, an emphasis of matter paragraph would have to be added. The
possibility of a disagreement with the management, on the issue of
disclosure, should have been discussed also.
(iii) This was a prior period error which was required to be corrected
retrospectively in accordance with the requirements of IAS-8. Majority of the
students were unable to identify the same and discussed it as a change in
accounting estimate.
Q.5
This question offered an opportunity to the students to secure good marks.
Surprisingly, they failed to demonstrate their practical knowledge and missed some
of the very important issues. They should have noted that question had three parts
and all carried different weights; thus the answer should have been structured
accordingly. In the first place they should have identified the risk followed by its
evaluation. This in turn, would have helped them to identify the strategy most
suited in the given scenario and the appropriate audit procedures that should be
carried out.
It was surprising that most of the student could not identify significant risks arising
due to excessive reliance on two products, rapid growth, inventory obsolescence,
increasing warranty claims and valuation of investment property. Likewise, the
component related to audit strategy was responded to by many in the form of an
audit program which had no nexus with the requirement of the question. The
component related to valuation of property and accounting treatment thereof was
also not well attended as a significant number of candidates restricted their focus on
qualification and competence of the valuer only and missed other related aspects.
Q.6
This was an easy question and a large number of students were able to correctly
demonstrate their knowledge relating to Code of Ethics for Chartered Accountants
and Code of Corporate Governance. However, several students did not appreciate
that in case of Sherbano Limited, the wife of the partner was Director Marketing by
designation and not a director sitting on the Board of Directors and hence, the
appointment as auditor could have been accepted after placing appropriate internal
checks.
(THE END)
Page 3 of 3
The Institute of Chartered Accountants of Pakistan
Advanced Auditing
Final Examination
Winter 2011
Module F
Q.1
9 December 2011
100 marks - 3 hours
Additional reading time - 15 minutes
Your firm has recently been appointed as the statutory auditor of Chaudhry Limited (CL) for the year
ending 31 December 2011. The previous auditors, from whom your firm has received professional
clearance, did not wish to be re-appointed as auditors.
CL is involved in the supply of imported consumer products. The company has its own retail outlets
in all major cities. It also supplies goods to large retailers most of whom are allowed 45 days credit.
Time required to import the goods is approximately two months. 50% of the amount is paid at the
time of booking of order and the remaining amount is paid at the time of receipt of goods. The goods
are required to be insured by CL.
CL’s suppliers are mainly based in Middle East. Due to political disturbances, a major supplier has
recently ceased its operations.
All imported goods are initially placed in a warehouse in Karachi. Supplies are made against orders
which are mostly received over telephone by the sales department. The warehouse in-charge prepares
a summary of all dispatches which is approved by the sales manager, on a daily basis. Stock records
are computerised. Physical stock taking is carried out on a regular basis, at the warehouse as well as
retail outlets. Therefore, a 100% physical count is not undertaken at the year-end.
Day to day expenses of the retail outlets are paid out of cash receipts from customers. Balance cash is
deposited into the bank on a daily basis.
The management accounts show that the company has not been able to achieve the sales target for
the current year although the sales have increased by 12% as compared with the same period in 2010.
Stocks and trade debtors have significantly increased and the management attributes this to be on
account of increase in sales.
CL is planning to expand its business and intends to fund the expansion through a bank loan. CL’s
existing bankers have declined to increase the borrowing limits and therefore, the company has
approached another banker for the loan. The management has requested you to complete the audit
by 15 February 2012 to enable it to submit the audited financial statements to the new bankers.
Required:
Identify and evaluate the audit risks in the above situation and specify the audit procedures that you
would perform to address those risks.
(22 marks)
Q.2
You are the engagement partner on the audit of Faraz Industries Limited. The company has recently
started using internet to carry out its business activities and the share of business conducted through
e-commerce is growing rapidly.
Required:
(a) Identify the matters that you believe would be relevant while updating your knowledge of the
company’s business.
(04 marks)
(b) Identify the business risks related to the company’s e-commerce activities.
(09 marks)
(c) Identify the matters that need to be addressed in order to ensure the integrity of the transactions
carried out through the company’s website.
(07 marks)
Advanced Auditing
Q.3
Page 2 of 3
You are the quality control partner in Pirzada and Company, Chartered Accountants. The following
matters are under your consideration:
(i)
Your firm has been approached for appointment as external auditors of Watto Limited (WL), a
listed company. Your firm has been providing valuation services to WL.
(ii) To evaluate the network security system of Babar Limited (BL), your firm had acquired the
services of a Systems Auditor. The Finance Director of BL has accused the Systems Auditor for
compromising information relating to the company’s customers and providing their contact
details to a competitor.
(iii) Your finance department has issued an invoice to Qamar Software Services (QSS) against
referral fees for recommending services of QSS to an assurance and a non-assurance client. Your
permission has been sought before sending the bill to QSS.
Required:
Identify and evaluate the threats involved and explain what action would you take in the above
circumstances including the steps required, if any, to reduce the risk to an acceptable level. (16 marks)
Q.4
As the audit partner responsible for the audit of Mubashar Limited (ML), you have recently issued an
audit report on ML’s annual financial statements.
The audit senior involved in the audit of another client Salman Limited (SL) has informed you that
SL’s records indicate that it has made purchases worth Rs. 37 million from ML. Since the same audit
senior was also involved in the audit of ML he knows that SL and ML are associated companies and
ML had not disclosed any related party transactions in its financial statements. This fact has also
been confirmed from the working papers of both the companies. Payments against these purchases
were made in the name of ML by way of crossed cheques.
Required:
Discuss the factors that you will consider with reference to above and specify the action that you
would take in this regard.
(20 marks)
Q.5
Ghulam Limited (GL) is a listed company. You have issued an audit report on GL’s financial
statements for the year ended 30 June 2011. In November 2011, the management of GL has
approached your firm to provide a report on their summary financial statements for the year ended
30 June 2011.
Following information is available:
(i)
The audit report on the annual financial statements had been qualified on account of
management’s failure to capitalize borrowing costs of Rs. 15 million, on the construction of a
building for GL’s own use. The building is in use of the company since January 2011.
(ii) Under a local regulation which has recently been introduced, you are required to issue a report
on the summary financial statements. However, there are no established criteria for the
preparation of summary financial statements. The management has developed the criteria but
which is not acceptable to you.
(iii) The summary financial statements include a note which explains the reasons for decline in the
profitability of the company. You concur with the reasons given in the note but it did not form
part of the annual audited financial statements.
Required:
Evaluate each of the above situations considering them to be independent of each other and discuss
what measures would you take in each case.
(09 mark)
Advanced Auditing
Q.6
Page 3 of 3
You are the manager responsible for the audit of Hafiz Limited (HL), a listed company, whose
fieldwork in respect of the statutory audit is in progress. You are reviewing the following issues which
were brought to your attention by the audit team:
(i) HL’s parent company is registered in a foreign country and has asked your firm to also provide
an audit report on a separate set of financial statements which have been prepared under the
accounting framework prevalent in that country.
(ii) HL has paid a substantial amount of consultancy fee to a firm in another foreign country. The
management of HL is unable to provide a convincing explanation for such a payment. An
employee of HL has unofficially informed the audit senior that the amount was paid to avoid
paying a fine. However, the management has denied this allegation.
Required:
Discuss how would you deal with each of the above issues and what may be the implications thereof
on your audit report.
(13 marks)
(The End)
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2011
A.1
(i)
Audit Risks
Opening Balances:


There is a risk that opening balances may not have been brought forward
correctly from the previous year’s financial statements as this is the first year of
audit.
This risk is compounded by the fact that the retiring auditor was not willing to
be re-appointed.
Actions to be taken to address the risk:




(ii)
We need to review the previous period’s accounting records and schedules to
ensure that opening balances have been correctly brought forward to the
current period.
If the predecessor auditor permits, review his working papers to ensure the
correctness of the opening balances.
Audit procedures performed in the current period may provide evidence relating
to the correctness of opening balances.
We also need to consider the reasons on account of which the retiring auditor is
not willing for re-appointment.
Foreign Currency Transactions:
As the imports of consumer goods will involve transactions in foreign currencies, there
is a risk that gains or losses on translation of foreign currencies are wrongly credited/
debited to purchases instead of charging to Profit and Loss Account.
Actions to be taken to address the risk:
(iii)
Perform test of controls to ensure that any gains/ losses arising on the translation of
foreign currency are correctly recognized as per the requirements of International
Financial Reporting Standards and appropriate exchange rates are used in translation
of foreign currency.
Overstatement/ Understatement of purchases/ stocks/ liabilities:
Since all goods are imported and 50% advance is paid at the time of ordering, the
amount of purchases may be misstated resulting in misstatement of stock as well as
payables.
Actions to be taken to address the risk:


(iv)
Check that purchases are recorded when all the risk and rewards of ownership
are transferred to the company.
Ensure that the amount of deposit is properly reconciled with the pending
orders and goods in transit.
Insurance in transit:
Goods in transit may not be adequately insured.
Actions to be taken to address the risk:
(v)
Review the insurance policies at year end and match them with the consignments in
transit.
Going Concern/Liquidity Issues:


Page 1 of 7
The company’s existing bankers have declined to provide financing facilities to
the company, which is indicative of a weakening relationship and risk of nonfulfilment of covenants of borrowing.
One of the major suppliers of the company has ceased operations. If the company
is unable to find a suitable replacement, the company’s results and liquidity may
suffer.
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2011
Actions to be taken to address the risk:


(vi)
Discuss with management and assess the significance of the supplies from that
particular supplier and the impact of disruption in supplies on the company’s
operations.
Discuss and review the related documentation to ascertain the reasons on
account of which the company bankers had declined to provide further financing
facility to the company, and assess its impact on the company’s operations.
Overstatement of assets:
Increase in stock in trade and debtors may not be on account of increase in sales only.
There may be other reasons, such as obsolete stocks and uncollectible debtors.
Actions to be taken to address the risk:




Review the stock count procedures and the related documentation and assess
whether adequate controls exist.
Ascertain the management’s system of identification of obsolete and slow
moving stock and assess whether appropriate controls exist.
Review age analysis of debtors to ensure that any long outstanding debt that
requires provisioning is appropriately identified and adjusted.
Carry out substantive procedures (Confirmation, Aging Analysis etc.) based on
your assessment of controls.
(vii) Misstatement of sales/ stock in trade:
Sales and stock in trade can be misreported/ misappropriated due to the fact that sales
orders are taken over telephone and in the absence of strong controls over the
processing of orders, there is a risk that sales/stock in trade can be misappropriated/
misreported through collusion among staff members.
Actions to be taken to address the risk:


Check whether summary of dispatches is confirmed with the list of orders by an
independent person.
In the absence of proper segregation of duties between the approving and
initializing authorities and other related controls, we need to consider the
impact thereof on the extent of substantive procedures.
(viii) Unrecorded cash sales/ Misappropriation of cash:

Cash sales can easily be misappropriated.

Teaming and lading is possible since day to day expenses are adjusted before the
deposit of cash into bank.
Actions to be taken to address the risk:



(ix)
Evaluate and test the controls over cash receipts, at the retail outlets.
Perform analytical review on profit margins to identify any unusual trends.
In case of weak controls, or unusual results of the analytical procedures the
extent of substantive testing may be enhanced.
Time schedule for audit:
Tight audit deadlines may restrict the:

Extent of procedures that may be carried out.

Time available for review of subsequent events.
Being a new client the restriction may represent a more serious threat.
Actions to be taken to address the risk:
Page 2 of 7
Working papers should be independently reviewed by second partner, specially those
related to judgmental and high risk areas.
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2011
A.2
(a)
(b)
(c)
Matters that are relevant while updating knowledge of business:
The following matters should be considered by the auditors while updating the
knowledge of company’s business:
(i)
(ii)
(iii)
(iv)
The company’s business activities and industry
The company’s e-commerce strategy
The extent of the company’s e-commerce activities
The company’s outsourcing arrangements
Business risks that the company may face on account of its e-commerce activities
(i)
Loss of transaction integrity
(ii) E-commerce security risks, like virus attacks and un-authorized access etc.
(iii) Improper accounting policies related to capitalization of website expenditures.
(iv) Misunderstanding of complex contractual arrangements
(v) Translation of foreign currencies etc.
(vi) Title transfer risks
(vii) Allowances for warranties/ returns
(viii) Revenue recognition issues and cut off issues
(ix) The treatment of volume discounts and introductory offers
(x) Non-compliance with taxation and other legal and regulatory requirements,
particularly in case of transactions with parties in other countries;
(xi) Failure to ensure that contracts evidenced only by electronic means are binding;
(xii) Over reliance on e-commerce when placing significant business systems or other
business transactions on the Internet; and
(xiii) Systems and infrastructure failures or “crashes.”
Risks to be addressed to ensure integrity of the transactions carried out through the
Company’s website
In an e-commerce environment, the main risk that could affect the integrity of the
transactions carried out are as follows:
(i)
(ii)
(iii)
Incorrect input of data
Duplication or omission of transactions
Party to a transaction may later deny having agreed to specified terms (nonrepudiation)
(iv) Transactions made without approval of the parties
(v) Incomplete processing and recording of data
(vi) Improper maintenance of files, systems and networks
(vii) Improper distribution of transaction details across multiple systems in a
network (Loss of data and systems)
A.3
(i)
Watto Limited
(a) A self review threat may be created if the results of the valuation carried out by
the firm are required to be incorporated in the client’s financial statements.
(b)
Page 3 of 7
If the firm has carried out valuation of items material to the financial statements
or the valuation involves a significant degree of subjectivity, the firm would not
be in a position to reduce the self review threat to an acceptable level by the
application of any safeguard, and should not accept the audit engagement.
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2011
(c)
(ii)
(iii)
A.4
If the valuation services are not material either separately or in aggregate, or if
they do not involve a significant degree of subjectivity, the following actions may
be taken to reduce the self review threat to an acceptable level:
 Involve another chartered accountant who will not be a member of the
assurance team, to review the work done or provide necessary advice.
 Obtain confirmation from the audit client about their understanding of the
underlying assumptions of the valuation and the methodology being used for
valuation
 Obtain approval of the client regarding use of the methodology and assumptions
in the valuation.
 Obtain the client’s acknowledgement of responsibility for the results of
valuation services performed by the firm.
 Ensure that personnel who had been providing such services do not participate
in the audit engagement.
Babar Limited
If the allegation by the client that the Systems Auditor has compromised the
information relating to the company’s customers is correct, retaining the employee
would pose similar threat at other clients also.
Therefore, we should immediately take the following actions:
(a) Remove the Systems Auditor from all jobs till the matter is investigated and the
allegation is confirmed or refuted.
(b) If the System Auditor is found guilty, he shall be dismissed immediately.
(c) The above situation casts doubt about the firm’s recruitment and training
policies. These would need to be reviewed and re-evaluated.
Qamar Software Services:
(a) Receiving of a referral fees for referring the services of QSS to clients may create
a self interest threat to objectivity, professional competence and due care.
(b) It should be ensured that the arrangement between Pirzada and Company,
Chartered Accountants and QSS, regarding referral fees, is fully disclosed to the
clients.
Factors that should be considered and actions to be taken
(a)
The amount of sales made to SL a related party is material (by nature) to the financial
statements.
(b)
We need to consider the reason for this event. The possible reasons are as follows:
(i)
(ii)
(iii)
(c)
We shall discuss the issue with the management and if necessary with those charged
with governance and ask them to:
(i)
(ii)
Page 4 of 7
It may be a deliberate attempt by ML to fraudulently siphon off funds by
suppressing the sales probably by the management itself or by any other
employee.
ML may have recorded the sale in the name of any other party with the intention
of non-disclosure of related party transaction.
The non disclosure of related party transactions may be due to unintentional
error made by the management.
revise the financial statements
take steps to ensure that those in receipt of the previous financial statements are
informed of the situation.
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2011
(d)
If we establish that the revised audit report should be issued and the management has
not yet issued the financial statements to the shareholders, in this case we shall:
(i)
(ii)
(iii)
(iv)
(e)
If financial statements have already been issued to the shareholders then we should, in
addition to the above audit procedures:
(i)
(ii)
(iii)
(f)
(g)
Carry out the audit procedures necessary for verification of amendment in the
financial statements.
Extend the audit procedures regarding subsequent events, to the date of the new
audit report.
Provide a new auditor’s report on the amended financial statements.
Include an emphasis of matter paragraph or other matter paragraph reflecting
such amendment.
Review the steps taken by the management to ensure that those in receipt of the
previous financial statements together with the auditor’s report thereon are
informed of the situation.
Notify the management and where necessary those charged with governance
that we would seek to avoid future reliance on the audit report, if the
management does not take appropriate steps to ensure that those in receipt of
previously issued financial statements are informed of the situation and does not
amend the financial statements.
Seek legal advice in order to prevent the reliance on the audit report on the
financial statements, if in spite of our communication, ML’s management or
those charged with governance fail to take necessary steps to prevent reliance
on the audit report issued on the financial statements.
Under the specific law, regulation or the financial reporting framework where we are
permitted to restrict the audit procedures on subsequent event specific to the amendment,
we will mention an additional date in the audit report restricted to the amendment that
indicates that the audit procedures on subsequent events are restricted to that specific
amendment as mentioned in the relevant note. We would also mention the fact in the
emphasis of matter paragraph or the other matter paragraph that our audit procedures on
subsequent events are restricted solely to the amendment of the financial statements as
described in the relevant note to the financial statements.
If as a result of a misstatement resulting from fraud or suspected fraud, we feel that our
ability to continue performing the audit has been affected, we should:
(i)
(ii)
Determine the professional and legal responsibilities applicable in the
circumstances, including the requirement to report the matter to the shareholders
or the regulatory authorities.
Consider whether it is appropriate to withdraw from the engagement, and if we
decide to withdraw:
 Discuss with appropriate level of management and those charged with governance,
our withdrawal from the engagement and the reasons for the withdrawal.
 Determine whether there is a professional or legal requirement to report to the
shareholders about the withdrawal from the audit or the responsibility to report it to
the regulatory authorities.
 Discuss with the legal advisor about withdrawal from the engagement.
Being an associated company the management of ML may be in a position to influence the
decision of SL also. Therefore the auditor should reassess the risk of material misstatement
in SL.
Page 5 of 7
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2011
A.5
(i)
(ii)
If audit report on the audited financial statements contains a qualified opinion but the
summary financial statements are consistent with the audited financial statements, the
audit report on the summary financial statements shall:
 state that the audit report on the audited financial statements contains a qualified
opinion;
 describe the basis for the qualified opinion on the audited financial statements and that
qualified opinion.
 describe the effect of the qualification in the audited financial statements, on the summary
financial statements.
Since it is necessary under the local regulation to report on the summary financial
statements, but the applied criteria is not acceptable, we would:
 Make appropriate reference of this fact in the terms of engagement.
 Indicate in the audit reports that the engagement was not conducted in accordance with
the International Standard on Auditing.
 Reconsider whether the firm may continue to accept the engagement to audit the
statutory financial statements.
(iii)
We would ask the management to change the presentation of the note explaining the
reasons for decline in profitability, in such a way that it is clearly differentiated from
the summary financial statements.
If the management does not agree to change the presentation, the audit report on the
summary financial statements shall disclose the fact that the said information is not
covered by that report.
A.6
(i)
(ii)
In this case of reporting on more than one set of financial statements,the auditor will
need to determine that whether the reporting requirements of other framework are
acceptable to the auditor in the prevailing circumstances.
Impact on Audit Report
If the framework is acceptable then the auditor will include an other matter paragraph
in the auditor’s report, which will include a reference that he has also issued an audit
report on another set financial statements which has been prepared as per the
reporting requirements of a different accounting framework.
 Evaluate the reasons provided by the management for making this payment, to assess
whether the amount paid in the circumstances was reasonable.
 If the management is unable to provide satisfactory explanation it may be indicative of
the following:
 That the amount paid was not for the purposes of the company’s business.
 There was a non-compliance with a law as has been unofficially claimed by an
employee.
 In either case, the auditor should consider the impact thereof on his initial risk
assessment and to revise the audit procedures accordingly.
Page 6 of 7
 The indication of non-compliance with laws and regulations may require the auditor
to consider the potential financial consequences of the non-compliance, on the
financial statements including, the imposition of fines and penalties and the impact
thereof on the company’s ability to carry out its business.
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2011
 The auditor may discuss his findings with those charged with governance if the
auditor considers that they will be able to provide with additional audit evidence in
relation to the transaction.
 If management or those charged with governance do not provide sufficient
appropriate audit information to the auditor, the auditor may consider it appropriate
to consult with the entity’s legal counsel or auditor’s own legal counsel if the auditor is
not satisfied with the entity’s legal counsel.
 The auditor may also consider whether it is necessary for him under the relevant laws
and regulations to report the matter to the concerned authorities.
Impact on Audit Report
If the auditor concludes that the non compliance has a material effect on the financial
statements which has not been adequately reflected therein, the auditor shall express a
qualified opinion or an adverse opinion.
If the auditor concludes that the expenditure incurred is not for the purpose of the business,
the auditor shall express a qualified opinion or an adverse opinion depending upon the
materiality of the transaction.
If the auditor is precluded by management or those charged with governance from obtaining
sufficient appropriate audit evidence to evaluate whether non-compliance that may be
material to the financial statements has, or is likely to have occurred, the auditor shall express
a qualified opinion or disclaim an opinion on account of scope limitation.
(The End)
Page 7 of 7
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination - Winter 2011
General:
Performance of the candidates was average. Most candidates did not display good
command over auditing standards. Likewise, several scripts lacked presentation skills
which are expected from candidates appearing at final level. Although reading time of 15
minutes is allowed yet most of the answer scripts lacked any structured and focused
approach and did not attend to the specific requirement of the question.
Q.1
The question required the students to identify the risks associated with the audit, in
a given scenarios and specify the necessary procedures, to address those risks. The
performance of majority of the candidates was far below the expected level. Most
of them were able to identify the apparent risks only. The second requirement i.e.
the audit procedures to address the identified risks, was better managed.
Q.2
Parts (a) and (b) of the question were well attempted although in part (b) some
students could not distinguish between business risks and other audit risks.
In part (c) the performance was below expectations as instead of identifying the
matters that need to be addressed for ensuring the integrity of the transaction, most
students focused on the controls relating to transaction integrity.
Q.3
The question required the students to give their comments on three different
situations, each of which is discussed below:
(a)
A firm which had been providing valuation services had been approached for
appointment as auditor. The students were expected to know that the response
of the firm would be different depending upon whether the items being valued
were material to the financial statements or involved subjectivity or not. Most
of the students could not elaborate in the desired manner.
(b) In the given situation, a client had accused an audit team member of
compromising company’s information to a competitor.
Most of the students failed to notice that the allegation may or may not be
true. Consequently, a structured response was rarely witnessed as most of the
students simply assumed that the staff member was guilty.
(c)
Many students could correctly point out that referral fee can be accepted
provided the matter is disclosed to the client. The risks that may be associated
with charging of referral fee in the given situation were also identified
correctly.
Page 1 of 3
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2011
Q.4
The situation given in the question required imaginative thinking and only those
who had deep insight and good command over the subject could secure good
marks. Most others gave unstructured answers and were only able to produce two
or three valid points.
The common deficiencies were as follow:
•
Discrepancy mentioned in the situation could have been intentional as well as
unintentional. Most students could not visualize this aspect.
•
It was clearly stated that the audit report has been issued whereas many students
answered the question with the assumption that the audit report has not been
signed.
•
Some key issues like re-assessment of the risk of material mis-statement in SL,
possibility of withdrawal from the engagement and the impact on audit report
were discussed by few students only.
Q.5
This question was based on audit of summary financial statements. The candidates
were required to evaluate three independent situations and specify the measures
that the auditor should take in each case. It was a straightforward question based on
ISA. Being an open book examination most students performed well. However,
poor performance was also seen in many cases, which meant that such students had
not touched this topic at all.
Q.6
In this question the overall performance was very poor. Some of the common
mistakes were as follows:
Part (i)
Most students were not able to highlight the need to determine whether the
reporting requirements of other framework are acceptable to the auditor in the
prevailing circumstances. Consequently, they also failed to specify that if the
framework was acceptable, the auditor would need to include an “other matter
paragraph” in the audit report.
Part (ii)
Most students were not able to highlight the following important matters:
•
If the management is unable to provide satisfactory explanation of the payment
made in a foreign country, it may be indicative that the amount paid was not for
the purpose of the Company’s business or there was a non-compliance with a
law as has been unofficially claimed by an employee.
•
In either case, the auditor should consider the impact thereof on his initial risk
assessment and to revise the audit procedures accordingly.
Page 2 of 3
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2011
•
The indication of non-compliance with laws and regulations may require the
auditor to consider the potential financial consequences of the non-compliance
on the financial statements including, the imposition of fines and penalties and
the impact thereof on the Company’s ability to carry out its business.
•
The auditor may also consider whether it is necessary for him under the
relevant laws and regulations to report the matter to concerned authorities.
(THE END)
Page 3 of 3
The Institute of Chartered Accountants of Pakistan
Advanced Auditing
Final Examination
Summer 2012
Module F
Q.1
4 June 2012
100 marks – 3 hours
Additional reading time – 15 minutes
You have been appointed as the auditor of Tee Pharmaceuticals Limited (TPL) for the year ended
31 March 2012. An extract from the draft financial statements is presented below:
Income statement
Revenue
Finance charges
Profit after tax
Statement of financial position
Intangible assets
Stocks
Trade receivables
Share capital (Rs. 10 each)
Retained earnings
Long term loans
Short term loans
2012
2011
Rs. in million
48,970
47,500
3,000
1,200
70
600
2012
2011
Rs. in million
7,000
3,000
27,000
15,500
13,800
11,500
20,000
20,000
1,170
1,100
10,500
3,000
27,000
15,000
During the planning process, you have gathered the following information:
(i)
TPL’s operations were highly successful until 2008. However, due to increased competition
the profitability has reduced significantly over the last four years. Consequently, the
company has embarked upon an ambitious plan whereby it has taken the following steps:
• Three new products have been introduced for which patent rights have been purchased.
The new products were introduced in the market in December 2011.
• A new plant has been acquired which is expected to reduce the cost of production
significantly.
• The above measures have been financed through a bank loan against hypothecation of
stocks and trade receivables.
(ii)
TPL has had a dispute with a major distributor who alleges that products were delivered in
damaged packets and the quantities therein were short as compared to the numbers
mentioned on the packets.
(iii)
A franchisor has initiated a legal action against the company on grounds of infringements of
patent rights.
(iv)
TPL had entered into a one year agreement with a foreign supplier for supply of raw
material. On 20 April 2012 the government of the country in which the supplier is registered,
has initiated legal proceedings against that supplier for breach of quality standards.
Consequently, the government of the country in which TPL is operating has banned all
imports from that supplier.
Required:
Identify the audit risks that exist in the above scenario and the manner in which you would address
those risks, during the audit under the following headings:
(i) Raw materials
(iii) Intangibles
(ii) Trade receivables
(iv) Liquidity issues
(19 marks)
Advanced Auditing
Q.2
Page 2 of 4
The following situations have arisen at different audit clients of your firm:
(a)
Zafar Technology Limited (ZTL), a listed company, is engaged in the manufacture of
compressors used in electrical appliances. During the conduct of the audit for the year ended
31 March 2012, a team member has discovered a letter dated 18 March 2012 from Sartaj
Electronics Limited (SEL) which states that SEL will not pay the current outstanding
invoices as according to it the compressors supplied by ZTL are of an incorrect specification.
ZTL’s Technical Director believes that the problem arose due to changes in the design of
appliances produced by SEL and not because of faulty production by ZTL. However, both
the companies have agreed to refer the matter to arbitration.
Sales to SEL account for approximately 25% of the revenue of ZTL and the balance due
from SEL as at 31 March 2012 amounted to Rs. 3.12 million. The profit after taxation of
ZTL is Rs. 25 million with an asset base of Rs. 150 million.
(07 marks)
(b)
The directors’ report of XCP Limited states without any further explanation that the 20%
increase in profit as compared to the previous year is due to increase in sales and austerity
measures introduced by the management. The income statement for the year shows an
increase in profits and sales amounting to Rs. 20 million and Rs. 8 million respectively
whereas the costs have reduced by Rs. 12 million. A review of your working papers however
indicates that costs have reduced mainly on account of reduction in import duty on certain
raw materials.
(04 marks)
(c)
IPL is a manufacturer of diversified products and has factories in seven major cities of the
country. The demand for some of its products has been falling and the company wants to
concentrate on its core products only. Consequently, it has decided to close three of its
factories and has made a provision of Rs. 30 million in respect of redundancies and
restructuring. The directors’ report for the year ended 31 May 2012 comprehensively
discusses the restructuring plan and states that the factories in Lahore and Multan would be
closed in the months of July and September 2012 respectively. The third factory will be
closed before December 2012 however, the location of that factory will be decided in
November 2012.
The profit after taxation of IPL according to its draft financial statements for the year ended
31 May 2012 is Rs. 80 million.
(06 marks)
Required:
Discuss the matters which the auditor should consider for each of the above situations and the
possible impact thereof on the respective audit reports.
Q.3
You are the quality control partner in Wiew and Company, Chartered Accountants. You have
been assigned additional responsibilities for assessment of risks associated with the firm’s existing
and proposed clients. At present, the following matters are under your consideration:
(a)
The government has invited ‘expression of interest’ for selling its strategic shares in Iqbal
Limited (IL). One of your clients’ Zain Limited is interested in the deal and has requested
your firm to carry out a due diligence exercise. Mian Limited has also approached your firm
for carrying out a business valuation of IL.
(b)
JKL Limited, a listed audit client of your firm, has been in dispute with a supplier. JKL is of
the view that it has suffered losses on account of breach of contract by that supplier. JKL
intends to file a suit in a civil court and has asked you to estimate the amount of damages
that may be claimed and provide a detailed calculation thereof.
Required:
Discuss the categories of threats involved in each of the above situations and advise the partners as
regards the possible course of action that may be followed.
(16 marks)
Advanced Auditing
Q.4
(a)
Page 3 of 4
XYZ Company Limited intends to seek a financing of Rs. 250 million from their bankers in
order to implement the board’s latest expansion proposal. The company’s CFO has prepared
a five years ‘cash flow forecast’ based on management’s estimates for presentation to the
bankers. The company has requested your firm to review the forecast and furnish a report
thereon.
Required:
Explain the matters which your firm would consider before accepting the above engagement.
(10 marks)
(b)
Assuming that your firm has accepted the above engagement and during the course of the
review, a significant reduction in the cash outflows on account of income tax has been noted
in the years 3, 4 and 5. The management has informed that the taxation authorities have
principally agreed to reduce tax rates for companies operating in the ‘industrial zone’ in
which the company is situated and the announcement of the reduction in tax rates will be
made in the next budget. However, the management has not provided any evidence to
support their claim. The impact of this assumption is Rs. 5 million for each year.
The management has justified its stance by stressing that the assumption related to the tax
rates has been clearly disclosed in the prospective financial information.
Required:
Evaluate the above situation and briefly discuss the steps that your firm should take.
Q.5
(06 marks)
A regulatory body has recently revised certain requirements pertaining to the information to be
disclosed in the financial statements of one of your existing clients. These requirements may be in
conflict with the financial reporting framework being followed by the client.
You have informed the client that in view of the possible conflict, the audit report may require a
modification. However, the client has expressed its reservations over the issue and requested you
to avoid modifying the report.
Required:
Based on the requirements of the relevant International Standards on Auditing draft an
(i)
appropriate response to the client, explaining the possible reasons for modification and the
circumstances in which such a modification may be avoided.
(07 marks)
Assuming
that
you
decide
to
modify
the
audit
report,
on
grounds
as
you
consider
(ii)
appropriate, draft the basis for modification paragraph to be included in that report.
(06 marks)
Q.6
You are the audit manager of Paidar Tameerat Limited (PTL) for the year ended 31 May 2012. PTL is a
listed company and is engaged in the construction of high rise buildings including residential and
commercial complexes.
Last year serious differences of opinion had arisen with the management of PTL while determining the
stage of completion of certain projects. The matter was ultimately resolved after an independent valuer
had rendered a report and on which the auditor had placed reliance. This year the management has
employed an engineer to monitor the various projects. The engineer has reported minor discrepancies in
the estimates provided by various project managers.
Required:
Assess the above situation and discuss how you would address the related issues during the course of the
audit.
(07 marks)
Advanced Auditing
Q.7
Page 4 of 4
Mr. Mahmood is the engagement partner for the audit of Khyber Limited (KL), a listed company.
In a meeting of the partners of the firm he had declared that Better Life Trust (BLT), in which he is
a trustee, intends to purchase fifty thousand shares of KL from the open market.
Required:
(a) State how should the firm deal with the above situation.
(b)
(07 marks)
What would the firm’s response be if Mr. Mahmood inadvertently fails to disclose the above
fact before the purchase of shares and it comes to the knowledge of the firm after the shares
have been purchased?
(05 marks)
(THE END)
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2012
A.1
(i)
Raw Material:
 Inventory of raw material may be overvalued and require provision for
obsolescence because raw material acquired from the foreign supplier may not
be used in production due to breach of quality standard.
 TPL may face shortage of raw material, if it is unable to find alternative supplier
from which the raw material can be obtained. The shortage of raw material may
affect the operations of the company.
Actions to be taken to address the risk:
 Review the reasons and reports based on which the Foreign Government has
acted against the concerned supplier;
 Ask client to determine the net realizable value of the raw material keeping in
view the risks identified above and review the clients working.
 Discuss with management about extent of reliance on the foreign supplier and
any alternative source of supplies.
 If the extent of reliance on foreign supplier is significant and TPL is unable to
find alternative supplier, assess the impact thereof on TPL’s operations.
(ii)
Trade Receivables:
 An increase of about 20% in trade receivables and significant dispute with a
customer over packaging and short delivery issues indicate that some accounts
receivable might not be recoverable.
 An increase in Debtors Turnover days from 87 days to 101 days indicates the
existence of slow moving and doubtful debts, which may require provisioning.
Actions to be taken to address the risk:
 Obtain age analysis from the management to identify any long outstanding
debts.
 Check subsequent recovery of debtors and obtain confirmation from major
debtors.
 Discuss with management about the reason for increase in debtors turnover
days i.e. is it on account of lower collection or on account of change in
collection policy.
 Consider adequacy of provisions.
(iii) Intangibles:
 Legal case filed by the franchisor on account of alleged patent infringements
indicates that the value of intangibles may be impaired.
 Valuation of inventory may be also be impaired on account of patent
infringements
 The legal case may lead to substantial fines and penalties.
Actions to be taken to address the risk:
 Review the agreement of patent with the franchisor and assignment deed.
 Obtain confirmation from the legal advisor relating to the possible outcome of
the case filed by the franchisor.
 Ask the client to calculate value in use, of the patents and check the working
thereof.
 Consider the opinion of legal advisor to assess the impact of patent violation on
the valuation of finished goods.
(iv)
Liquidity Issues:
 Although TPL had successfully negotiated with the bank by obtaining long and
short term loans, interest expense as a percentage of profit has increased
significantly. It could hamper the company’s ability to pay the finance charges
and the principal.
Page 1 of 6
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2012
 Short term loans were obtained by hypothecation of the stocks and receivables.
A significant decline in the value of stock in trade and trade receivables is
probable as discussed in (i) and (ii) above. TPL’s bankers may ask the company
to provide further securities or to pay off the loan amount.
Actions to be taken to address the risk:
 Review the steps taken by the management of the company to counter the
liquidity problems faced by it.
 Review the projections of the company to assess whether the company will be
able to overcome the current liquidity crisis.
 If the steps taken by the management are not considered satisfactory consider
the impact thereof on the company’s ability to continue as a going concern.
A.2
(a)
 Two significant uncertainties exist for ZTL i.e. recoverability of balance due
from SEL and whether the going concern assumption is appropriate in light of
the possible termination of the contract by SEL.
 The Accounts receivable balance is material to the financial statements as it is
12.48% of profit after tax.
 The possible loss of contract from SEL is material to the financial statements as
the revenue from SEL contributes about 25% of total revenue.
 It appears that the uncertainty relating amount receivable balance and
termination of contract will not be resolved till the time of signing off the
financial statements and audit report.
 If uncertainties are adequately disclosed in the financial statements then an
unqualified opinion can be given, however an emphasis of matter paragraph is
to be included in the auditor’s report to draw user’s attention to the significant
uncertainties. In case appropriate disclosure is not given a qualified opinion or
adverse opinion as appropriate.
(b)
 If there are material inconsistencies in the other information presented with the
financial statements the auditor should discuss the reasons thereof with the
management and ask them to revise the other information.
 In case of disagreement, the auditor shall communicate the matter to those
charged with governance.
 Include in the auditor’s report an ‘other matter paragraph’ describing the
material inconsistencies.
(c)
 A provision of Rs. 30 million has been made in the financial statements and it
represents 37.5% of the profit after tax and is material to the financial
statements.
 A constructive obligation to restructure arises only when an entity has a
detailed formal plan for the restructuring identifying at least the principal
locations affected.
 In this case it is unlikely that a constructive obligation exists in respect of third
factory because the factory which is to be closed is not identified.
 The auditor shall determine whether provision of Rs. 30 million pertains to two
factories which are identified or it pertains to three factories (including one
which is not identified).
 If the provision relates to three factories, auditor will ask the management to
adjust the amount of provision to reflect the provision for two factories
Moreover, the plan for closure of the third factory should be disclosed.
 If the management refuses to do so, a qualified or adverse opinion may be
issued depending upon the materiality and pervasiveness.
Page 2 of 6
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2012
A.3
(a)
Iqbal Limited:
(i) A threat to objectivity or confidentiality may be created when a Chartered
Accountant in practice performs services for clients whose interests are in
conflict.
(ii) The above threat may be reduced to an acceptable level by taking the following
steps:
 Notifying both the parties that we are acting for both of them, and
obtaining their consent to so act; and
 The use of separate engagement teams; and
 Procedures to prevent access to information (e.g., strict physical
separation of such teams, confidential and secure data filing); and
 Clear guidelines for members of the engagement team on issues of
security and confidentiality; and
 The use of confidentiality agreements signed by employees and partners
of the firm; and
 Regular review of the application of safeguard by a senior individual not
involved with relevant client engagements.
(b)
JKL Limited:
(i) A self-review threat may be created when the litigation support services
provided to a financial statement audit client include the estimation of the
possible outcome and thereby affects the amounts or disclosures to be reflected
in the financial statements.
The significance of any threat created will depend on:
 The materiality of the amounts involved:
 The degree of subjectivity inherent in the matter concerned;
(ii)
A.4
(a)
Wiew and Company, should evaluate the significance of any threat created
and, if the threat is other than clearly insignificant, it should:
 Inform JKL that the decision with regard to the filing of suit and all allied
matters is at the sole discretion of its management.
 The employees on the assignment should be clearly advised, not to
participate in any managerial decision making.
 The professional on this assignment should not be involved in the
assurance engagement.
 The involvement of others, such as independent experts should be
considered, if necessary.
Before accepting the engagement, I would consider the following matters:
 Period covered by the information: The business plan covers the five year.
Assumptions normally become more speculative as the length of period covered
increases. The final conclusion in this regard would however depend on the
nature of business and other conditions affecting the business.
 Reliability of the information: This will depend on management’s expertise
and integrity. Past experience with the company may help in assessing this
aspect. Otherwise the reputation of the company in the market and business
risks may have to be considered.
 Access to Information and personnel: I would seek assurance from the client
that all relevant information and personnel would be accessible during the
audit. This matter may be clarified in the engagement letter, in order to avoid
any misunderstanding at a later stage.
 Nature of assumptions: I would ensure that the assumptions are realistic and
assess whether I would be able to obtain a sufficient level of knowledge of
XYZ’s business to evaluate all significant assumptions.
Page 3 of 6
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2012
The assumptions involved in projections of revenue on account of expansion
could be difficult as compared to assumptions related to normal business
operations.
Similarly the I may consider hiring the services of an expert to assess the
assumptions pertaining to the costs of expansion (i.e. new plant, building etc)
 General or Limited Distribution: I would consider the extent of my
responsibility as an auditor towards the intended users.
 Elements to be included in the Prospective Financial Information(PFI) and
their appropriateness for the intended use: I would determine through review
of the elements included in the PFI that whether a opinion can be formed and
issued on the PFI’s and whether these are appropriate for the intended use. Too
much detailed analysis of each item would increase the risk and consequently
the auditor’s responsibility.
A.5
(b)
(i)
 It is a best estimate assumption and the auditor is required to obtain
sufficient appropriate evidence from internal and external sources.
 Preferably the management should provide the correspondence/
confirmation from the Federal Board of Revenue relating to the reduced
tax rates.
 If the correspondence/ confirmation from FBR is not available the
auditor may discuss the matter with the management of other companies
in the same Industrial Zone or their representative association to assess
the validity of XYZ’z claim.
 If the auditor is unable to obtain sufficient appropriate audit evidence, the
auditor will conclude that the assumption related to the taxation rates
does not provide a reasonable basis for the prospective financial
information and will either express an adverse opinion or withdraw from
the engagement.
(i)
Dear Sir,
If there is a conflict between the new requirements introduced by the regulatory body
and the existing financial reporting framework we will have to assess the situation
and proceed in the following manner:
(a)
(b)
(c)
(d)
If the compliance with additional requirements can be met through additional
disclosures, you shall be required to incorporate the additional disclosures in the
financial statements..
as the external auditor we shall ensure the adequacy of the disclosures.
If the additional requirements cannot be met with the additional disclosures, you will
need to amend the description of applicable financial reporting framework mentioned
in the Statement of Compliance in Policy notes of the financial statements
In case you don’t agree with incorporating additional disclosures or the amendment
of the description of the applicable financial reporting framework, then in this case
we may require modifying our opinion in accordance with the applicable
International Standard on Auditing.
We hope that the above points will clarify your concerns relating to the compliance
with the additional requirements, introduced by the regulatory body and the possible
reasons due to which we may need to modify our opinion.
Yours faithfully,
XYZ and Company, Chartered Accountants
Page 4 of 6
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2012
(ii)
BASIS FOR MODIFICATION PARAGRAPH
In accordance with the requirement of the XYZ Act 2012, the company is required to
disclose the amount of all the Contingent Assets that existed at the balance sheet
date. The Company has not disclosed the amount of Contingent assets as required
under clause XX of the XYZ Act, 2012, because the inflow of economic benefits was
not probable and hence such disclosure would not be in compliance with the
requirements of the International Financial Reporting Framework.
A.6
Discrepancies in the estimates provided by the project managers:
(i)
The auditor would need to determine whether he can rely on the reports of the
engineer hired by the management.
(ii) In determining the extent of reliance on the work of the engineer, the auditor would:
 Evaluate the competence, capabilities and objectivity of the engineer,
 obtain an understanding of the procedure followed by the engineer and
 evaluate the appropriateness of using the engineer ‘s reports as an audit
evidence for verification of stage of completion and the estimated cost of
completion.
(iii) Subsequent receipts/costs/completion status would be reviewed to assist the
reasonableness of the engineer’s estimate.
(iv) The auditor will determine the extent of substantive procedure for verification of
estimated cost of completion if he can place reliance on the reports of the engineers.
(v) If the auditor cannot place reliance on the work performed by the engineer, he will
reassess the initial risk assessment and consider the need of involvement of
independent external engineer.
A.7
(a)
Circumstances in which the shares of KL can be purchased by BLT:
If BLT makes investment in shares of KL Mr. Mahmood may continue to act as the
audit engagement partner of KL as well as a Trustee in BLT, if:
 Mr. Mahmood or any of his immediate family members is not a beneficiary of
the trust; and
 The value of shares purchased is not material to BLT (Trust); and
 Even after purchase of shares, BLT will not be able to exercise significant
influence over the assurance client; and
 Mr. Mahmood and the firm does not have significant influence over any
investment decision involving a financial interest in KL.
In case the answer to any of the above is in negative, the firm shall require that the
shares held by the Trust are disposed off or shall have to change the engagement
partner.
(b)
Circumstances And Actions:
If Mr. Mahmood has inadvertently not disclosed the fact about purchasing shares of
KL and the shares are subsequently purchased, the firm should take the following
steps in order to ensure that the independence of the firm is not impaired:
 In case where Mr. Mahmood discloses the fact regarding purchase of shares to
the firm immediately after the purchase of shares, the firm should require him
to either ensure that the shares are sold by the Trust immediately. If that is not
possible, he should be removed from the engagement team.
 In case where Mr. Mahmood does not discloses the fact regarding purchase of
shares to the firm immediately after the purchase of shares, the firm should
consider involving an additional chartered accountant who did not take part in
the assurance engagement to review the work done by Mr. Mahmood.
Page 5 of 6
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2012
(THE END)
Page 6 of 6
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination – Summer 2012
General:
Most of the candidates could not perform very well and extended an unstructured effort
which is completely unwarranted from a student of final module. Responses were by and
large found extremely lacking in knowledge as well as application. The candidates had
insufficient grasp over the related professional standards/pronouncements, lacked
presentation skills and were unable to provide focused answers to the questions. Most
candidates preferred discussing the topic in a general manner rather than attending to the
specific requirements of the question.
Question-wise comments are as under:
Q.1
This question was set by the examiner to test the knowledge of the students about
assessment of the audit risks in four areas and how an auditor would address those
risks. The students were generally able to mention the risks. However, many
students had the tendency to mention all the risks that are usually associated with
these areas, instead of identifying only those risks that were relevant to the given
situation. Some of them identified the risk but did not relate it to the given
situation.
While explaining as to how the auditor may address the particular risks, many
students tended to produce the entire audit program. Some candidates wrote minor
steps like, trace opening balances, agree balances with ledger and carry out stock
taking etc. which are not usually required to be mentioned at this level, unless they
are significant on account of a very specific situation.
Q.2
The question required the students to discuss the matters that an auditor would need
to consider in three different situations and the impact thereof on the auditor’s
report. A significant number of students were not even able to identify the core
issues. As a result, they were not able to assess the consequences and likely impact
thereof on the auditors’ report. Each situation is discussed below:
(a)
Surprisingly, many students could not identify the two risks viz the risk of
uncollectibility of the amount and the possibility of creating a going concern
or at least a liquidity issue on account of possible loss of a major customer.
Many candidates started discussing modification of audit report without
discussing the materiality of the amounts involved.
Majority of the students emphasized on booking a provision and in case of
disagreement suggested a qualified opinion, whereas the question was clear
that the result of the arbitration is not yet known. Hence, only a disclosure
was required and in case of adequate disclosure emphasis of matter paragraph
was to be given whereas in case of inadequate disclosure, qualified or adverse
opinion as appropriate was to be given.
Page 1 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2012
(b)
Students were required to describe the audit steps to deal with the material
inconsistencies between the financial statements and the Directors’ report. Most
of the candidates attempted the answer in right direction and thereby gained high
marks. However, many candidates did not know that if the inconsistency persists,
an “other matter paragraph” would have to be included in the auditor’s report.
(c)
In the given situation, a company named IPL had closed two of its seven
factories and had decided to close another factory but the factory to be closed had
not been identified at the time of finalization of the accounts. IPL had made a
provision of Rs. 30 million to cover the costs of redundancies and restructuring.
The profit for the year amounted to Rs. 80 million.
The students were expected to identify the following aspects:
•
The provision of Rs. 30 million is material.
•
A constructive obligation existed in respect of the two factories which have
been identified but not for the third factory.
•
The auditor would need to see whether the provision pertains to the two
factories for which the constructive obligation exists. If provision had also been
made in respect of the third factory, the related amount would have to be
reversed.
•
The fact that a third factory would be closed in due course would need to be
disclosed in the financial statements.
•
In case of disagreement with the client, a qualified or adverse opinion would be
required.
Most of the student could not answer this part in proper sequence and related the
answer to the going concern issue which did not exist. More than 50% of the
students could not identify the 2nd point i.e. the one related to constructive
obligation.
Q.3
In this question the students were supposed to identify the categories of threats
involved in two different situations and advise the possible cause of action for the
practicing firm. Response to each situation is discussed below:
(a)
Many students could not understand that in the given situation, the firm was
serving two different clients with conflicting interest. Being an open book
examination, those students who were able to assess the situation correctly,
mostly secured full marks.
(b)
In this part, most of the students were able to identify correctly that a self
review threat has arisen in the situation. Consequently, they were able to list all
the key mitigating measures. However, many students were confused as
between litigation support services and legal services. They erroneously
presumed that the services being provided by the firm were legal services
which are prohibited under CCG/listing regulations and therefore advised that
the firm should refuse to perform these services.
Page 2 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2012
Q.4
(a)
This was a straightforward question based on ISAE 3400. The requirement was
to explain the matters that a firm should consider before accepting an
engagement to review prospective financial information. Though many
candidates were able to list all the points yet the explanations were not upto the
mark.
(b)
In this part an interesting situation was given whereby an organization had
prepared its financial projections on the assumption that income tax rates
would be reduced as had been agreed informally by the taxation authorities, for
companies operating in a particular trade zone. However, as is usual in such
circumstances, no apparent evidence was available to support this assumption.
While evaluating the above situation most of the students simply concluded
that the opinion should be modified. It was expected that the students would
discuss some measures that the auditor can adopt in such situations like,
studying the related correspondence with FBR, discussions with management
of other companies in the same zone and correspondence with relevant trade
associations etc. However, very few students discussed such alternative sources
of audit evidence. Moreover, many of them did not identify the possible types
of modification, in case the evidence was considered to be insufficient.
Q.5
(i)
In this part of the question, majority of the students did not seem to possess
knowledge of the requisite auditing standard ISA 210. Consequently, they did
not seem to know exactly as to how will the auditor deal with a situation in
which the local regulatory requirements are in conflict with the financial
reporting framework. On top of it, poor presentation and writing skills made it
all the more difficult for them to explain the situation to the client, as was
required in the question.
This question is a typical example where the students should use the suggested
answers that would be available subsequently, to really understand as to how
such questions are required to be dealt with. The primary requisite is the
knowledge of the related standard whereas good presentation and writing skills
are also essential to cope with such questions.
(ii)
In this part the students were required to draft the “basis for modification
paragraph” for inclusion in an audit report, which needed modification on
account of a conflict between the local regulatory requirements and the
financial reporting framework. Other relevant details (grounds for
modification) were to be assumed by the students.
Very few students could provide an appropriate example of a situation whereby
the local regulation may be in conflict with the accounting framework. Many of
them opted to leave the answer incomplete after writing a few lines. Many
students produced opinion paragraph instead of “basis for modification
paragraph”.
Page 3 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2012
Q.6
Q.7
Initially it seemed an easy question which required the students to discuss various
issues related to the use of an expert. A large number of students restricted their
discussions to assessing the competence of the expert and assessing as to whether the
auditor can rely on the work of the expert. The use of the term “discuss the related
issues” meant that the requirement went beyond that i.e. they should also have pointed
out that:
•
The auditor will determine the extent of substantive procedures for verification
of estimated cost of completion if he can place reliance on the reports prepared
by the engineer.
•
If the auditor cannot place reliance on the work performed by the engineer, he
will reassess the initial risk assessment and consider the need for involvement
of an independent expert.
According to the situation given in the question, a trust intended to purchase shares in a
listed company. The engagement partner on the audit of that company was also a
trustee in the said Trust and had informed the firm about his conflict of interest in the
given situation.
(a)
In this part very few students could give a complete answer as to how the firm
should deal with the above situation. Most of them were unable to point out
that the concerned partner may or may not continue to act simultaneously in
both positions, depending upon the existence or otherwise, of certain
conditions. Most others could not correctly quote all the relevant conditions.
(b)
In this part, candidates were required to specify the procedures which the audit
firm could follow if the concerned partner fails to declare the fact inadvertently
and the matter comes to the knowledge of the firm after the shares had been
purchased. It was hardly attempted by a few examinees and even very few
among them could secure more than one or two marks.
(THE END)
Page 4 of 4
The Institute of Chartered Accountants of Pakistan
Advanced Auditing
Final Examination
Winter 2012
Module F
Q.1
3 December 2012
100 marks - 3 hours
Additional reading time - 15 minutes
You are the Audit Manager of Mustafa and Company, Chartered Accountants, responsible for
the audit of Standard Home Appliances Limited, a listed company.
Extracts from the company’s financial statements are presented below:
Income statement
Revenue
Gross profit
Operating profit
Finance charges
Profit before tax
30-Sep-2012
30-Sep-2011
----------Rs. in million--------1,190
1,174
509
537
242
227
(77)
(69)
165
158
Statement of financial position
Property, plant and equipment
Intangible assets
Inventory
Trade receivables
Cash and bank balances
Total assets
1,054
140
423
417
29
2,063
833
100
260
250
54
1,497
Equity and liabilities
Share capital
Retained earnings
Long-term borrowings
Liabilities against assets subject to finance lease
Bank overdraft
Trade and other payables
Total equity and liabilities
1,000
218
277
180
185
203
2,063
1,000
233
50
52
162
1,497
During the year, the company has introduced various products based on latest technologies.
These new products are being manufactured on a new plant which has been acquired under a
lease agreement for a period of four years. The plant commenced operations on 01 January 2012.
The useful life of the plant is 5 years.
Intangible assets represent cost of software installed and designs which have been acquired from
a renowned multinational company.
Required:
Identify and evaluate the audit risks in the above situation.
(12)
Advanced Auditing
Q.2
Identify and evaluate the threats involved and explain how these threats can be reduced to an
acceptable level, in each of the following situations:
(a)
(b)
Q.3
Page 2 of 3
(a)
During the year, Jamil Limited (JL) had acquired Sarfraz Limited (SL) and the companies
were subsequently merged. The due diligence exercise for the acquisition was performed by
the same firm which carries out the annual audit of JL. At the time of planning, the auditor
found that a significant provision has been made against SL’s inventories and accounts
receivables. The management informed the auditor that the fact that the value of these
assets was impaired came to its knowledge after taking control of SL. JL and SL are unlisted
public companies.
(10)
A limited assurance engagement has been accepted at a fee which is lower than the fee
charged by the predecessor auditor.
(03)
The audit report of Bhit Gas Limited (BGL) was qualified on account of recognition of
mark-up on delayed payment from Salim Enterprises Limited (SEL) amounting to Rs. 2.7
billion, because at the time of signing of audit report, SEL had not acknowledged its liability
towards mark-up due to BGL and the matter was pending in the Court.
After the issuance of the financial statements, the matter was decided by the Court and SEL
was ordered to settle the mark-up by paying Rs. 1.5 billion. After the Court’s decision, BGL
had filed an appeal against the order for the remaining amount of Rs. 1.2 billion and the
management has requested the auditor to remove the qualification and issue a revised audit
report. The management has also informed the auditor that subsequent to the Court’s
decision, it has decided to revise the financial statements by making a 25% provision against
the remaining amount of mark-up.
Required:
Discuss the factors that the auditor should consider with reference to the above and specify
the steps that he should take under each of the following circumstances:
The management and those charged with governance are prohibited by law and
(i)
regulation from restricting the amendment and approval of the financial statements to
the effect of the above event.
(ii) The management and those charged with governance are not prohibited by law and
regulation from restricting the amendment and approval of the financial statements to
the effect of the above event.
(b)
Identify and explain the shortcomings in the following paragraph of the draft audit report of
Javed Limited:
Emphasis of Matter:
We draw attention to the fact that the company has accumulated losses of Rs. 115,436,540
(2011: Rs. 85,365,479) and certain payments against long term loans were overdue as at the
reporting date. As at 30 September 2012, its total liabilities exceeded its total assets by Rs.
15,450,300 (2011: Rs. 11,542,200). These conditions indicate the existence of a material
uncertainty that the company may be unable to continue as a going concern.
Q.4
(17)
(04)
The statutory auditor of Mighty Limited (ML) has expressed an adverse opinion in the audit
report on the financial statements of ML for the year ended 30 June 2012. After the issuance of
the annual report, ML has approached the auditor for reporting on the trade debts of the
company as on 30 June 2012. This report is required for submission to the bank which has
provided financing facilities to ML. The audit working papers reveal that the trade debts have
been reported correctly in the financial statements.
Required:
Discuss what may be the auditor’s response in the above situation.
(06)
Advanced Auditing
Q.5
(a)
(b)
Page 3 of 3
Describe the implications on the audit report where the prior year’s audit has been
conducted by another auditor.
(04)
You are the audit manager of Wasim Limited for the year ended 30 June 2012. The
previous year’s audit was performed by another firm of chartered accountants who have
expressed an unmodified opinion. The following issue has been brought to your notice by
the audit team:
The company has written off intangible assets amounting to Rs. 30 million in the current
year because the new CEO believes that the expenditure does not meet the criteria for
capitalization as per the International Financial Reporting Standards. The said amount was
capitalized during the year ended 30 June 2011. The profit before tax for the year ended 30
June 2012 is Rs. 52 million (2011: Rs. 91 million).
Required:
Describe the steps which the auditor needs to take in the above situation and explain the
implications on the audit report assuming that the auditor is satisfied with the valuation of
intangibles as on 30 June 2012.
Q.6
(11)
TFL has recently applied for listing on a Stock Exchange in Pakistan. Following information has
been extracted from TFL’s financial statements for the year ended 30 June 2012.
Issued, subscribed and paid up capital - Ordinary shares
Issued, subscribed and paid up capital - Non redeemable preference shares
Share deposit money- Non redeemable preference shares
Un-appropriated profit
Unrealized gain on re-measurement of available for sale investments (net of tax)
Surplus on revaluation of fixed assets
Unpaid dividend on preference shares
Rs. in 000
4,000,000
600,000
3,000
30,000
500,000
120,000
75,000
The face value of both types of shares is Rs. 10 each. Preference shares are convertible into
ordinary shares at any time after listing of ordinary shares. The conversion price shall be Rs. 10
per ordinary share. For the purpose of conversion, unpaid dividend on preference shares,
accumulated up to the date of announcement of conversion by the company, shall also be taken
into account for determining the number of ordinary shares to be issued upon conversion.
Required:
On behalf of the auditors of the company, draft a report on factual findings on break-up value of
shares for submission to the client
Q.7
(16)
The audit of Karim Limited (KL) is in progress. The audit team has requested you to advise on
the following issues:
(a)
The confirmation request sent to a customer who owed Rs. 35 million was responded by an
e-mail addressed to KL’s CFO.
(b)
The management of KL is not allowing auditors to send confirmation to Fareed Limited
(FL), on account of certain disputes, as the sending of confirmation will undermine the
ongoing negotiations with FL. However, the management has offered to provide specific
written representation on the matter.
Required:
Discuss how the auditor should deal with the above situations.
(THE END)
(17)
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012
A.1
Audit Risks:
(i)
Impairment of assets:
 A meager increase in sales by Rs. 16 million i.e. 1.4% against a capital
expenditure of approximately Rs. 200 million in property, plant and equipment
and in intangible assets, indicates that the new products have generated
minimal sales or the sales of existing products have declined.
 The minimal increase may indicate the impairment of plant specifically bought
for the manufacturing of new products or impairment in the value of existing
assets and of intangible assets including the software and designs which have
been acquired for new products.
(ii)
Understatement of operating expenses:
Operating expenses have declined by 13.87%. This seems unrealistic because the
company had introduced new products and installed a new plant, which should
have resulted in an increase in the operating expenses such as on advertisement
costs and other sales related costs incurred on launching of new product. Hence
there is a risk of understatement of expenses.
(iii)
Finance charges:
The financial charges have increased by approximately 11.59% whereas the debt on
the company has increased by 6.20 times. This seems unrealistic and there is a risk
that some of these charges may have remained unrecorded.
(iv)
Liquidity:
The company’s liquidity position has weakened which is normal i.e. on account of
heavy expenditures on new product/plant. However, the situation has worsened on
account of a disproportionate increase in receivables and inventories as compared to
increase in sales.
MPCL is clearly relying on its overdraft to fund operating cash flows. Liquidity
issues may arise in future, especially when repayment of long term loan and lease
payments becoming due.
A.2
(v)
Current Assets:
Inventories and receivables both have increased. As compared to increase in sales
amounting to Rs. 16 million the receivables have increased by Rs. 167 million and
inventory Rs. 163 million which is approximately 67% and 63%, respectively.
Therefore, there is a risk that inventories and receivables might be overstated.
(Necessary provision may not have been made)
(a)
Threats Faced:
(i) Self Review Threat:
Since judgments and conclusions reached during the due diligence exercise
needs to be reviewed again for the purpose of the audit, there exists a self
review threat.
The situation is all the more complex on account of the fact that impairment in
the value of these assets could not be identified during the due diligence
exercise.
(ii) Advocacy Threat:
The auditor has an interest in concluding that no impairment has taken place
and the previous valuation (as per the due diligence exercise) was correct.
Hence there is an advocacy threat.
Page 1 of 9
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012
Safeguards:
On account of above threats, the staff who had participated in the due diligence
work should not be made part of the audit team.
Even if the audit is carried out by staff other than the staff who carried out the
due diligence exercise, the firm may take the following safeguards:



Involve an additional chartered accountant to review the work done or
otherwise advise as necessary.
Consult an independent third party such as a professional regulatory body.
Involve another firm to perform or re-perform part of the engagement.
If the firm still wants to include the same team members, than besides the
above safeguards the following additional safeguards would be advisable:
 Not assigning work to team members (who had participated in the earlier
assignment) in the audit areas, which were connected with the due
diligence work.
 Reviewing their work carefully.
 Keeping the audit committee or those charged with governance of KL
informed about the inclusion of the members in the audit team that were
involved in due diligence.
 Assigning more senior staff to audit team than would be required if no such
impairment in the value of assets had occurred.
(b)
By agreeing to perform the engagement at a lower fee than that charged by the
predecessor firm, or quoted by other firms, a self interest threat has been created.
Safeguards:
The self interest threat created may be reduced to an acceptable level if the firm is
able to demonstrate that:

Appropriate time and qualified staff are assigned to the task.

All applicable assurance standards, guidelines and quality control procedure
are being compiled with.
A.3
(a)
The decision given by the court confirms the existence of mark-up due from SEL,
therefore the qualified report issued on account of recognition of mark-up amounting
to Rs. 2.7 billion does not hold good and therefore the auditor needs to amend the
report.
In view of the above, the auditor needs to take the following steps in each of the
two situations i.e. situation given in para (i) as well as the situation given in para
(ii).

Assess whether Salim Limited is in a position to repay the amount as per
court’s decision.

If the auditor and the management agree on the amount of provision to be
made, (Whether 25% or as may be agreed) or if the amount of dispute is not
material to the financial statements, the auditor will issue an unqualified
opinion on the amended financial statements. Otherwise, the auditor would
issue a qualified opinion after duly changing the amounts in the audit report.

Carryout the audit procedures (as may be necessary under the circumstances)
on the amendment.

Review the steps taken by management to ensure that anyone in receipt of the
previously issued financial statements together with the auditor’s report
thereon is informed of the situation.
Page 2 of 9
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012

If the management does not take the necessary steps to ensure that anyone in
receipt of the previously issued financial statements is informed of the
situation, the auditor shall notify management and where appropriate, those
charged with governance, that the auditor will seek to prevent reliance on the
auditor’s report. If despite such notification, management or those charged
with governance do not take necessary steps, the auditor shall take appropriate
action to seek to prevent reliance on the auditor’s report.
When Law and Regulation prohibit management from restricting the amendment
of the financial statements to the effects of subsequent events causing that
amendment the auditor will take the following steps:



Extend the audit procedures on (all) subsequent events to the date of the new
auditor’s report.
The new auditor’s report shall not be dated earlier than the date of the approval
of the amended financial statements.
The auditor shall include in the new auditor’s report an emphasis of matter
paragraph or other matter paragraph referring to a note to the financial
statements that more extensively discusses the reason for the amendment of the
previously issued financial statements and to the earlier report provided.
When Law and Regulation does not prohibit management from restricting the
amendment of the financial statements to the effects of subsequent events causing
that amendment, the auditor will take the following steps:



(b) 


Restrict the audit procedures on subsequent events to the decision given by the
court.
Amend the auditor’s report to include an additional date restricted to that
amendment that thereby indicates that the auditor’s procedures on subsequent
events are restricted to the adjustment of an amount of mark-up due from SEL
as a result of decision given by the Court; or
Provide a new or amended auditor’s report that includes a statement in an
Emphasis of matter paragraph or Other matter paragraph that conveys that the
audit procedures on subsequent events are restricted solely to the amendment
of the financial statements as described in the relevant note to the financial
statements. The emphasis of matter paragraph or other matter paragraph will
also include reference to a note to the financial statements that more
extensively discusses the reason for the amendment of the previously issued
financial statements and to the earlier report provided.
The emphasis of matter paragraph should indicate that auditor’s opinion is not
qualified in respect of the matter referred.
The audit report should refer to all relevant notes including the note where
material uncertainty has been described. If there is no such note than the
opinion should be qualified.
The phrase “that the company may be unable to continue as a going concern”
is to be replaced with the phrase “which may cast significant doubt on the
company’s ability to continue as a going concern”.
Page 3 of 9
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012
A.4
If the auditor is satisfied with the valuation of trade debts, he may issue an unmodified
opinion on the element, even if he has expressed an adverse opinion on the entity’s
complete set of financial statements as a whole.
However, an unmodified opinion is permitted, subject to the following conditions:
The auditor is not prohibited by law or regulation from issuing separate opinion on
specific element of financial statements.
The opinion expressed on specific element is not to be published with the auditor’s report
containing the adverse opinion
The trade debts balance does not constitute major portion of the entity’s complete set of
financial statements.
The auditor may refer to the adverse opinion on the complete set of financial statements in
the Other matter paragraph in the audit report on trade receivables, when the auditor
judges it to be relevant to the users’ understanding of the audited element or the related
audit report.
In the other matter paragraph it is also to be stated that the report is intended solely for the
Bankers of ML and should not be distributed to parties other than bankers of ML.
A.5
(a)
The auditor will include other matter paragraph in the auditor’s report stating that:
—
—
—
(b)
The financial statements of the prior period were audited by the predecessor
auditor
The type of opinion expressed by the predecessor auditor
The date of that report
In addition to the inclusion of other matter paragraph as in (a) above, the auditor
will need to take the following steps:




Review the amount capitalized last year to verify that the amount was
incorrectly capitalized as has been claimed by WL’s CEO.
Consult the previous auditors (with the permission of WL) to know their point of
view on the issue, if possible review the previous auditor’s working papers.
Discuss the reasons for resignation and removal of the previous CEO.
If the mis-statement in previous financial statement is confirmed it may create
doubts as regards:
Competence and integrity of client’s staff.
The internal control systems in place and the possibility that other material
mis-statement may also have gone undetected.
In view of the above, the auditor may like to re-assess the risk of material misstatement and revise the audit procedures if required.
—
—

Since there exists a material misstatement in the prior period financial statements
on which the predecessor auditor had previously reported without modification,
the auditor shall communicate the misstatement in the prior year financial
statements to appropriate level of management and where appropriate those
charged with governance and ask them to revise the prior year financial
statements.
Page 4 of 9
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012

If the management agrees to correct the misstatement and amend the prior year
financial statements then the auditor shall request the management that the
predecessor auditor be informed and a revise audit report be obtained if possible.
—
—
—

If the prior period financial statements are amended, and the predecessor
auditor agrees to issue a new auditor’s report on the amended financial
statements of the prior period, the auditor shall report only on the current
period.
If the predecessor auditor is unable or unwilling to issue the auditor’s report
on the prior year financial statements, the Other matter paragraph of the
auditor’s report may also indicate that the predecessor auditor reported on
the financial statements of the prior period before amendment.
In addition, the auditor is required to be satisfied with the adjustment and
amendment made in the prior year financial statements, and the auditor’s
report will also include reference to the audit of adjustment/ amendment
made in the prior period financial statements and a disclaimer of opinion
with reference to the audit of prior year.
If the management does not agree to amend the prior year financial statements:
—
the auditor may issue a qualified or adverse opinion depending upon the
materiality and pervasiveness of the matter, with respect to prior period and
express a clean opinion on the financial statements of the current period
—
disclose substantive reasons for the different opinion as compared to the
opinion expressed by the predecessor auditor on prior period financial
statements in the Other matter paragraph.
Page 5 of 9
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012
A.6
AUDIT REPORT
ENGAGEMENT
TO
BASED
ON
AGREED
UPON
PROCEDURES
REPORT ON FACTUAL FINDINGS
The Board of Directors,
TFL (the Company),
Karachi.
Dear Sirs,
We have performed the procedures agreed with you and enumerated below with respect to
the book value per share as of 30 June 2012, as set forth in the accompanying statement.
Our engagement was undertaken in accordance with the International Standard on
Related Services applicable to agreed-upon procedures engagements. The procedures were
performed solely to assist you in evaluating the validity of the book value per share and its
submission to regulatory Stock Exchange and are summarized as follows:
1. We obtained the statement of book value per share as prepared by management
and compared the information with the audited financial statements as at 30 June
2012.
2. We checked that the calculation of the book value per share is in accordance with
the directives of the Institute of Chartered Accountants of Pakistan contained in
Technical Release 22 “Book Value Per Share”
We report our findings below:
(a)
The book value per share of the face value of Rs. 10 each, taking into
consideration, surplus on revaluation of fixed assets, works out to Rs. 11.41 per
share.
(b) The book value per share of the face value of Rs. 10 each without taking into
consideration surplus on revaluation of fixed assets works out to Rs. 11.15 per
share.
Because the above procedures do not constitute either an audit or a review made in
accordance with International Standards on Auditing or International Standards on
Review Engagements (or relevant national standards or practices), we do not express any
assurance on the book value per share as of 30 June 2012.
Had we performed additional procedures in accordance with International Standards on
Auditing or International Standards on Review Engagements, other matters might have
come to our attention that would have been reported to you.
Our report is solely for the purpose set forth in the first paragraph of this report and for
your information and is not to be used for any other purpose or to be distributed to any
other parties. This report relates only to the item specified above and does not extend to
any financial statements of the Company, taken as a whole.
AUDITOR
Date Address
Page 6 of 9
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012
TFL
BOOK VALUE PER SHARE
(With and without surplus on revaluation of fixed assets)
As at 30 June 2012
Break-up value per
Ordinary
Preference
Share (ordinary
share
share
& preference)
--------------Rupees in thousand--------------Equity
Issued, subscribed and paid-up
capital
Share deposit money (preference
share related)
Unappropriated profit
Unrealized gain on revaluation of
available for sale investment net
Surplus on revaluation of fixed assets
Total equity (with Surplus on
revaluation of fixed assets)
Total equity (without Surplus on
revaluation of fixed assets)
Number of ordinary shares is issue
Number of convertible preference
share in issue
Number of convertible preference
shares to be issued in respect of share
deposit money received
Break-up value per share (with
surplus on revaluation of fixed assets)
Break-up value per share (without
surplus on revaluation of fixed assets)
4,000,000
600,000
4,600,000
30,000
3,000
-
3,000
30,000
500,000
120,000
-
500,000
120,000
4,650,000
603,000
5,253,000
4,530,000
603,000
5,133,000
400,000,000
400,000,000
60,000,000
60,000,000
400,000,000
300,000
60,300,000
300,000
460,300,000
11.63
10.00
11.41
11.33
10.00
11.15
Preference Shares are non-redeemable but convertible into Ordinary Share at face value at
any time after the issuance of Ordinary shares. The conversion price shall be Rs. 10 per
Ordinary Share and dividend not paid to the preference shareholders, if any, accumulated
upto the date of announcement of conversion by the Company, shall be taken into account
for determining the number of the Ordinary Shares to be issued upon conversion and
therefore the number of Ordinary Shares to be issued to the preference shareholders shall
be in the ratio 1:1, plus unpaid accumulated preferential dividends, if any. Such unpaid
preferential dividend aggregated Rs. 75 million as at 30 June 2012.
A.7
(a)
Since the confirmation has been received via email and that too, indirectly through
the client’s CFO, the situation involves the following risks:
(i)
(ii)
(iii)
Confirmation may not have been received from the intended party as email
do not contain the signature nor the letterheads of the intended party.
Since the confirmation has been received through the client, there is a risk
that it may have been tampered before being forwarded to the auditor.
The possibility that the integrity of the transmission may have been
compromised during electronic transmission.
Page 7 of 9
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012
In view of the above risks, the auditor may consider the following:
(b)
(i)
See whether the identity of sender of email and authenticity of the message be
validated using appropriate techniques such as digital signatures etc. If this is
not possible, the auditor may:
Verify the source and contents of the response by contacting the
—
confirming party and may request the confirming party to respond in
writing directly to the auditor.
Carry out other audit procedures such as checking of subsequent receipts
—
or checking appropriate documents such as invoices, shipping
documents etc.
(ii)
If the auditor concludes that the response was forged or otherwise tampered
with, the auditor may need to revise the assessment of the risks of material
misstatements and modify planned audit procedures or take other necessary
steps.
A refusal by management to allow the auditor to send a confirmation request is a
limitation on the audit evidence to be obtained by the auditor.
In such situation, the auditor shall proceed as under:
(i)
Inquire and assess whether the reason provided by the management for not
sending confirmation request to ML is correct i.e. the dispute as mentioned in
the question is the only reason.
(ii)
If the management’s refusal to send confirmation request seem appropriate,
the auditor may perform alternative audit procedures, such as examining
subsequent cash receipts, shipping documents etc.
(iii)
Since the management refusal is on account of a dispute with the customer,
the auditor should:

Check correspondence etc to the nature of dispute.

Obtain lawyer opinion.

Assess whether provision has been made, as may be appropriate under
the circumstances.
Evaluate the implications of management’s refusal on the auditor’s
assessment of the relevant risks of material misstatement, including the risk of
fraud and on the nature, timing and extent of other audit procedures.
(iv)
(v)
If the auditor concludes that the management request for not sending
confirmation is reasonable but alternative audit procedures do not provide
appropriate audit evidence, then the management representation can be used
as audit evidence.
However in above situation the following factors should be kept in
perspective:
—
—
—
The written representation provided by management is less reliable.
The existence of any other audit evidence that may support the written
representation.
If controls are operating effectively then the representation provided by
management may be considered as reliable.
Page 8 of 9
ADVANCED AUDITING
Suggested Answers
Final Examination - Winter 2012
(vi)
If the auditor concludes that:
—
—
Management’s refusal to allow the auditor to send a confirmation
request is unreasonable, it may indicate the existence of a fraud risk
factor or;
If the auditor is unable to obtain relevant and reliable audit evidence
from alternative audit procedures, the auditor shall:


communicate the matter to those charged with governance.
consider the impact on the audit and audit opinion.
(THE END)
Page 9 of 9
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination – Winter 2012
General:
Generally, the performance of students was not upto the desired level keeping in view that
all the students at least had a couple of years of practical audit experience. The main
reason for below average performance was the inability to carry out an in-depth analysis
of the given situations. Consequently, most students were unable to mould their answers
in line with the exact requirements of the question. However, the knowledge of ISAs
seemed a lot better and that was why a relatively better result was witnessed.
Question-wise comments are as under:
Question 1
Extracts from financial statements were given alongwith information pertaining to
acquisition of a new plant and intangible assets (software installed). Students delved a lot
on horizontal changes with little focus on vertical analysis. Most of them were able to
identify the apparent risks such as impairment in inventories and debtor, liquidity issues,
understatement of financial charges. However, they were found lacking as regards the
following:
•
While discussing the liquidity, most of the students were concerned about the concept
of ‘going concern’. Although the liquidity position of the company seemed to have
worsened, yet, apparently there was no indication that it may lead to a going concern
issue.
•
Most of the students were unable to identify the fact that operating expenses have
declined as compared to the previous year which was quite unusual in the given
scenario, i.e. when the company had introduced new products.
•
Most of the students pointed out the risk of impairment of plant and intangible assets
but did not provide any significant reason to support their point of view. In fact there
was quite an imminent risk of impairment in the value of plant because of the fact that
the overall sales had increased by only Rs. 16 million i.e. 1.5% despite the fact that
several new products were being manufactured on the new plant.
Question 2
This question required identification and evaluation of threats in two different situations
and the mitigating factors to reduce these threats to an acceptable level.
Page 1 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2012
Part (a)
This was an interesting situation whereby the annual audit was being performed by a firm
which had also carried out a due diligence exercise for the company in respect of
acquisition of a subsidiary and that during the due diligence exercise, the fact that the
assets of the subsidiary were impaired, had not been identified.
Most of the students were able to identify the self review threat which was quite apparent
and also suggested rightly that the staff who had participated in the due diligence exercise
should not form part of the audit team, but beyond that they were not very sure.
The advocacy threat was rarely identified. Some of the students confused the scenario
with a situation where services are being provided to two entities both of which are
clients.
Part (b)
This part pertained to the acceptance of an assurance engagement at a fee which is lower
than the fee charged by the predecessor auditor. This was quite easy and was generally
responded well and a significant number of students were able to score full marks also.
Question 3 (a)
In this part of the question, a brief scenario was given where the financial statements
needed to be amended. The scenario was to be discussed under two different conditions
i.e. where (i) law and regulations prohibit management and (ii) when it does not prohibit
management from restricting the amendment of financial statements to the effect of the
specific event.
Since most of the points were available direct from the Auditing Standard, generally the
students were able to score well. However, most of them missed an important point that
though the court had decided in favour of the company, the auditor needed to assess
whether Salim Limited (the debtor) was in a position to repay the amount.
Moreover, many students talked about reviewing the judgment and checking whether
management and those charged with governance would like to amend the financial
statements or not, despite the fact that it was clearly mentioned in the question that it was
the management who had requested for removal of the qualification and issuance of a
revised audit report.
Instances were noted where students appeared to be confused and intermingled the two
situations.
Question 3 (b)
This part of the question required students to identify errors in the given emphasis of
matter paragraph. Most of the students seemed well versed on this issue and were able to
secure full marks.
Page 2 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2012
Question 4
This question required students to explain as to how an auditor would respond in case he
is requested to report on a specific element of the financial statements on which he had
expressed an adverse opinion. Generally the students knew that there is no bar on issuing
an unmodified opinion on a specific element of a financial statement even when an
adverse opinion had been given on the same financial statements. However, they were not
aware of all the conditions which the auditor would be subject to while expressing such an
opinion. Specially the restriction that the report on the specific element shall not be
published alongwith the report on the financial statements and the requirement regarding
disclosure about the adverse opinion, in the other matter paragraph of the report on the
specific element, were rarely mentioned.
Question 5 (a)
This part of the question required students to simply mention the extra contents of the
audit report where prior year audit was performed by another auditor. Most of the students
mentioned the requirements correctly. However, some students seemed confused and
unnecessarily gave detailed steps regarding audit of opening balances.
Question 5 (b)
This part of the question required the steps to be taken by an auditor where there is an
error in prior year’s financial statements and the implications thereof on the current year’s
audit report. The performance in this part of the question was poor. Most of the students
did not seem to appreciate the requirement correctly. Instead of mentioning the steps that
the auditor would need to take, they somehow focused their attention on discussing the
accounting treatment under IAS-8. Those students who adopted the correct approach often
missed the following points:
•
•
•
The auditor would need to verify the management’s claim as regards the error in the
previous year’s financial statements.
The auditor would need to communicate with the previous auditors, after consulting
with the client.
If the mis-statement in prior period is confirmed, it may create doubt about
competence and integrity of the clients staff and the internal control system in place
which may in turn, require the auditor to re-assess the risk of material mis-statement
and revise the overall audit procedures accordingly.
Question 6
This question required the students to write a report based on agreed upon procedures i.e.
on break-up value of shares. An average performance was seen. Some of the common
errors were as follows:
•
•
•
•
Some students did not provide book values of ordinary and preference shares
separately.
Many students did not reproduce the correct version of the report despite being an
open book examination.
Many students did not provide break-up values inclusive of surplus on revaluation.
Many students apportioned the unappropriated profit, surplus on revaluation of fixed
assets and unrealized gain on available for sale investments, to ordinary as well as
preference shares.
Page 3 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2012
Question 7
This question pertained to third party confirmations. Two situations were given. In the
first situation the reply had been received through e-mail. In the second situation, the
client had not allowed the auditor to send a confirmation request.
The performance was reasonable. However, the response was below expectations and
should have been better as both situations were quite simple and all the students must have
had experience of auditing the trade debts.
Even in this age of internet, many candidates were unable to point out that confirmation
through e-mail carries the risk that it may not have been received from the intended party
and that there was a possibility that the contents of the message may have been altered
during the transmission.
In the second situation, many candidates missed the point that the auditor needed to assess
whether the reasons provided by the management for not sending the confirmation request
were justified and what would be the auditor’s response if he was not satisfied with the
reasons provided by the management. Moreover, majority of the students did not discuss
the management’s offer of providing written representation.
(THE END)
Page 4 of 4
Advanced Auditing
Final Examination
Summer 2013
Module F
Q.1
3 June 2013
100 marks – 3 hours
Additional reading time – 15 minutes
Qasmi Steels Limited (QSL) is a manufacturer of steel and iron products. During the year
the company has incurred a net loss of Rs. 306 million. The following information is also
available:
(i)
At the year end, the company’s accumulated losses amounted to Rs. 17 million
whereas its net equity was Rs. 283 million.
(ii) During the year, QSL has defaulted in repayment of a loan. The management is
however quite hopeful that the lender would agree to a rescheduling.
(iii) The management believes that the company’s profitability has been hampered on
account of soaring electricity prices along with a fall in demand for steel which have
had a negative impact on the prices of its finished products. Moreover, its production
has also suffered on account of the prevailing energy crisis. Consequently, the
management has decided to discontinue its operations temporarily.
(iv) To counter the impact of high electricity prices, the company intends to convert its
plant to run on gas as well.
(v) The management has informed you that it would need to install a gas converting unit
which would be imported at a cost of Rs. 30 million. However, as the process of
installing the gas conversion unit and completing the necessary formalities would take
at least a year, therefore the management is negotiating to lease the plant to Nadeem
Enterprises for a period of one year.
Required:
(a) Evaluate the above situation and state the procedures which you would perform as an (10)
auditor in the above situation.
(b) Describe the implications of the above issues on the audit report.
(10)
Q.2
You are the manager responsible for the audit of Dilawar Paints Limited (DPL). The draft
financial statements for the year ended 31 March 2013 show revenue of Rs. 1,250 million
(2012: Rs. 1,175 million), profit before taxation of Rs. 100 million and total assets of
Rs. 1.2 billion.
The audit incharge has noted the following points for your consideration:
(i)
(ii)
In May 2012 a chemical leakage from one of the tanks in the factory caused a fire
which damaged the plant and machinery and the premises. DPL has incurred
Rs. 3 million in cleanup costs, Rs. 10 million for modernisation of tanks to prevent
future leakages and a fine of Rs. 500,000 to a regulatory agency. The fine has been
expensed whereas the remaining costs have been capitalised.
(08)
While the tanks in the factory were undergoing modernisation, DPL had made
arrangements with a nearby factory for storage of its chemicals. At the time of stock
check you were informed that it is not possible to segregate DPL’s stock from that of
the other factory. According to DPL’s record, the value of its stock of chemicals as at
31 March 2013 which is lying in the nearby factory is Rs. 200 million. The value of
stock of chemicals as at 31 March 2012 was Rs. 120 million.
(08)
Required:
Discuss the matters that you would consider and how would you obtain the necessary audit
evidence.
Advanced Auditing
Q.3
Page 2 of 3
The following matters relating to different clients are under the consideration of
Mr. Jameel, who is the engagement partner:
(a)
(b)
The management of Muneer Limited had been illegally dumping its chemical waste
in the neighbouring plot of land. When confronted, the chief financial officer, instead
of providing an assurance to address the issue, informed the audit senior that the
management is least bothered about the minor fines that may be levied by the
regulatory agencies.
(07)
Abdullah was the audit senior assigned to the audit of Insha (Private) Limited. During
the course of the audit, Abdullah had resigned from the firm. While reviewing the
audit files Mr. Jameel has noticed that the audit fieldwork was completed in almost
half the time than is usually required.
(06)
Required:
Evaluate each of the above situations and briefly describe what course of action the
engagement partner would be expected to adopt.
Q.4
You are the quality control partner of Nasir and Company, Chartered Accountants (NCC)
and presently following matters are under your consideration:
(a)
Your firm has issued an unmodified opinion on the financial statements of Salim
Limited (SL) for the year ended 31 December 2012. The tax authorities have recently
launched an investigation against SL, alleging that SL has under declared its income
for the year ended 31 December 2012. NCC is also acting as the tax advisor of SL.
(09)
(b)
While appreciating the services rendered by your firm, the managing director of a
client has informed the engagement partner that an audit trainee has helped him in
the purchase of a plot of land. On investigation, the engagement partner was able to
establish that the trainee works part-time in an estate agency and receives 0.5%
commission on all deals.
(05)
(c)
Josh Limited (JL), an unlisted audit client of your firm has approached your firm to
recruit a chartered accountant for the position of finance director in JL. In response to
an advertisement published in the newspaper, NCC received various applications
which include individuals working at some of your clients and some of your
ex-employees.
(05)
Required:
Identify and evaluate the threats involved and explain what actions you would take in the
above circumstances including the steps required, if any, to reduce the risks to an acceptable
level.
Q.5
Zubair & Shahid Limited is a distributor of personal care products. Its sales manager had
committed a fraud by making sales to fictitious customers. Cheques received from various
genuine customers were credited to these fictitious accounts to keep their balances within
reasonable limits. The sales manager had the outstanding amounts, appearing against
fictitious and genuine customers, written off by convincing the sales director that those
customers were unable to pay their remaining balances. A total of 38 invoices amounting to
Rs. 7.2 million were issued over a period of seven months. The fraud was detected when the
sales manager had left the company’s employment.
Required:
Identify the usual controls which may have been lacking in the aforementioned situation.
(06)
Advanced Auditing
Q.6
Page 3 of 3
You are the job incharge on the audit of Ghalib Petroleum Limited (GPL) for the year
ending 30 June 2013. GPL is engaged in the exploration and production of crude oil. The
last year’s audit file contains the following information:
In 2005, GPL had entered into an agreement with the Government for exploration
and production of oil for fifteen years. The licence for exploration was granted at a fee
of Rs. 600 million.
Under a separate agreement Mir Petroleum Limited (MPL), a 100% government
owned entity, had guaranteed the purchase of all crude oil to be produced by GPL for
a period of ten years from the start of commercial production i.e. 2008.
The plant and equipment was imported in 2006 at a total cost of Rs. 6 billion which
includes a decommissioning provision of Rs. 500 million. The cost of the plant was
financed by GPL’s parent company by way of a long-term foreign currency loan.
During the current year’s planning stage, you have observed the following conditions:
(i)
The problem of circular debts has become severe and as a result GPL as well as MPL
have accumulated huge receivables and payables.
(ii) An environmental control agency has filed a suit alleging that at the time of
abandoning one of its oil wells, GPL has failed to restore the site in accordance with
the prescribed standards. The company believes that it has met all its obligations and
plans to contest the case strongly.
(iii) Due to law and order situation the Government has not been able to provide
infrastructure facilities as were agreed in the exploration agreement.
(iv) The management had budgeted a profit of Rs. 200 million for the current year but
latest estimates suggest that the profit would be somewhere between Rs. 100 to
Rs. 120 million.
Required:
Identify and evaluate the audit risks in the above situation and specify the audit procedures
that you would perform to address those risks.
Q.7
(a)
Haali Limited has a policy to carry its buildings at revalued amounts. At the balance
sheet date i.e. 31 December 2012, the valuer had finalised the valuation reports of
only 3 out of a total of 8 properties. According to these reports these properties were
assigned a valuation of Rs. 50 million as against the carrying amount of
Rs. 62 million.
Required:
Evaluate the above condition and discuss the impact on the audit report in each of the
following situations:
(i) The impairment of Rs. 12 million is recorded in the financial statements.
(ii) The impairment is not recorded.
(b)
(16)
(06)
During the year ended 31 December 2012 Chiragh Limited has changed its policy for
valuation of investment in a subsidiary from the ‘fair value’ to ‘cost’. Had the
company continued with its previous policy for valuation of investment at ‘fair value’,
the subject value would have been reduced by Rs. 50 million.
Required:
Discuss the matters which you should consider in respect of the above situation and
the possible impact thereof on the audit report.
(04)
(THE END)
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2013
A.1
(a)
Although QSL’s accumulated losses are only Rs. 17 million i.e. about 5% of the share
capital yet the following circumstances indicate that QSL is facing going concern
issues:
 QSL has incurred huge loss during the past year which is almost equal to its share
capital.
 QSL has defaulted on its loan repayments.
 The management has certain plans to revive the business however these are subject
to major uncertainties as discussed below:
— The company plans to convert the plant to make it possible to run it on gas.
However, it would require significant costs whereas QSL is in financial crisis.
— It is not certain whether the company’s banker would agree on the
restructuring of loan.
— The above conversion would require a year’s time and the company may be
required to bear the fixed costs for that period.
— Due to current energy crisis prevailing in the country it seems doubtful that the
company would be able to secure a gas connection in the first place and
whether sufficient gas would be available to it or not.
— The company is negotiating to lease its plant temporarily to reduce losses
during the period of its planned inactivity. However this plan does not seem
very convincing as the prospective lessee would also be subject to the same
circumstances.
The auditor would need to evaluate the company’s detailed plan by carrying out the
following procedures:
(i)
Review the cash flow projections provided by QSL and assess their
reasonableness
(ii) Discuss with the management about the uncertainties described above and
assess whether the management would be in a position to overcome them.
(iii) Consider subsequent events and discuss the impact thereof, with the
management, if necessary.
(iv) Seek written representation from management regarding its plans for future
actions.
(v) After performing the above procedures, if there is a doubt about the
appropriateness of the going concern assumption, auditor will need to carryout
additional audit procedures depending upon the circumstances.
 Besides the going concern issues, the discontinuance of operations of company and
reduction in production of steel may result in impairment of plant and machinery, as
the company may not be able to recover the carrying amount of the plant. The auditor
needs to review the value in use of the plant and machinery provided by the client.
(b)
Implications on the Audit Report:
(i) If it is concluded that going concern assumption is appropriate and no material
uncertainty exists, the auditor shall express an unmodified opinion.
(ii)
If it is concluded that going concern assumptions is appropriate but a material
uncertainty exists which is adequately disclosed in the financial statements, the
auditor shall express:
 an unqualified opinion
 include an emphasis of matter paragraph in the auditor’s report to:
— highlight the existence of material uncertainty relating to the event or
condition that may cast significant doubt on the entity’s ability to
continue as a going concern; and
Page 1 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2013
—
draw attention to the note in the financial statement which contains the
disclosure.
However, If material uncertainty exists and is not adequately disclosed in the
financial statements. The auditor shall express a qualified opinion or adverse
opinion as appropriate.
(iii) If it is concluded that the going concern assumption is not appropriate, in the
preparation of the financial statements the auditor should advise the company to
revise the accounts appropriately. In case of disagreement, the auditor shall
express an adverse opinion.
(iv) If the company revises its financial statements, the auditor shall include an
emphasis of matter paragraph referring to the note in the financial statements
and explaining that the financial statements are prepared on estimated realizable
settlement values of assets and liabilities respectively as the company is no
longer a going concern for the reason stated in the aforesaid note.
(v)
A.2
(i)
If management is unwilling to make or extend its Assessment, the auditor will
issue a qualified opinion or a disclaimer of opinion, as appropriate.
Chemical leakage- Evaluation of the situation:
Matters to be considered
 Fine of Rs. 500,000 has been correctly expensed out but is immaterial.
 The cost of clean-up represents 0.25% of the total assets and 3% of the profit before
tax and is therefore not material. However this expense does not improve the
future operating capacity of the property and hence it should not be capitalized.
If management does not agree to reverse the capitalized amount it will not affect
the audit opinion, however, this amount could be included in the aggregate of
uncorrected misstatements.
 Rs. 10 million spent on modernizing the storage tanks represents a major overhaul
of the asset. It constitute 10% of profit before tax and is therefore material to the
financial statements. The Company has rightly capitalized the said cost.
 The substantial cost of modernization of tanks when included in the present
carrying value, may result in carrying value being in excess of the recoverable
amount. In this case auditor would need to carryout impairment testing of the
storage tanks and if said testing concludes any impairment loss, the auditor would
need to check whether such losses have been recognized appropriately.
How audit evidence would be obtained
 The management would be asked as to whether any other fine has been levied by
any regulatory agency, due to this leakage; and the matter would be documented.
 Review legal confirmations obtained by you and see whether they contain any
information in this regard.
 Physical verification of storage tanks should be carried out.
 Major payments should be vouched.
 Obtain management representation that the matter is now closed and no further
proceeding are in progress against the company.
Page 2 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2013
(ii)
Outsourced storage facility- Evaluation of the situation:
Matters to be considered
 Inventory at the end of the reporting period (31 March 2013) represents 16.67% of
the total asset value and is therefore a material item in the statement of financial
position.
 The inability of the auditor to carry out a stock check may result in a limitation of
scope.
 It can be seen that inventory has increased by 67%, although the revenue has
increased by 6.4% only. Moreover, there is a decline in the inventory turnover
from 9.79 times in 2012 to 6.25 times in 2013. This situation when viewed in the
light of auditor’s inability to carry out a stock check may indicate the possibility of
material misstatement.
How audit evidence would be obtained
 The management should be asked to provide written representation regarding the
value of inventory as at 31 March 2013, although it does not provide sufficient
evidence regarding its condition or obsolescence.
 Test of control established by the management in respect of quantity, quality and
access to the inventory stored at nearby factory.
 Confirmation from the nearby factory needs to be obtained, relating to the
quantity of the stock held by them.
 Monthly returns / stock details submitted by neighboring factory should be
analysed and significant movements in inventory should be traced to the material
consumption reports and purchase invoices.
 The auditor may refer to the inventory aging analysis to determine the possibility
of obsolescence of stock.
 Subsequent transfers of chemicals from the neighboring factory to DPL’s premises
should be reviewed.
A.3
(a)
Dumping of waste
 The fines levied by the regulatory authority maybe immaterial but the same could
have significant implications on ML as any mishap may lead to severe legal action
specially in case a mishap occurs.
 The engagement partner should discuss the matter with those charged with
Governance and advise them to take necessary steps to avoid future noncompliances.
 The engagement partner should consult the legal advisor about the laws and
regulations and the possible impact of the non-compliance on the client. If
engagement partner is not satisfied with the opinion of ML’s legal advisor it
should consult with its own lawyer, relating to possible legal consequences.
 If those charged with governance agree to rectify the situation, the auditor need to
consider the cost of cleaning up the site and ask the client to make necessary
provision. If necessary, the partner may ask ML to obtain opinion from the
relevant expert as regards the present condition of the plot and the cost of the
measures necessary to clean-up the site in accordance with the requirements of
law.
 The partner should consider the possibility of similar non-compliance in other
areas.
 In case no action is taken by those charged with governance, the partner must
consider:
— The impact on the audit report.
— Withdrawing from the engagement now or not accepting the assignment for
the next year, as may be appropriate.
 The engagement partner should consider the legal responsibilities to report to the
authorities.
Page 3 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2013
A.4
(b)
Engagement performance
 Quality control issues:
— Mr. Jameel should have the audit files reviewed by another chartered
accountant who had not been involved in the said engagement.
— If the working papers reflect anything done improperly or not done in
accordance with the auditing standards Mr. Jameel should discuss the matter
with the concerned manager.
— If the audit manager fails to provide a satisfactory reply, it would be indicative
of a quality control issue.
— In such a situation Mr. Jameel would need to take the following steps:
 Address the issues which have remained unattended during the audit.
 Assess the reasons for the manager’s failure to detect the situation and take
corrective measures which may include all or any of the following:
 Reviewing the firms systems, procedures and policies etc., and taking
corrective actions
 Emphasis on due training of staff at all levels.
(a)
Investigation by tax authorities
 The tax authorities have launched an investigation against SL on suspicion of
under-declaring income. This implies one of the following:
— The financial statements are materially misstated.
— The tax return is misstated.
— The tax official’s suspicions are unjustified.
 The quality control partner may engage another chartered accountant to review
the financial statements as well as the tax return to investigate the allegations
leveled against the client.

If Financial Statements are Misstated:
— Quality control partner may ask the engagement partner to review the
situation and establish whether the financial statements need to be revised.
— Quality Control Partner may like to know whether the mistake could have
been avoided if the Quality control policies of the firm had been followed.
— If there is a lapse on the part of the firm’s employees, appropriate action
would be taken and the capacity of the reviewer would also be questioned.
— If the mistake was such that it could not have been detected using the
standard audit procedures of the firm, the firms policies and procedures
may be reviewed to ensure that weaknesses if any are properly addressed.

If Tax Return are Misstated:
— If it is established that tax returns filed by NCC on behalf of the client are
materially misstated then NCC should ensure that proper remedial actions
(such as revision of tax returns etc) are followed subsequent to the
discovery of misstatement.
— If the above actions are not taken by the client, the auditor should consider
the firm’s legal responsibilities.
Page 4 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2013
 In the case of error in the financial statement or the tax return, quality control
partner would need to assess whether the error was made intentionally by the
management.
— If it is established that the misstatement was made intentionally the auditor
would need to review whether it would be appropriate to discontinue its
relationship with the client.
(b)
A close business relationship between a member of assurance team and the
management of the client will involve a common financial interest and may create self
interest threat.
The materiality and significance of the financial interest, needs to be evaluated. If the
financial interest is immaterial or relationship is clearly insignificant then the audit
trainee may be allowed to work on that client, otherwise only safeguard available is to
not to allocate that audit trainee on the client.
If the conduct of the trainee is not in accordance with the firm’s policies, appropriate
action may be taken.
(c)
The recruitment of finance director for JL may result in self interest, familiarity and
intimidation threat.
The service to be provided shall not involve making management decision and the
decision as to whom to hire should be left to JL.
A threat to Objectivity will be created, because the recruitment team may become
biased while dealing with the applications of their former colleagues or if the
recruitment team members know the employees of the clients who have applied for
the job.
Significance of threat should be evaluated and if the threat is other than clearly
insignificant, safeguards should be considered, which may include:
Use of separate engagement teams for the audit and recruitment procedure.
Procedures to prevent access to information (e.g. strict physical separation of audit
and recruitment teams, confidential and secure data filing); and
Clear guidelines for members of the engagement team and recruitment teams on
issues of objectivity, confidentiality.
The use of confidentiality agreements to be signed by employees and partners of the
firm.
A.5
Controls which may have been lacking in the given situation:

Control over authorization and approval of customer, as the sales manager was able to
make the sale to fictitious customers which means that no proper investigation or
processes were followed during approval of said customers.

Lack of segregation of duties as the write off of receivable balance should have been
approved by credit control department/section, instead of or in addition to sales
director.
Page 5 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2013

Controls over write off of debts seem to be lacking. Debts should only be written off
when the legal department confirms that they are not recoverable.
Moreover the legal department should also notify as to what action was taken before
deciding that the debts are not recoverable and why a suit was not being filed against the
customer. This process does not seem to have been followed.
A.6

Control over accounting of customer’s cheques is lacking as the sales manager manages
to credit the fictitious customers’ accounts with other customers’ cheques.

Controls over preparation, checking and dispatching of debtor’s statements to customers
is lacking as sales manager manages to manipulate the debtor’s accounts for seven
months, without any check and balances.
Audit risks:
(i)
Impairment of assets:
 Values of license granted by the Government and the value of plant and
machinery for exploration purposes may be impaired due to the following:
— Government has not been able to provide the required infrastructure facilities
due to which the exploration work might be affected and GPL might not be
able to obtain the expected benefits from the use of plant and machinery.
— Due to the problem of circular debt, MPL may not be able to purchase oil as
agreed in the contract.
— Due to circular debt problem there is a possibility that amount of receivable
from MPL may be impaired.
Actions to be taken to address the risk:
 Review the exploration contract with the Government to assess whether it
contains appropriate clauses to address the situation.
 Ask GPL to carry out the impairment testing of the value of license and check the
working thereof.
 Review the agreement with MPL and check what remedy is available to GPL in
case MPL fails to purchase oil from GPL.
 Ask GPL to calculate value in use, of the plant and machinery and check the
working thereof.
 Discuss with GPL’s its relationship with MPL and what measures MPL is taking
to resolve its liquidity issue and to ensure that it continues to purchase oil and
make regular payments.
 Review the measures that are being taken by the two companies and the
Government to resolve the circular debt issue.
 Ensure that incase there is a doubt about the recoverability of the amount,
appropriate provision is made in the financial statements.
 If the measures taken above indicate an impairment, ensure appropriate
adjustment in the financial statements.
(ii)
Going Concern:
On account of MPL’s inability to purchase oil as agreed or to make payments there
against GPL’s may face going concern issues.
Actions to be taken to address the risk:
 Ask management to make its assessment of the entity’s ability to continue as a
going concern, if already not performed by the entity.
 Evaluating management’s plans for future actions in relation to its going concern
assessment.
Page 6 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2013
 Where the entity has prepared a cash flow forecast, the auditor shall:
— Evaluate the reliability of the underlying data used in preparation of the
forecast.
— Determining whether there is adequate support for the assumptions used in
preparation of the forecast.
 Request written representations from management and where appropriate, those
charged with governance, regarding their plans for future action and feasibility of
these plans.
(iii)
Foreign Exchange Translation Risk:
The company is exposed to foreign exchange risk as a major part of the cost of plant
was financed through foreign currency loan from a parent company and the value of
foreign currency loan may fluctuate due to fluctuation in the exchange rates.
Actions to be taken to address the risk:
 The auditor should ensure that year-end balance is accurately reported keeping in
view that the year-end balance may differ depending upon whether the client has
helped the risk or is maintaining an open position.
(iv)
Undervaluation of liabilities:
The alleged suit against the company may be indicative of contingent liabilities that
may require provision or disclosure in the financial statements and there is a risk that
liabilities related to the alleged suits may not be recognized appropriately in the
financial statements.
Actions to be taken to address the risk:
 Obtain opinion of the legal advisor.
 Ensure that proper disclosure or adjustment is made in the financial statements, in
accordance with IFRS.
(v)
Over/ Undervaluation of assets:
In case the undervaluation of liabilities (as discussed above) is probable it may be
indicative of the fact that the decommissioning provision in other case has also not
been estimated correctly and the related plant and machinery may be undervalued or
overvalued.
Actions to be taken to address the risk:
 Review the suit filed by the environmental agency and what other actions GPL
would need to take to become compliant.
 Review the prescribed standards related to the requirements of restoring the site.
 Ask the management to review the de-commissioning provision accordingly.
 Review the steps taken by management for re-estimating the amount of
decommissioning provision.
(vi)
Overstatement of Results:
The latest estimates show that the company would fail to achieve the budgeted profit.
Therefore, there is a possibility that the management may be inclined to overstate or
manipulate the results in order to show better position of the company as compared
to the budgeted profits.
Actions to be taken to address the risk:
 Increase the extent of substantive procedures because the above factor would
increase the risk of material misstatement.
 Review last minute adjustments and cut-offs more carefully to ensure that the
accounts are not misstated.
Page 7 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2013
A.7
(a)
As per IAS 16, if an item of property, plant and equipment is revalued, the entire class
of property, plant and equipment to which that asset belongs shall be revalued.
It is not appropriate to incorporate the revised value of only three properties out of
eight as the effect of revaluation of entire class of properties has not been incorporated
in the financial statements.
Impact on audit report
(i) The auditor would need to mention that the recording of impairment restricted
to only 3 properties instead of entire class of assets is not in accordance with the
IAS. Moreover, since the valuation of the other properties has not been
completed it represents scope limitation and therefore the auditor would be
required to give a qualified opinion or a disclaimer, depending upon the
materiality of the issue.
(ii)
(b)
The auditor will need to report that the value of three properties at the valuation
date is impaired and to report the amount of impairment. Moreover, since the
valuation of the other properties has not been completed it represents scope
limitation and therefore the auditor would be required to give a qualified opinion
or a disclaimer, depending upon the materiality of the issue.
Auditor will ask the management for justification for change in accounting policy
from fair value to cost method.
The auditor shall mention the exception to the consistent application of accounting
policy and a statement that whether they concur with the change in accounting policy
or not.
Moreover, the auditor would need to evaluate whether all the accounting treatment/
disclosures related to the change have been appropriately recorded in accordance with
IAS -8.
If the management is unable to provide reasonable justification for change in
accounting policy than the auditor will issue a qualified or adverse opinion,
depending upon the materiality and pervasiveness of the matter.
(THE END)
Page 8 of 8
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination – Summer 2013
General:
The overall performance of the students was poor apparently because the students failed to
apply the practical knowledge which they must have acquired during their training. In
questions involving practical scenarios, it is important that in addition to the knowledge of
IFRSs, the students should also apply their understanding of the business environment.
This is because matters related to audit risks, sources of audit evidence and other practical
situations require a good understanding of the business environment.
Question-wise comments are as under:
Question 1 (a)
An average performance was observed in this question. The scenario pertained to a
company which was faced with a going concern situation. While most students mentioned
about the huge loss during the past year and default on loan repayments, the following
points were not adequately covered:
•
The management had given various plans for the revival of the company which
included leasing the plant for a year and converting it to gas. The auditor is required to
evaluate such plans and the candidates should have commented whether these plans
were realistic.
•
Possibility of impairment of plant and machinery.
•
The need to carryout additional audit procedures if the uncertainty regarding going
concern assumption persists, even after performing the necessary procedures.
Question 1 (b)
In this part, the candidates were required to describe the implications of the issues
described in the question, on the audit report. The question was reasonably well
attempted. However, it was a 10 mark question but many students gave very short answers
in which they only discussed the implications on audit report in case the going concern
assumption was not valid. In fact, they should have discussed various possible situations
such as when there is uncertainty regarding going concern assumption but that uncertainty
is adequately disclosed and also when it is not adequately disclosed or when the going
concern assumption is definitely invalid.
Page 1 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2013
Question 2
Two issues arising on the audit of a paints manufacturing company were described. The
candidates were required to discuss the important matters which the auditor would
consider and to explain as to how the required audit evidence would be obtained in the
given situations.
In part (i) different types of costs incurred by the company after its plant, machinery and
premises had been damaged by fire. Generally, the students were able to appropriately
discuss the required accounting treatment and the element of materiality. However, very
few could realize that the situation warranted impairment testing and ignored this aspect.
Some of them went too far and highlighted Going Concern issue whereas there were no
such indications in the question particularly when the company had earned an after tax
profit of Rs. 100 million. Further, some students also mentioned the impact on the audit
report which was not required.
Most of the steps involved in obtaining audit evidence were discussed; however, very few
students mentioned about obtaining representation from management that all the related
details have been disclosed.
The performance in part (ii) was quite poor. Students failed to realize that this was a
limitation of scope situation and auditor needed to apply alternative means to verify
stocks. Most students did not identify or analyze the extraordinary increase in inventory
though sales had only increased nominally, resulting in a substantial decline in inventory
turnover rates. While discussing the source of audit evidence, most students remained
restricted to confirmation and subsequent events only. Other possible steps were missed.
Moreover, although the impact on Auditor’s report was not required yet many students
wasted time in discussing various forms of audit opinion.
Question 3
In this question, two independent situations arising on different clients were given. The
candidates were required to evaluate each situation and describe the course of action
which the engagement partner would adopt in each case.
Part (a)
In this case, the client was dumping waste chemical on a neighboring plot of land.
Moreover, instead of acknowledging the fault, the Chief Financial Officer (CFO) had
displayed a very indifferent attitude towards the situation.
The students did not fully appreciate the illegal act of the company and its implications.
Apart from one or two correct steps like communication to those charged with governance
or consultation with legal advisors, they failed to identify other issues. Most students did
not specify the auditor’s response in case those charged with governance failed to take
appropriate action. Very few touched upon issues such as cleaning costs and their
provision, possibility of a major disaster in case the non-compliance continues and its
repercussions and the careless attitude of the management which raises questions on the
quality of management controls, systems and procedures.
Page 2 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2013
Part (b)
The question focused on a quality control issue whereby the audit senior on the job had
resigned during the audit and it had been noticed that fieldwork on the job had been
completed in half of the time that is usually required. Most students focused only on
proper and adequate documentation. Some students mentioned the possibility that the job
senior may have joined the same client, leading to conflict of interest issues although there
was no such indication in the question. Most of them failed to discuss important matters
such as:
•
•
•
need to discuss the matter with the Audit Manager;
need to have the files reviewed by another Chartered Accountant; and
the questions that may arise as regards the effectiveness of the firms quality control
polices and procedures, in case significant deficiencies are found, despite the fact that
the working papers had been reviewed by the Audit Manager.
Question 4 (a)
According to the given situation, the tax authorities had launched investigation against an
assurance client, who was also being provided with tax services, by the same firm. The tax
authorities had alleged that the client has under-declared its income.
A very poor performance was witnessed in this question as most of the students discussed
the issue of permissible and non-permissible services under the Code of Ethics. Most of
the students did not consider as to what else can go wrong in the given situation, such as
possibility of mis-statements in the financial statements or mis-statement in tax returns.
Obviously, mis-statement in either or both of the above documents would have warranted
various actions by the auditors, which were mostly missed.
Question 4 (b)
In the given scenario, a trainee who worked part time at a estate agency had helped the
CEO of the assurance client in purchasing a plot of land. In this part, most of the students
identified the self interest threat correctly. However, they failed to identify or discuss
other important issues such as the materiality and significance of the financial interest
involved and whether the trainee’s conduct was in accordance with the firm’s policies.
Question 4 (c)
In this case, a Chartered Accountants firm was assigned to recruit a finance director and
the applications received included those from former employees of the firm as well as
employees of existing clients. The performance was better as the candidates were
generally able to identify the threats involved and also mentioned some steps for reducing
those threats to an acceptable level. However, most students missed the following points:
•
•
Use of separate teams for audit and recruitment procedures.
Confidentiality of the assignment and procedures to prevent access to confidential
information.
Page 3 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2013
Question 5
According to the given situation, a fraud had been committed and the candidates were
required to identify the controls which may have been lacking in the given situation.
Though the requirement was quite simple, yet overall performance varied a lot as many
students did not concentrate on the requirement of the question. Instead of identifying the
missing controls, they gave recommendations and suggestions to improve the situation in
future which was quite irrelevant.
Question 6
The situation given in this question pertained to a company engaged in oil exploration
activities. The company was faced with a difficult situation in which its profits were
falling and its receivables and payables had increased significantly. Certain other
information was also given such as terms of licencing agreement with the government,
governments guarantee for purchase of entire production of the company, a suit filed
against the company and general difficulties faced by the company in the given business
environment.
An average performance was witnessed as the students were able to identify some of the
risks and actions required to be taken by the auditor. However, very few students could
identify all the major risks as the following were rarely mentioned:
•
Foreign Exchange Translation Risk (due to long term foreign currency loan).
•
Impairment of plant and machinery
•
Under or over valuation of assets due to incorrect estimation of decommissioning
costs.
•
Over statement of profit, due to pressures on account of reduced earnings.
Many students seemed to have little understanding of the implications of the given
information. For example, while discussing that the company’s profits were significantly
below the budget, many students started commenting on the management’s ability to
prepare the budgets and importance of assumptions used etc. instead of relating it to the
risk of mis-statement in Profit and Loss because of earning pressure on the management.
Question 7 (a)
An interesting situation was given in this question whereby the company’s policy was to
value the buildings at revalued amount but the valuation of only 3 out of 8 buildings had
been completed. Moreover, according to these valuations, the carrying amounts exceeded
the re-valued amounts by Rs. 12 million.
The candidates were required to discuss the impact on the audit report if the impairment
was recognized and also if the impairment was not recognized.
Page 4 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2013
The students were generally able to identify that revaluing only 3 out 8 properties would
not be in accordance with IAS. Most of them also mentioned correctly that inability to
have all the properties revalued represents a scope limitation. However, very few could go
any further i.e. they were unable to specify as to how the auditor would deal with the two
possible situations, in his audit report.
Question 7 (b)
In the given situation, the client had changed an accounting policy. The candidates were
required to discuss the matters that the auditor needed to consider and the impact on audit
report. Most student failed to highlight the fact that the auditor needed to report whether
he concurs with the change or not. Consequently, they were also unable to specify as to
what the auditor would do if he does not concur with the change. Most students made
suggestions regarding the correct accounting policy which was not required.
(THE END)
Page 5 of 5
Advanced Auditing
Final Examination
Winter 2013
Module F
Q.1
2 December 2013
100 marks – 3 hours
Additional reading time – 15 minutes
You are the audit manager of Ravi Pharmaceuticals Limited (RPL) for the year ended
30 September 2013. The draft financial statements disclose a profit before tax of Rs. 200
million (2012: Rs. 150 million) and total assets of Rs. 5 billion (2012: Rs. 4.8 billion).
The following matters arose during the course of audit and are under your consideration:
(a)
(b)
RPL has been awarded a 20 year patent right for a new drug with a brand name of
Dengcol. The drug has been developed at a cost of Rs. 400 million.
(10)
As part of the Dengue Control Programme, the Government had provided a
conditional grant of Rs. 150 million to RPL for development of Dengcol. Under the
terms of the grant, RPL was required to sell 40% of the total production to the
Government Hospitals subject to a minimum of 1,000,000 vaccines per annum, for the
next five years.
(06)
Required:
Identify the matters that you should consider in the above situations, and state the audit
evidence you would expect to find in your review of the audit working papers for the year
ended 30 September 2013.
Q.2
Fawad Limited (FL) is a manufacturer of personal care products. FL intends to diversify its
operations by entering into the packaged food business. For this purpose it intends to seek a
financing of Rs. 2 billion from Ameen Commercial Bank Limited (ACBL). The company’s
CFO has prepared a five year cash flow forecast and has presented it to the bank. ACBL has
requested your firm to review the forecast in consultation with FL and furnish a report
thereon.
On reviewing the cash flow projections, you have noted the following:
(i)
Cash sales constitute 80% of the total sales of the new business.
Debtors turnover days related to current business are projected to be reduced from
75 days to 30 days.
(ii)
In the forecast, 24% of the income is under the head “Income from an associate”,
which is the management’s estimate of the company’s share of the associate income.
The associated company has confirmed the amounts which are incorporated in the
forecast; however no other details are available with FL to support this assumption.
Required:
(a) Comment on the above situations and briefly discuss the steps that you would take in
the given circumstances.
(12)
(b) Assuming that your firm decides to modify the report on prospective financial
information, draft the basis for modification paragraph and opinion paragraph to be
included in the report. (You may assume necessary details and choose to base the
modification either on para (i) or para (ii) above)
(06)
Advanced Auditing
Q.3
Page 2 of 3
You are the manager responsible for the annual audit of Tameer Limited (TL) for the year
ending 31 December 2013. TL is a listed company and is engaged in the business of
construction, renting and selling of apartments and office buildings to individuals,
businesses and government departments.
Extracts from TL’s draft Profit and Loss Account are as follows:
Revenue
Operating expenses
Operating profit
Financial charges
Profit before tax
2013
2012
(Upto Nov)
-------Rs. in million------1,520
1,883
(1,165)
(1,470)
355
413
(190)
(225)
165
188
During the planning stage, the audit team has presented the following points for your
consideration:
(i)
On 31 January 2014 tenancy agreements of office buildings rented to municipal
corporations in 15 small cities in the province of Sindh, are expiring. The concerned
departments have informed TL that they would not renew the agreements. These
properties are also held as security with the company’s bankers.
(ii) In August 2013, an apartment block which was completed and sold in 2009 was
severely damaged in an earthquake. The residents have filed a claim for damages
against TL amounting to Rs. 400 million. The company denies any liability in this
regard. However, to maintain its goodwill TL has agreed to compensate the residents
by making a payment of Rs. 100 million in four quarterly instalments and accordingly
this amount has been provided in the accounts. The residents have rejected the offer
and filed a suit against the company.
(iii) During the year, construction equipment costing Rs. 300 million was acquired on
lease. The lease rentals were allocated to the contracts on the basis of time utilized.
Lease rentals pertaining to idle time were charged to financial expenses.
(iv) During the year TL sold a two storey office building to Ali Limited. According to the
contract of sale, TL is entitled to construct further offices on the third and fourth floors.
Required:
Identify the audit risks that exist in the above scenarios and describe the manner in which
you would address those risks.
Q.4
(18)
Jhelum Machinery (Private) Limited (JMPL) is engaged in the manufacture of customised
machinery. Recently a fraud has been discovered which was perpetrated by Salahuddin, the
purchase manager. Salahuddin was responsible for approving the suppliers after obtaining
and evaluating the competitive quotes and placement of orders. Final approval was made by
the managing director.
Salahuddin had set up a private limited company Neelum (Private) Limited (NPL) in which
his brother and wife are directors. NPL supplies spare parts to JMPL. The fraud was
committed with the help of Karamat, a production supervisor and Farhan, the store keeper.
The supplies delivered by NPL contained a large proportion of damaged spare parts.
However, full payments were made to NPL as Farhan never raised any objections on the
quality of goods received. On the other hand, Karamat issued inflated consumption reports
to cover significant part of the damaged spare parts.
The fraud was discovered when Farhan went on leave due to illness. A review of inventory
sheets indicates that large quantities of spare parts are still lying in inventory.
Required:
Identify the control weaknesses in the above situation which may have enabled the
perpetration of fraud.
(06)
Advanced Auditing
Q.5
(a)
Page 3 of 3
Dynamic (Private) Limited (DPL) is a client of your firm. At the finalization stage of
annual audit, it was discovered that a senior member of the assurance team is the
co-owner of a property, for the possession of which DPL has filed a legal case. On
investigation, the member informed that the said case is pending for the last three years
and he did not consider necessary to disclose it at the time of commencement of audit.
Required:
Discuss the matters that should be considered and the course of action which may be
followed in the above situation.
(07)
(b)
Murree Limited (ML) and Bhurban Limited (BL) are listed assurance clients of your
firm. BL has filed a claim of Rs. 50 million in the court in respect of low quality of
goods delivered by ML. Upto last year ML had not acknowledged the claim of BL.
However, in the planning phase, you were informed by ML’s management that in
order to avoid bad reputation in the market and to continue its business relationship
with BL, ML intends to settle the dispute by making a payment of Rs. 20 million to
BL. The debt of Rs. 50 million is fully provided in the books of BL.
Required:
Being the auditor of both the companies, identify and evaluate the threats for the firm
and explain how these can be reduced to an acceptable level.
Q.6
Kabul (Private) Limited (KPL) has advanced Rs. 100 million to Qandhar Limited (QL), one
of its suppliers of raw material. KPL and QL have recently signed an agreement whereby the
above advance has been converted into a loan and QL has agreed to pay mark-up on the
outstanding balance at prevailing market rates. QL has confirmed the amount of loan and
the interest accrued thereon. However, you have acquired some information which suggests
that QL is facing financial difficulties.
Required:
Discuss how you would deal with the above situation and possible implications thereof on
the audit report.
Q.7
(06)
(a)
(10)
ABC and Company, Chartered Accountants, have been requested to give their consent
for appointment as the auditor of Sindh Limited (SL), in place of XYZ and Company,
Chartered Accountants. The matter of appointment of ABC and Company is to be
placed in the annual general meeting of SL.
Required:
(i) Explain the responsibility of ABC and Company and the steps that it needs to
take before acceptance of the audit.
(05)
(ii) What would be the retiring auditor’s responsibilities with respect to the above
and the responsibility of ABC and Company, in case the retiring auditor does not
fulfil its responsibility?
(05)
(b)
Assume that in (a) above XYZ and Company had qualified the previous year’s audit
report because it was unable to physically verify the factory building and to observe
physical inventory count, due to law and order situation. However, during the course
of current year’s audit, ABC and Company was able to observe the physical inventory
count and also carry out physical verification of the factory building as the law and
order situation has improved.
Required:
Discuss the matters which you would consider in the above situation and the possible
impact thereof on the audit report.
(09)
(THE END)
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2013
Ans.1 (a)
Matters to consider:
 Development cost is approximately 8% of total assets and 200% of profit before
tax and is therefore material.
 Whether the development costs incurred on Dengcol meet the capitalization
criteria as specified in IAS 38.
 Carrying value of the patent and possibility of impairment thereof.
Audit Evidence:
 Details of development costs to ensure that all the costs meet the criteria
specified in IAS 38 for capitalization as intangible asset.
 Assessment and conclusion whether all the costs are related to the development
of Dengcol.
 Supports/ vouching related to major payments
 Details of market research performed to ensure that the project is commercially
viable.
 Projections prepared by management, assessment of reasonableness of
assumptions, recalculation of projections, conclusion whether or not economic
benefits to be generated from the use of asset exceed the cost.
 Documents related to registration of patent.
 Written representations from management as to the commercial viability,
technical feasibility and adequacy of findings.
(b)
Matters to consider:
 The Government grant represents 75% of profit before tax and is therefore
material to the financial statements.
 Accounting treatment of the Government Grant.
 Company’s ability to meet the conditions associated with the grant.
Audit Evidence
 Receipt of the government grant of Rs. 150 million, to confirm that the amount
has been granted.
 Agreement with the government, to confirm that it is a grant.
 Assessment of whether the company is complying with or in a position to
comply with the terms and conditions contained in the agreement.
 Management representation confirming that it is in compliance and would be
able to comply with all the conditions attached to the Government Grant.
Ans.2 (a)
(i) It is a best estimate assumption and the auditor is required to obtain sufficient
appropriate evidence from internal and external sources that best estimate
assumptions on which prospective financial information is based are not
unreasonable. The following steps may be carried out in this regard:
 Discuss and evaluate how the management plans to reduce the credit period
from 75 days to 30 days.
 Consider the market norms and practices, related to credit period prevailing
in personal care to assess the reasonableness of assumptions.
 Consider whether food packaging business can expect to achieve 80% cash
sales. For this purpose, the general practice prevailing in companies which
are in the same line of business may be considered.
Page 1 of 7
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2013
 The auditor will need to ask the management to explain basis on which they
have made the assumptions specially as regards the assumptions which
appear to be un-reasonable in comparison with market practices and norms.
 If the management is unable to provide the basis on which any of the
assumption is based or the basis provided by the management are not
appropriate to conclude that the assumptions are reasonable, then the
auditor will conclude that the assumption relating to debtors turnover days
or cash sales does not provide a reasonable basis for the prospective financial
information and will either express an adverse opinion or withdraw from
engagement.
(ii) It is a best estimate assumption and the auditor is required to obtain sufficient
appropriate evidence from internal and external sources that best estimate
assumptions on which prospective financial information is based are not
unreasonable. The following steps may be carried out in this regard:
 The confirmation provided by the associate company cannot be taken as
sufficient appropriate audit evidence in support of company’s income from
the associated company.
 The auditor should check the dividend history of the associate to ascertain
the reasonableness of the forecasted receipts.
 The auditor should communicate with management to prepare an investee
company income forecast to support the assumptions.
 If the forecast is prepared, the auditor would need to assess the assumptions
on which it is based and to evaluate the overall reasonableness of the
forecast.
 If the forecast is not provided or the audior is unable to obtain evidence in
relation to reasonableness of assumption then it will constitute a scope
limitation.
 If the investee company do not provide forecast then the auditor should
either withdraw from the engagement or disclaim the opinion and describe
the scope limitation in the report on the prospective financial information.
(b)
As discussed under the caption “Debtors” in the summary of significant forecast
assumptions, the debtor’s turnover days are forecasted to be 30 days as compared to
present debtors turnover days of 75 days. The debtors turnover days forecasted are
not consistent with the prevailing market practices. Further, the company has not
committed any resources or taken any steps to reduce the debtors turnover days that
provide the basis for reducing debtors’ turnover days.
The accompanying forecast is not presented fairly in accordance with the
International Standard on Assurance Engagements applicable to the examination of
prospective financial information because management assumption, as discussed in
the preceding paragraph, do not provide a reasonable basis for management’s
forecast.
Page 2 of 7
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2013
A.3
Audit Risks:
The audit risks that exists in the given scenarios and the manner in which the auditor
would have to deal with them are discussed hereinafter:
(i)
Expiry of tenancy agreements
If the management of CL does not find any tenant after the expiry of rental
—
agreements with the municipal corporation there is a possibility that value of
Investment Property may be impaired.
Manner in which the risk is to be addressed:



The auditor should ask the management to make impairment testing of the
Investment Property and make appropriate provision, if required.
The auditor would need to assess the assumptions used by the management in
determining the fair value and whether the management has considered the
effect of expiry of tenancy agreements. If the assumptions applied are
unreasonable or does not include the effect of expiry of tenancy agreements, the
auditor should discuss and resolve the matter with the management .
In case the auditor is not satisfied with the assumptions applied by the
management or the effect of such assumptions on the valuation he may consider
hiring an expert.
(ii) Claim against destruction of apartment block
The claim for damages against the company is indicative of contingent liabilities
—
that may require provision or disclosure in the financial statements and there is
a risk that liabilities related to the alleged claim may not be recognized
appropriately in the financial statements.
Manner in which the risk is to be addressed:





The petition filed by the residents and the basis of their claim would be
reviewed.
The information provided to the prospective buyers during the marketing
campaign would be reviewed to assess whether any claim was made by the
company e.g. claim regarding the building being earthquake proof etc.
Legal opinion would be obtained from the company’s lawyers.
A valuer may be consulted to assess the loss.
If loss is probable and can be determined with reasonable accuracy management
would be asked to make a provision, otherwise a disclosure would be
appropriate.
(iii) Construction equipment
The accounting treatment of allocation of lease rentals to financial expenses is
—
not appropriate.
There is a risk of wrong classification of lease that may affect the operating
—
results and financial position of the company.
Manner in which the risk is to be addressed:

It appears that TL is treating the leasing equipment as an operating lease. The
auditor should determine from the leasing agreements whether the lease is a
finance lease or operating lease.
Page 3 of 7
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2013



If the auditor considers that treatment of lease is incorrect, the auditor should
ask the management to recognize the lease appropriately.
In case of operating lease, recognizing of lease rentals pertaining to idle time in
financial charges is not appropriate. The auditor should ask the management to
charge the rentals to the overhead expenditures.
If the lease is a finance lease, then the auditor should ask the management to
recognize it accordingly.
(iv) Construction of three storey building
There is a risk that value of right related to use of land for construction of 3rd and
—
4th floor is not valued and is not recognized appropriately.
Manner in which the risk is to be addressed:




A.4
Control weaknesses in the System:






A.5
The auditor would need to assess how this right has been valued in TL’s
financial statements.
The auditor would need to review the terms of the sale agreement relating to the
first two floors and assess the extent of rights available with the TL relating to
the use of building i.e. construction of third and fourth floor. If required a legal
opinion may be obtained.
If appropriate, the auditor may obtain a valuation report to assess the value of
the rights available with the client regarding the rights presently attached with
the building.
Based on the above information, the auditor would assess whether the
accounting treatment (carrying value of land) is appropriate.
=
(a)
There is a lack of segregation of duties as the functions of obtaining and evaluation of
bids, approval of supplier and placement of orders are performed by Salahuddin.
Controls over authorization and approval of supplier, as purchase manager was able
to get the approval of NPL, without any detailed background checking.
There appears no system of stock inspection by an independent person when it is
received in the store.
There appears to be no system of physical verification of stock to identify any
damage stock, so that it can be identified on timely basis.
It appears that there are no benchmarks/standards or other controls over stock
consumption i.e. identification of over consumption/under consumption as no
concern is raised when production supervisor charges extra costs as to the
consumption reports.
It appears that there are no benchmarks/standards regarding the quantities of
inventory that are to be maintained.
When litigation takes place, or appears likely, between the firm or a member of the
assurance team and the assurance client, a self-interest or intimidation threat may
be created. The significance of the threat created will depend upon materiality of the
litigation. In this regard, the following steps may be undertaken:
Page 4 of 7
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2013


Disclosing to the audit committee or others charged with governance, the extent
and nature of litigation.
Involving an additional chartered accountant in the firm who was not a member
of the assurance team to review the work done or otherwise advise as necessary.
If the assurance team member knew about the suit filed and he does not disclose the
fact to the firm then, it raises questions related to independence and integrity of the
assurance team member, and possible course of action, in additions to the steps taken
above may include:



(b)
If the employee avoided declaring his interest by making an incorrect declaration,
appropriate action should be taken against him as per the firm’s policies.
If no such declaration is required under the firms policies then the QCR policies
of the firm need to be reviewed and revised appropriately.
Assurance member’s argument that he did not consider it necessary to disclose
the matter is indicative of deficiency in the training program of the firm and
needs improvement.
A threat to objectivity or confidentiality may be created when a chartered accountant
in practice performs services for clients that are in dispute with each other.
Significance of threats should be evaluated, if threats are other than clearly
insignificant, following safeguards should be considered and applied as necessary to
eliminate them or reduce them to an acceptable level:









Notifying the client of the firm’s business interest or activities that may represent
a conflict of interest and obtaining their consent to act in such circumstances; or
Notifying all known relevant parties that the chartered accountant in practice is
acting for two parties in respect of a matter where their respective interests are in
conflict, and obtaining their consent to do so; or
Notifying the client that the chartered accountant in practice does not act
exclusively for any one client in the provision of proposed services and obtaining
their consent to so act.
The use of separate engagement teams; and
Procedures to prevent access to information (e.g., strict physical separation of
such teams, confidential and secure data filing); and
Clear guidelines for members of the engagement team on issues of security and
confidentiality.
The use of confidentiality agreements signed by employees and partners of the
firm; and
Regular review of the application of safeguards by a senior individual not
involved with relevant client engagement.
Where a conflict of interest poses a threat to one or more of the fundamental
principles, including objectivity, confidentiality or professional behavior, that
cannot be eliminated or reduced to an acceptable level through the application of
safeguards, the chartered accountant may resign from the engagement.
Page 5 of 7
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2013
A.6



The balance confirmation provided by QL, will provide sufficient and appropriate
audit evidence with respect to existence and completeness, but not with respect to
valuation and disclosures.
As QL is facing financial difficulties, there is an indication that the recovery of
advance is doubtful.
In order to address the issue the auditor should:
— Review latest audited financial statements of QL to determine QL’s ability to pay
back the loan in future.
— Review the audited financial statements to determine whether QL has defaulted
in repayment of any loans and advances etc.
— Review agreements between KL and QL to check what remedy is available in
case of non-payment by QL.
— Inquire as to the steps taken by QL in order to overcome the financial difficulties.


Discuss the issue with management and consider their assessment about the
recoverability of the amount and assess the reasonability of the assumptions on
which such assessment is based.
If the above procedures, suggest impairment in the value of advance, the auditor
should ask the management to make appropriate provision in the financial
statements.
Impact on Auditor’s Report:
If in the auditor’s opinion the recovery of the loan or mark-up accrued thereon is doubtful
and the client fails to make appropriate provision in the financial statements, the auditor
will issue a qualified opinion or an adverse opinion depending upon materiality and
pervasiveness of the matter.
If the management fails to assess the issue objectively or the auditor is unable to obtain
relevant and appropriate audit evidence, then it would represent a scope limitation , and
the auditor will issue a qualified or disclaimer of opinion depending upon materiality and
pervasiveness of the matter.
A.7
(a) (i)
New Auditor’s (ABC and Company) responsibility before acceptance of
audit:
 ABC and Company should consider whether the acceptance of new client
would create any threats to compliance with fundamental principles.
 Evaluate significance of threats before accepting the audit engagement
.
If the threats are other than clearly insignificant, safeguards should be
considered and applied as necessary, to eliminate them or reduce them to
an acceptable level.
 Communicate with the retiring auditor to establish the facts and
circumstances behind the proposed change, however, before
communicating it shall seek permission of the client for such
communication.
 Comply with relevant legal and other regulations in communicating with
retiring auditor.
Page 6 of 7
ADVANCED AUDITING
Suggested Answers
Final Examination – Winter 2013
(ii) Retiring Auditor’s responsibility:
Retiring auditor is responsible to respond to any communication by the
incoming auditor. However, before giving any information about the client, he
should seek client’s permission.
While communicating with the auditor, the retiring auditor need to meet the
legal and ethical requirements related to such communication and disclosure.
The retiring auditor should promptly transfer to the new auditor all books and
papers related to SL, which may be held after the appointment has been effected
and should also advise SL accordingly.
Incoming Auditor’s Course of action if SL and retiring auditor donot fulfill
their responsibility:
In case ABC and Company is unable to communicate with the retiring auditor
due to any reason, it should try to obtain information about any possible threats
by other means such as inquiries from third parties or background investigation
of senior management or those charged with governance.
If unable to reduce threats through alternative procedures, it may decline the
engagement.
(b) The matters that would be considered in the above situation are as follows:


Whether auditors are in a position to obtain sufficient appropriate audit
evidence with respect to quantities of inventory at the beginning of the year by
means of other operating procedures.
If auditors are unable to obtain sufficient appropriate audit evidence with respect
to quantities of last year through other audit procedures, it will imply that the
matter giving rise to modification is still unresolved, and the auditor shall
modify the auditor’s opinion on the current period’s financial statements.
Impact on the audit report would be as follows:


Auditor shall explain in the audit report that the audit opinion has been
modified because of the effects or possible effects of the unresolved matter on
the comparability of the current period’s figures and the corresponding figures,
although the matter is not relevant to the current period figures.
Even if the above matters are resolved auditor shall be required to include in the
audit report, an other matter paragraph stating that:
—

The financial statements of the prior period were audited by the predecessor
auditor, who has issued a qualified opinion due to non-observance of
inventory count and date of prior year’s audit report.
The qualification related to non-verification of building of last year is not
relevant as the auditor is able to physically verify the building.
(THE END)
Page 7 of 7
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination – Winter 2013
General:
The performance in this attempt was somewhat similar to the previous attempt. Majority
of the students lacked proper understanding of the various issues concerning the audit. In
scenario based questions, the candidates are required to prepare their answers in the
context of the given situation. Generally, the candidates were unable to comprehend the
entire situation and mold their answers accordingly.
Following issues were also noted:
•
A number of candidates restated the question in their answer scripts. This is an
unnecessary waste of time that can be spent in planning and addressing the actual
question.
•
When questions are given in parts [eg. (a) i & ii , (b), etc] many candidates tend to
merge the parts in their answers instead of giving the answers to each part separately.
Where separate marks are identified in the question paper for each part, then the
candidate should try to attempt the question accordingly as well.
•
Candidates should try to give answers in the form of well-defined points, preferably
starting on a new line for each additional matter being covered, as opposed to giving a
continuous answer without any structure. This would enable them to identify matters
that may have been missed out.
Question-wise comments:
Question 1
In this question the candidates were required to identify matters that should be considered
and audit evidence that should be obtained in the verification of patent rights and their
development costs and the government grant which had been received but under the terms
of the grant the company was required to meet certain production targets. Most of the
students were able to highlight the matters related to materiality, capitalization criteria and
registration of patents. However most of them did not discuss the following:
•
Possibility of impairment and how would the auditor satisfy himself in this regard.
•
Company’s ability to meet the conditions associated with the grant.
•
Verification of development costs.
•
Management representations.
Page 1 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2013
Question 2 (a)
According to the situation given in this question, the auditor was required to report on
prospective financial information. The students were required to comment on the
assumptions on which the forecast was based.
A significant number of candidates managed to explain why the assumptions seemed
unreasonable and how the auditors should satisfy themselves in this regard. However,
majority of the candidates did not mention the effect on the audit opinion in case the basis
of the assumptions was not appropriate.
In case of income from associates, most candidates correctly stated that the confirmation
did not provide sufficient audit evidence in support of the prospective income from
associate but did not mention that a scope limitation could arise if evidence was not
available to support this assumption.
Some students incorrectly felt that this was a ‘related party’ issue. They did not appreciate
that being prospective financial information, disclosure of related party was not relevant in
this case.
Question 2 (b)
In this part of the question, the requirement was to draft the basis for modification
paragraph and opinion paragraph. It was noted that in many cases, even though the
candidates correctly identified the issues at hand, they were unable to draft an appropriate
audit opinion with respect to the same. Many candidates did not read the requirement
properly and wasted time in drafting modification on all three issues whereas the
requirement was to choose any one issue, for this purpose. In many cases it was noted that
opinion paragraph was not framed adequately with reference to modification and general
paragraph was reproduced.
Question 3
According to the scenario given in this question, a construction company was faced with
four different situations and the candidates were required to identify the audit risks and
how the auditor would address those risks. The performance in each case is discussed
below:
(i)
Rent agreements of 15 different properties were expiring subsequent to year end and
were not being renewed. Majority of the students jumped to the conclusion that this
issue may result in failure of the company to continue as going concern. This was
not a valid argument because the company had many other ongoing projects and it
had earned substantial profits during the year under review. However, it did pose the
risk of impairment in the value of properties which majority of the students failed to
identify.
(ii)
A building constructed by the company had been seriously damaged in an
earthquake and the residents had lodged a substantial claim. The company denied
any wrongdoing but as a gesture of goodwill, had offered to pay 25% of the claimed
amount.
Page 2 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2013
The performance here was much better as the students were generally able to
identify the risk of over or under statement of liability and the need to seek lawyer’s
opinion and the use of an expert for valuation of the loss. However, many
candidates emphasized on making appropriate provision without appreciating that a
provision in excess of the amount already agreed by the company would only be
required if the loss is probable and can be determined with reasonable accuracy.
(iii) The company had obtained a construction equipment on lease and the lease rentals
were being allocated to the contracts on the basis of time utilized whereas rentals
pertaining to idle time were being recorded as financial charges.
The candidates were generally able to identify the risk of misclassification of the
lease and the need to verify whether the treatment was correct. However, many
candidates did not identify the error whereby the lease rentals pertaining to idle time
were being charged as financial expenses.
(iv) This was an interesting situation whereby the company had sold a two story
building but retained the right to construct the 3rd and the 4th floors. Majority of the
candidates failed to identify the risk of incorrect valuation of the company’s right of
construction and sale of 3rd and the 4th floors. Majority of them discussed accounting
of construction contracts which was not relevant.
Question 4
This was quite a simple question on process of procurement and inventory control.
According to the given situation, a fraud had been committed and the candidates were
required to identify the control weaknesses.
The performance was good but it was not as well answered as it should have been because
with the level of experience possessed by the candidates at this stage of their careers, they
were expected to perform much better. In many cases, the answers were flooded with
repeated points hence missing out other important ones. Complete answers covering all
angles were generally missing. Majority of the candidates skipped two very important
points regarding controls over stock consumption and stock balances.
Question 5 (a)
According to the situation given in this part, litigation between the client and a senior
assurance team member was discovered during finalization stage of the audit. On inquiry,
the concerned member had informed that he knew of the litigation but did not consider it
necessary to disclose it. The candidates were required to discuss the matter and specify the
course of action that the firm may adopt.
Most of the students were able to identify the related threats, discuss the significance of
the threat and the measures to mitigate such threat. However, very few of them could look
beyond that. They did not realize that the possible reason for failure of the assurance team
member to disclose the fact was important. His statement that he didn’t felt the need to
disclose this information was indicative of the fact that the firm had no policy in this
regard or this policy was not clearly stated or communicated to the staff. This aspect was
not covered by majority of the students.
Page 3 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2013
Question 5(b)
According to the situation given in this part of the question, a firm was the auditor of two
listed companies. One of the companies had filed a claim of Rs. 50 million against the
other company for supply of low quality products.
The performance in this part was good as majority of the candidates were able to fulfill
the requirement of identifying the related threats and the measures to mitigate such
threats. Many candidates secured full marks also.
Question 6
The question was based on a situation whereby a company had advanced an amount of Rs.
100 million to one of its suppliers. The advance was later converted into a loan. The
supplier had confirmed the amount but the auditor had received certain information
suggesting that the supplier was in financial difficulties. The candidates were required to
identify as to how the auditor should deal with the situation and the possible implications
on the audit report.
This was simply a situation of possible non-recovery of loan and evidence was to be
gathered in relation to that. However, a large majority of the students gave little attention
to this key issue and focused most of their attention towards the issue of related party
which was a secondary issue. Some students stretched too far i.e. the possibility of failure
of the supplier to supply the raw material resulting in going concern issue for the lending
company. This was also irrelevant because there was no indication in the question that the
supplier was the sole supplier or that the company relied too heavily on such supplier for
the supply of raw material. Some students misunderstood the whole situation and replied
the question as if they were auditors of the supplier which has taken the loan.
While discussing the impact on audit report most of the students only mentioned that a
qualified opinion would be required without specifying that a qualified opinion will only
be required if there is a disagreement between the client and the auditor. Moreover, since
materiality of the amount in the overall perspective was not specified the possibility of an
adverse opinion also existed if the amount was considered pervasive.
Question 7 (a)
In this part, the candidates were required to specify:
•
•
•
the steps that an auditor would take before signifying acceptance to act as the
auditor of a company.
the retiring auditors responsibility in such a situation; and
the incoming auditor’s responsibility if the retiring auditor fails to fulfill its
responsibilities.
Most of the candidates seemed to possess sound knowledge of these areas and performed
well. However, a number of candidates went into too much detail about client acceptance
procedures and what information would be required before acceptance. While explaining
the retiring auditor’s responsibilities many candidates did not mention that the retiring
auditor shall take prior permission of the client before communicating with the incoming
auditor and that he needs to comply with any legal or other regulation during such
communication.
Page 4 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2013
Question 7 (b)
According to the situation given in this part, the previous auditor had qualified the audit
report on account of his inability to physically verify a building and observe stock taking
because of poor law and order situation whereas the situation had improved this year and
the current auditor was not subject to such limitations. The requirement was to discuss the
above situation and the impact thereof on the audit report.
The performance in this part was average. Most candidates identified the need to include
an “other matter paragraph” in the audit report as the previous audit was conducted by
another auditor. However, there was lot of confusion as regards the impact of previous
year’s qualifications. Very few candidates were able to identify that the impact on current
year’s audit report would depend on whether the current auditor is able to obtain sufficient
appropriate audit evidence in respect of opening balances of inventory, by other operating
procedures and the impact on the audit report in either case. Many students concluded
incorrectly that as the matter has been resolved this year, so there is no impact thereof on
the current year’s audit report. On the other hand, some candidates went to the other
extreme and concluded that the previous auditor shall be asked to re-issue last year’s
report.
Many candidates did not seem to appreciate the difference between the qualification
related to non-verification of building and the qualification related to non-verification of
inventory balances.
(THE END)
Page 5 of 5
Advanced Auditing
Final Examination
Summer 2014
Module F
Q.1
4 June 2014
100 marks – 3 hours
Additional reading time – 15 minutes
You are the manager responsible for the audit of Health and Beauty Brands Limited
(HBBL) for the year ended 31 March 2014. HBBL has been selling its products through its
own retail outlets only. However, during the year under review, HBBL had entered into an
agreement for sale of its products at JDS, a chain of departmental stores.
Following information is available in respect of the above:
According to the agreement, JDS would make payments within 30 days of the sale to
customers. Any unsold/expired products would be returned to HBBL.
The stock sheets provided by JDS to HBBL revealed differences as compared to the
balances appearing in the HBBL’s inventory system. According to JDS these were due
to posting errors in the system of JDS, and have been subsequently corrected. HBBL’s
management is of the view that such differences are not material as compared to sales
made through JDS.
There is a significant improvement in the operating results of HBBL. The management
considers that the agreement with JDS has played a major role in such improvement.
The confirmation sent to JDS was not received. Alternatively, the audit team had
examined partial payment amounting to 65% of the outstanding balance upto
31 May 2014.
Required:
Discuss with reasons, what course of action you would adopt in the above situation and the
possible impact thereof on the audit report.
(14)
Q.2
You are the quality control partner in a firm of chartered accountants. The following
independent situations are under your consideration.
(a)
Kamal, a manager in the firm is assigned on deputation for training of the newly
hired staff in the accounts department of a brokerage house. The brokerage house is
also an audit client of your firm.
(04)
(b)
Your firm has received a proposal from an audit client for implementation of a new
IT system which the company has acquired.
(08)
(c)
The client has written a letter of appreciation showing their gratitude for the
involvement and guidance provided by an audit manager on various issues regarding
application of accounting standards.
(05)
Required:
Identify and evaluate the threats involved and explain what actions should be taken in the
above circumstances including the steps required, if any, to reduce the risks to an acceptable
level.
Advanced Auditing
Q.3
Page 2 of 3
Diversified Businesses Limited is a listed company engaged in the business of
manufacturing paints, pharma and chemicals. During the planning stage of an audit, the
auditor has found that:
(a)
The company has advanced a significant amount of Rs. 2.5 billion to a related party,
for construction of an office tower. In the notes to the financial statements, it has been
stated that transactions with related parties were carried out on arms length basis.
(08)
(b)
The audit committee meetings were not held during the year, because all audit
committee members remained out of country. Consequently, the interim financial
statements were issued by the company without being reviewed by the audit
committee.
(04)
Required:
Evaluate and discuss how the auditor should deal with the above situations.
Q.4
You are the audit manager responsible for audit of consolidated as well as separate accounts
of Five Star Limited (FSL) and its subsidiaries. In the initial meeting, the financial
controller has informed you that during the year:
(a)
(b)
the group has changed its policy for valuation of plant and machinery from cost to
revalued amount. The revaluation has been carried out by a global firm of
professional valuers, who have been advising FSL for the last several years.
(08)
one of FSL’s subsidiary has incurred substantial losses. Deferred tax has been
recognized on these losses. The financial projections prepared by the CFO show that
as a result of planned re-structuring, the subsidiary would be able to recoup the losses
during the next three years.
(05)
Required:
Describe the steps that you would take in each of the above situations.
Q.5
(a)
You are a partner in a firm of chartered accountants, looking after the audit and
advisory services department. One of your clients has approached you for services in
relation to certification of compliance with a specific control framework, with regard
to their production process.
Required:
What are the different types of reports that you can offer to the client, clearly
specifying the key characteristics of each form of report.
(b)
Your manager has identified that the client should prepare a statement of compliance
with the said control framework and your firm can only issue a report on that
statement.
Required:
Identify the type of assurance engagement to which the manager is referring to and
the key characteristics of such engagement.
Q.6
(08)
(03)
Education For All Foundation (EFAF) is a large charity based organization, engaged in
providing education to needy children, at a token fee of Rs. 100 per child. It receives
donations for its activities both in cash and through its bank accounts. The major
expenditure relates to payment to teachers and petty cash.
Required:
Briefly describe the key controls which you as an auditor expect to find in respect of receipts
and payments.
(07)
Advanced Auditing
Q.7
Page 3 of 3
You have been appointed as a manager in the audit department of Sachal Sarmast &
Company, which is a medium size firm of chartered accountants. The audit of Consumer
Products Limited has been assigned to you. This audit was previously assigned to another
manager who has resigned. The predecessor manager has identified a number of risks. Two
such risks alongwith their classification and related assertions are discussed in the working
paper files.
The relevant extracts are as follows:
S.No.
Risk factor
(i)
Decentralized
operating structure
supported by different
IT applications
(ii)
Financial crisis
Type of risk
Related assertions
Inherent risk Presentation and disclosures –
occurrence and right and obligation and
completeness
Significant
risk
Accounts payable – rights and
obligations, valuation and completeness;
Property and equipment – rights and
obligations;
Accounts receivable – valuation;
Inventory – valuation;
Cash – valuation;
Turnover – occurrence
Required:
Do you agree with the above risk assessments? Discuss.
Q.8
(10)
Shakeel Foods Limited (SFL) manufactures a variety of food products. The incharge of the
audit team at SFL has requested you to advise on the following issues:
(a)
During an informal discussion with a company’s employee, he came to know that SFL
is in litigation with one of its competitors. However, the said case was not included in
the list of cases provided by SFL nor was it mentioned by the legal advisor in his
confirmation. On being confronted, the management has informed that they are in the
negotiation phase with the competitor and intend to settle the dispute through
payment of Rs. 150 million.
(10)
(b)
Stock in trade valuing Rs. 65 million is placed in a warehouse owned by Hameed
Limited (HL). According to news reports, FIA has recently initiated an enquiry
against HL for evading import duties and taxes. HL has confirmed the quantities of
stock at year end.
(06)
Required:
Discuss how the auditor should deal with the above situations.
(THE END)
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2014
Ans.1
Significant improvements in profits reflects the risk that the revenue and profit in the 2014
financial statements may be significantly overstated.
The following point are needed to be considered in relation to the given situation:





HBBL’s arrangement with JDS is such that JDS facilitated sales to customers but
does not purchase the inventory itself and HBBL retains title to the product until it
is sold to the final customer.
HBBL may have knowingly or erroneously, recognize the Sales Revenue on
dispatch of goods to JDS.
Subsequent recovery of 65% upto 31 May 2014, is also not sufficient appropriate
audit evidence of receivable balance from JDS, because as per the agreement JDS is
required to make the payments within 30 days of sale to customers.
It is also indicative of the risk that sales/receivable balance is overstated.
Although, the differences between stock sheets and balances were corrected
subsequently, but it is indicative of a risk that during the year there is a possibility of
wrong posting in the system of JDS, which consequently will result in
overstatement/ understatement of sales and stock in trade
In response to the above we would need to carryout the following procedures:
(i)
(ii)
(iii)
(iv)
Obtain an understanding of when the sales are recorded in the system.
Enquire the reasons of 65% of subsequent recovery from JDS, and ask for
confirmation from JDS.
Review global reconciliation of Sales, Receivable and stock at JDS.
Assess what type of mistakes were made in the stock posting system at JDS and
review the reconciliations prepared before making the corrections.
Implications on the Audit Report:


Ans.2
(a)
After performing the above procedures if the auditor finds any error in the recording
of sales or receivables, he should ask the client to make appropriate adjustments,
failing which the report may be modified i.e. qualified or adverse depending upon
the materiality of the amounts involved.
If we are unable to obtain sufficient appropriate audit evidence, as regards the
recording of sales or in relation to receivable from JDS, it will be scope limitation
and based on the materiality and pervasiveness of the matter, the auditor may issue
a qualified or disclaimer of opinion.
Supervising employees of assurance client in the performance of their normal
recurring activities may create self review or self interest threats.
The significance of threats should be evaluated and if the threat is other than clearly
insignificant, safeguards should be considered and applied as necessary to eliminate
the threat or reduce to an acceptable level. Such safeguards might include:


Making arrangement so that personnel providing such services do not
participate in the assurance engagement;
Involving an additional chartered accountant to advise on the potential
impact of the activities on the independence of the firm and the assurance
team;
Page 1 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2014
(b)
The listing regulations clearly stipulate that prohibited services by the auditors
include financial information technology system design and implementation,
significant to overall financial statements.
However, if the auditor concludes that it is not significant to overall financial
statements and is therefore permissible under the listing regulations, the situation
would need to be assessed from the point of view of Code of Ethics, which states
that:
The provision of services involving design and implementation of information
systems that are used to generate information forming part of financial statements
may create a self review threat.
The self-review threat is likely to be too significant to allow the provision of such
services to a financial statement audit client unless appropriate safeguards are put in
place ensuring that;
—
—
—
—
The audit client acknowledges its responsibility for establishing and monitoring
the system of internal controls;
The audit client designates a competent employee preferably in the senior
management cadre, with the responsibility to make all management decisions
with respect to the design and implementation of the hardware or software
system;
The audit client evaluates the adequacy and result of the design and
implementation of the system; and
The audit client is responsible for the operation of the system (hardware or
software) and the data used or generated by the system.
Consideration should also be given to whether such non-assurance services should
be provided only by personnel not involved in the financial statement audit
engagement and with different reporting lines within the firm.
(c)
Involvement of audit personnel and guidance to client on accounting principles are
an appropriate means to promote the fair presentation of financial statements and
the audit process routinely requires dialogue between the firm and management of
the audit client and such types of activities are considered to be a normal part of the
audit process and do not, generally, create threats to independence
Self-review threat will be involved in above situation, if the auditor assumes
management responsibility while providing guidance to the client’s management.
Safeguards should be applied to prevent the auditor from assuming management
responsibility when providing advice. Safeguards could include :



Obtaining acknowledgement of responsibility from the client for any actions or
decisions made.
Evaluating the ultimate decision of the client and ensuring that the reasons for
their decisions are self-determined
The risk is further reduced when the firm gives the client the opportunity to
make judgments and decisions based on an objective and transparent analysis
and presentation of the issues.
Page 2 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2014
Ans.3
(i)
The auditor need to ascertain whether transactions with the related party have been
appropriately accounted for and disclosed in accordance with the IFRS and
Companies Ordinance, 1984.
Management’s assertion that the transactions were conducted on terms equivalent
to those prevailing in an arm’s length transaction may be materially misstated due
to practical difficulties that limit the auditor’s ability to obtain audit evidence that
all aspects of the audit evidence are equivalent to those of the arm’s length
transaction.

In order to address the above factors, the auditor shall:
—
—
—
—

Inspect the underlying contracts or agreement.
Determine the business rationale behind the transaction.
Determine whether the terms of the transactions are consistent with
management’s explanations.
Obtain audit evidence that the transactions have been appropriately
authorized and approved.
The auditor will evaluate management’s support for the assertion of arms
length transaction, which may involve one or more of the following:
Considering the appropriateness of management’s process for supporting
the assertion.
Verifying the source of the internal or external data supporting the
—
assertion, and testing the data to determine their accuracy, completeness
and relevance.
Evaluating the reasonableness of any significant assumptions on which
—
the assertion is based.
In addition to the above, we shall seek representation that management has
disclosed all the facts and documents related to the above transaction.
—

(ii)

It is a case of non compliance with the Code of Corporate Governance and the
auditor would also need to re-assess the risk of material misstatement and
consider its impact on other areas of audit.

Beside the above:
—
—
Ans.4
(i)
If the matter is appropriatly disclosed in the Statement of Compliance
with the requirements of Code of Corporate Governance the auditor will
highlight this non compliance in the review report drawing attention to
the note where the matter has been appropriately disclosed by the
management.
If the management has not disclosed this matter in the Statement of
Compliance or the disclosure is not factually accurate, the auditor will
need to qualify his report on the Statement of Compliance with the Code
of Corporate Governance.
Change in Accounting Policy
Steps needs to taken by the auditor:

Review change in accounting policy for biases and evaluate whether the
circumstances producing the bias, if any, represent a risk of material
misstatement due to fraud.
Page 3 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2014








(ii)
Whether the change in accounting policy will result in reliable and more
relevant information about entity’s financial position, its performance and
cashflows.
Whether the requirements of IAS 16 in relation to change in accounting
policy, has been complied with.
Evaluate the competence, capabilities and objectivity of the professional
valuers;
Obtain an understanding of the work of that valuer; and
Evaluate the appropriateness of that valuer’s work as audit evidence for the
relevant assertion
Consider the need for appointment of an auditor’s expert.
Ensure that all the assets in the entire class of plant and machinery has been
revalued.
Checking appropriateness of disclosures related to the requirements of
Companies Ordinance, 1984 and IAS 16.
Deferred tax asset:
Steps needs to be taken by the auditor:

Whether the recognition criteria for deferred tax asset as specified in IFRS has
been met.

Whether the methods estimating the amount of deferred tax are appropriate
and have been applied consistently, and whether changes, if any, in
accounting estimates are appropriate in the circumstances.

Determining whether events occurring up to the date of the auditor’s report
provide evidence regarding the deferred tax asset.

Review the company’s restructuring plan (assumptions) to assess its
reasonableness and viability.

Review the future projections provided by the client and their viability vis a vis
restructuring plan.

Checking appropriateness of disclosures related to the requirements of IAS 12.

Written representations from the management.
Page 4 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2014
Ans.5
(a)
The services may be provided either as an Agreed Upon Procedures Engagement or
as an Assurance Engagement other than Audit of Historical Financial Information.
In case of Agreed Upon Procedures,
the report will contain the procedures
performed and the results of such
procedures in the form of factual
findings.
In case of assurance engagement, the
report may take two different forms
i.e. a reasonable assurance report or a
limited assurance report.
In a reasonable assurance report the
auditor will provide a positive
assurance on the compliance of the
entity with the framework.
In the limited assurance report the
auditor will provide negative assurance
on the compliance of entity with the
framework.
(b)
Ans.6
The manager is referring to assertion based engagement , in which:

the evaluation or measurement of the subject matter is performed by the
responsible party; and

the subject matter information is in the form of an assertion by the responsible
party that is made available to the intended users.
Overall controls – statement showing donations, fee and income and payments are
reviewed by senior management personnel on a monthly basis (i.e. business performance
review covering all assertions)
Control over donations
(i)
Cash
 For cash received at counters, the cashier counts the cash and prepares a
receipt voucher (Completeness, Accuracy, Rights/Obligation, Cut off)
 For donation boxes – donation boxes are unlocked / opened in the presence
of two / three persons and then a cash count is performed following which a
receipt voucher is prepared showing details about the date, time, place of box
and the total cash collected. (Completeness, Accuracy)
 Cash count is performed on regular basis by a person independent of the
custodian of cash and results are matched with the daily receipt record
maintained in the system (Existence)
 Cash is kept in safe custody and at day end the cash is deposited with bank.
(Existence)
 Surprise cash counts are also conducted by the persons independent of the
custodian of cash (Existence)
 Appropriate segregation of duties exist, i.e. person receiving the cash,
maintaining its custody and recording the transactions is not the same
Bank accounts
 Bank reconciliation statements are prepared and reviewed on a regular basis
and unadjusted / reconciling items are investigated and recorded on timely
basis. (Completeness, Accuracy, Rights / Obligations, Cut off)
Page 5 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2014
Controls over fee income
 The cashier counts the cash and prepares a receipt voucher showing details about
the date, time, name of student and the cash collected. (Completeness, Accuracy,
Rights / Obligations, Cut off)
 A student wise fee outstanding report is prepared and reviewed on a monthly basis
and the schedule of overdue fee is presented to the management for appropriate
action as per policy.
Controls over Payments
(i)
Teachers
 Payroll process is initiated by the payroll department based on the master data
maintained by HR department.
 The attendance record reviewed by the Head of the Department before the
processing of payroll.
 A month-to-month payroll reconciliation is prepared before the distribution of
payroll.
 Changes to master data is made by the HR department only after due
authorization.
Ans.7
(ii)
Petty cash
 Pre-numbered / sequentially controlled petty cash vouchers are maintained.
 Cash on the basis of IOUs is not disbursed.
 Surprise cash counts are conducted by the persons independent of the
custodian of cash (Existence)
 Payments are recorded in general ledgers after the details are reviewed by the
Finance Manager.
(i)
Decentralized operating structure supported by different IT applications:
It is classified as inherent risk, which is not correct, because it does not indicate a
susceptibility of an assertion about a class of transactions or account balance or
disclosures to misstatements.
Decentralized operating structure could potentially lead to misstatements in the
financial statements due to the following:
Unintentional mistakes due to variety of applications holding the information
and the complexity involved.

Potential frauds being committed by taking advantage of the complexities of
the system.
Therefore it may be argued that this risk should be classified as a significant risk
and in certain circumstances even a fraud risk.

The noted assertions are correct, but the following should also be added:

the occurrence, completeness, classification assertions for the class of
transactions.

The existence, rights and obligations and completeness assertions for year end
account balances.
Page 6 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2014
(ii)
Financial Crisis
The classification of risk as a significant risk can be justified on its linkage with the
recent economic development; however it would be more appropriate to classify the
factors of financial crisis into specific risks, depending upon:

How the financial crisis will effect the client and how does it translate into a
risk. This will vary depending on the industry sector in which the client
operates or how the financial crisis will impact certain portfolios/customers
related to client.
The linkage with related assertions is too vague, because almost assertions related to
all areas have been included. The auditor should reassess the relevance of the risks
to link to the financial statement assertions and may need to reclassify the Related
assertions with respect to categories of risk.
Ans.8
(a)
(i)
The failure to include all the cases in the confirmation depicts that the legal
advisor has not replied appropriately to the general enquiry letter. In this case:

The auditor may directly communicate with the legal advisor (after client
permission) through a letter of specific enquiry, which shall include the
following:
—
—
—
(ii)
Details of litigation for which the auditor needs to obtain information.
Management’s assessment of the outcome of the identified litigation
and its financial implications.
A request for confirming the reasonableness of management’s
assessment and providing further information if the details of case or
management’s assessment is incorrect.
The auditor’s course of action would depend upon the reply to the specific
enquiry, and the auditor will proceed in the matter, as follows:
Legal Advisor confirms the viewpoint of management:
If the legal advisor confirms that he has not included the said case in his
confirmation due to the reasons that the management is in negotiation phase
with the competitor and confirms the amount of loss estimated by the
management, it will confirm the viewpoint of management.
Legal Advisor confirms the view point of management but does not agree
with the amount provided in the financial statements:
If the legal advisor confirms the viewpoint of management , but disagrees with
the management relating to the amount of settlement, then the auditor will
ask the management to resolve the matter.
In both the above cases, the auditor will:
 review the legal files of the cases to confirm the lawyer’s point of view
regarding the outcome of the case
 seek management representation that there are no other undisclosed
pending cases.
If the matter cannot be resolved or the management fails to make appropriate
adjustments in the financial statements the auditor would consider the impact
on the audit report and modify the report accordingly.
Page 7 of 8
ADVANCED AUDITING
Suggested Answers
Final Examination – Summer 2014
Legal Advisor negates the viewpoint of management:
 If the legal advisor does not confirm the information provided by the
management or expresses that he does not have any knowledge of the said
case, then it will raise concerns with regard to the integrity of
management.
 As it is a significant matter therefore the auditor may contact the legal
advisor of the company, to address the matter.
 The auditor will also communicate the matter to those charged with
governance and asked them to address the situation and determine
whether it is possible to perform alternate audit procedures to obtain audit
evidence.
 The auditor will determine the professional and legal responsibilities
applicable in the circumstances, including whether there is a requirement
for the auditor to report to the persons who made the audit appointment
or to regulatory authorities.
 If those charged with governance donot take corrective measures or
auditor is unable to obtain audit evidence from alternative procedures, and
as the matter relates to the integrity of management, then the auditor will
consider options, as withdrawing from engagement or disclaiming the
opinion
(b)
(i)
Discuss the news report with the client to assess the authenticity of your
information and what action is the client taking in this regard.
(ii) Ask the client for physical verification of stock held by the HL in the presence
of an audit team member.
(iii) Review the reconciliation between yearend stock and the quantities verified at
the auditor’s request.
(iv) Update your information about the status of FIA’a action so far.
(v) In case the severe action against HL is imminent, then consider its impact on
the financial statements.
(vi) If the expected impact is significant ask the client to resolve the issue (shifting
of stock, guarantee from HL etc)
(vii) If HL fails to take reasonable action consider its impact on the financial
statements and audit report.
(THE END)
Page 8 of 8
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination – Summer 2014
General:
The overall performance was below expectations similar to the results in the previous two
attempts. Very few candidates could perform well in areas which required analytical
decision making or opinion formation.
Question-wise comments are as under:
Question 1
This was a scenario based question where a Company HBBL had entered into an
agreement for sale of its products at a chain of departmental stores named JDS. Principal
terms of agreement relating to transfer of risk and reward and credit period/payment
arrangement between the parties were given in the scenario. Certain issues relating to
payment and inventory reconciliation were also specified in the question. It was further
stated that there was significant improvement in operating results of HBBL. Candidates
were required to discuss with reasons, what course of action the auditor should adopt in
the given situation and the possible impact thereof on the audit report.
The performance was average as most of the students discussed the apparent issues and
the related audit steps but missed some important steps like global reconciliation of sales,
receivables and inventory related to JDS and possibility of scope limitation on account of
inability to obtain sufficient and appropriate audit evidence. Moreover, most of the
students also listed many irrelevant/inappropriate matters like provision against expired
stock and disclosure of stock differences in the financial statements.
Question 2
This question consisted of three parts and required the candidates to evaluate the threats
and specify measures to reduce the risk to acceptable level in three outlined situations. A
review of the students response in each part is presented below:
Question 2(a)
In this case, the manager of an audit firm was assigned to train the staff of an assurance
client. In most of the cases only self review threat was identified whereas very few could
identify the self-interest threat. A number of candidates were of the opinion that no threat
was involved in this situation.
Page 1 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2014
Question 2(b)
In this part many students missed the fact that listed companies regulations clearly
stipulate that prohibited services include financial information technology system design
and implementation and such services can only be undertaken if the auditor concludes that
it is not significant to overall financial statements.
Question 2(c)
According to the scenario in this part, an audit manager had helped the client, though
voluntarily, in the application of accounting standards. Majority of the students were able
to identify self-review threat in case the audit manager becomes involved in management
decision making, however, they were unable to mention the relevant safeguards as per the
requirements of Code of Ethics.
Question 3
This question consisted of two parts, both pertaining to the same audit assignment. In each
part a situation was identified and the candidates were required to evaluate and discuss
how the auditor should deal with it. Performance in each part is discussed below:
Question 3(a)
According to this situation, the client had advanced Rs. 2.5 billion to a related party for
construction of an office tower and it was claimed that it was an arm’s length transaction.
Generally, the students were able to highlight most of the steps required to verify the
assertion that it was an arm’s length transaction, except the following:

Verifying the source of the internal or external data supporting the assertion and
testing the data to determine its accuracy, completeness and relevance.

Evaluating the reasonableness of any significant assumptions on which the assertion is
based.
A significant number of candidates assumed that it was a case of undisclosed related party
or related party transaction and consequently mentioned wholly irrelevant procedures.
Question 3(b)
It was a straightforward question of non-compliance with Code of Corporate Governance
and needed to be appropriately addressed in the auditors review report on Statement of
Compliance with the Code of Corporate Governance. However, majority of the students
seemed to lack clarity and made the following types of errors:

Many candidates were of the view that it was not necessary for the audit committee to
review interim financial statements before their issuance whereas many others
accepted the management’s plea regarding audit committee members being out of
country.
Page 2 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2014

A significant number of candidates suggested that the matter should be reported in the
management letter.

Some candidates identified it as an issue of non-compliance but did not specify what
action the auditor was required to take.

Majority of those candidates who identified correctly that the review report may be
modified but did not discuss the two possibilities i.e. where the management discloses
the factual position in the Statement of Compliance and where it fails to do so.
Question 4
In this question the candidates were required to describe the steps which the auditor
(responsible for the audit of the consolidated accounts as well as the accounts of
subsidiaries) would take in the following situations.
(a)
The group management has revised its policy and stated the fixed assets on revalued
basis.
(b)
A subsidiary had incurred losses and deferred tax was recognized on such losses.
Question 4(a)
This was an easy question and generally the students were able to perform well. However,
a number of students restricted themselves to audit steps relating to the use of an expert
only and ignored other important issues like accounting and disclosures.
Question 4(b)
This part was attempted well by most of the students. However, some candidates focused
all their attention on accounting aspects of deferred tax and did not discuss the steps
needed to gather evidence that the recognition criteria for booking of deferred tax had
been met.
Question 5(a)
According to the situation given in this question, an audit firm had been approached to
provide certification of compliance with a specific control framework with regard to the
production process. The candidates were required to specify the different forms of reports
that the auditor may issue in this case and the key characteristics of these reports.
This question required good conceptual understanding of the various types of assurance
engagements but unfortunately this was lacking. A number of candidates did not attempt
this question. A significant number of candidates mentioned report under Agreed Upon
Procedures whereas few students mentioned report under Assurance Engagement. Only a
limited number of students could correctly identify that both types of reports were
possible. Moreover, only few could specify that in case of assurance engagement, the
auditor may either issue a Reasonable Assurance Report or a Limited Assurance Report.
Question 5(b)
Most of the candidates mentioned about reasonable assurance report or limited assurance
report whereas the correct answer was assertion based engagement.
Page 3 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2014
Question 6
This was an easy question in which the candidates were asked to identify key controls
relating to receipts and payments under the given scenario pertaining to a charity based
organization. Majority of the students were able to secure passing marks. However, very
few could take full advantage of this easy question because they stated general control
measures with hardly any emphasis on specific areas like donations, fee income and petty
cash.
Question 7
This was a scenario based question in which the candidates were required to comment on
the risk assessment carried out by an audit manager. This was a practical question and the
overall response was very poor as discussed below:
(i)
The risk factor identified in the question was “Decentralised operating structure
supported by different IT applications”. Almost 50% of the candidates agreed
with the view that it was an inherent risk which was incorrect. Only 25% of the
candidates could identify correctly that it was a significant risk whereas most of
the remaining students did not discuss this aspect. The comments as regards
assertions were reasonable, however some students tried to include all assertions
that they could think of. Such an approach had a negative impact on their
performance evaluation.
(ii)
The risk factor identified in the question was “Financial Crisis”. Generally, the
students agreed with the classification given in the question i.e. significant risk
but the majority did not provide any justification thereof. Comments on the
assertions specified in the question were relatively better as quite a few students
were able to distinguish between the relevant and the irrelevant assertions in the
given situation.
Question 8
Two situations were given in the question and the candidates were required to discuss how
the auditor should deal with the given situations.
Question 8(a)
According to the scenario presented in this part of the question, the auditor became aware
of a litigation which was neither disclosed by the management nor mentioned by the legal
advisor of the company. On inquiry, management informed that since an out-of-court
settlement was being negotiated with the concerned party, it was not included in the list of
cases.
Most of the candidates did not structure their answers well and wrote whatever steps they
could think of. In the process, they scored few marks by mentioning some of the
elementary procedures such as specific inquiry to legal advisor, review of correspondence
with the litigant competitor, representation letter from management, discussion with those
charged with governance, etc.
Page 4 of 5
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2014
However, most of them failed to mention how they would address the most important
issues i.e. whether the management’s omission to disclose this case was a deliberate act
aimed at concealment of facts or it was just an omission. Those who addressed this issue
before going on to list the other procedures, were able to formulate better answers and
cover most of the steps and secured much higher or even full marks.
Question 8(b)
According to the given scenario, the stock of a company was placed in a warehouse
owned by a third party against whom the FIA had initiated an enquiry for evading import
duties and taxes.
An average performance was witnessed as majority of the candidates could specify some
of the correct steps but very few could give a completely correct answer. Some of the
issues in the answer were as follows:

Most of the students suggested physical verification of stock held with the third party
but did not specify the need to reconcile the physical quantities with the year-end
quantities.

Only few students could specify the need for the auditor to get a latest update on the
situation.

Many students suggested third party confirmation without realizing that a
confirmation could not be considered as appropriate audit evidence in the given
situation and also the fact that the same had already been obtained.
(THE END)
Page 5 of 5
Final Examination
The Institute of
Chartered Accountants
of Pakistan
Module F
3 December 2014
3 hours – 100 marks
Additional reading time – 15 minutes
Advanced Auditing
Q.1
ABC and Company, Chartered Accountants, have been appointed as the auditor of Neptune
Limited (NL). During the audit it has been revealed that:
(a)
(b)
The previous auditor’s working papers are available; however, they are not of required
standards.
NL’s operation involves significant and frequent transactions with related parties.
(08)
(09)
Required:
Discuss the overall audit approach and related audit procedures to address the above issues.
Also state the possible implications on the audit report.
Q.2
You are the engagement partner on the audit of Mars Limited, for the year ended
30 September 2014.
On commencement of the review of working paper file, the audit manager has informed you
that the audit report would need modification. The following draft modification is available
in the file:
“We draw attention to note 10 to the financial statements that fully explains that
amount of Rs. 70 million due from Utopia Limited (UL), that is outstanding since
September 2013, is not recoverable as UL is in the process of winding up from
20 December 2013. Therefore, the said amount has been fully provided for in the
financial statements of the current year due to which the company has incurred
loss during the year. As the revenue from UL amounts to 40% of total revenue of
2013, we are of the view that it is fundamental to users’ understanding of the
financial statements. Our opinion is not qualified in respect of this matter.
The financial statements for the year ended 30 September 2013 were audited by
another auditor who expressed an unmodified opinion on those statements on 25
December 2013.”
The draft financial statements show a loss of Rs. 92.4 million (2013: Profit of Rs. 16.4
million) and total assets of Rs. 395 million (2013: Rs. 410 million).
Required:
(a) Evaluate all the facts from the information available above and state the actions the
auditor needs to take on the basis of evaluation.
(b) Making necessary assumptions on the basis of the above information, draft an
appropriate modification on any one matter, to be included in the audit report.
Q.3
(12)
(05)
Your firm has been appointed as an advisor to Jupiter Limited (JL) an unlisted public
company, which is an assurance client of your firm. JL wants to dispose of its shares in
Pluto Limited, to a foreign buyer. As part of the assignment, your firm is required to act as
an intermediary between the foreign buyer and JL, negotiate the payment terms, receive
payments on behalf of JL and ultimately make disbursement to JL after the transfer of
shares.
Required:
Identify the nature of threat(s) involved and explain how you would meet your professional
obligations and responsibilities while carrying out the above assignment.
(10)
Advanced Auditing
Q.4
Page 2 of 3
You are the auditor of Reliable Generators Limited (RGL) for the year ended 30 September
2014. RGL is primarily engaged in the business of manufacturing and sale of generators.
The generators are supplied all over the country through a network of distributors.
On receipt of order from a distributor, the order is recorded electronically and transmitted to
the factory. 100% payment is received in advance. Following are the extracts from draft
financial statements provided by the client:
Income statement for the year ended 30 September
Revenue
Purchases
Gross profit
2014 (Draft)
2013 (Audited)
------------ Rs. in ‘000’ -----------60,222
59,638
42,676
40,848
21,249
19,681
Statement of financial position as at 30 September
Trade payables
Provision for warranty claims
2014 (Draft)
2013 (Audited)
------------ Rs. in ‘000’ -----------1,653
1,895
1,265
1,193
Other related information is as follows:
(i)
(ii)
(iii)
(iv)
Effective 01 October 2013, in order to match its competitors, RGL has increased the
warranty period from 3 to 5 years.
A discount of 20% was offered to address the issue of reduced demand witnessed in
the 3rd quarter. As a result of the discount, the situation improved significantly, during
the 4th quarter.
In August 2014, serious defects were discovered in one of the major components.
Consequently, significant quantity of such components was returned to the supplier.
However, the return was recorded in September 2014 on receipt of supplier’s credit
note.
Scanning of the suppliers’ ledger accounts revealed various payments for which no
satisfactory reply was given by the management. However, said amounts were
recovered before the year end.
Required:
Identify and evaluate the audit risks in the above situation and how would you respond to
these risks.
(Note: Routine verification steps may not be mentioned)
Q.5
(a)
(b)
(15)
An audit client has approached your firm for advice on various issues concerning a
financing arrangement. The client has provided you information regarding terms of
financing offered by three different financial institutions including draft agreements
which the client may be required to sign.
Required:
Identify threats involved in the above case and also suggest related safeguards, if any.
(06)
Assuming that two of the above financial institutions are audit clients of your firm,
explain whether such situation would result in a conflict of interest, under the Code of
Ethics for Chartered Accountants.
(04)
Advanced Auditing
Q.6
Page 3 of 3
You are involved in the audit of Modern Furniture Limited (MFL), for the year ended
30 September 2014. The client has provided you a draft profit and loss account which is as
follows:
Sales
Cost of sales
Gross profit
Operating expenses
Profit before taxation and financial charge
Financial charge
Profit before taxation
Taxation
Profit after taxation
30-Sep-2014
30-Sep-2013
-------- Rs. in million -------223.14
196.54
(151.74)
(147.40)
71.40
49.14
(43.78)
(31.52)
27.62
17.62
(3.82)
(3.04)
23.80
14.58
(6.80)
(4.96)
17.00
9.62
Certain other information obtained from the management is given below:
(i)
MFL mainly sells its products through its own retail outlets and franchises. During the
period under review, MFL had established five new retail outlets in different cities.
(ii) After a lapse of 18 months, MFL had increased the price of its products by 12%
effective 1 April 2014.
(iii) The raw material prices increased by 5% in October 2013.
(iv) Effect of annual increment in salaries was 8%.
(v) Salaries of non-manufacturing employees have increased from Rs. 22 million to
Rs. 28.2 million. There were 120 such employees on the payroll on 30 September
2014. 15 new employees were hired for new retail outlets whereas one employee
retired during the year.
Required:
Evaluate the above financial data in the context of information provided by the management
and specify the matters requiring further explanations from the management.
Q.7
(10)
The following situations have arisen at different audit clients of your firm. The year end in
each case is 30 September 2014.
(a)
(b)
(c)
Galaxy Limited has a policy to carry its building at revalued amounts. In the financial
statements for the year ended 30 September 2014, the revalued amounts were stated
on the basis of valuation report issued by Buildings Valuation Experts (BVE).
However, during the audit it was accidentally discovered that prior to valuation by
BVE, another valuation exercise was carried out, which was done by Accurate Valuers
Enterprise.
(07)
The financial statements of Modern Technologies Limited, a company involved in
manufacturing of customized machinery and parts, reveal that the company has paid
an advisory fee of Rs. 100 million to a non-executive director according to an
agreement approved by the board of directors. The advisory services were rendered in
connection with an agreement with Burewala Tractors Limited, for supply of
customized parts. Total operating expenses amount to Rs. 282 million (2013: Rs. 161
million). The profit before taxation is Rs. 350 million (2013: Loss before taxation of
Rs. 120 million)
(07)
Your firm has issued an audit report on the financial statements of Earth Limited. In
the published annual report which was received along with the notice of annual
general meeting, you noted that certain disclosures that were agreed to be included in
the directors’ report were missing.
(07)
Required:
Discuss the matters which the auditor should consider and the steps that he may need to
take, in each of the above situations.
(THE END)
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014
Ans.1
(a)
In view of the fact that prior year’s working papers are not of required standards, these
cannot be used to verify opening balances. Therefore we should:


Evaluate whether audit procedures designed for the current period provide evidence
relevant to opening balances; or
Perform specific audit procedures to obtain evidence regarding opening balances.
The procedures that can be used by auditor in obtaining audit evidence with respect to
opening balances are:

Accounts receivable/payable: The collection (payment) of opening accounts
receivable (accounts payable) during the current period will provide some audit
evidence of their existence, rights and obligations, completeness and valuation at the
beginning of the period.

Inventories: The current period’s audit procedures on the closing inventory balance
provide little audit evidence regarding inventory on hand at the beginning of the period.
Therefore, additional audit procedures may be necessary, and one or more of the
following may provide sufficient appropriate audit evidence:
— Reconciling the current year closing inventory quantities with the opening
inventory quantities.
— Performing audit procedures on the valuation of the opening inventory items.
— Performing audit procedures on gross profit and cutoff.

Property, plant and equipment, investments and long-term debt: Audit evidence may
be obtained by examining the accounting records and other information underlying the
opening balances.

Other items such as reserves and share capital and movement during the year can be
verified through Form A filed with SECP.
The auditor may also be able to obtain some audit evidence regarding opening balance
through confirmation with third parties, for example, long-term debt and investments.
Implications on Audit Report:
After performing above procedures:
 If the auditor is unable to obtain sufficient appropriate audit evidence regarding the
opening balances, the auditor shall express a qualified opinion or disclaim an opinion
on the financial statements, as appropriate.
 If the auditor concludes that the opening balances contain a misstatement that
materially affects the current period’s financial statements, then the auditor will ask the
management to make appropriate adjustment and in case of disagreement the auditor
shall express a qualified opinion or an adverse opinion as appropriate.
(b)
Significant related party transactions:
(i)
The auditor shall inquire of the management and others within the entity, and
perform other risk assessment procedures considered appropriate, to obtain an
understanding of the controls, if any, that management has established to:

identify, account for, and disclose related party relationships and transactions in
accordance with the applicable financial reporting framework;

authorize and approve significant transactions and arrangements with related
parties; and transactions and arrangements outside the normal course of
business.
Page 1 of 9
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014
(ii)
During the audit, the auditor shall remain alert, when inspecting records or
documents, for arrangements or other information that may indicate the existence of
related party relationships or transactions that management has not previously
identified or disclosed to the auditor.
(iii)
The auditor shall consider the susceptibility of the financial statement to risk material
misstatement due to fraud or error that could result from the entity’s related party
relationships and transactions.
(iv)
The auditor shall obtain the data from the management in respect of:

associated companies

Subsidiaries

list of related parties personnel (as per the definition) in the International
Financial Reporting Standards;
(v)
The auditor shall inspect the following for indications of the existence of related party
relationships or transactions that management has not previously identified or
disclosed to the auditor:

Bank and legal confirmations obtained as part of the auditor’s procedures;

Minutes of meetings of shareholders and those charged with governance; and

Any other records or documents as the auditor considers necessary (e.g. Form
A, Form 29, Register of members, Documents related to compliance with Code
of Corporate Governance etc).
(vi)
The auditor shall inquire of management regarding the following:

The identity of the entity’s related parties, including changes from the prior
period;

The nature of the relationships between the entity and these related parties;

Whether the entity entered into any transactions with these related parties
during the period and, if so, the type and purpose of the transactions.

Ensure that all key management personnel and known related parties are
included there in.
(vii)
The auditor shall review the extent and nature of business transacted with major
customers, suppliers, borrowers and lenders for indications of previously undisclosed
relationships.
(viii) The auditor shall review the significant transactions outside the normal course of
business, paying particular attention to the transaction recognized at or near end of
the reporting period and inquire of management:

the nature of these transactions

whether related parties are involved in these transactions
(ix)
The auditor shall ensure that all related party transactions are disclosed appropriately
in the financial statements as per applicable financial reporting framework.
Implication on Audit Report:
Where the controls over related party transactions are ineffective or non-existent and the
auditor is unable to obtain sufficient appropriate audit evidence about related party
relationships and transactions, the auditor will issue a qualified or disclaimer of opinion as
appropriate.
If the above procedures performed by auditor identifies a material misstatement in the
financial statements, then the auditor will ask the management to make appropriate
adjustment, and in case of disagreement will issue a qualified or adverse opinion as
appropriate.
Page 2 of 9
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014
Ans.2
(a)
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(b)
The inclusion of emphasis matter paragraph in the audit report for explaining the
irrecoverability of amount due from UL is not appropriate.
As the amount is outstanding since last September, it needs to be provided in the
financial statements of September 2013.
The auditor will ask the management to restate the prior period figures in the current
financial statements and make appropriate disclosures thereof.
If the management agrees to restate the figures and make appropriate disclosures in the
financial statements, the auditor report may include an emphasis of matter paragraph
describing the circumstances and referring to the note in the financial statements.
If the management refuses to restate the financial statements or make appropriate
disclosures, the auditor shall express a qualified opinion or an adverse opinion on the
current period financial statements, modified with respect to the corresponding figures
included therein.
Furthermore, UL is a major customer of ML as 40% of its revenue is earned from it, as
the company has incurred a loss of Rs. 22.4 million in the absence of sales to UL. The
appointment of a liquidator at UL is an event which (alone or aggregated with other
events) may cast significant doubt on ML’s ability to continue as going concern.
If the management has not yet performed an assessment of the entity’s ability to
continue as a going concern, requesting management to make its assessment.
Evaluating management’s plans for future actions in relation to its going concern
assessment, whether the outcome is likely to improve the situation and whether
management’s plans are feasible in the circumstances.
If after reviewing management’s plan and performing procedures, it is concluded that
material uncertainty exists as regards the going concern assumption, a note should be
given in financial statements describing the liquidation of UL, which may cast
significant doubt on the company’s ability to continue as a going concern and
management’s plan to deal with the situation and therefore, that it may be unable to
realize its assets and discharge its liabilities in the normal course of business.
The audit report will be modified in the form of inclusion of an emphasis of matter
paragraph which will explain the uncertainty and draw the shareholders’ attention to
the note in the financial statements.
If the management donot agree to disclose a note, a qualified or adverse opinion should
be considered.
It shall also be stated in the audit report that there is a material uncertainty that may cast
significant doubt about the company’s ability to continue as a going concern.
If the financial statements have been prepared on a going concern basis but, in the
auditor’s judgment, management use of going concern assumption is inappropriate, the
auditor shall express an adverse opinion.
If the use of going concern assumption is not appropriate, and the management prepares
the financial statements on alternative basis, the auditor will express an unmodified
opinion, provided adequate disclosure is made in the financial statements, but may
consider it appropriate or necessary to include an Emphasis of matter paragraph in the
auditor’s report, to draw user’s attention to that alternate basis and the reasons for its
use.
If management is unwilling to make or extend its assessment, a qualified or disclaimer
of opinion may be appropriate, because it may not be possible for the auditor to obtain
sufficient appropriate audit evidence regarding the use of the going concern assumption
in the preparation of financial statements.
As described in note X to the financial statements, the company has recognized the
provision of Rs. 70 million against amount due from Utopia Limited in the current year.
We consider that the said provision should have been recognized in the year 2013. Had a
provision been made of the amount receivable from Utopia Limited, the profit after taxation
of year 2013 would have been reduced by Rs. 70 million and loss after taxation of year 2014
would have been reduced by Rs. 70 million.
Page 3 of 9
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014
In our opinion, except for the effect on the financial statements of the matter referred to in
the preceding paragraph, the financial statements present fairly the financial position of
Mars Limited as at 30 September 2013 and the results of their operation for the year then
ended.
Ans.3
Acting as an intermediary between the prospective buyers and the client, negotiating the payment
terms, making arrangements for securing payments and ultimately making disbursements to the
group of shareholders to a non-audit assurance client, will involve two aspects, i.e.
(i)
Provision of advisory services
(ii) Having custody of JL Assets
(i)
Provision of advisory services
Self review threat and threat to independence would arise if services performed by your firm
affect the subject matter information of assurance engagement performed by your firm.
The significance of threats created should be evaluated and if the threat is other than clearly
insignificant, safeguards should be considered and applied as necessary to reduce it to an
acceptable level, which may include:
 Policies and procedures to prohibit professional staff from making management
decision or assuming management responsibility for such decision.
 Discussing independence issues related to the provision of non assurance services and
nature and extent of fees charged, with those charged with governance, such as audit
committee.
 Policies within the assurance client regarding the oversight responsibility for provision
of non-assurance services by the firm.
 Involving an additional chartered accountant to advice on the potential impact of the
non-assurance engagement on the independence of the member of the assurance team.
 Involving an additional chartered accountant outside of the firm to provide assurance
on a discrete aspect of the assurance engagement.
 Obtaining the assurance client’s acknowledgement of responsibility for the results of the
work performed by the firm.
 Making arrangements so that personnel providing non-assurance services do not
participate in the assurance engagement.
(ii)
Having custody of JL Assets
While taking up the assignment, we should consider whether taking custody of client’s
assets is permitted by law. Even if the law allows, it will still create a self interest threat to
professional behavior and may be a self interest threat to objectivity.
To safeguard against the threats identified, we should,
 keep such money separately from firm assets;
 use such money only for the purpose for which they are intended;
 at all times, be ready to account for the money received, and any income, dividends or
gains generated, to any persons entitled to such accounting;
 comply with all relevant laws and regulations relevant to the holding of and accounting
for such assets.
We should be aware of threats to compliance with the fundamental principles through
association of such assets. For example, money derived from illegal activities. In order to
safeguard against these threats, we should:
 make appropriate inquiries about the source of such assets;
 consider their legal and regulatory obligations.
 seek legal advice.
Page 4 of 9
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014
Ans.4
Audit Risks
(i) Revenue
There is a risk that revenue is overstated
due to:
 Early recognition as customers pays in
full when placing an order.
 The increase in revenue by 1%, is
although immaterial, but requires
attention due low sales between in 3rd
quarter and discount allowed.
 The increase in gross profit margin from
33% to 35% is also surprising in light of
the 20% discount granted on sales
between July and September
(ii) Purchases and trade payables
 There is a risk of understatement as
payables days have fallen from 17 to 14
days and the gross margin has increased
 Fall in payables despite the increase in
purchase is something exceptional.
(iii) Warranty provision
 There is a risk of understatement as the
provision as a percentage of revenue is
the same as the previous year. By the
increase in warranty period, the
provision of 2% is expected to be
increased keeping in view the quality
issues and increased warranty claims.
(iv) Impairment of stock:
 The stock in hand might have been
impaired due to the fact that although
the significant quantity of defected
component is returned to the supplier,
there is a possibility that some defected
parts might have been used in finished
products and some defected parts might
have been remaining in the inventory.
Auditor’s response
 Evaluate and test the system for recording
revenue
 Inspect post year-end payments/credit notes for
significant amounts to ensure whether revenue is
overstated or not.
 Review last minute adjustments and cut-offs
more carefully to ensure that revenue is not
overstated.
 Review overall sales reconciliation for the year
(global) and carry out tests for verification
thereof.
 Evaluate and test the system for recording
suppliers’ invoices and payments to suppliers
 Reconcile payables balances in the purchase
ledger with supplier statements or consider direct
confirmation where supplier statements are not
available
 On sample basis, match the inventory on sample
basis in the store with inventory records in the
accounts departments, any difference found
should be investigated.
 Discuss with the client as regards lower than
expected increase in provision and verify reasons
provided by the client with the related workings.
 Inspect board minutes for an indication of
problems with any of the company’s products
 Compare the warranty provisions with those of
similar companies.
 Discuss with client about the possibility of
defected components being used in the finished
goods, or their presence in the closing inventory.
 If the client reply is affirmative, then ask the
management to make impairment testing and
accordingly adjust the financial statements.
Page 5 of 9
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014
(v) Payment to suppliers
 The company’s money might have been  In case the above reflects the indication of Fraud
then consider changing the audit strategy for
used by the employees for their
extensive substantive procedures on all the areas.
personal benefits/purposes or by the
company itself not for the purpose of  Consider having discussion with those next in
hierarchy to the people involved in this act and if
business.
the most senior management is involved then
 This might affect the audit opinion as
consider discussing with those charged with
under the Companies Ordinance, 1984
governance.
we are required to give our opinion that
all business conducted during the year  Consider the implication on the audit opinion.
were in accordance with the objects of
the company.
 The auditor may decide to place less reliance on
(vi) Control Weaknesses:
controls, and undertake more substantive
The recording of purchase return after a
testing.
time lag of 1 month reflects the failure
to reconcile payable balances with
supplier and it may result in excess
payments to suppliers which will result
in financial loss to company or may
cause disputes with suppliers.
Ans.5
(a)
Threats:
The firm should ensure that while giving advice to the audit client, it does not commit the
client to the terms of the transaction or consummate transaction on behalf of a client.
If the advice to the client involves any of the above acts, then the firm should not accept
such an engagement, because accepting such an engagement would create a threat to
independence that are so significant that no safeguard could reduce the threat to an
acceptable level.
After considering the above, if the assignment relating to the advice on the financing
arrangement is accepted then it would still create threats to advocacy and self review threat.
Safeguards that should be considered include:

Policies and procedures to prohibit individuals assisting the assurance client from
making managerial decision on behalf of the client;

Using professionals who are not members of the assurance team to provide the service;
and
(b)
If the audit client intends to enter into financing arrangement with the financial institutions
which are also your audit clients, this will not create any conflict of interest as obtaining
loan from bank does not produce any apparent conflict of interest between the client and the
bank.
A conflict of interest might exist between two financial institutions, which are providing the
finance, but as your firm is not providing the said service to these institutions, hence no
threat will be created and this assignment can be accepted. However the confidentiality
requirements and relevant safeguards should be considered while carrying out the said
assignment.
Page 6 of 9
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014
Ans.6
Analysis of the information:
Sales:
As sales prices are increased by 12% w.e.f 01 April, 2014, hence the prices are increased effectively
by 6%. Taking the effect of 6% increment on last period sale will give an increased sale of Rs.
208.33 million, giving a difference of Rs. 14.81 million which can be attributed to the increase in
quantity.
The said difference of 7.11% (223.14÷208.33) represents the increase in quantities sold. The client
should be asked to provide major reasons for such increase.
Cost of sales:
Increase in quantities sold by 7.11% plus 5% increase in prices of raw material means that cost of
goods sold should have been increased by approximately 12.11%. However, the actual increase is
only 3%.
The above variation in cost of sales needs to be investigated further, i.e. why the cost of sales has
not increased in line with the increase in quantity and increase in raw material prices.
Operating expenses:
Increase in operating expenses is Rs. 12.26 million. If the effect of increase in salary i.e. Rs. 6.2
million is excluded, remaining expenses have increased by Rs. 6.06 million i.e. 63.66%, which is
quite significant. Reasons for such a significant increase should be obtained.
Increase in salary expenses of non manufacturing employees:
Since number of staff is increased by 11.67% and increment is 8%, gives the expected increase of
19.67%, whereas salaries have increased by 28% as compared to previous year.
This matter needs to be look into further specifically because new employees are hired in retail
outlets which are usually low salary staff.
Financial charges:
Increase in financial charges by 26% seems reasonable, as the company has opened new branches,
which is supposed to increase the borrowings of the company. Moreover, the amount is not
material.
Taxation:
Current year taxation expense is approximately 28% of profit before taxation as compared to 34%
of profit before taxation of previous year. A reconciliation of this difference may be helpful.
Ans.7
(a)
Galaxy Limited:
 The carrying out of two valuation exercise for buildings raises doubts as to the valuation
assertion of the buildings in the financial statements.
 The auditor should make an inquiry and evaluate the reasons provided by management
for engaging BVE as valuers, when the valuation was already been carried out by AVE.
 If the reason provided by management are not satisfactory, then the auditor is required
to revise his risk assessment and accordingly amend the nature, timing and extent of
audit procedures.
 The auditor should consider the extent of difference between the two valuation reports
and assess the reason thereof.
 If the valuations of both the valuers are different then it also raises doubts as to the
competence, capability and objectivity of the valuers.
 The auditor may also consider the need of appointing an auditor expert.
Page 7 of 9
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014


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
If auditor is not satisfied with differences in both reports, he shall ask the management
to justify the situation in consultation with BVE.
If after considering the clients and BVE’s clarification’s and auditor expert, the auditor
is of the view that financial statements are materially misstated then he will ask the
management to make appropriate adjustment in the financial statements.
In case of management refusal, the auditor will issue a qualified or adverse opinion
depending upon the materiality and pervasiveness of matter.
In case the auditor concludes that management integrity is doubtful, then the auditor
will consider withdrawing from engagement or issuing a disclaimer of opinion.
(b)
Modern Technologies Limited:
 Advisory fees is material to financial statements as it comprises of 35% of operating
expenses and 28% of profit before taxation.
 The auditor will consider the nature of advisory provided and necessity of such advisory
in execution of agreement with Burewala Tractors Limited (BTL).
 The auditor will assess the role that the agreement with BTL has played in the highly
improved performance of the company.
 The auditor will also review the agreement with the non-executive director and assess
its reasonableness.
 The auditor will need to assess whether the amount paid is appropriate considering the
nature and extent of business provided by the director and compare with market value
of such services provided by other professional experts.
 The auditor will also consider any relationship between the non executive director,
MTL and BTL.
 The auditor will also consider the verification of approval and authorization and mode
of payment of such advisory fees.
 If the auditor is satisfied with the payment, he should ensure that it is appropriately
disclosed in accordance with IAS 24 and Companies Ordinance, 1984
 If after considering the above, the auditor is of the view that transaction of advisory fee
lacks substance and proper business consideration, and the auditor concludes that the
matter is material to financial statements, the auditor will issue a qualified opinion.
 In case the auditor concludes that management integrity is doubtful, then the auditor
will consider withdrawing from engagement or issuing a disclaimer of opinion.
(c)
Earth Limited:
 The auditor should communicate with the client and inform them about the omission.
 After discussion with the management the auditor will consider the nature of omission,
whether the omission in director’s report results in:
— material inconsistencies between the financial statements and director’s report;
— material misstatements of facts
 If revision of the other information is necessary and management agrees to make the
revision, the auditor shall review the steps taken by management to ensure that
individuals in receipt of the previously issued financial statements, the auditor’s report
thereon and the other information are informed of the revision.
 If, following such discussions, the auditor still considers that there is an apparent
material misstatement of fact, the auditor shall request management to consult with a
qualified third party, such as the entity’s legal counsel, and the auditor shall consider
the advice received.
 If management refuses to make the revision of such other information either in case of
material inconsistencies or material misstatement of fact and the auditor concludes that
revision is necessary, the auditor shall notify those charged with the governance, but if
all of those charged with governance are involved in managing the entity the auditor
may obtain advice from the auditor’s legal counsel.
Page 8 of 9
Advanced Auditing
Suggested Answers
Final Examination – Winter 2014


If the management does not take corrective action to the satisfaction of the auditor, then
under the Companies Ordinance, 1984, the auditors are entitled to attend the Annual
General Meeting where they should inform the shareholders themselves.
The auditor should also seek other means of communication to inform the issue to
shareholders who could not attend the Annual General Meeting.
(The End)
Page 9 of 9
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination Winter – 2014
General:
Performance was reasonable in relatively straightforward questions from the standards or
the Code of Ethics. However, poor performance was witnessed in Question 4 and 6 which
required analytical skills and understanding of the overall situation at financial statements
level. With at least 3 years of practical auditing experience, such level of performance is a
cause of serious concern.
Question-wise comments:
Question 1(a)
In this question the candidates were required to discuss the overall audit approach, the
audit procedures and the possible implication on the audit report in a situation where the
previous audit was undertaken by another auditor and the audit working papers were not
of the required standard.
Most of the students were able to identify the key issue of verification of opening balances
and discussed the overall audit approach reasonably well. As regards audit procedures,
many students discussed accounts receivable and cash and bank balances only. Other
areas were mostly ignored. Moreover, implications on the audit report were also ignored
by the majority. Further, many students went a step backward and tried to explain the
client acceptance procedures without realizing that according to the given scenario the
audit had already been accepted.
Question 1(b)
The requirement in this part was the same as above but with respect to related party
transactions. The overall performance was good. However, a significant number of
students restricted their answers to procedures that were aimed at verifying the list of
related party transactions provided by the client and did not address the main issue i.e. risk
of unidentified related parties or related party transactions.
Question 2(a)
A draft emphasis of matter paragraph was given in the question which had been prepared
by an audit manager along with certain other information. The candidates were required to
state what actions they would take under the given situation and to redraft an appropriate
modification paragraph.
Page 1 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2014
The performance was below average. Majority of the students were able to raise the issue
of going concern correctly but very few could realize that the provision that was made in
the current year should have been made in the prior year and hence there was a need for
restatement of figures. Consequently, a modification paragraph would only be appropriate
if the client agreed to the restatement; otherwise a qualified report would be required.
Some students who correctly noted the error in previous year’s financial statements could
not recommend the proper approach. Some of them even mentioned that previous year’s
auditors should be asked to give a revised report or report on the corrected financial
statements, which could have been relevant in case of comparative financial statements
approach which was not the case.
Question 2(b)
While drafting the required modification paragraph using necessary assumptions, most
students were aware how to start and end the modification i.e. by using appropriate
reference to the note whilst introducing the issue and ending the same with the opinion.
However, many of them did not explain the reasons for their opinions and the monetary
effect of the same. Some of them drew conclusions which were not in line with their
assumptions. Some students also made entirely unrelated assumptions.
Question 3
This question required the students to identify the threats involved when a chartered
accountant in practice acts as an intermediary between prospective buyers and the client,
negotiating payment terms, securing payments, etc. The students were expected to identify
the two main aspects giving rise to the threats, namely, the provision of advisory services
(that may result in self-review threat and threat to independence), and having custody of
assets (resulting in self-interest threats to professional behavior and objectivity).
There was a mixed response from students with some identifying both aspects and the
related threats and others identifying only one. However, almost all those who identified
the threats correctly were also able to state the professional responsibilities and procedures
required from the auditor.
Some students did not segregate their answers amongst the two issues and tried to provide
a combined answer which resulted in various errors and omissions.
Question 4
Some of the information contained in the financial statements specially those regarding
revenue, purchases, gross profit, trade payables and provision for warranty claims was
provided in the question. On the basis of the given information, the students were asked to
identify and evaluate the audit risks and how the auditor should respond to such risks.
This question was poorly answered and candidates displayed lack of analytical ability. In
most cases, they missed out the fact that the question required them to identify the “risks”
involved rather than just giving comments on the financial information. For example, they
mentioned correctly that increase in gross profit is not in line with the decline in sales and
special discount allowed during the year; but could not assess as to what type of risk it
posed and how it may be addressed. Majority of the students missed an important risk i.e.
the risk of misuse of company’s funds by making payments and showing them as payment
to suppliers and re-depositing them near the year-end.
Page 2 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2014
Further, many among those who were able to identify the risks, failed to mention how
such risks may be addressed. In this regard, a lot of repetition was also observed. Some
students mentioned routine verification steps which were not required.
Question 5(a)
According to the given scenario, the auditor had been asked to provide advice to assist the
client in selecting one of the three financial institutions who had offered credit facilities to
the client. Most of the candidates scored well in this question and correctly identified the
threats, namely self-review and advocacy threats as well as the course of action required.
Question 5(b)
In this part the candidates were required to explain whether conflict of interest would arise
if two of the three financial institutions with whom the matter referred to in (a) above was
being negotiated, were clients of the audit firm. Most of students did not score any marks
as they believed that a conflict of interest did exist. In fact, the conflict existed between
the financial institutions but these were of no relevance as the firm was not providing the
said service to financial institutions. Further, very few students mentioned about
safeguards related to maintenance of confidentiality.
Question 6
In this question, a summarized profit and loss account was given along with comparative
figures and some related information. The candidates were required to assess what further
information and explanations they would require from the client.
The response was however not upto the mark which was quite discouraging because all
the students must have had experience of handling such situations. Most of the responses
were casual and unstructured. Most of the students computed year on year variances but
could not maintain the focus as to how these variances are to be corroborated and what
inference can be drawn in this respect. Still, the areas relating to sales, cost of sales,
operating expenses were better probed but comments in respect of financial charges and
tax charge were quite inadequate. Only few could note that tax expense was only 28% of
profit before tax as compared to 34% in the previous year.
Some of the students passed strong judgments assessing fraud or mis-statements which
should have been avoided as such assessment is only possible after obtaining explanations
from the client.
Question 7
In this question three independence situations were given and the candidates were
required to discuss the matters of importance for the auditors. Comments on each part are
given below:
(a)
According to the given scenario, the auditor came to know that the client had twice
carried out the exercise for revaluation of fixed assets whereas the earlier report
had not been disclosed to the auditor. The requirement of this part was not
appropriately construed by many students as they were more focused on area
relating to use of expert instead of the core issue relating to use of two separate
Page 3 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2014
experts and non-disclosure of this fact to the auditors. Further, in such situations
the auditor may be inclined to appoint his own expert. This aspect was covered by a
few students only.
(b)
According to the given scenario, a company had paid Rs. 100 million to a nonexecutive director whereas the company’s total operating expenses and profit
before tax were only Rs. 282 million and Rs. 350 million respectively. This part
was reasonably attempted by many students as they covered many relevant issues
like materiality of the amount, related party implications, arm’s length
consideration, business rationale, benefit derived and disclosures etc. However,
many of them did not mention that if the advisory services lacked substance then
the auditor should issue a qualified opinion and if integrity of management was
doubtful then the auditor should withdraw or disclaim the report.
(c)
According to this part, the directors’ report in the published financial statement did
not contain certain disclosures which were agreed with the auditor. This was
attempted well as majority of the students discussed both possibilities i.e. where
management agrees to a revision and where it does not agree to the revision.
(THE END)
Page 4 of 4
Final Examinations
The Institute of
Chartered Accountants
of Pakistan
Module F
2 June 2015
3 hours – 100 marks
Additional reading time – 15 minutes
Advanced Auditing
Q.1
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.
(Note: While describing the key audit steps, the answer should be restricted to a maximum of 3
major points in case of each risk)
Q.2
(15)
You are the audit manager of Dreams Limited (DL), a listed company, for the year ended
31 May 2015. DL has significant investments in two securities, which are listed on the Over
the Counter (OTC) market.
While planning the audit procedures, it has been observed that there was a liquidity concern
in the OTC market and therefore no trading has been witnessed in these securities since
26 March 2015. Consequently, DL has finalised the valuation of these securities on the
advice of a company, which specialises in providing pricing services. The company has used
a pricing model which it uses at majority of its clients.
Required:
Explain how the auditor would obtain sufficient and appropriate audit evidence in the above
scenario. (Implications on audit report are not required)
Q.3
(12)
You are the partner incharge of quality control department of Mian and Company,
Chartered Accountants. The following independent matters are under your consideration:
(a)
(b)
(c)
Engagement partner’s brother-in-law has joined as CFO on an audit client.
Your firm has been asked to verify the results of an award competition being
organized by an audit client.
On an unlisted audit client, the audit engagement team prepares financial statements
from the trial balance and proposes adjusting entries.
Required:
Identify and evaluate the threats involved (if any), in each of the above situations and
explain the actions which should be taken as regards the above matters.
(04)
(04)
(04)
Advanced Auditing
Q.4
Page 2 of 3
You are carrying out the audit of Akhtar Autos Limited (AAL) for the year ended
31 March 2015, a listed company, engaged in the business of manufacture of spare parts for
trucks, buses and tractors. Extracts from the draft financial statements are as follows:
Sales
Loss before taxation
2015
2014
---------- Rs. in ‘000 ---------1,250,000
1,440,000
(70,000)
(15,000)
Current assets
Other assets
Total assets
325,000
145,000
470,000
350,000
135,000
485,000
Current liabilities
Other liabilities
Total liabilities
345,000
175,000
520,000
305,000
160,000
465,000
Equity
(50,000)
20,000
Previous year’s audit report was qualified on account of inability to obtain sufficient and
appropriate audit evidence with respect to stores and spares, as ledger of stores and spares
contained many negative balances.
The following further information has been obtained during the audit:
(i)
Agreements with two local distributors contain clauses that offer a significantly higher
percentage of discounts which are above normal market rates. Due to the tough
competition in the local market, the management of the company is currently
negotiating with certain foreign customers for export of company’s products.
(ii) In May 2015, court notices from two major customers were published in the
newspapers, alleging the company of supplying inferior quality spare parts in the
month of April 2015 and claiming damages of Rs. 150 million. The management is of
the view that the allegations are baseless.
(iii) A supplier of the company has become bankrupt. The company owes an amount of
Rs. 138 million to the supplier. However, the liquidator has lodged a claim of
Rs. 140 million.
(iv) AAL is a family owned company. Out of its seven directors, four are executive
directors. The non-executive directors have been elected on the board for the 4th time.
(v) The Board has formed a three member Audit Committee, which is chaired by a
non-executive director, who is also the maternal uncle of the chief executive.
(vi) The half yearly accounts were not finalised because of a legal dispute. The company
had informed SECP in respect of such non-compliance.
(vii) Internal audit department includes only one person who is a chartered accountant and
is engaged on a part time basis.
(viii) The warehouse from where goods are dispatched is under the management of sales
department.
Required:
(a) Specify the procedures to be performed in case of litigation and claims with respect to
matters mentioned above. (Impact on auditor’s report is not required)
(b) What further information/documents would you require from the management in
respect of matters described in (i), (ii) and (iii) above? State the main reason for
acquiring such information/documents.
(c) Discuss the possible implications on audit report with respect to previous year’s
modification.
(d) Suggest appropriate measures to improve compliance with the Code of Corporate
Governance.
(e) Explain the impact of information contained in para (vi) on the reporting
responsibilities of the auditor with respect to Code of Corporate Governance.
(f)
Give suggestions for improvement in the control environment.
(04)
(05)
(05)
(08)
(03)
(04)
Advanced Auditing
Q.5
Page 3 of 3
Your audit firm has been appointed as auditor of Lucrative Industries Limited (LIL) a listed
company for the year ended 31 March 2015. LIL’s financial statements for five years depict
the following:
Sales
Profit before tax
Profit after tax
Total assets
2014
2013
2012
2011
2015 (draft)
--------------------------- Rupees in millions --------------------------1,570
1,276
1,064
980
859
1,159
212
190
165
155
815
130
135
106
110
1,521
1,344
1,270
1,188
1,100
Following further information is available:
Sales revenue-exports
Sales revenue- local supplies
Cost of sales and administrative expenses
Gain on sale of office building
Other provisions / write offs
Other charges
Profit before taxation
Profit after taxation
Intangible assets
2015
2014
Rs. in million
1,057
944
513
332
(1,299)
(1,049)
901
(11)
(13)
(2)
(2)
1,159
212
815
130
350
362
The results for the current year include the impact of following items:
(i)
During the year, an increase in export and local sales was noticed due to new
agreement with foreign customers and supplies made to Government for flood
affected people. Sales to new customers and Government amount to Rs. 105 million
and Rs. 225 million respectively. Mark-up on such sales was 15%.
(ii) Administrative expenses include loss of raw material amounting to Rs. 210 million,
which was destroyed due to fire. Raw material was not insured.
(iii) During the year, the head office of the company was shifted to new premises and the
old building was sold for Rs. 1.2 billion.
Required:
(a) Determine the materiality for the financial statements as a whole and also discuss the
basis/benchmarks adopted by you in this regard.
(b) Enumerate audit procedures to be performed on opening balance of the intangible
assets.
Q.6
(10)
(07)
You are the audit incharge of Domestic Appliances Limited, a listed company, for the year
ended 31 March 2015. The draft financial statements disclose profit before tax of Rs. 1.2
billion (2014: Rs. 0.98 billion) and total assets of Rs. 15.5 billion (2014: Rs. 13.8 billion)
Company’s products are covered under warranty arrangements for twelve months. The
company has changed its policy for recording warranty expense from cash basis to accrual
basis. The company has made provision for warranty claims equal to twelve times the actual
warranty claims of March 2015.
Required:
Analyse the above situation and discuss how you would deal with it in your audit.
Q.7
(07)
Salman Limited (SL), a listed company, is engaged in the manufacturing and sale of Fast
Moving Consumer Goods. SL has approached your firm for conduct of internal audit.
Required:
Write a letter to SL to briefly explain the scope of the proposed internal audit assignment.
(You may assume necessary details)
(THE END)
(08)
Advanced Auditing
Suggested Answers
Final Examination – Summer 2015
Ans.1
(i)

Audit Risks
From listed company’s point of view, 
the appointment of son of the previous
Chief Executive, as a new Chief
Executive is indicative of a closely held
entity, transparency of business might
be in doubts.


(ii)

Sales may be overstated as it has 
suddenly increased during the last 
month of the year
(iii)

(iv)

Deferred tax asset can only be 
recognized to the extent that the
company expects that it would generate
sufficient profits to realize the benefit.
There is a risk that the company might
be recording deferred tax assets to
overstate profits.
Increase in scrap sales may indicate the 
following:
— Abnormal losses and defected
inventory
— Inventory valuation issues
— Scrap sales may be used to
transfer out funds from the
company illegally.
— Impairment in value of plant and
machinery.
(v)

Significant turnover in management
can also result in significant risk. In
case of high rotation the responsibilities
cannot be fixed. There might be some
unethical practices/fraud going on in
the company.
(vi)

Frequently switching suppliers is not
itself a problem, but it does not mean
that a list of approved suppliers cannot
be maintained. If totally new suppliers
really are being used so frequently, then
there might be issues with quality
rather than price.
Audit Steps
These would be ensured specially by
checking that there are no control lapses,
and controls have not been overridden by
CEO in specific instances.
Make inquiries about the changes in
control environment during the current
year and assess the latest situation.
Ensure that legal requirements are
complied
with
respect
to
the
appointment/ remuneration of new
Chief Executive.
Send confirmations to debtors.
Checking recoveries made subsequent to
the year end, analyzing and checking
subsequent sales return, comparing them
with last year and assessing their
reasonableness Checking cut-off
The auditor would be required to review
the management’s future projection
reasonableness of the assumptions used
and perform recalculation.
The auditor would be required to assess
the reasons for increase in scrap sale by
performing the following:
— review the list of Scrap sales to
establish its reasonableness.
— Ensure proper procedure such as
obtaining quotations/ auction has
been followed for scrap sales.
— check segregation of duties in the
processing of sales and dispatch
documents.
— Review the impairment testing done
by the client.
 The auditor would be required to:
— establish the reasons through
inquiry;
— review of exit interview of
ex-employees and;
— specially performing procedures
on the areas where there have
been significant turnover of
employees.
 Consider changing the audit strategy for
extensive substantive procedures on areas
such as:
— Inventory valuation
— Warranty issues
— Sales return subsequent to year
end
Page 1 of 6
Advanced Auditing
Suggested Answers
Final Examination – Summer 2015
Ans.2
The detailed steps needed to be performed in the above situation are as follows:
1.
Gain an understanding of the controls applied by DL for assessing the reliability of the
pricing service’s valuation.
2.
Gain an understanding about pricing service. This includes:

The reputation and experience of the third party and its experience in providing
similar type of valuation.

Auditor’s past experience with the third party (if any).

Objectivity of the pricing service. The objectivity may be impaired if Pricing service
Company has a close relationship with DL or where has a financial or other interest in
such valuation.

The processes and controls established by Pricing Services while conducting such type
of valuations.
3.
Gain an understanding about Pricing Service’s valuation method. It includes:

Evaluating Pricing Service’s controls and processes, valuation techniques, inputs and
assumptions used by Pricing Services.

Testing the controls at DL to assess the reliability of the information provided by
Pricing Service Company.

Test the controls and processes, valuation techniques, inputs and assumptions used by
Pricing Service Company.

Obtain pricing from other sources and/or carry out own calculations of the valuation
and compare it with valuation provided by Pricing Service.
4.
In addition to the above or if the auditor is unable to carry out the above procedures or if
the results thereof do not seem satisfactory, the auditor may consider hiring an expert.
Obtain an understanding of information/ input provided by management of DL to pricing
services and verify its reliability and reasonableness.
5.
Ans.3
6.
In case the auditor is unable to obtain sufficient and appropriate audit evidence, he should
consider the implications thereof on the audit report.
(a)
Partner’s brother in law has joined as CFO:

Partner’s brother in law does not come under the definition of close or immediate
family member.

However, this may be perceived as a close personal relationship in our society and it
would threaten the perceived independence (independence in appearance) of the
engagement partner.

The close relationship between engagement partner & CFO may give rise to self
interest familiarity and intimidation threats.

The appropriate safeguard would be to rotate the partner and do not allow him to
involve in any matter pertaining to that client.

In case no other partner is available then it would be better to withdraw from the
engagement.
(b)
Verify results of award competition

If the award competition materially affects the information/results of financial
statements, self review threat may be created.
Significance of threat need to be evaluated that whether the award competition is
material to the audit client and to what extent affects the figures appearing in the
financial statements.

If the threat is significant then the assignment should be declined.
Page 2 of 6
Advanced Auditing
Suggested Answers
Final Examination – Summer 2015
(c)
The threat involved in this situation is self-review threat.
The following safeguards can be applied to reduce the threat to an acceptable level: it may

Obtaining client approval for any proposed adjustments/ avoid managerial decision
making.

Requiring the underlying assumptions / source data for accounting to be originated
and approved by the audit client.

Having a qualified person, who is not a member of the audit team, take responsibility
for performing the non-audit services

Establishing procedures and policies to guide persons performing such services
Ans.4
(a)
Audit procedures in case of litigation and claims:
 Inquiring the management and, where applicable, others within the entity, including inhouse legal counsel;
 Reviewing minutes of meetings of those charged with governance and correspondence
between the entity and its external legal counsel; and
 Reviewing legal expense accounts.
 Review the legal confirmations to assess whether all liabilities have been appropriately
disclosed.
 If the legal advisor confirms the existence of liability or contingent liability which have
not been disclosed in the financial statements then the auditor will ask the management
to make appropriate adjustment/ disclosure in the financial statements.
(b)
The tough competition faced by the company, negative equity, dispute with customers and
bankruptcy of major supplier clearly depicts that the company is facing going concern
issues.
In order to evaluate the management’s plan for future action in relation to its going concern
assessment, including consideration of mitigating factors, following information/
documents would be required from management:








(c)
Management assessments of entity’s ability to continue as a going concern:
Status of negotiation with the foreign customers.
Reason for offering discounts to suppliers above market rates.
Status of legal proceedings of the allegations levied by the customers.
Availability of alternate suppliers to deal with the unfulfilled orders
Cash flow, profit and other relevant forecast
Latest available interim financial statements
Minutes of shareholders’ meeting and those charged with governance.
If the matter related to previous years modification is still unresolved, the auditor shall
modify the auditor’s opinion on the current period financial statements, and in the basis for
modification paragraph, the auditor shall refer to both the current period’s figures and the
corresponding figures in the description of the matter giving rise to the modification when
the effects or possible effects of the matter on the current period’s figures are material.
If the previous years’ matter is resolved and properly accounted for or disclosed in
accordance with the applicable financial reporting framework, the auditor’s opinion on the
current period need not refer to the previous modification.
If the previous years’ matter is not relevant to the current period figures, it may still be
appropriate for the auditor to qualify the opinion on current period financial statements
because of the effects or possible effects of the unresolved matter on the comparability of
the current and corresponding figures.
Page 3 of 6
Advanced Auditing
Suggested Answers
Final Examination – Summer 2015
(d)
The suggestion for improving compliance with the Code of Corporate Governance would
be as follows:
The board of directors is required to be recomposed on the following guidelines:
The executive directors that is the paid directors of the company shall not be more
than one third of the elected director, presently there are four executive directors
which is more than one third of the elected directors.

The board of director is required to include at least one independent director and
preferably one third of the total members of the board should be independent directors.

Presently there are three non-executive director but they are not independent as they
are on the board for the fourth time.
The audit committee is required to be recomposed by inclusion of:



An independent director from the board of directors.
The chairman of the audit committee should preferably be the independent director,
although the audit committee is presently chaired by a non executive director,

but he is not independent as he is elected for the fourth time on the Board;

further although real uncle does not come under the definition of close relatives,
but it can be perceived as a close personal relationship and proof of
independence would be very difficult.

It is required to be ensured that at least one member of the audit committee has
relevant financial skills/ expertise and experience;
In addition to the audit committee, the Board should form a Human Resource and
Remuneration (HR&R) Committee;
Appointment of a full time Head of Internal Audit. The company can either form an
in house internal audit department by hiring suitably qualified people or can
outsourced to a professional services firm but it should be ensured that they are
suitably qualified and experience people and are conversant with the company’s
policies and procedures.


(e)



(f)
As per the requirements of Code of Corporate Governance, the 2nd quarter accounts
are to be placed for review by audit committee and are to be approved by the board
of directors.
If the matter is appropriately disclosed in the Statement of Compliance with the
requirements of Code of Corporate Governance the auditor will highlight this noncompliance in the review report drawing attention to the note where the matter has
been appropriately disclosed by the management.
If the management has not disclosed this matter in the Statement of Compliance or
the disclosure is not factually accurate, the auditor will need to qualify his report on
the Statement of Compliance with the Code of Corporate Governance.
Apart from suggestions given in part (d), the other suggestions for improvement in control
environment are as follows:





The warehouse should not be under supervision of sales department;
The management of the company should be independent of those charged with
governance and there should be minimum interference of those charged with
governance in the management of the company.
The internal audit department or some other department independent of sales should
be assign the responsibility for ascertaining discount of distributors before any
payment / credit is processed;
Historical trend analysis of sales made to distributor should be done in order to assess
if any unethical practice is being going on in the company.
Appointment of qualified personnel in internal audit department.
Page 4 of 6
Advanced Auditing
Suggested Answers
Final Examination – Summer 2015
Ans.5
(a)
Profit before taxation
Less: Sales to Government department
Add: Cost of sale to Government department
Add: Loss due to raw material destroyed
Less: Gain on sale of building
Planning materiality (439×5%)
Discussion
reference
N-1
Rs. in million
N-2
1,159
(225)
196
210
(901)
439
N-3
21.95
Discussion on the benchmark adopted in above calculation:
N-1: Profit before tax often forms the basis for calculating planning materiality unless it is
significantly volatile.
N-2: Circumstances that give rise to an exceptional decrease or increase in such profits
may lead the auditor to conclude that materiality for the financial statement as a
whole is more appropriately determined using a normalized profit before tax from
continuing operations figure based on past results, therefore following items are
excluded to arrived at normalized profit:
— sales to Govt. department is excluded;
— Loss due to raw material destroyed; and
— Gain on sale building
Further, increase in sale due to new agreement is part of normal operations therefore
it is not excluded.
N-3: Determining a percentage to be applied to a chosen benchmark involves the exercise
of professional judgment, as ISA 320, suggests the rate of 5% of profit before tax
therefore it is used.
(b)
Intangible Assets
Procedures to consider when auditing intangible assets at the beginning of the period
include:

obtain schedule of intangible assets summarizing the amounts of (and the nature of
changes in) the assets and related amortization for a reasonable period.

determine the basis on which the additions to and reductions in intangible assets have
been recorded by tracing them to the underlying documents.

identify major items and check them with related supports and verify the dates on
which these were recorded.

Review the predecessor auditor’s working papers.

check accumulated amortization to ensure that amortization has been provided over
the years as per company’s policy.

check whether any impairment testing was performed last year, and if the answer is in
the affirmative, then check the basis/ assumptions and the calculations and evaluate
the competency and capacity of the valuer.

review the write offs and impairment recorded in the current year to ensure that these
do not reflect situation created in previous year.
Page 5 of 6
Advanced Auditing
Suggested Answers
Final Examination – Summer 2015
Ans.6
Warranty claims:
(i)
As the company has been historically recording its warranty claims on cash basis, a
restatement under IAS 8 is required, if material.
(ii)
The auditor should obtain an understanding of the entity’s assumptions on which the
estimate is based.
(iii) If the basis is considered inappropriate, the auditor should make a revised estimate either
on his own or by using expert opinion. The revised estimate should be based on:

Industry practice and trend of warranty claims

company’s terms of warranties
(iv) Own estimate prepared on the above assumptions will be compared with management’s
estimate. If the difference is material, the management will be asked to explain.
(v)
Subsequent sales return upto the date of authorization will also provide an evidence about
the reasonableness or otherwise of the management’s estimate.
Ans.7
The Chief Executive Officer
Salman Limited
Date: 2 June 2015
RE: SCOPE OF INTERNAL AUDIT ASSIGNEMENT
Dear Sir,
Based on the discussion and the understanding derived therefrom, we understand that we are
required to conduct a comprehensive internal audit assignment.
Therefore, the scope of our work would be as under:
SCOPE OF INTERNAL AUDIT ASSIGNMENT:










Developing understanding of risk associated with audit areas and the related controls.
Controls evaluation, controls testing, potential substantive testing and the formulation of
findings in all areas.
Comparison of policies and procedures adopted by the Company with the best practices and
procedures based on our study for improvement in the existing procedural framework.
Redesigning of procedures in consultation with management, to achieve the desired
objective, in case if the specific test / procedure fails to address a desired objective.
Issuance of a detailed report presenting our schedule of findings / observations and
recommendations for improvements thereof.
Seeking comments from the management and issuing formal reports.
Investigate cases of misappropriation, misconduct, fraud.
Keep audit committee and Board fully informed on a timely basis of the activities of the
Internal Auditing Department.
Communicating with the external auditors to the extent required by the management.
Review and monitor corrective actions to be taken by the management.
We hope that the above information will suffice your need with respect to scope of our internal
audit assignment.
ABC & Company
Chartered Accountants
(The End)
Page 6 of 6
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination Summer 2015
General
The performance in this attempt was much below the previous many attempts. The
foremost reason for such below average performance was the student’s inability to
perform well in questions which pertained to those areas which are not tested frequently
i.e. question numbers 2, 5(a) and 7. This was a clear indication of selective study which
should be avoided, in order to be successful.
Question-wise comments
Question 1
This question was designed to test the students’ ability to identify relevant audit risks
under the given situation and explain appropriate audit procedures there against. The
overall response was average. Generally the students were able to specify some of the
risks but very few could provide complete answers. Some of the specific observations are
mentioned below:

A large number of students could not correctly assess the situation whereby the son of
previous chief executive was appointed as the new chief executive. Most of them
talked about qualification and possible lack of competency. Impact of the change on
control environment of the company was rarely mentioned.

With regard to non-existence of the list of approved suppliers, many candidates
stressed upon the pricing issues instead of discussing the issues pertaining to quality
such as valuation of inventory, warranty issues, subsequent returns etc.

With regard to increase in scrap sales, majority of the candidates discussed the
revenue side and totally ignored issues such as possibility of abnormal losses/defects,
inventory valuation and possibility of illegal transfer of company’s assets etc.
Question 2
It was a relatively straightforward question from International Auditing Practice NotesIAPN 1000 Special Consideration in Auditing Financial Instruments. The overall
response on this question was not up to the standard of final level students despite that it
was an open book examination.
It was noted that majority of the students restricted their answers to discussion on
competency and resources of the company which provided pricing services. Procedures
relating to understanding the valuation method used by the pricing service, controls
applied by the client for assessing the reliability of the pricing service’s valuation,
verification of information/data provided by the client to the pricing services company,
etc. were not mentioned in most of the cases.
Page 1 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2015
Question 3
This question required the candidates to give their views on three outlined situations in the
light of the principle of independence applicable to an auditor. Comments on each of the
three parts are provided below:
(a)
Majority of the students rightly identified the threats involved and actions that
should be taken. However, a large number of students could not explain that
partner’s brother in law does not come under the definition of close or immediate
family member, although, this may be perceived as a close personal relationship in
our society and accordingly it would threaten the perceived independence of the
engagement partner.
(b)
Majority of the students either did not attempt this part or mentioned that there is
no threat in accepting this assignment. Very few of them were able to discuss the
possibility of impact on the financial statements.
(c)
The response of this situation was good and most of the candidates were able to
identify the self-review threat and the relevant safeguards. However, some
students wasted time in explaining the threats instead of stating the relevant
safeguards.
Question 4
This was a scenario based question. It had multiple parts and covered a broad range of
issues. The information provided also included a summarized income statement. Most of
the students performed well in certain parts but the question as a whole was not answered
well. Certain common shortcomings are listed below:
(a) A large number of candidates missed the point that if the legal advisor confirms
existence of liability or contingent liability then the same needs to be appropriately
adjusted or disclosed as the case may be. Many candidates also missed simple steps
such as review of minutes of those charged with governance, reviewing legal
expense accounts etc.
(b) This part was poorly responded. A large number of students could not identify that
the tough competition faced by the company, negative equity, dispute with customers
and bankruptcy of major supplier clearly depict that the company is facing going
concern issues and accordingly, certain information/documents would be required
from the management such as assessment of entity’s ability to continue as a going
concern, possibility of alternate suppliers, cash flow forecast, latest available
financial statements etc.
(c)
In this part, the candidates were required to discuss the possible implications on
current year’s audit report with respect to issues which formed the basis of
qualification in previous year’s audit report. The performance was good as most of
the candidates were able to identify the possible implications on the audit report in
case the matter was resolved and also in case the matter remained unresolved.
However, very few students could clarify that even if issues related to previous year
are not relevant with regard to current period, the auditor may still have to qualify
the report because of the effect of the unresolved issues on the comparability of
current and corresponding figures.
Page 2 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2015
(d)
Candidates were required to suggest appropriate measures to ensure compliance
with the Code of Corporate Governance in the given scenario. The performance was
average in this part as generally the students were able to secure passing marks but
very few could score high marks as comprehensive knowledge was found lacking.
(e)
In this part, the candidates were required to comment on the auditors reporting
responsibilities related to Code of Corporate Governance. Most of the students were
able to identify that the non-finalization of half yearly accounts has resulted in noncompliance of the Code of Corporate Governance. However, while discussing the
possible implication on review report, most candidates could not distinguish
between situations where the non-compliance is disclosed by the management in the
statement of compliance with Code of Corporate Governance and where it is not
disclosed.
(f)
Candidates were required to give suggestions for improvement in the control
environment in the given scenario. Most of the students wasted time on writing
general components of internal control and control environment and failed to
identify the improvements specific to the given scenario such as segregation of
duties, greater role of internal audit department, independence of management visà-vis those charged with governance, etc.
Question 5(a)
This question was quite simple in which candidates were required to determine the
materiality for the financial statements as a whole and also discuss the basis/benchmarks
adopted, as has been discussed in ISA 320.
The overall performance was poor. Most of the students did not recommend any particular
benchmark and wasted time in calculating the materiality on all available benchmarks i.e.
sales, total assets, profit before tax and after tax. Further, many students adopted different
benchmarks separately for profit and loss account and balance sheet.
It was expected from the students of final level that they would be able to critically review
the scenario and find out the best relevant benchmark and mention the basis of conclusion.
Profit before taxation often forms the basis for calculating materiality unless it is
significantly volatile. A large number of students used the benchmark but very few of
them could explain this aspect. Further, only few students could appropriately deal with
the issue of exceptional items.
Further, determining a percentage to be applied to a chosen benchmark involves the
exercise of professional judgment. Majority of the students applied inappropriate rate
without taking into consideration the recommendations as per the above stated ISA.
Question 5(b)
This part was also not attempted well and most of the candidates wasted time in writing
general procedures relating to verification of opening balances instead of identifying the
specific procedures for verification of opening balance of intangible assets.
Page 3 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2015
Question 6
This was a simple question in respect of verification of provision for warranty claims. The
overall performance was average as the students wrote many correct steps but generally
missed the following points:

The policy during the previous year to recognize the warranty expense on cash basis
was not appropriate and hence a re-statement of last year’s figures was required.

If the management’s basis of making the estimate was considered inappropriate, the
auditor should make a revised estimate, either on his own or by using an expert.
Question 7
In this question, the candidates were required to explain the scope of the proposed internal
audit assignment and were allowed to assume necessary details. Most of the candidates
failed to appropriately explain the scope of internal audit which may include developing
understanding of risks associated with various audit areas and the related controls, control
evaluation, control testing, comparison of policies and procedures, reporting and seeking
comments, communication with audit committee and external auditor, etc. Instead, they
wasted time in copying the general points from Application and Explanatory Material
given in ISA-610 ‘Using The Work Of Internal Auditor’ whereas many students stated the
contents of Agreed upon procedures’ report.
Many candidates tried to convert engagement letter of external audit to that of internal
audit without appreciating that their scope and objectives are significantly different.
(THE END)
Page 4 of 4
Final Examinations
Module F
8 December 2015
3 hours – 100 marks
Additional reading time – 15 minutes
The Institute of
Chartered Accountants
of Pakistan
Advanced Auditing
Q.1
You are the audit manager of Diversified Products Limited (DPL), a listed company.
Following are the extracts from the draft financial statements for the year ended
30 September 2015.
Sales
Cost of sales
Total assets
Net equity
Creditors *
Debtors *
Deferred tax asset
Rs. in billion
95.0
62.0
150.0
15.0
10.4
10.5
1.2
*Debtors and creditors have normal credit terms of 40 days
The company is engaged in polyester, pharmaceutical and fertilizer businesses. Performance
of each segment is discussed below:
(i)
Polyester Business (PB)
Major source of revenue is the export of polyester to European countries. PB has
been incurring losses since last five years. In 2014-15, PB incurred a loss of Rs. 600
million. During the pervious year, DPL had made a provision of Rs. 3.5 billion for
impairment of existing plant.
The major reason for the losses is the non-availability of gas. Accordingly, DPL had
started a project to convert its plant from gas to coal. The original completion date of
the project was 31 January 2015 but it has been extended by two years due to delay in
financing arrangements. A cost of Rs. 1.5 billion has been incurred on the project up
to 30 September 2015.
(ii)
Pharmaceutical Segment
The major source of revenue is the sale of medicines imported from Xanax
International Plc (XIP). Segment profit for 2014-15 amounted to Rs. 200 million.
DPL is currently negotiating with various suppliers to replace XIP because during the
past few years XIP has significantly increased the prices and has expressed its
intention to increase it further at the time of renewal of the contract, which is due in
March 2016.
(iii)
Fertilizer Business
The main source of income is the supply of fertilizers and pesticides. Segment profit
for 2014-15 amounted to Rs. 700 million. Due to major floods in August 2015, the
Government has requested the fertilizer manufacturers to reduce their prices to
support the farmers in the flood affected areas and as an incentive, it has guaranteed
the regular supply of gas for the fertilizer factory.
Required:
Discuss the audit risks based on the above situation.
(12)
Advanced Auditing
Q.2
(a)
Your firm has received a Request for Proposal from a regulator to investigate the
affairs of Ghalib Limited (GL), a listed company. The investigation has been initiated
on complaint of fraud from a shareholder. The annual reports of the company contain
the following information:
Sales
Cost of sales
Gross profit
Selling and administration expenses
Profit/(loss) before tax
2015
2014
2013
------------- Rs. in ‘000 ------------923,215
875,471
863,215
(757,388)
(608,950)
(533,476)
165,827
266,521
329,739
(585,194)
(436,582)
(242,455)
(419,367)
(170,061)
87,284
80% of raw material is purchased from a related party.
The audit reports of 2014 and 2015 contain emphasis of matter paragraphs
discussing the going concern issues.
The Board consists of 5 members from the parent company and 2 executive
directors, excluding the chief executive officer.
The Company Secretary (CS) and Internal Auditor (IA) resigned in
March 2015.
The replacements of CS and IA were appointed in August 2015 and approved
by the CEO and the Board of Directors respectively.
Required:
Prepare paragraph(s) for inclusion in the proposal, describing the scope of work.
(b)
(07)
Continuing with the above situation, assume that you have been appointed to
investigate the affairs of GL and the following further information has come to your
knowledge during the field work:
The advisory department of the audit firm assisted the company in the
preparation of three year forecast supporting the going concern assumption. The
budget envisages financial support from the parent company which was
unanimously approved by the Board of Directors.
The responsibilities of the CS and the IA were assigned to the staff deputed by
the audit firm on secondment, till the appointment of their replacements.
Both appointments were made on the recommendation of the auditors.
Required:
(i)
Describe the key governance issues that you would like to report to the
regulator.
(ii) Identify matters that should be considered in evaluating the role of auditors in
the above situation.
Q.3
Page 2 of 3
(04)
(05)
You are the manager in Quality and Risk Management department in a firm of Chartered
Accountants. A partner of the firm has informed you about the following:
(a)
Audit of Nadir Limited (NL), a non-listed company, is in the finalization stage as
almost 85% of the field work has been completed. NL has acquired 51% holding in
Hamid Limited (HL), a listed company, few days ago. A partner of the firm holds
500,000 shares valuing Rs. 20 million in HL. The partner has agreed to sell the shares;
however it would take some time as the shares of HL are not actively traded.
(08)
(b)
An audit manager of the firm has effectively negotiated a non-assurance assignment
with an audit client. Such deals are usually considered in the annual appraisal of the
managers.
(06)
(c)
Zaheer Limited has approached your firm for transaction advisory services related to
acquisition of Javed Limited, which is your audit client.
(07)
Required:
Give your views on each of the above situations with regard to Code of Ethics.
Advanced Auditing
Q.4
(a)
Page 3 of 3
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.
(09)
(b)
Assume that after performing the audit procedures, the auditor is not satisfied with the
valuation and has finally decided to modify the audit report.
Required:
Draft an appropriate basis of modification paragraph in the above situation, for
inclusion in the audit report. (Assume necessary details)
(06)
Q.5
(a)
The following situations have arisen at different audit clients of your firm. The
year-end in each case is 30 September 2015.
(i)
40% of client’s operations are in a foreign country which has been impacted
severely by political and law and order situation since March 2015.
(ii) Certain management functions of the audit client had been outsourced. Most of
the outsourced functions are performed at the service organisations’ premises.
(iii) A client obtained confirmation of balance through email. The email contains a
Word file attachment which lists the inter-company balance as well as certain
other information. The client has forwarded the email to the audit team.
(05)
(07)
(03)
Required:
Evaluate the above situations and briefly explain the steps that the auditor would be
required to carry out in each of the above situations. (Impact on audit report is not
required)
(b)
Your firm is the auditor of Daud Limited (DL), a listed company, since last four
years. DL is a low risk client with a very cooperative management. At year-end you
have noticed significant increase in the number of journal entries. The management
has given various reasons for the same which appear to be reasonable.
Required:
(i) Identify the characteristics of entries which involve fraudulent adjustments.
(ii) Discuss how would you deal with the above situation.
Q.6
(08)
(05)
You are the audit manager of a listed company having seven subsidiaries. Three of them are
audited by other audit firms.
Required:
State the key matters / instructions which you would communicate to the component
auditors.
(08)
(THE END)
Advanced Auditing
Suggested Answers
Final Examination – Winter 2015
Ans.1
(i)
Fraud Risk Factors:
(a) Risk of fraud in revenue recognition:
There is a risk of overstatement of revenue as the management may be inclined to show
better results or because it is seeking financing for its Polyester Business.
(b) Management override of control:
Management is in a position to perpetrate fraud because of its ability to manipulate
accounting records and prepare fraudulent financial statements by overriding controls
that otherwise appear to be operating effectively.
(ii)
Going concern:
The company might face going concern issues due to following reasons:
 The overall profit is only Rs. 300 million with a gross profit margin of around 35%.
Even a marginal decline in profit margin could bring significant losses.
 Profits would be under pressure in the coming years because of the following:
Impact of floods, as the Gas supply in fertilizer business is subject to lowering of
prices.
Lower margins in pharmaceutical segment, which are not expected to improve as
XIP intends to increase the prices further.
Company is already a highly leveraged company, obtaining more financing for new
plant will also have a negative impact on profitability of the company.
Due to Flood, the fertilizer business of the company can be affected and situation
may not improved as the supplies may be affected in coming period.
Delay in Obtaining funding for conversion of plant from gas to coal may deteriorate
the situation.
 Creditors turnover days are 61 as against the normal credit term of 40 days which
depicts that payment capacity of the company has weakened.
(iii)
Impairment of plant and machinery:
Because of the delay in completion of coal to gas commission project, the company may
continue to incur losses. However, the value of the capital work in progress as well as the
existing plant and machinery relating to polyester business may have been impaired.
Although impairment was also recorded in 2014, however, since the completion of plant
has been delayed again by two years further impairment is possible.
(iv)
Provision against value of stock:
Reduction in price of fertilizers as requested by the Government may adversely affect the
prices of company’s products and company may be required to book a provision against
impairment of stock.
(v)
Deferred tax assets:
Deferred tax asset can only be recognized to the extent that the company expects that it
would generate sufficient profits to realize the benefit. In the current scenario it seems
difficult for the company to generate sufficient taxable profits in the near future to realize
the deferred tax assets.
(vi)
Foreign Currency Risk:
As the company is engaged in export of polesyter and import of medicines, the company is
exposed to significant foreign currency exposures which are required to be properly
managed.
Page 1 of 6
Advanced Auditing
Suggested Answers
Final Examination – Winter 2015
Ans.2
(a)
Areas of focus from investigation perspective:
(i)
Cost of sales/ Gross profit:

Checking the pricing mechanism agreed with the related party;

Checking whether increase in cost or decline in profitability is in line with the
industry trends.

Investigating any other reasons for increase in cost or decline in profit.
(ii) Selling and administration expenses:
Verifying major expenses with specific emphasis on assessing whether all
expenditure incurred are for the Company’s business and not otherwise;
(iii) Resignation of key management personnel:
Inquiring the reasons for resignation and delayed replacement of the Company’s
Secretary and Internal Auditor and interviewing them if required. The probability
that they resigned because of differences on ethical issues would be assessed;
(iv) Compliance with laws and regulations:
Obtaining an understanding of laws and regulations and where relevant checking
compliance with them.
(b)
Deficiency in the Governance areas:
(i)
As per the requirements of Code of Corporate Governance, the executive directors
(including Chief Executive) should not be more than 1/3rd of the elected directors,
whereas in this case there are 3 out of 8 directors.
(ii) The appointment of Company Secretary should be approved by the Board of
Directors, whereas in this case it was approved by the management i.e. CEO.
(iii) As per the requirement of Code of Corporate Governance there shall be at least one
and preferably 1/3rd of total number of directors should be independent directors.
However there is no independent directors on the board of GL.
(iv) Preparing budget/forecast, as it is a management function and is perfomed with the
assistance of auditors, these management function is prohibited under listing
regulations.
(v) Hiring of company secretary and internal auditor by the auditors is prohibited under
the Listing Regulations.
Role of Auditor:
(i)
How the auditor considered the independence requirements while;
 Deputing staff on secondment to the client.
 Preparing budget/forecast, as it is a management function and is prohibited
under Listing Regulations.
 Providing hiring services for company secretary and internal auditor, as these are
also prohibited under the Listing Regulations.
(ii) Reporting by the auditor in respect of non compliances of legal requirements
(covering letter or management letter etc.) such as independence of directors.
(iii) How the auditor obtained evidence that all transactions were recorded properly.
Page 2 of 6
Advanced Auditing
Suggested Answers
Final Examination – Winter 2015
Ans.3
(a)
After the acquisition, HL has become related entity of NL and as per the Code of Ethics,
reference to Audit Client includes reference to its related entities. Therefore after the
acquisition, the partner holds direct financial interest in a related entity and it would create
a self-interest threat.
As the amount of holding is material to the partner and NL can exercise significant
influence over HL, the self-interest threat created would be so significant that no safeguards
could reduce the threat to an acceptable level.
However, as 85% of the audit work has been completed, the remaining work can be
completed in a short period of time and, in such case if those charged with governance
request the firm to complete the audit without disposing off the interest, the firm can
continue the engagement provided that the firm:
discusses the evaluation of threat with those charged with governance.
ensures that relevant partner is not the member of the audit team nor the partner
responsible for engagement quality control review.
has deputed a Chartered Accountant to review the audit work.
has deputed another Chartered Accountant, other than the members of the audit
team, to perform a review that is equivalent to engagement quality control review.




(b)
A self-interest threat is created when a member of the audit team is evaluated on or
compensated for selling non-assurance services to the audit client.
The significance of the threat will depend on:

The proportion of the individual’s compensation or performance evaluation that is
based on the sale of such services;

The role of the individual on the audit team; and

Whether promotion decisions are influenced by the sale of such services.
The significance of the threat shall be evaluated and, if the threat cannot be reduced to an
acceptable level, the firm shall either revise the compensation plan or evaluation process for
that individual or apply safeguards to eliminate the threat or reduce it to an acceptable
level. Examples of such safeguards include:


(c)
Removing such members from the audit team; or
Having a Chartered Accountant review the work of the member of the audit team.
Accepting of assignment from Zaheer Limited will result in conflict of interest, which will
result in threat to objectivity.
Significance of threat need to be evaluated and relevant safeguards should be applied to
reduce the threats to an acceptable level. Such safeguards may include:

Implementing mechanisms to prevent unauthorized disclosure of confidential
information as the interests of the two clients may be are in conflict. This could
include:
- Using separate engagement teams who are provided with clear policies and
procedures on maintaining confidentiality.
- Creating separate areas of practice for separate functions within the firm, which
may act as a barrier to passing of confidential client information from one
practice area to another within a firm.
- Establishing policies and procedures to limit access to client files, the use of
confidentiality agreements signed by employees and partners of the firm and/or
the physical and electronic separation of confidential information.

Obtaining consent from Javed Limited , relating to acceptance of assignment from
ZL.

Regular review of the application of safeguards by a senior individual not involved
with the two engagements.
Page 3 of 6
Advanced Auditing
Suggested Answers
Final Examination – Winter 2015


Ans.4
Requiring a chartered accountant who is not involved in providing the services or
otherwise affected by the conflict, to review the work performed to assess whether
the key judgments and conclusions are appropriate.
Consulting with third parties, such as a professional body, legal counsel or another
Chartered Accountant.
(a)
Following could be the examples of relevant controls while determining the fair value
through internal evaluation:
(i)
Proper procedures are in place to ensure completeness, relevance and accuracy of the
data used to determine the fair value of investment properties.
(ii) Proper procedures are in place for evaluation of competence, capabilities and
objectivity of that expert.
(iii) The valuation including the assumptions or inputs used in their development are
reviewed and approved at an appropriate level or when required by those charged
with governance.
(iv) Proper procedures are in place to refine the estimate when comparisons of the actual
to the estimated results indicate such a need.
(v) Proper segregation of duties exist between persons committing the entity to
underlying transactions and those responsible for determining the fair value of
investment properties.
(vi) Specific policies and procedures are in place for specific models used for making
accounting estimates. Relevant controls may be established over:

The design and development, or selection, of a particular model for a particular
purpose

The use of the model

The maintenance and periodic validation of the integrity of the model
(b)
BASIS OF MODIFICATION PARAGRAPH:
As stated in Note X to the financial statements it is the company’s policy to value its
investment properties at fair value. However the value determined by the company of
properties located at Lahore, Islamabad and Peshawar is Rs. 25.4 million, Rs. 30.2 million
and Rs. 20.2 million respectively. The values of respective properties determined by DEF
valuers appointed by our firm are Rs. 16.2, 19.4 and 15.4 million respectively.
Management and its experts are unable to explain the differences in values and has stated
the properties at values determined by the company. Had the said properties stated at
values determined by DEF Valuers, profit before taxation would have been decreased by
Rs. 24.8 million and income tax, net income/shareholders’ equity would have been
reduced by Rs. 7.44 million and Rs. 17.36 million respectively.
Ans.5
(a)
(i)
The steps that the auditor would need to carryout in the given situation are as
follows:

Check the impairment assessment of the foreign operations (cash generating
unit) carried out by the management and assesses the reasonableness thereof.

Ensure that impairment (if any) has been appropriately recorded or disclosed in
the financial statements.

Involve the subject matter expert in assessing the workings and assumptions of
the impairment, in case the auditor does not have the relevant expertise.

In case the use of going concern assumption is no more appropriate, discuss the
matter with management for relevant disclosure and change in accounting
treatment.
Page 4 of 6
Advanced Auditing
Suggested Answers
Final Examination – Winter 2015
(ii)
(iii)
Since the client uses the services of a service organization, in such a situation, the
auditor would perform the following steps:
(1)
Obtain an understanding of the nature and significance of the services provided
by the service organization and their effect on the client’s internal controls
relevant to the audit, which would provide the basis of identification and
assessment of risks of material misstatement; and
(2)
Obtaining knowledge relating to competencies, capabilities and qualifications
possessed by personnel in Service organizations.
(3)
In case the auditor is unable to obtain understanding from the client, the
auditor shall obtain that understanding from one or more of the following
procedures:
 Obtain a type 1 or type 2 report, if available;
 Contact the service organization, through the client, to obtain specific
information;
 Visit the service organization and perform procedures that will provide
the necessary information about the relevant controls at the service
organization; or
 Using another auditor to perform procedures that will provide the
necessary information about the relevant controls at the service
organization.

The underlying text in the email string as well as the underlying attachment
can be altered by the person forwarding the email, therefore there is a risk that
the attachment file received by the audit team may not be the same as the
original file by the counterparty.
Contacting the customer to determine whether the customer has in fact sent the
e-mail.
Such confirmation may be acceptable if, the auditor or a member of the audit
team is also copied in the original email


(b)
(i)
Characteristics of fraudulent journal entries:
(i)
(ii)
(iii)
(iv)
(v)
entries involving unrelated, unusual or seldom used accounts;
entries made by individual who typically does not prepare journal entries;
entries recorded at the end of the period;
closing entries that have little or no explanation or description;
entries made either before or during the financial statements that do not have
account numbers;
(vi) entries containing round numbers or consistent by ending numbers;
(vii) entries involving complex transactions;
(viii) entries containing significant estimates and period-end adjustments;
(ix) entries affecting accounts which:

have been prone to misstatement in the past;

have not been reconciled on a timely basis or contain unreconciled
differences;
(x)
entries involving inter-company transactions;
(xi) entries made during unusual timing or on weekends;
(xii) entries involving large number of small account balances.
(ii)
Although DL is a low risk client, however as per the requirement of ISA, irrespective
of the auditor’s assessment of the risks of management override of controls, the
auditor shall design and perform audit procedures to test appropriateness of journal
entries recorded in the general ledger and other adjustments made in the preparation
of the financial statements.
Page 5 of 6
Advanced Auditing
Suggested Answers
Final Examination – Winter 2015
In designing and performing audit procedures for such tests, we would:

make inquiries of individuals involved in the financial reporting process about
inappropriate or unusual activity relating to the processing of journal entries
and other adjustments;

select journal entries and other adjustments made at the end of reporting
period; and

consider the need to test journal entries and other adjustments throughout the
period.
Ans.6
The following matters may be communicated to the auditor of the subsidiaries (component
auditor):

work to be performed, the use to be made of that work, and the form and content of the
component auditor’s communication with the group engagement team

A request for confirmation from the component auditors that they would cooperate with
group engagement team.

The ethical requirements that are relevant to the group audit and, in particular, the
independence requirements.

Component materiality and the amount lower than the materiality level for particular
classes of transactions, account balances or disclosures, if applicable and the threshold
above which misstatements cannot be regarded as clearly trivial to the group financial
statements.

Already identified significant risks of material misstatements in the group financial
statements, due to fraud or error that are relevant to the work of the component auditor.

Request to the component auditor to communicate on a timely basis any other significant
risks of material misstatement of the group financial statements, due to fraud or error, in
the component, and the component auditor’s responses to such risks.

A list of related parties prepared by group management, and any other related parties of
which the group engagement team is aware. Request the component auditor to
communicate on a timely basis related parties not previously identified by group
management or the group engagement team.

Request the component auditor to communicate mattes relevant to the group engagement
team’s conclusion with regard to the group audit.

Reporting deadlines by which the component auditor is required to comply.
(The End)
Page 6 of 6
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination Winter 2015
General
The performance in this attempt was above average. The result could have been much
better had the students been able to perform well in all questions. In fact, performance in
questions which pertained to those areas which are not tested frequently i.e. question
numbers 2 and 5 was quite poor. This was a clear indication of selective study which
should be avoided, in order to be successful.
Question-wise comments
Question 1
This question was designed to test the students’ ability to identify relevant audit risks
under the given situation which is a very important audit step during the planning phase.
The overall response was average. Generally, the students were able to specify the more
apparent risks such as going concern, impairment of plant and machinery, failure to make
adequate provision against stock, recognition of deferred tax assets and foreign currency
risks. However, majority of the students were unable to mention the risks such as risk of
fraud in revenue recognition and management over-ride of controls. Further, since the
requirement is to discuss the issue, it is important that in addition to the identification of
risk, the students should also specify why they consider a particular issue to be a risk. For
example, while discussing the going concern issue, many candidates gave just one or two
insignificant reasons which did not seem enough for raising the going concern issue.
Further, a large number of candidates did not approach the question on a composite basis
i.e. preferred to disintegrate the entity level issues into divisions/segments resulting in
duplication of response and deviation from the entity level audit risks.
Question 2(a)
According to the scenario in this question, the regulator had decided to investigate the
affairs of a company and in this regard, a firm was required to submit a request for
proposal whereas the requirement for the candidates was to prepare a paragraph
describing the scope of work (in the given circumstances). It was probably the most under
scoring question of this attempt. Most of the students were unable to understand the
requirement and produced the standard wording of an agreed upon procedures
engagement letter whereas the requirement was to write only the scope of the
investigation assignment/proposal and that too with relevance to the given situation.
Question 2(b)
This part of question was also not appropriately addressed by majority of the candidates.
Either they lacked the basic knowledge about governance matters or they did not read the
question properly. The question clearly stated that the entity under consideration was a
Page 1 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2015
listed company and therefore the approach should have been devised accordingly. Further,
the discussion on the role of auditor was confined to the extent of independence violation
with very little emphasis on how non-compliances were reported or attended to by the
external auditor and how completeness of transactions with related party was ensured.
Further, some students made sweeping statements that composition of the board is in noncompliance of CCG but did not explain the reasons thereof.
In sub-part (ii), many students misunderstood the basic concept that the question required
evaluating the role of auditors rather than them being the auditors in the given scenario.
Based on this misunderstanding, many students answered what they would do as auditors
which was not relevant.
Question 3
This question required the candidates to give their views on three outlined situations in the
light of the principle of independence applicable to an auditor. Comments on each of the
three parts are provided below:
Question 3(a)
The performance in this part was average. Many students lost marks by mentioning only
that partner should dispose of shares immediately or firm should not accept the
assignment. They ignored the fact that since 85% of the work had been completed, if those
charged with governance request the auditor to continue with the engagement then the
auditor could have continued with his appointment by applying certain safeguards.
Further, most students who recommended immediate disposal of shares, did not consider
that in the question it was specifically stated that the shares can not readily be sold.
Further, many students kept referring to Companies Ordinance which was not relevant.
Question 3(b)
This aspect of the code was tested for the first time and therefore either the students
scored very high marks or no marks at all. Most of the students seemed unaware of the
given type of situation and produced wayward answers.
Question 3(c)
This was a relatively straightforward question from the code of ethics and most of the
students were able to secure good marks.
Question 4(a)
This part of the question related to the controls that an entity would employ where it used
internal valuers for determining fair value of investment properties. A large number of the
candidates did not perceive the question correctly and restricted their response only to the
assessment of the expert, his qualification and set of skills. They failed to specify the
controls that are employed in such situations such as controls over the development and
use of evaluation model, segregation of duties, completeness, relevance and accuracy of
data, etc. Further, many candidates discussed totally irrelevant things such as:


Inherent complexities of the fair value estimates;
Complexities involved in hiring an external valuer.
Page 2 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2015
Question 4(b)
In this part of the question the candidates were required to draft a basis of modification
paragraph. The overall response was average. Many candidates produced the opinion
paragraph instead of basis of modification paragraph. Many candidates took the view that
the situation gave rise to limitation of scope which was not correct because according to
the situation, the auditor had carried out the necessary audit steps. Further, reference to the
note to the financial statements was missing in many cases.
Question 5(a)
In this part of the question, the candidates were required to evaluate three different
situations and explain the steps that the auditor would be required to take in each case.
Comments on each situation are given below:
Question 5(a)(i)
According to the given situation, foreign operations of a company had suffered severely
on account of various external factors and the foreign operations constituted 40% of the
company’s operations.
Considering the limited information that was available, there were two key issues that
should have been addressed i.e. possibility of impairment of foreign operations or
possibility of going concern issue. The performance was poor as majority of the students
only discussed the going concern issue which was less likely of the two possibilities.
Question 5(a)(ii)
This sub-part pertained to a situation whereby certain management functions had been
outsourced and were being performed at the service provider’s premises. The candidates
who had good grasp over the concept of service organization were able to give a
structured and precise answer which yielded them good marks. However, a number of
candidates responded by identifying the possible risks rather than specifying the auditors
response to the associated risks.
Question 5(a)(iii)
A large number of candidates correctly outlined the importance of external / third party
evidence and importance of its direct receipt by the auditor. However, a large number of
the candidates did not appreciate that if auditor is also copied in the original mail, along
with the client, the said email may also be acceptable for the auditor.
Question 5(b)
According to the situation given in this part of the question, the auditor had noted a
significant increase in the number of journal entries near to year-end although the
management’s explanation thereof appeared reasonable. The requirement was divided into
two sub-parts as discussed below:
Page 3 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Winter 2015
Question 5(b)(i)
The requirement was to specify the characteristics of journal entries that may be indicative
of fraudulent adjustments. The performance in this part was good. However, many
students described procedures for verification of journal entries instead.
Question 5(b)(ii)
In this sub-part the candidates were required to discuss how they would deal with the
given issue. The overall response was average. Most of the candidates did not explain that
irrespective of the auditor's assessment regarding management’s over-ride of controls, the
auditor should test the appropriateness of journal entries recorded in the general ledger.
Further, many students failed to identify the risk of management override of controls and
it’s implications, altogether.
Question 6
This was a straightforward question where the candidates were required to state the key
matters which the auditor of a holding company communicates to the component auditors
(ISA 600). This was a high scoring questions and a large number of students were able to
secure full marks also.
(THE END)
Page 4 of 4
ADVANCED AUDITING
Summary of Marking Key
Final Examination – Winter 2015
Note regarding marking scheme:
The marking scheme is given as a guide. However, markers also award marks for alternative
approaches to a question and relevant/well-reasoned comments/explanations.
A.1

0.5 mark for identification of each risk and up to 01 mark for discussion thereon. Overall 03
marks for identification of risks and 09 marks for discussion
A.2
(a)

01 mark for each area proposed to be included in the scope of work, subject to a
maximum of 07 marks
(b)
(i)
Up to 1.5 marks for each deficiency discussed subject to a maximum of 04 marks
(ii)
Up to 1.5 marks for identification of each matter that should be considered in
evaluating the role of auditors, subject to a maximum of 05 marks



Identification of threat and discussion thereon
Discussion on materiality and significant influence
Discussion on continuation of audit engagement with safeguards
Mark(s)
2.0
2.0
4.0
Identification of threat and discussion thereon
Factors on which significance of threat would depend
Evaluation of threat along with discussion on application of safeguards
Mark(s)
1.0
3.0
2.0
Mark(s)
1.0
6.0
A.3
(a)
(b)
A.4
A.5



(c)


Identification of threat and discussion thereon
Evaluation of threat along with discussion on application of safeguards
(a)

01 mark for each control identified subject to a maximum of 09 marks
(b)



Reference to the accounting policy and note to the financial statements
Reason for qualifications
Implications on financial statements
(a)
(i)

Up to 1.5 mark for evaluation and explanation of each step, subject to a
maximum of 05 marks
(ii)

01 mark for evaluation and explanation of each step, subject to a maximum of
07 marks
(iii)

01 mark for evaluation and explanation of each step, subject to a maximum of
03 marks
Mark(s)
1.5
3.0
1.5
Page 1 of 2
ADVANCED AUDITING
Summary of Marking Key
Final Examination – Winter 2015
(b)
A.6

(i)

(ii)

01 mark for identification of each characteristic of fraudulent entries, subject to
a maximum of 08 marks
02 marks for evaluation of the situation
01 mark for identification of each step to deal with the issue of significant
increase in number of journal entries
Subject to a maximum of 05 marks
01 mark for identification of each matter / instruction which may be communicated to the
component auditor, subject to a maximum of 08 marks
(THE END)
Page 2 of 2
Final Examinations
The Institute of
Chartered Accountants
of Pakistan
Module F
7 June 2016
3 hours – 100 marks
Additional reading time – 15 minutes
Advanced Auditing
Q.1
Mr. Burhan is working as audit manager in a firm of Chartered Accountants. The audit
teams have brought the following matters to his attention:
(a)
(b)
(c)
On the first audit of Nasir Limited (NL), the Chief Finance Officer of NL has revealed
that due to an error, a material liability was understated in the preceding financial
year.
(08)
There are multiple uncertainties which impact the ability of Link Telecom Limited to
operate as a going concern. An important assumption in the working provided by the
client is the continuous financial support from the parent company. The team
incharge wants guidance as to how the validity of this assumption can be evaluated.
(05)
During the audit of Moon Limited, it has been noted that 40% sales are made to an
associated company on credit. The management claims that the prices charged by the
company to the associated company are set in accordance with the prevailing market.
(06)
Required:
Explain how the audit teams should deal with the above situations.
Q.2
XYZ Limited has been an audit client of your firm for the last several years. The
engagement has been assigned to you and you have received the following briefing from the
engagement partner:
(i)
(ii)
(iii)
The recovery of fee on this client has become very low over the years.
In the past few years, audit managers have been rotated twice on the request of the
client.
Over the years, several significant decisions were taken by the company which were
communicated to audit teams at the time of finalisation of audits.
Required:
As the audit manager what will be your strategy to improve the relationship at this client?
Q.3
(09)
You are the partner in a firm of Chartered Accountants having three partners. Presently,
following matters are under your consideration:
(a)
(b)
Your firm is conducting the audit of Tahir Limited (TL). A partner in your firm is a
close friend of Kashif, who is the financial controller in TL.
(05)
Your firm has been approached by Javed Limited for advice regarding investment in
Kamran Limited (KL). The spouse of a partner of the firm holds 500,000 shares in
KL.
(05)
Required:
Evaluate threats involved in the above situations and suggest related safeguard(s), if any.
Advanced Auditing
Q.4
Page 2 of 4
You are the engagement manager of Saleem Electronics Limited (SEL). SEL is engaged in
manufacturing and selling of electronic appliances including air conditioners, washing
machines, refrigerators, electric lights and bulbs. The results of analytical review carried out
by your team, based on the draft financial statements, are summarised below:
Profit and loss account
Sales
Cost of sales
Gross profit
Administration expenses
Other operating income
Other expenses
Interest expense
(Loss)/profit before taxation
Taxation
(Loss)/profit after taxation
31-12-2015
31-12-2014
Increase/(decrease)
---------- Rupees '000' ---------%
85,661
78,793
6,868
9
(56,650)
(51,029)
5,621
11
29,011
27,764
1,247
4
(13,594)
(14,841)
(1,247)
(8)
11,000
13,000
(2,000)
(15)
(24,095)
(8,450)
15,645
185
(12,785)
(10,716)
2,069
19
(10,463)
6,757
(17,220)
(255)
(3,690)
(1,880)
1,810
96
(14,153)
4,877
(19,030)
(390)
Property, plant and equipment
31-12-2015
31-12-2014
Increase/(decrease)
---------- Rupees in '000' ---------%
190,903
195,003
(4,100)
(2)
Note reference
Note (i)
Note (ii)
Not material
Not material
Note (iii)
Not material
Note (iv)
Balance sheet
Current assets:
Receivables
Inventories
Cash and bank
Total assets
Share capital
Retained earnings
Long term liabilities:
Loan from related parties
Deferred tax liabilities
Current liabilities:
Provisions
Creditors and accrued expenses
Equity and liabilities
Note reference
Note (v)
19,961
45,721
7,985
73,667
264,570
18,313
44,403
8,068
70,784
265,787
1,648
1,318
(83)
9
3
(1)
Note (vi)
Note (vii)
Not material
182,000
(36,830)
145,170
150,000
(22,677)
127,323
32,000
(14,153)
21
62
Note (viii)
see P&L
48,192
14,806
62,998
80,000
12,398
92,398
(31,808)
2,408
(40)
19
Note (viii)
Note (iv)
8,567
47,835
56,402
264,570
9,253
36,813
46,066
265,787
(686)
11,022
(7)
30
Note (ix)
Note (x)
Audit team’s notes/comments:
(i)
The increase in revenue is due to increase in sale of air conditioners by Rs. 12.6
million because of introduction of instalment sales, which are made at 10% above the
normal price. The price is recovered in 12 equal monthly instalments.
(ii) The increase is in line with the increase in revenue.
(iii) Other expenses include a loss of Rs. 5 million on disposal of assets of services
department. Remaining amount represents cost of warranty.
(iv) The matter has been discussed with our tax team who would give its views shortly.
(v)
The decrease is due to the disposal of assets of services department of air conditioner’s
division. The services department was outsourced last year.
(vi) The increase in receivables is in line with the increase in sales.
(vii) The inventory balance is in line with prior year.
(viii) The company has converted the loan from related party into equity and issued shares
amounting to Rs. 32 million.
(ix) Last year’s provision includes provision for impairment in assets of services
department. The remaining increase of Rs. 1.3 million is immaterial.
(x)
In December 2014 all the employee related expenses were paid before year end.
Advanced Auditing
Page 3 of 4
Required:
Comment on the analytical review performed by the audit team and specify which
explanations in the analytical review seem unreasonable and/or incomplete.
Q.5
(a)
(18)
You are the engagement manager of National Pharmaceuticals Limited (NPL). The
company’s intangible assets include patents amounting to Rs. 100 million belonging to
the company’s Health Care Division.
It is the company’s policy to value the intangible assets at cost less accumulated
impairment. NPL has recorded an impairment loss on the basis of impairment review
which contains certain projections regarding future profits.
Required:
List the procedures which you would perform to verify the working prepared by the
management.
(b)
While reviewing the draft of the director’s report of NPL you have observed that
projections of future profitability in the director’s report with respect to the Health
Care Division show much higher amounts as compared to the amounts shown in the
working related to the impairment of patents. The CFO has explained that on the
basis of prudence and to avoid any overstatement of intangible assets, projections in
the working related to impairment have been kept on the lower side.
Required:
Evaluate the above scenario and explain how the auditor should deal with the above
situation.
Q.6
(07)
As the Quality Control partner of a newly established medium sized firm of Chartered
Accountants, prepare the following:
(a)
Q.7
(10)
Checklist for assessing quality of audit engagements with regard to planning of
audit. (any ten points)
(05)
(b)
Checklist for pre-engagement activities. (any eight points)
(04)
(a)
ABC and Company, Chartered Accountants are faced with the following situations:
(i)
(ii)
On the audit of Jalal Holdings Limited, the auditor of a subsidiary has issued a
qualified report.
On a joint audit, there is a difference of opinion whereby ABC wants to issue a
qualified report whereas the joint auditor are convinced with the client’s
explanation and intend to issue an unmodified report.
Required:
Explain how the above situations should be dealt with.
(b)
(06)
During the course of audit of a brokerage house, following observations were
documented in the working papers.
(i) Journal vouchers were not pre-numbered.
(ii) There was no mechanism for recording the phone lines of equity traders.
(iii) Margin requirements in case of certain individual clients were below the normal
margin requirements of 30%.
Required:
Identify the implications of the above matters which are to be included in the
management letter.
(01)
(02)
(02)
Advanced Auditing
Q.8
Page 4 of 4
You are the engagement partner of Ghalib Limited (GL) whose audit report for the year
ended 31 December 2015 was issued on 20 February 2016. The management of GL has now
approached your firm to report on summary financial statements pertaining to the same
period.
Required:
Discuss the nature of risks involved in carrying out/reporting on such assignment.
(THE END)
(07)
Advanced Auditing
Suggested Answers
Final Examination – Summer 2016
Ans.1
(a)
The procedure adopted would be as follows:
 Discuss the reasons of understatement with the client’s management and assess
whether reasonable grounds exist to assume that it was an error.
 If it was an error or due to control weaknesses then consider the impact on overall risk
assessment and nature, timing and extent of audit procedures.
 Obtain the working for re-statement from the client along with the relevant disclosure
in the financial statements.
 Identify impact, if any, for the current year as well.
 If it appears that the understatement was intentional, then consider the impact on the
assessment on integrity of management.
 If the integrity is doubtful, then consider withdrawing from engagement, if possible.
 If considered appropriate, discuss the matter with the previous auditor.
 Ensure proper accounting and disclosure of the restatements i.e. the re-statement will
have to be made in accordance with the requirements of IAS-8 pertaining to accounting
and disclosures
 Highlight the matter of re-statements to those charged with governance.
(b)





(c)









Obtain evidence with respect to the financial support from the parent company, such as
support letter/ agreement, etc.
Review the financial statements of the parent company to assess whether the parent
company is in a position to support LTL.
Ascertain the form of support i.e. loan or equity injection and ensure that both the
companies would be able to comply with the relevant legal requirements.
Review the business plans of LTL and assess whether it would be able to continue for
the foreseeable future and generate sufficient future profits/cashflows.
After performing the above procedures, if there is a doubt about the appropriateness of
the going concern assumption, carryout additional audit procedures (including
discussion with management) depending upon the circumstances.
The terms of the transactions with the associated company need to be obtained and
compared with market terms.
If the price charged to the related party is not the market price seek justification from
the management and document it appropriately.
If credit terms are not comparable with those prevailing in the market, the transaction
with the related party may be construed as a financing transaction. In such case, ensure
that approval of shareholders through special resolution in accordance with Section 208
of the Companies Ordinance, 1984 has been obtained.
If the entity is unable to produce relevant approval of the shareholders in respect of
loan, it will constitute a non-compliance with laws and regulations.
The auditor shall consider the need to obtain legal advice.
The auditor shall also evaluate the implications of non-compliance in relation to other
aspects of the audit, including the auditor’s risk assessment and the nature, timing and
extent of audit procedures.
Ensure that transactions with associated company are approved and authorized by the
board of directors.
If the transaction with associated company lacks logical business rationale then reassess
the management integrity.
Check whether the transaction has been disclosed as required under IAS 24 and 4 th
schedule of CO-1984.
Page 1 of 7
Advanced Auditing
Suggested Answers
Final Examination – Summer 2016
Ans.2 My strategy for improving relationship at client, would be as follows:

Discuss with the partner, the reasons for changes of audit managers and address the issues
appropriately.

Arrange meeting between the partner and CEO well before the start of the audit for
discussing business issues/ challenges and developments during the current year. Highlight
the potential audit issues and make specific inquiry regarding expected dates of finalisation
of audit.

Have meeting with the finance department well before the start of the audit and obtain
understanding of their processes and controls including any changes introduced during the
year and the issues that were faced in the previous audit and identify root causes for the
issues.

Send and discuss the Audit plan to the Board/Audit Committee for clear communication of
issues. The business issues and developments and their potential audit impacts and audit
strategy needs to be discussed in order for the Board/Audit Committee to acknowledge the
efforts of auditor.

Float the list of requirements for audit on a timely basis.

Conduct frequent meetings with client’s staff and give input on timely basis in order to
smooth out the client relationship.

Ensure that the field work is completed on a timely basis.

Perform timely review, ensure timely involvement of engagement partner and timely
submission of client deliverables for onward submission to Board/Audit Committee.

Write a memo to the Board/Audit Committee in which the issues faced during the audit
and foreseeable reasons thereof may be identified.

Once this has been done, discuss with the Board/Audit Committee regarding enhancement
of fees.
Ans.3 (a)
Self-interest, familiarity or intimidation threats may be created due to a personal relationship
between the partner and the finance controller of TL.
The existence and significance of any threat will depend on factors such as:


The nature of the relationship between the partner and the finance controller;
The interaction of the partner with the assurance team;
The significance of any threat shall be evaluated and safeguards applied when necessary to
eliminate the threat or reduce it to an acceptable level. Examples of such safeguards include:


(b)
Structuring the partner's responsibilities to reduce any potential influence of the
partner over the assurance engagement; or engagement team.
Having a chartered accountant review the relevant assurance work performed.
The interest of relevant partner and Javed Limited, with respect to Kamran Limited are in
conflict and it will create a threat to objectivity.
The firm is required to evaluate:

the significance of relevant interest or relationships.

the significance of the threats created by performing the professional services.
Page 2 of 7
Advanced Auditing
Suggested Answers
Final Examination – Summer 2016
The following safeguards shall be applied to reduce the threats to an acceptable level:




Ans.4 (a)
Closely monitor the implementation of policies within the firm with regard to
procedures to limit access to client files, the use of confidentiality agreements and/or
the physical and electronic separation of confidential information.
Regular review of the application of safeguards by a senior individual not involved
with the client engagement or engagements.
Having a chartered accountant who is not involved in providing the service or
otherwise affected by the conflict, review the work performed to assess whether the
key judgments and conclusions are appropriate.
Consulting with third parties, such as a professional body, legal counsel or another
chartered accountant.
Sales:

The analysis of the audit team does not include any comments on the decrease of sales
of other divisions.

It is mentioned in the comments that sale of air conditioners has increased due to the
introduction of installment sales, however the interest income on said installment sales
has not been identified in the analytical review.

Due to interest income on installment sales, other income (if interest income is
included in it) should have increased. However, it has decreased by Rs. 2 million.
Cost of sales:

Although the variation in cost of sales is in line with the variation in sales, however if
the sales are overstated due to recognition of interest income in the sales revenue then
consequently the cost of sales will not remain in line with the variation in sales amount
and needs to be investigated further.

If sales are increased due to higher prices as mentioned in the comments then cost of
sales cannot remain in line with the sales amount.
Administrative expenses:
Although the variation in administrative expenses is Rs. 1.2 million which is not material,
however, data related to administrative expenses is required to be disaggregated and
analytical review should be prepared separately for each individual expense to properly
evaluate the impact of variations.
Other income:
No comments have been offered with regard to the composition of other income, i.e. what
items constitute the other income.
Other expenses:
A major constituent is the warranty expenses and reasons for significant variation in it have
not been provided.
Interest expenses:
Although variation in interest expenses is not material, however, keeping in view the
decrease in amount of loans from related parties, interest expense should have decreased
instead of increasing.
Taxation/ deferred tax liabilities:

Simply saying that the matter has been discussed with our tax team who would give
their views shortly is not enough. The explanation/ opinion of the audit team with
respect to variation in tax figures should be incorporated in the analytical review.

Increase in deferred tax liability by Rs. 2.4 million despite the losses incurred by the
company seems unreasonable.
Page 3 of 7
Advanced Auditing
Suggested Answers
Final Examination – Summer 2016
Receivables:
The comment that increase in receivables is in line with the increase in sales is not correct.
Though increase in both cases is 9%, sales have increased due to introduction of installment
sales and therefore the receivables should have increased in much larger proportion.
Inventories:
The comment that increase of 3% in inventory balance is in line with prior year does not
seem appropriate because the revenues and cost of sales have increased by 9% and 11%
respectively.
Property, plant and equipment:
The comment is incomplete as there is no mention of the addition to fixed assets during the
year.
Provision of warranty:
The variation in warranty provision does not seem to be correct since warranty expenses
amount to Rs. 19.10 million i.e. have increased by 126% whereas the provision has
increased by Rs. 1.3 million i.e. 18% only.
Creditors and accrued expenses:
Creditors and accrued expenses are required to be analysed further.
Ans.5 (a)
Procedure for verification of working of impairment review:

Interview management to evaluate whether or not the assumptions on which the value
measurements are based, are reasonable and consistent with:
– the general economic environment, the economic environment of the specific
industry, existing market information and the entity’s economic circumstances;
– assumptions made in prior periods; and
– the risk associated with cash flows, including the potential variability in the amount
and timing of the cash flows and the related effect on the discount rate.

Check whether the forecast have been approved at the appropriate level of management.

Compare prior year forecasts with current year actual result and identify and assess the
variances.

Check the cash flow projections with the most recent financial budgets/forecasts approved
by management.

Check the projections covered the maximum period of five years as prescribed by IAS 36.
If the period is greater than five years, understand how the entity has justified it.

Ensure that projections donot include any cashflows arising from future restructuring.

Evaluating the competence, capabilities and objectivity of personnel preparing the
projections.

Check the appropriateness of discount rate used by the management

Test the underlying data to confirm that it is accurate, complete, relevant and provides
objective support for the assumptions used in the valuation analysis.

Consider involving internal expert to review the working.

Check subsequent period performance as far as possible.
(b)
Procedures to deal with the situation:

Discuss the matter with management and inquire the reason for keeping the projections on
lower side for computing the impairment on patents.

Convince the management that prudence does not allow deliberate understatement of
assets of the company, therefore the management argument that they have kept the
projections on lower side to avoid any overstatement of patent is not correct.

However, as the different projection provided in the directors’ report creates doubt as to
reliability of projections provided earlier, therefore the auditor is required to verify the
correctness of both the projections.
Page 4 of 7
Advanced Auditing
Suggested Answers
Final Examination – Summer 2016





Ans.6 (a)
Determine whether revision is required in the financial statements (impairment) or in the
directors’ report.
If impact on the financial statements is material then discuss the matter with the
management to adjust the financial statements.
If the management refuses to amend the financial statements, the auditor shall modify the
opinion in the auditor’s report.
If the impact on financial statements is not material, the matter may be reported in the
management letter.
If revision of directors’ report is necessary and management refuses to make the revision,
the auditor shall communicate this matter to those charged with governance and include in
the audit report an Other Matter paragraph describing the material inconsistency.
The checklist would comprise of following things:
(i)
Planning of Audit
In planning the audit engagement, did the auditor properly consider and/or document:

– matters affecting the industry in which the entity operates, such as
accounting practices, economic conditions, laws and government
regulations, and technological changes?
– matters affecting the entity's business, such as organization and types of
products and services?
– preliminary judgment about materiality levels for audit purposes?
– client's fraud risk factors?

(b)
In planning the audit, did the auditor consider:
– client’s business and accounting system.
– key issues discussed in the preliminary meeting.
– assessment of the risk of material misstatements of the financial statements.
– the risk of management misrepresentation by reviewing information
obtained about risk factors and the internal control structure?
– use analytical procedures in planning the nature, timing and extent of other
audit procedures?
– obtain a sufficient understanding of the entity's internal control structure and
anticipated reliance on internal accounting controls.
– use of Work Performed by Others such as:
o Internal Audit
o Other Independent Auditors
o External Experts
– applicable assertions in developing audit objectives and in designing
substantive tests?
– sampling method(s) used and their relevance in the given situation.
Pre engagement activities

Professional clearance
In case of new engagement, whether the practice of communication with previous
auditor was followed.

Independence
– If this is a new engagement, whether the auditor carried out evaluation procedures
prior to accepting the engagement.
– If this is an ongoing engagement, whether the auditor considered need to reassess
the engagement acceptance criteria.
– Whether independence issues relating to performance of non-audit services were
given due consideration.
– Whether professional personnel of the firm have appropriately informed as to need
to observe independence requirements.
Page 5 of 7
Advanced Auditing
Suggested Answers
Final Examination – Summer 2016
–
–

Ans.7 (a)
(b)
Assurance of independence obtained from staff members engaged in the audit.
If any evidence was noted during the review that may indicate a lack of
independence (including a lack of objectivity), whether the matter were identified
and appropriately resolved by the firm and its impact appropriately considered.
Whether an engagement letter was issued/ Whether the auditor considered the
issuance of new engagement letter

Compliance with the law
Whether auditor ensured that his appointment has been made after fulfilling all the
requirements of applicable laws and regulations.

Acceptability of the financial reporting framework
Whether auditor evaluated acceptability of the financial reporting framework in
accordance with ISA 210.
(i)
When a component auditor presents a qualified audit report on the financial
statements of a subsidiary, the principal auditor has to first assess whether:

The modification is material from the view point of the group as a whole.

If the qualification is material to the group’s financial statements the modification
should be carried forward to the auditor’s report on the group’s financial
statements. However, the type of modification may need to be changed
depending upon the degree of materiality for the group.

If the qualification is not material with a view point of group’s financial
statements, the group auditor will make no reference to them in the audit report.
(ii)
In order to resolve the difference of opinion, discuss the matter with the joint auditor.
In case the matter is not resolved, both the joint auditors should express their own
opinion.
(i)
Journal vouchers were not pre-numbered
 There could be no assurance that all JVs have been posted in the ledger.
(ii)
There was no mechanism for recording the phone lines of equity traders
 In the absence of recording of phone lines the transparency of deals executed by
the dealers cannot be ensured.
 There would be no recourse incase of a dispute or incase something goes wrong.
(iii) Margin requirements in case of certain individual clients is below the normal
margin requirements of 30%
 In case of any default by customer or crash of market, company will be required to
bear the losses.
 Excess financial charges or margin requirements are to be borne by the company.
 Maintaining margin requirements below the prescribed limits may attract legal
implications.
Page 6 of 7
Advanced Auditing
Suggested Answers
Final Examination – Summer 2016
Ans.8 






Summary financial statements are prepared to criteria and there is a risk that criteria applied
may not be adequately disclosed or financial statements may not be prepared as per the
criteria.
Because summary financial statements by their nature contain aggregated information and
limited disclosure, there is an increased risk that they may not contain the information
necessary so as not to be misleading in the circumstances.
The summary financial statements may be used for purposes other then the stated purpose.
As the summary financial statements are dated later than the audited financial statements
there is a risk of non-inclusion of effects of events subsequent to the date of auditor’s report
on the audited financial statements.
The unaudited supplementary information presented with summary financial statements
may not be clearly differentiated from the summary financial statements.
Risk of inconsistency in other information presented in documents containing summary
financial statements.
The risk that documents containing the summary financial statements may not contain the
auditor’s report on the summary financial statements.
(The End)
Page 7 of 7
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Advanced Auditing
SESSION
Final Examination Summer 2016
General
The overall performance in this attempt was much below the last attempt. The
performance in all the questions except Question 3 was below average. However, the
worst attempted questions were Question 2, 4 and 7. Dealing with practical situations in
audit requires knowledge as well as imagination. The latter was lacking in most cases.
Question 1
This question contained three independent situations and in each case the candidates were
required to explain how the audit team should deal with it. The performance was quite
poor. The most notable issue in this question was that the question required the students to
answer on the approach to be taken but a significant number of candidates put their major
stress on the reporting aspect. Comments on each situation are given below:
Question 1(a)
According to the situation, on the first audit of an entity, the CFO informed the auditors
about an error in the previous year’s financial statements. Most of the candidates only
covered the accounting treatment under IAS – 8 and the implications on the financial
statements. Very few of them raised the key issue i.e. ascertaining whether it was actually
an error and the related implications if it was an intentional misreporting rather than an
error.
Question 1(b)
The overall performance was average as the candidates generally covered the routine
procedures that are performed when there are doubts as regards going concern
assumption. However, very few of them got deeper into the given scenario as they failed
to discuss about the ability and the willingness of the parent company to provide support.
Question 1(c)
According to the situation, 40% of the total sales of a company were made to an
associated company on credit. The overall performance was below average as the
responses in most of the cases were restricted to the issue of sales price and its comparison
with market prices. The credit terms and its related implications were seldom discussed.
Moreover, most of the students did not understand as to what the auditor should do if the
price charged is different from those prevailing in the market and many of them simply
suggested that the report should be qualified.
Page 1 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2016
Question 2
This question was based on a situation whereby there were certain issues with the client
such as low audit fee, frequent requests to change the audit manager and delays in
communication of major decisions.
It was the least scoring question of this session. About 18% of students did not attempt it
altogether. The main mistake was that the candidates mainly focused on the independence
issues and on suggestions for improving the performance of the audit team whereas it was
more of a client issue. Other common mistakes were as follows:




Regarding the recovery of the fee, most of the students misunderstood the scenario as
if the fee was actually not being received by the firm. In the given context it was an
issue of engagement economics i.e. more resources were being occupied than
warranted by the fee level.
The matter regarding the rotation of managers was answered with respect to code of
ethics rather than mentioning a need for discussing the matter with the client.
The issue of last minute adjustments was answered by suggesting how the team should
be trained and supervised.
A very important step i.e. resolving the issues by discussing them with the client
(CFO, CEO, Audit Committee, Board of Directors) was mostly ignored.
Question 3
This was a relatively well answered question. The answer for this question was directly
from the code of ethics so the students who have gone through the study material were
able to score very good marks. However, in part (b), instead of appreciating conflict of
interest and threat to objectivity, a number of students mentioned self-interest threat and in
some cases intimidation threat. Moreover, a large number of students stated that the
spouse of the partner must liquidate her shareholding.
Question 4
This question contained comparative profit and loss account and balance sheet of a
company along with the audit team’s comments based on analytical review carried out.
The candidates were required to review the comments and specify which explanations
seemed unreasonable or incomplete. The overall performance in this question was quite
poor because of the following:
1. Many students focused on identifying the risks from the comments provided in the
question which was not required.
2. Few of the students went at quiet a length on describing what should be the
materiality, what threshold should be used and the purpose and form of overall
analytical review etc. which was not required at all.
3. Very few students were able to identify the following issues/deficiencies in the
comments prepared by the audit team:

No comments were offered regarding the fact that the introduction of installment
sales for the first time should have been accompanied by an increase in interest
income and receivables.
Page 2 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2016




The comment “increase of 3% in inventory balance is in line with prior year” was
unreasonable because the revenues and cost of sales have increased by 9% and
11% respectively.
Comments as regards addition to fixed assets were missing.
No comments have been offered on the fact that warrant expense for the year has
increased by 126% whereas the provision in the balance sheet has increased by
18% only.
Further break-up and analysis was required in case of some items such as other
income, administrative expenses, creditors and accrued expenses.
Question 5(a)
This part of the question was well answered. However, some students focused on control
review and testing instead of substantive procedures. Moreover, many students simply
talked about assessing the reasonableness of the assumptions. How and from what
perspective this aspect has to be reviewed was not discussed.
Question 5(b)
The performance in this part of the question was above average. However, there were
many students who seemed quite satisfied with the client’s policy of making over
provision on the basis of prudence and only covered one aspect of the situation i.e. the
difference between the information on which the provision was based and the information
provided in the directors’ reports whereas the issue of over provisioning was completely
ignored. Some of the students who did discuss the provisioning issue confined themselves
to matters such as qualifying the report or withdrawing from the audit without considering
any efforts to resolve the situation amicably.
Question 6
The overall performance in this question requiring preparation of checklists for (i)
assessing quality of audit engagement with respect to planning of audits and (ii) preengagement activities was average because most of the students mentioned few valid
points accompanied by a lot of duplication and invalid points also. Some of the key
observations are as follows:
1. Areas other than planning were also included, probably to achieve the required
number of points.
2. Many students did not understand the meaning of pre-engagement activities and
confused them with points that are covered in the engagement letter.
3. Most of the students mentioned a few valid points and tried to achieve the required
number of points by mentioning the same points in different words or by including
irrelevant points.
Question 7(a)
This part of the question consisted of two sub-parts, each containing a different scenario
and the candidates were required to explain how the auditor should deal with them.
Performance in each sub-part is discussed below:
Page 3 of 4
Examiners’ Comments on Advanced Auditing – Final Examination Summer 2016
(i)
According to the situation described in this part, the audit report of a subsidiary
had been qualified. The most common error in this part was that the students
suggested that the auditor should consider the materiality of the subsidiary to the
group instead of mentioning that the impact of the qualification on the group as a
whole should be considered. Further, many students suggested that the matter
should be discussed with the subsidiary’s auditor which was totally irrelevant.
(ii)
This was a rare situation in which two joint auditors had a difference of opinion.
One of them wanted to issue a qualified report whereas the other was quite
satisfied and wanted to issue an unmodified report. The overall performance was
quite poor as very few students could clearly specify that if the dispute cannot be
resolved, each of the two auditors may express their own opinion. Many students
did not attempt this sub-part whereas a wide variety of incorrect answers were
observed such as referring the dispute to ICAP/SECP, withdrawing from the
assignment, going for a third party review, etc.
Question 7(b)
In this part, three observations of the auditor were stated and the candidates were required
to identify the implications in each case. This part was mostly well attempted. However,
many students only mentioned that it was a weakness but didn’t identified the implication
thereof i.e. the resultant risk due to the weakness.
Question 8
According to the situation given in this question, the statutory auditor of a company had
been requested to report on the summary financial statements of the same period. The
candidates were required to specify the risks involved in carrying the assignment.
The overall performance was very poor as very few students seemed prepared for such a
question. A variety of incorrect points were observed such as:
1
The assignment cannot be undertaken because of restrictions imposed by code of
ethics, listing regulations, etc.
2
It involves conflict of interest.
3
It involves self-review threat.
The candidates are advised to refer to ICAP’s suggested answer for guidance on this
question.
(THE END)
Page 4 of 4
ADVANCED AUDITING
Summary of Marking Key
Final Examination – Summer 2016
Note regarding marking scheme:
The marking scheme is given as a guide. However, markers also award marks for alternative
approaches to a question and relevant/well-reasoned comments/explanations.
A.1
A.2
A.3
A.4
A.5
(a)
01 mark for each procedure to be adopted
Mark(s)
8.0
(b)
01 mark for each procedure to be adopted
5.0
(c)
01 mark for each procedure to be adopted
6.0
Up to 1.5 mark for each step/ strategy for improvement of relationship with
the client
1.5
0.5 mark for identification of each threat
Up to 01 mark for mentioning each factor on which significance of
threat would depend on
01 mark for suggesting each safeguard
(b)
Identification of threat and discussion thereon
Discussion on evaluation of significance of relationships and threats
Up to 01 mark for discussion on application of each safeguard
1.0
1.0
3.0
Up to 1.5 marks for identification and discussion on each unreasonable and
incomplete information/matter
18.0
Up to 01 mark for each procedure for verification of working prepared
by the management
10.0
01 mark for evaluation and explanation of each procedure to deal with
the situation
7.0
0.5 mark for each matter to be presented in the checklist with regard to
planning of audit
5.0
0.5 mark for each matter to be presented in the checklist with regard to
pre-engagement activities
4.0
(a)
(a)
(b)
A.6
(a)
(b)
A.7
9.0
1.5
2.0
(a)
(i) 01 mark for discussion/explanation of each step
(ii) 1.5 mark for discussion/explanation of each step
3.0
3.0
(b)
(i) Identification of the related implication
(ii) 01 mark for identification of each related implication
(iii) 01 mark for identification of each related implication
1.0
2.0
2.0
Page 1 of 2
ADVANCED AUDITING
Summary of Marking Key
Final Examination – Summer 2016
Mark(s)
A.8
Up to 1.5 mark for discussion on each risk involved in carrying out/
reporting on summary financial statements
7.0
(THE END)
Page 2 of 2
Certified Finance and Accounting Professional Stage Examinations
The Institute of
Chartered Accountants
of Pakistan
8 December 2016
3 hours – 100 marks
Additional reading time – 15 minutes
Audit, Assurance and Related Services
Q.1
You are a partner in a firm of Chartered Accountants. Annual audits of various clients are
at finalization stage and since this is the first time that ISA related to Key Audit Matters is
to be applied, several issues have been referred to you for guidance. These include:
(a)
(b)
(c)
(d)
An adverse report is being issued in the case of Muneer Limited. The draft report also
contains certain matters as Key Audit Matters.
(02)
A qualified report has been drafted by the audit manager of Nadir Limited as the
company has failed to make adequate provision of contingency. The details of
qualification are mentioned in the Key Audit Matters section.
(03)
The Key Audit Matters section of audit report of Zia Limited includes details of Key
Audit Matters of only the current period. However, the opinion has been expressed
on current as well as prior year.
(03)
At one of the listed clients, investigation by a Government agency against some of its
staff members is in progress. Due to sensitivity of the matter the management has
requested you to not to include such information in the Key Audit Matters section.
(03)
Required:
Advise the concerned partners/managers with respect to the above matters.
Q.2
You are the audit manager of Bolan Pharmaceuticals Limited (BPL) a listed company. For
the year ended 30 September 2016, BPL has prepared its financial statements which indicate
a net operating loss, current ratio of 0.79 and significant amount appearing as capital work
in progress comprising of expenses incurred on acquisition and installation of plant and
machinery. The following information is also available:
(i)
(ii)
(iii)
(iv)
(v)
The operations of BPL are currently suspended due to Balancing, Modernization and
Replacement (BMR) work.
The decision to carry out BMR was approved by the Board of Directors in 2015 with
a completion deadline of 31 March 2016.
Due to certain technical issues, BPL has not been able to complete the project to date.
Because of the above situation, loan from a bank became overdue on
1 September 2016. Further, BPL had also not complied with certain key covenants.
In this difficult situation BPL has requested its major shareholders to inject additional
equity.
Required:
(a)
You have asked the client to give a comprehensive plan explaining the steps to
counter the above situation. Briefly discuss what kind of details you would expect in
the above plan.
(12)
(b)
Besides the issue of going concern, state the other key matters that the auditor should
consider with respect to the above situation.
(05)
Audit, Assurance and Related Services
Q.3
Page 2 of 4
Your firm has been appointed as the auditor of New Cement Limited (NCL), for the year
ended 30 November 2016. NCL is a listed company which owns one of the largest cement
plants in the country. 60% of the company’s shares are owned by the same family. The
CEO, CFO and Director Operations belong to the family. Following are the extracts from
the draft financial statements:
Extracts from statement of financial position
Assets
Rs. in million
Property, plant and equipment
21,115
Deferred tax
270
Trade debtors
4,700
Other current assets
2,753
Equity and liabilities
Share capital
Reserves
Surplus on revaluation of fixed assets
Non-current liabilities
Current liabilities
6,500
(1,462)
2,000
13,000
8,800
Extracts from statement of comprehensive income
Turnover – net
17,210
Gross profit
1,417
Operating loss
(164)
Other income
223
Finance cost
(1,560)
Loss before taxation
(1,501)
Other information:
(i)
(ii)
(iii)
(iv)
(v)
Sales have declined during the past two years because of lower exports, however, the
decline in exports has been partially offset by slightly higher local sales. The
management is hopeful of a significant increase in local sales in the coming years.
NCL’s debtors have increased by 25%. The debtors include an amount of
Rs. 330 million due from a government owned entity. The amount became due on
30 June 2016. However, the amount has been rescheduled and is now recoverable in
6 equal instalments over a period of three years.
On 1 November 2016, the management entered into a contract with a new supplier
for supply of its main raw material. The new supplier has offered 15% lower prices.
The contract with the previous supplier has been terminated. The audit team has also
been informed that a senior member of purchase department was fired in
September 2016.
NCL revalues its plant and machinery after every three years. The last revaluation
was carried out in 2014.
The internal audit department comprises of five staff members including Chief
Internal Auditor, who is a Chartered Accountant. The Chairman of the audit
committee is an independent director. The internal audit department has carried out
number of assignments. The reports of the internal auditor include many good
suggestions for improving the efficiency of the operations; however, they do not
contain any serious deficiencies/adverse comments in any area.
Required:
(a)
Briefly evaluate the overall control environment of the company.
(b)
Based on the above information identify areas of risk for the audit and the planned
audit approach.
(Note: Detailed audit procedures are not required)
(05)
(15)
Audit, Assurance and Related Services
Q.4
Q.5
Page 3 of 4
Identify the differences between the auditor’s report on financial statements of a listed
company as compared to an unlisted company, based on International Standards on
Auditing.
(04)
Dawood Limited (DL), a listed company, has approached your firm to provide a limited
assurance on sustainability report of the company and presently you are verifying the
following statement related to carbon emissions:
“Carbon emissions were within the limits allowed by the regulator.”
Required:
Determine how you would verify the above claim.
Q.6
Your firm has been hired by Sensitive Products Limited (SPL), for an assurance engagement
regarding compliance with regulatory requirements. SPL is engaged in the production of
highly sensitive products and is required to comply with strict regulatory requirements. In
this regard a report is submitted by SPL to the regulatory authority which contains certain
information.
Required:
Draft a limited assurance report to be issued to the regulatory authority regarding the
information provided to the authority by SPL. The report should contain a qualification and
mention atleast three procedures performed by your firm.
(You may assume necessary details, however any annexures to the report are not required)
Q.7
(06)
(14)
You are the audit manager responsible for the audit of Mechanic Engineering Limited,
(MEL) which provides mechanical parts to different industries. The draft financial
statements for the year ended 30 September 2016 show profit before taxation of
Rs. 150 million (2015: Rs. 200 million) and total assets of Rs. 1.2 billion (2015: Rs. 1.1
billion).
Presently following matters are under your consideration:
(a)
(b)
MEL has recognized a late payment surcharge of Rs. 2.5 billion on amount due from
Government agencies. Last year, the audit report was qualified with respect to the
recognition of late payment surcharge. The management has informed you that the
Government authorities have conveyed their willingness to pay Rs. 2 billion instead
of Rs. 2.5 billion and has provided you a written representation with respect to the
said amount. MEL however wants to preclude you from sending a confirmation to
the relevant agency.
(07)
During the year, MEL has sold one of its buildings to Natasha (Private) Limited
(NPL) at a loss of Rs. 20 million. The building was purchased at a cost of
Rs. 80 million seven years ago and was depreciated @ 5% per annum on straight line
basis. The minutes of the meeting of the Board of Directors at which the sale was
approved indicate that a director of MEL holds 20% shares in NPL. However, the
minutes also indicate that he did not vote on the transaction due to conflict of
interest.
(09)
Required:
Evaluate the above situations and determine the course of action in respect of each of the
above independent situations. (Reporting implications are not required)
Audit, Assurance and Related Services
Q.8
Page 4 of 4
You are the partner in a firm of Chartered Accountants and presently following matters are
under your consideration:
(a)
Annual audit of Kamran Limited (KL) for the year ending 31 December 2016 is due
to commence in a few weeks. Jamal has been an audit team member for eleven years;
two years as the job incharge, three years as manager and six years as partner.
KL was listed on the Pakistan Stock Exchange in July 2016.
Required:
(i)
Identify the threats in the above situation and discuss the significance thereof.
(ii) Discuss the need for rotation of engagement partner in each of the following
situations:
The firm has adequate resources and personnel who can replace Jamal as
engagement partner but Jamal does not want to leave this assignment.
The firm is unable to find a suitable replacement.
(b)
(06)
(03)
Your firm has received request from a listed audit client to assess the quality of the
internal audit function and give recommendations as regards improving the structure
of the internal audit department and the quality of its staff.
Required:
Evaluate the above situation and identify threats, if any and related safeguards.
(THE END)
(03)
Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Winter 2016
Ans.1
Ans.2
(a)
If one or more matters other than the matter(s) giving rise to an adverse opinion are
determined to be key audit matters, it is particularly important that the descriptions
of such other key audit matters do not imply that the financial statements as a whole
are more credible in relation to those matters than would be appropriate in the
circumstances, in view of the adverse opinion.
(b)
A matter giving rise to a qualification by their nature is a key audit matter. In such
circumstances, these matters shall not be described in the Key Audit Matters section
of the auditor’s report, rather the matter is to be reported in accordance with the
requirements of related ISA. Reference to the basis for qualified opinion is to be
included in the Key Audit Matter section.
(c)
The non inclusion of Key Audit Matters of prior period is appropriate as the
auditor’s determination of key audit matters is limited to those matters of most
significance in the audit of the financial statements of the current period, even when
comparative financial statements are presented (i.e., even when the auditor’s opinion
refers to each period for which financial statements are presented).
(d)
The auditor can only accept the management request if:

law or regulation precludes public disclosure about the matter; or

the auditor determines that the matter should not be communicated in the
auditor’s report because the adverse consequences of doing so would
reasonably be expected to outweigh the public interest benefits of such
communication. This shall not apply if the entity has publicly disclosed
information about the matter.
(a)
I would expect the following details in the plan:
 Probable date of commencement of operations.
 Measures to deal with the technical issue which is faced, either in the form of
correspondence with an expert or minutes of board of directors meeting.
 Financial effects of breach of key covenants of bank loan.
 Cost overruns due to delay in completion of project (till the estimated date of
commencement of operations).
 Negotiation with the banks and how the bank has reacted on default of the
company including information of restructuring (if any) and penalties.
 Plans of the company to recapture its lost customer ship and costs related to
unfulfilled customer orders.
 Employee’s reaction to suspension of operation e.g. employees turnover since
the suspension of operations. Calculation of redundancy payments relevant to
employee’s turnover.
 Implications on company of loan default e.g. calling of security by the bank etc.
 Form of equity injection, whether by way of right or subordinated loan. In case
of right shares, probability of subscription.
 Status of regulatory compliances in the case of equity injection e.g whether
necessary resolutions had been passed or permissions have been obtained from
relevant bodies.
 Does company have adequate number of resources other than finance to
commence operations? e.g. technical staff etc.
 Status of other liabilities, whether these had become overdue and if yes what are
the company’s plans to deal with these liabilities.
 Cash flow forecast in support of going concern assumption.
 Assumptions used in support of the cashflow forecast.
 Evidence of continuous financial support from the major shareholders/ evidence
in support of funding of working capital requirements.
Page 1 of 8
Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Winter 2016
Ans.3
(b)
Besides the going concern issue, the auditor should also consider the following
matters with respect to the given situation:

As the loan covenants have been breached by the Company, the fact should be
disclosed in the financial statements.

Proper understanding of the loan agreements need to be obtained.

The correspondence with the banks should also be obtained / examined and
the potential contingency arising as a result of any case filed by the bank, if any
be disclosed in the financial statements.

The classification of liabilities either “current” or “long term” should also be
assessed in the light of the loan agreements.

The proper accrual of markup, penalties and any related charges due to nonpayment on a timely basis should be properly accounted for in the financial
statements.

Appropriate accrual of redundancy payments and salaries with respect to
leavers should be reflected in financial statements.

Proper adjustments in the financial statements to be ensured in respect of
Impairment of existing plant and machinery as well as Capital work in
progress.

Treatment and bifurcation of revenue and capital nature expenditures incurred
on BMR.

Impact of subsequent events on the financial statements of BPL.
(a)
Evaluation of control environment:



The Internal Audit department is headed by a Chartered Accountant whereas
the chairman of the audit committee is an independent director. These two
factors are positive and consequently are evident of strong control environment.
However, at the same time, it should also be kept in consideration that:
 NCL is a family owned enterprise and family members of the company are
actively involved in the management of the company. This may lead to the
possibility of management override of controls.
 The commitment to competence of management may appear to be weak as
the major positions in the company are assigned to the family members
instead of hiring professionals from the market.
It seems that internal audit staff is under the influence of the family members as
their reports contain no serious issues or problems identified.
Procurement policies and procedures appear to be weak as in the last month of
the year a supplier was hired offering 15% less rates as compared to previous
rates. The firing of senior member of the procurement department is an
indication in that direction.
Above discussed factors are indicating that NCL may lack effective and efficient
internal controls, resulting in weak control environment.
Page 2 of 8
Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Winter 2016
(b)
Risks
Audit Approach
 Obtain the management assessment /
Use of going concern assumption
future projections prepared justifying
Although the company’s equity is
the use of going concern assumption
positive, NCL’s current ratio is 0.85,
as appropriate in the financial
which is quite low with reference to
statements of the company
acceptable benchmarks; and debt equity
ratio is 65:35 which is very high and  Analyse the assumptions used therein.
adverse and has incurred a loss of Rs.
The underlying assumptions used by
1.501 billion which has completely
the management needs to be supported
by solid facts.
wiped off the reserves of the company.
 Ensure that proper disclosure is given
If the debt due from government is also
in the financial statements of the
classified in the non-current assets, it
material
uncertainty
and
the
will further deteriorate the current ratio.
management’s assessment.
Further, if the debt due from
government bears no interest then it
would further deteriorate the position.
If NCL’s performance follows the same
track in the coming year then NCL
might
face
operating
difficulties
resulting in a material uncertainty that
NCL might not be able to continue as a
going concern in the coming years.
Increase in receivable despite decrease
in turnover:
Trade receivable might include slow
moving or doubtful debts as these had
increased by Rs. 610 million excluding
the effect of dues from Government
entity, which is unusual due to decrease
in turnover. This might result in
overstated
current
assets
and
understated provisions / bad debts and
losses thereof.
Dues from Government owned entity
might not be accounted for properly and
may exclude the effect of discounting.
 Review the entity’s policy for
provision of doubtful debts.
 Check aging of debtors and identify
any slow moving and doubtful debts.
 Obtain confirmation from major
debtors and check against ledger
balances.
 Ensure
proper
disclosure
and
accounting of Government owned
debts as per IFRS.
Rescheduled loan from Government
might be classified in short term
receivables.
Impairment in the value of plant and  Engage experts (management and
auditor’s) to revalue the property to
machinery:
identify any impairment/decline in
Due to decline in sales the value of plant
surplus on revaluation.
and machinery might be impaired

Review working for value in use, if
which could result in overstatement of
necessary.
property,
plant
&
equipment,
understatement of impairment and
overstatement of profits.
 Understand and evaluate NCL’s
Risk of fraud: Operating results
financial reporting process and the
NCL may be inclined to show better
controls over journal entries and other
results to the financial institutions from
adjustments and determine whether
which it has obtained financing.
they have been implemented.
Page 3 of 8
Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Winter 2016
Risk of fraud: Management override
of controls
As it is a closely held entity with
majority shareholding owned by a single
family and with key positions occupied
by family members, there is always a
risk of fraud due to management
override of controls.
 Perform substantive testing in all the
areas with low control reliance.
 Perform cut-off test to check that the
vouchers have been completely
recorded.
 Test
the
appropriateness,
authorization and completeness of
journal entries recorded in the general
ledger and other adjustments.
 Use
professional
judgment
to
determine the nature, timing and
extent of journal entries testing and
other adjustments and assess the
completeness of the population subject
to testing
There is an increased risk of fraud as
evident from the termination of
employee in September 2016, and
working of internal audit department
as it is evident from their reports.
Risk of misstatement in opening  Review prior year working papers of
the previous auditor.
balances:
It is the first year audit and there is a  Design audit procedures to provide
evidence relevant to opening balances.
possibility that prior year opening
balances are materially misstated and
are not correctly brought forward.
 Review the management’s future
Deferred Tax Asset:
projection of taxable profits and
Deferred tax asset can only be
reasonableness of the assumptions
recognized to the extent that the
used.
company expects that it would generate
sufficient profits to realize the benefit. In
the given scenario it seems difficult for
the company to generate sufficient
taxable profits in the near future to
realize the deferred tax assets.
Ans.4
Following are the additional matters that have to be included in the audit reports of listed
companies:

Key audit matters

Statement from the auditor that it has provided those charged with governance with
a statement that the auditor has complied with relevant ethical requirements
regarding independence and communicate with them all relationships and other
matters that may reasonably be thought to bear on the auditor’s independence, and
where applicable, related safeguards;

Statement that from the matters communicated with those charged with governance,
the auditor determines those matters that were of most significance in the audit of
the financial statements of the current period and are therefore presented as the key
audit matters.

The name of engagement partner.
Further in the audit report of listed companies the auditor is supposed to include a
separate section named “other information” if at the date of audit report the auditor has
obtained or expects to obtain other information whereas in the case of unlisted company
this paragraph is only given if the auditor has obtained any such information.
Page 4 of 8
Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Winter 2016
Ans.5
Steps for verification of the claim “Carbon emissions were within the limits allowed
by the regulator”:

Inspection of relevant guidelines and benchmarks related to carbon emissions, as
may be allowed/ specified by the regulator.

Review the company’s processes for collecting, analyzing and aggregating data on
the carbon emissions.
Assess the use of work of an expert with reference to compliance with environmental
regulations and standards.

Interview management and employees of relevant departments.

Compare the weekly/monthly / yearly carbon emission report and analyze and
discuss the reason for major variations, if any.
Ans.6
Independent Limited Assurance Report
To the Director Compliance of Nuclear Drug Control Authority:
We have been engaged by Sensitive Products Limited (SPL) to perform a limited
assurance engagement in respect of the following information (said information) presented
in the 2016 Report to the Director Compliance, Nuclear Drug Control Authority, for the
year ended December 31, 2016:

The type and number of nuclear medicines produced during the year;

The details of machinery and equipment used to manufacture nuclear medicines;

Details of safety and quality control measures adopted by SPL during the year.
Inherent Limitations
Non- financial information, such as that included in the SPL’s report to the Nuclear Drug
Control Authority, is subject to more inherent limitations than financial information,
given the more qualitative characteristics of the said information and the methods used for
determining said information.
Management’s Responsibilities:
Preparation and fair presentation of the said information in accordance with the specified
regulations is the responsibility of the SPL’s management. Management is also
responsible for such internal control as management determines is necessary to enable the
preparation of the said information such that it is free from material misstatement.
Practitioner’s Responsibility:
We are responsible for:

Planning and performing the engagement to obtain limited assurance about whether
the said information is is free from material misstatement, whether due to fraud or
error;

Forming an independent conclusion, based on the procedurse we have performed
and the evidence we have obtained; and

Reporting Our Conclusion To The Director Compliance, Nuclear Drug Control
Authority.
Professional Standards applied and level of assurance:
We conducted our limited assurance engagement in accordance with the International
Standard on Assurance Engagements 3000 (ISAE 3000), “Assurance Engagements other
than Audits or Reviews of Historical Financial Information” published by the
International Federation of Accountants. A limited assurance engagement is substantially
less in scope than a reasonable assurance engagement in relation to both the risk
assessment procedures, including an understanding of internal control, and the procedures
performed in response to the assessed risks.
Page 5 of 8
Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Winter 2016
Independence, quality control and competency statement:
We have complied with the Code of Ethics for Professional Accountants issued by the
International Ethics Standards Board for Accountants, which includes independence and
other requirements founded on fundamental principles of integrity, objectivity,
professional competence and due care, confidentiality and professional behavior. In
accordance with International Standard on Quality Control 1, we maintain a
comprehensive system of quality control including documented policies and procedures
regarding compliance with ethical requirements, professional standards and applicable
legal and regulatory requirements.
Work Done
We are required to plan and perform our work to obtain limited assurance about whether
the said information is free from material misstatements In doing so we:

Make enquiries of SPL’s management.

Evaluate the design of the key structures, systems, processes and controls for
managing, recording and reporting the said information.

Perform limited substantive testing on a selected basis and access the records and
discussion with the relevant staff to check that data had been appropriately
measures, recorded, collated and reported; and

Evaluate the disclosure and presentation of the said information.
Basis for qualified opinion
As per Nuclear Drug Control Regulations, SPL is required to get approval of the updated
list of suppliers from NDCA on yearly basis, however during the year no such approval
was obtained and we observed that the raw materials were purchased from suppliers who
were not in the list of suppliers of last year. Therefore we are unable to determine whether
the raw material procured by SPL comply with the minimum safety requirements as
specified by NDCA.
Qualified opinion
Based on our limited assurance procedures performed, as described above and the
evidence we have obtained, except for the possible effects of the matter described in the
basis for qualified opinion paragraph, nothing has come to our attention that causes us to
believe that the selected information for the 2015 reporting year has not been prepared, in
all material respects, in accordance with the Nuclear Drug Control Regulations.
Other Matters
Our report has been prepared solely for the purposes of SPL’s compliance with the
reporting requirements relating to Sections XXX of the NDCR and is not intended to be
and should not be used for any other purpose. Our duties in relation to this report are
owed solely to NDCA, and accordingly, we do not accept any responsibility for loss
occasioned to any other party acting or refraining from acting based on this report.
XYZ Chartered Accountants
Engagement partner: ABC
Dated: 08 December 2016
Karachi
Page 6 of 8
Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Winter 2016
Ans.7
(a)
Evaluation of the situation:

Amount of Rs. 2.5 billion is approximately 16.67 times of profit before tax and
is therefore material.

Status of Rs. 500 million outstanding since last year, whether the company is
still negotiating with the government or has decided to write off the same.

Evidence available in respect of Rs. 2 billion (agreement or any
correspondence)

The written representation provided by management is not an alternative to
other audit evidence in the absence of any written agreement or
correspondence and cannot in itself taken as a reliable audit evidence, when in
this case the audit report was also qualified with respect to this matter.

Evaluate the implications of management’s refusal on the auditor’s assessment
of the relevant risks of material misstatement, including the risk of fraud, and
on the nature, timing and extent of other audit procedures; and
Course of action:

Inquire management of reasons of refusal and seek audit evidence as to their
validity and reasonableness.

Perform alternative audit procedures to obtain relevant and reliable audit
evidence.

Check subsequent clearance from post year end bank statements to verify if
Rs. 2 billion has been received.

Communicate with those charged with governance. If:
–
the auditor concludes that management’s refusal to allow the auditor to
send a confirmation request is unreasonable; or
–
the auditor is unable to obtain relevant and reliable audit evidence from
alternative audit procedures,
(b)
Evaluation of the situation:
The loss on disposal has reduced profit before tax by Rs. 20 million and is
approximately 13.33% of profit before tax and is therefore material. Moreover, the
transaction is a related party transaction due to 20% director’s holding
in NPL.
Course of action:
(i)
Consider reasons for disposal of building.
(ii) Promptly communicate the relevant information of the related party
transaction to other members of the audit team.
(iii) Request management to identify all transactions with NPL for further
evaluation.
(iv) Reconsider the risk that other related parties or significant related party
transactions may exist that management has not previously identified or
disclosed to the auditor, and perform additional audit procedures.
(v) Review the appropriateness of depreciation policy. If it is not appropriate then
review the remaining non-current assets to ensure that they are not impaired.
(vi) Investigate the influence of director with respect to the said transactions even
though he did not participate in the voting.
(vii) Inquire as to why the entity’s control over related party relationships and
transactions failed to enable the identification or disclosure of the related party
relationships or transactions.
(viii) If the non-disclosure by management appears intentional (and therefore
indicative of risk of material misstatement due to fraud), evaluate the
implications for the audit.
Page 7 of 8
Audit, Assurance and Related Services
Suggested Answer
Certified Finance and Accounting Professional Examination – Winter 2016
(ix)
(x)
Ans.8
(a)
(i)
Obtain the following evidence:

A copy of the sale agreement

A copy of any valuation report carried out on the asset

Evidence of receipt of the proceeds through the bank

The calculation of the loss (this should be checked for accuracy)
Ensure proper disclosure of related party transaction in the financial
statement.
As Jamal is associated with KL since last eleven years it will create a
familiarity and self-interest threats.
The threats created are significant as:
 association of Jamal with KL is of 11 years;
 Jamal has a key/main role in the audit engagement of KL, being the
engagement partner; and
 the engagement is a statutory audit.
Other factors on which the significance of threats will depend are:
 Structure of the firm;
 Whether the client’s management team has changed;
 Whether the nature or complexity of the client’s accounting and reporting
issues has been changed.
(ii)
As Jamal has served the audit client for six or more years when the KL
becomes a listed company, however as per the requirements of Code of Ethics
Jamal can still continue to serve as an engagement partner for a maximum of
two additional years.
Further, Jamal can continue to serve as an engagement partner for more than
the period specified, provided an independent regulator has provided an
exemption from partner rotation. If such an exemption is not provided then
the auditor should leave the audit engagement.
(b)
Since the services comprise of reviews and recommendations (as quality assessment)
for improvement of the client's Internal Audit function and giving recommendations
with respect to improving the structure of the internal audit department and the
quality of its staff, does not seem to involve any management decision or taking
management responsibility, therefore these are the allowed services under code of
ethics and listing regulations.
However, if it appears that the recommendations are binding on management which
may be the case if the management is not competent to evaluate the
recommendations or exercise its own judgment, then these services cannot be
performed,
(The End)
Page 8 of 8
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Audit, Assurance and Related Services
SESSION
Certified Finance & Accounting Professional
(CFAP) Examination - Winter 2016
General
Quite a poor performance was witnessed in this attempt. It was noticed that the candidates
were not prepared on the new areas that have been introduced in the syllabus i.e. special
reports, which were tested in Questions 5 and 6. Poor performance was also witnessed in
Question four which required knowledge about audit report of unlisted companies which
was most probably due to selective studies. However, poor performances were also
witnessed in Questions 2 and 3 which was quite surprising as these were routine questions
on issues which have been tested quite frequently.
Question-wise Comments
Question 1
This question pertained to Key Audit Matters section of the audit report. It consisted of
four parts and in each part, a situation was given and the candidates were required to give
their advice in the given context. Performance in each part is discussed below:
Question 1(a)
Majority of the students could not explain the main issue i.e. that other key audit matters
can be reported in the case of an adverse report also but reporting of such matters does not
imply that the financial statements as a whole are more credible than would be appropriate
in the circumstances. Many students were of the view that Key Audit Matters are not
reported where an adverse report is issued.
Question 1(b)
This was fairly answered by majority of the students as they correctly identified that
matters giving rise to a qualification are not discussed again in the Key Audit Matters
section, however, reference to basis of qualified opinion is included therein.
Question 1(c)
Average performance was witnessed in this part as only about 50% of the students could
state categorically that prior period items would not be included in Key Audit Matters
even if opinion in the audit report has been expressed in respect of current as well as the
prior period.
Page 1 of 4
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination Winter 2016
Question 1(d)
This proved difficult as only few candidates were able to specify the circumstances under
which the client’s request for non-disclosure could have been accepted by the auditor.
Most of the students were of the view that the matter had to be disclosed in any case.
Question 2
This question was based on a scenario whereby a company was facing a situation in which
its status as a going concern seemed to be in doubt. The requirements were specified in
two different parts as discussed below:
Question 2(a)
Overall, the students failed to understand the crux of the requirement which was to list the
details which the auditor would expect in the management’s plan regarding turnaround of
the company. Instead, most of them tried to narrate the procedures which the auditor
would perform to assess the plan. Some of the students restricted themselves to the
recommencement of operations and ignored the other aspects. Many students kept on
repeating the same point again and again. Such practice not only results in wastage of
precious time which could be better utilized in planning the other answers but also results
in mistakes as contrary views are sometimes expressed which exposes the candidate
unnecessarily.
Question 2(b)
Performance in this part was the worst. Most of the students focused on explaining the
concept of Key Audit Matters rather than the key aspects or risk that the audit team should
focus on besides the issue of going concern. Many students seemed to be in continuation
of part (a) and kept on discussing the issue of commencement of operations.
Question 3
This question contained extracts from the financial statements of a company and certain
other information about some aspects of the business. As discussed earlier, despite being a
straight forward question, the overall response was quite poor. The requirements were
broken up into two parts. Comments on each part are given below:
Question 3(a)
The requirement was to evaluate the overall control environment which includes both the
positive and the negative aspects. Most of the students identified that the entity was
closely held but failed to cover the resulting risks. Further, most of them failed to cover
the positive aspects which include that internal audit department is headed by a chartered
accountant and chairman of the audit committee was an independent member of the
Board.
Page 2 of 4
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination Winter 2016
Question 3(b)
The requirement was to identify the areas of risk for the audit and the planned audit
approach. The performance remained poor because most of the students focused only on
one or two areas and ignored the rest. Those who stressed on the going concern aspect
ignored some of the other issues such as risk as regards the opening balances, risk of fraud
and overstatement of deferred tax asset. On the other hand, some of the candidates ignored
the going concern issue altogether. Some of the students identified the risk that discount
would not be accounted for, which was totally irrelevant as lower prices by a new supplier
does not mean that discount has been offered.
Question 4
The overall performance was below average although some of the students (about 2%) did
really well and secured full marks also. About 15% of the students could not secure any
mark and most of them stated that there are no differences between the two reports. Many
candidates identified the key audit matters as the only difference.
Question 5
The overall performance was quite poor. Most of the students laid all their emphasis on
appointment and evaluation of the expert, which was just one of the many procedures that
needed to be performed. For other relevant points, the candidates are advised to refer to
ICAP’s suggested answers.
Question 6
This was the worst answered question of the attempt as only 16% of the students could
secure passing marks whereas more than 50% of the students could not secure any mark.
The requirement was quite straight forward because drafting of the report is usually
considered easy at this level but utter lack of knowledge resulted in poor performance.
The candidates are advised to seek guidance in respect of this question from ICAP’s
suggested answers.
Question 7
This question consisted of two scenarios and in each case the candidates were required to
evaluate the situation and discuss the course of action to be taken by the auditor. Each
scenario (part) is discussed hereunder:
Question 7(a)
According to the scenario given in this part of the question, a company had recognized
late payment charges of Rs. 2.5 billion as due from the government and during the
previous year the auditor had qualified the report in this regard. This year, the auditor was
informed that the government has agreed to pay Rs. 2.0 billion and that the management
was willing to provide written representation in this regard but did not want the auditor to
send a confirmation request.
Page 3 of 4
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination Winter 2016
The Overall performance was average as about 20% of the students did really well.
However, among the rest, majority could not explain that the written representation would
not be considered a reliable audit evidence in the given situation and the reason thereof.
Further, most of the students did not say anything about the significance of the amount.
Moreover, while discussing the course of action for the auditors, communicating with
those charged with governance was discussed by a small proportion of the students only.
Question 7(b)
Surprisingly, majority of the students were not able to identify that transaction is a related
party transaction because a director of the company also held 20% shares in the other
company (the buyer). Quite obviously, such students could not specify the appropriate
course of action available to the auditor.
Besides the above, most of the students failed to identify the depreciation and impairment
aspects as well. Many of the students failed to evaluate the situation properly including
materiality.
Question 8(a)
The performance in this part of the question was satisfactory. The only point which caused
confusion was that the company had been listed during the current year only and hence the
rotation of the partner was not necessary under the given circumstances. Moreover, very
few could comment on the second possibility i.e. where firm was unable to find suitable
replacement. The candidates are advised to seek further guidance in respect of this
question from ICAP’s suggested answers.
Question 8(b)
According to the scenario in this part of the question, a firm has received a request from
one of its audit clients to evaluate the internal audit function and give recommendations
for improvement. The performance was below average as most of the students were
unable to realize that since the work did not involve any management decision or taking
management responsibility, therefore it comes under the purview of allowed services
under the code of ethics and listing regulations.
(THE END)
Page 4 of 4
AUDIT, ASSURANCE AND RELATED SERVICES
Summary of Marking Key
Certified Finance and Accounting Professional Examination – Winter 2016
Note regarding marking scheme:
The marking scheme is given as a guide. However, markers also award marks for alternative
approaches to a question and relevant/well-reasoned comments/explanations. Moreover, the
available marks in a question may exceed the total marks.
Mark(s)
A.1
Advice on appropriateness of inclusion of Key Audit Matters in the audit
report where the audit report contains adverse opinion
2.0
Advice on appropriateness of inclusion of details of qualification in the audit
report in the Key Audit Matters section of the audit report
3.0
Advice on whether Key Audit Matters of prior years should also be included
where the audit report pertains to current as well as previous year
3.0
Advice with regard to a situation in which a significant matter may not be
included in Key Audit Matters section of the audit report
3.0
(a)
01 mark for each point/matter to be included in the management’s plan
12.0
(b)
01 mark for stating each matter that the auditor should consider
5.0
(a)
Evaluation of the overall control environment
5.0
(b)
(a)
(b)
(c)
(d)
A.2
A.3
Up to 01 mark for identification of each risk
0.5 mark for each planned audit approach against the identified risk
7.0
8.0
01 mark for identification of each difference between audit report of a listed
company and an unlisted company
4.0
A.5
01 mark for verification of each procedure / step to be performed
6.0
A.6
Preparation of draft report layout and inclusion of standard statements
Drafting the ‘basis for qualified opinion; and ‘qualified opinion’
01 mark for each procedure which may be performed by the auditor
6.0
5.0
3.0
A.7
(a)
01 mark for evaluation of each issue
Up to 01 mark for determination of each course of action
4.0
3.0
(b)
01 mark for evaluation of each issue
01 mark for determination of each course of action
2.0
7.0
A.4
Page 1 of 2
AUDIT, ASSURANCE AND RELATED SERVICES
Summary of Marking Key
Certified Finance and Accounting Professional Examination – Winter 2016
A.8
(a)
(b)
(i)
0.5 mark for identification of each threat
01 mark for discussing each factor on which significance of threat
would depend
Mark(s)
1.0
5.0
(ii)
Up to 02 marks for discussing the need of rotation, under each situation
3.0
Evaluation of the situation
Discussion on allowability of services under Code of ethics and listing
regulations
2.0
1.0
(THE END)
Page 2 of 2
Certified Finance and Accounting Professional Stage Examinations
The Institute of
Chartered Accountants
of Pakistan
8 June 2017
3 hours – 100 marks
Additional reading time – 15 minutes
Audit, Assurance and Related Services
Q.1
Your firm is the external auditor of Namura Limited (NL), a listed company. Following
information has been made available to you at the planning stage:
Extracts from statement of comprehensive income for the year ended 31 March 2017
2017
2016
------- Rs. in ‘000 ------Profit/(loss) before tax
161,990
(241,075)
Taxation
(50,000)
74,000
Profit/(loss) after taxation
111,990
(167,075)
Extracts from statement of financial position as at 31 March 2017
2017
2016
Assets
-------- Rs. in ‘000 -------Property, plant and equipment
1,472,690
1,475,000
Intangible assets
650,000
750,000
Investment in PCL Limited
75,000
250,000
Deferred tax asset
175,000
199,000
Current assets
850,000
723,015
3,397,015
3,222,690
Equity and liabilities
Share capital
Reserves
Long term debt
Current liabilities
700,000
(378,010)
1,652,000
1,248,700
3,222,690
700,000
(490,000)
1,920,000
1,267,015
3,397,015
In February 2017, the company has increased its product prices by 20% after consultation
with it’s legal advisor, which has resulted in additional revenue of Rs. 200 million.
However, in March 2017, a Regulatory Authority has issued a show cause notice against the
price increase and has fixed a date for hearing at 28 June 2017.
In 2013, NL had developed a product, Vital, at a cost of Rs. 350 million. Vital is a premium
product which has a very large market with no significant competition. It was registered
with the patent registration authority in the same year. The total useful life of the intangible
is estimated as 10 years. A competitor has recently announced the successful development
of a product which is expected to reduce the market share of Vital. NL’s marketing director
has informed that the product would be launched by the end of next year.
Required:
(a) Specify the information which you would like to obtain for evaluating the key issues
arising from the above scenario.
(b) Assuming that all matters identified by you have been resolved to a larger extent and
you intend to issue an unqualified report, draft points to be included in the letter to
those charged with governance specifying the significant matters which you would
like to highlight.
(10)
(10)
Audit, Assurance and Related Services
Q.2
Page 2 of 3
Alpha Petroleum Limited (APL) has obtained a loan in foreign currency from Asian
Development Bank. APL has entered into currency swaps contract to hedge foreign
currency risk. APL carries it’s currency swap contract at fair value in the financial
statements.
APL also has significant amount of staff retirement benefit liability (defined benefit plan) on
the statement of financial position.
Required:
(a) Specify the matters to be considered by the auditor in planning the audit of currency
swap contract.
(b) Recommend the audit procedures in respect of the defined benefit plan liability and
for valuation of currency swap contract.
Q.3
(a)
(07)
Sameer works as manager assurance in your firm. He has close personal relationship
with Saqib, who is the CFO at one of your audit client. However, you haven’t
assigned that client to Sameer.
Required:
Evaluate the above situation and identify threat(s), if any, and related safeguards.
Q.4
(09)
An audit client of Akbar Ali & Co. has approached your firm for appointment as
internal auditor. Your firm and Akbar Ali & Co. Chartered Accountants have a
common quality control department and share common quality control policies and
procedures.
Required:
Discuss the above scenario in the light of Code of Ethics assuming the said client is a
public interest entity.
(b)
(06)
(03)
Spectrum Limited has patented a manufacturing process for the production of Product X. It
has allowed Lava Company Limited (LCL) to produce and market product X against a
royalty of 4% of the sales value. LCL is a large manufacturing concern and sells a number of
products. It issues serially numbered invoices and each invoice contains a number of
products. Different prices are charged from different categories of customers, according to
price lists duly approved at the start of the year.
Spectrum Limited has engaged your firm to carry out agreed upon procedures relating to
verification of the amount of royalty.
Required:
Draft a report of factual findings in accordance with the relevant standard. The report
should contain at least three procedures and three findings. You may assume necessary
details wherever required.
Q.5
(12)
Your audit client Mars Pakistan Limited (MPL), is a multinational company. At the group
level, a decision has been taken whereby the payroll function of all group companies has
been outsourced to a payroll processing firm PayPro situated in London.
According to the terms of the contract, after processing, the payroll is sent to MPL for
authorisation. PayPro shares type 1 report with all of its clients on an annual basis. Due to
resource constraints for this engagement, it might not be possible for you to visit PayPro for
testing their controls.
Required:
Evaluate the above situation and explain how would you test the operating effectiveness of
controls over payroll applied by PayPro?
(10)
Audit, Assurance and Related Services
Q.6
(a)
Page 3 of 3
You have recently completed the audit of Naveed Limited, a listed company.
Significant matters concerning the audit include classification of certain debts as long
term. The debt covenants of the loans have been breached but subsequent to the year
end the banks have confirmed verbally that they will not demand immediate
repayment.
Required:
Evaluate the above situation and draft the modification, if required, for inclusion in
the audit report. You may assume necessary details.
(b)
The Board of Directors of an insurance company is very concerned about the
increasing incidents of fraud in verification of claims by the surveyors.
Required:
Suggest controls that should be implemented by the company for claim verification.
Q.7
(05)
Your firm is the auditor of Noor Group of Companies which has three subsidiaries namely
Venus Limited, Jupiter Limited and Sun Limited. Your firm is the auditor of all the group
companies except for Sun Limited, which is incorporated in a foreign country.
Required:
Explain the procedures you would perform to decide the extent of reliance on the work of
the auditor of Sun Limited.
Q.8
(06)
(10)
Delicacy Foods Limited (DFL) produces and sells ice cream and juices. It’s ice cream plant
is quite old and the management is planning to invest in an advanced technology for
manufacturing ice cream, which would result in lowering the costs and would also enable
the company to launch a new range of premium flavours. DFL has sufficient cash to fund
50% of the necessary capital expenditure and has approached its bank for a loan of
Rs. 400 million to finance the remaining amount.
To meet the banks requirement DFL has prepared a forecast comprising of statement of
comprehensive income for the next three years. It has asked your firm to provide a report on
the forecast.
The following information is available to you in respect of the above:
(i)
(ii)
(iii)
The machinery is expected to be available for commercial production from
1 January 2018.
DFL is expecting a decrease in production cost by 20% and plans to sell the new
premium flavours at 30% above the price of regular flavours.
Operating expenses mainly include staff cost, depreciation, repairs and maintenance.
Required:
State the examination procedures to be used in respect of the above forecast.
(THE END)
(12)
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2017
Ans.1
(a)
I would like to obtain the following information for evaluating the key issues arising
from the given scenario:
Going concern:
(i) Management’s assessment/future projections justifying the use of going
concern assumption.
(ii) Assumptions used therein.
Impairment of intangible assets:
(i) Patent agreement and the amortization policy.
(ii) Working related to impairment testing and the assumptions used there in.
Deferred tax asset:
(i) Projections of future profitability.
(ii) Assumptions used therein.
Show cause notice:
(i) Grounds on which RA has issued the notice.
(ii) Legal advisor’s opinion on the matter.
(iii) Details of previous price increases, their basis and whether any approval was
sought /taken.
(iv) Correspondence with the relevant regulatory authorities.
Investment in PCL:
(i) Reason for decrease in investment i.e. disposal, impairment, recording of
loss/dividend under equity method.
(ii) Gain/loss on such disposal and how was it accounted for.
(iii) Procedure followed to carry out the disposal.
(iv) In case of loss, impact on remaining investments, if any.
Other matters:
(i) Information regarding the events occurring up to the date of the auditor’s
report.
(b)
The following matters will be reported to those charged with governance:
Going concern:

The entity has significant brought forward losses.

Significant amount of liabilities are outstanding. The current liabilities exceed
the current assets of the company and the current ratio is only 0.68.

Long-term debt is 5.13 times the equity.

Although, the profitability, debt equity ratio and current ratio has improved
this year, the improvement is mainly due to the price increase. If the decision
of the RA goes against the company, the situation could become much worse.

Key assumptions of the future projections provided by the management.
Decrease in carrying value of investment in PCL:

Reason for the decrease and its implication (if any).

Significance of the matter and any defect in the process followed to carry out
the transaction.
Show cause notice by RA:

Details of the notice issued by RA, its significance to the financial statements.

Disclosure requirement in the financial statements.
Page 1 of 7
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2017
Impairment of intangibles:

Results of impairment testing and the key assumptions used.
Deferred tax:

The recognition of deferred tax asset is subject to the availability of future
taxable benefits.

Key assumptions of the working provided by the management in respect of the
above.
Ans.2
(a)
While planning the audit of currency swap contracts, the auditor is required to
obtain the understanding of the following in order to provide a basis of the
identification and assessment of the risks of material misstatement for estimates
used in the valuation of currency swap as per the requirement of ISAs:
(i)
The requirements of the applicable financial reporting framework relevant to
accounting estimates, including related disclosures.
(ii) Management means / procedures for identification of transactions, events and
conditions that may give rise to new, or the need to revise existing, accounting
estimates.
(iii) How management makes the accounting estimates, and an understanding of
the data on which they are based, including:
 The method used in making the accounting estimate.
 The assumption underlying the accounting estimates.
 Relevant controls.
 Whether management has used an expert.
 Consider the use of auditor’s expert
 Whether there has been or ought to have been a change from the prior
period in the methods for making the accounting estimates, and if so, why.
 Whether and, if so, how management has assessed the effect of estimation
uncertainty.
(b)
Audit procedures to be performed for valuation of currency swap contract:
(i)
Obtain the details of the foreign currency swap contracts;
(ii) Assess the reasonableness of assumptions used in the foreign currency swap
contracts;
(iii) Verify the valuation rates used, if available from authentic websites (e.g.
Bloomberg);
(iv) Check subsequent settlement of contracts, if any, for verification of the
valuation rates.
(v) In case valuation methodologies have been used in valuation of derivative
contracts then apart from assessing the reasonableness of the assumptions, get
the valuation re-performed for the contract by the auditor.
(vi) Evaluate whether the auditor’s expert has the necessary competence,
capabilities and objectivity for the auditor’s purposes.
Audit procedures to be performed for actuarial liability:
(i) Assess that the management expert should have relevant competence and
capable enough of doing the tasks assigned.
(ii) Evaluate whether the auditor’s expert has the necessary competence,
capabilities and objectivity for the auditor’s purposes.
(iii) Obtain and ensure the completeness and accuracy of the data in respect of staff
retirement benefits provided by the management to the management and
auditor’s expert.
Page 2 of 7
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2017
(iv) Independently assess the accuracy of the assumptions pertaining to salary
increase rate, discount rate, retirement age, pension indexation, if any on the
basis of historical trend and current status of the things.
(v) Discuss and resolve the differences, if significant, between the report of the
expert and report of auditor’s expert.
(vi) Ensure that proper disclosure is given in the financial statements in respect of
defined benefit plan liability.
Ans.3
(a)
Our firm and Akbar Ali and Company are Network firms due to common quality
control department and common quality control policies and procedures.
The firm shall be independent of the audit client of the network firms, also.
Therefore, the provision of internal audit services will create a self-review threat to
independence, in the same manner, as if the assignment was taken by the firm itself.
Since our client is a public interest entity, we shall not provide the internal audit
services relating to the following:

A significant part of the internal controls over financial reporting.

Financial accounting systems that generate information that is significant to
the client’s accounting records or financial statements on which the firm will
express an opinion: or

Amounts or disclosures that are material to the financial statements on which
the firm will express an opinion.
The firm may accept the engagement except for the above mentioned internal audit
service but it should ensure that it does not get involved in management decision
making.
If the firm gets involved in management decision making, the threat created would
be so significant that no safeguards would reduce the threat to an acceptable level.
(b)
Due to close personal relationship between Sameer and Saqib, self-interest,
familiarity and intimidation threats may be created.
The threats are significant due to close personal relationship and managerial
positions of Saqib and Sameer. The significance will also depend on the interaction
of Sameer with the assurance team;
Safeguards may include:

structuring Sameer’s responsibilities to reduce any potential influence over the
assurance engagement; or

having the relevant assurance work reviewed by a chartered accountant.
Page 3 of 7
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2017
Ans.4
REPORT OF FACTUAL FINDINGS
Board of Directors,
Spectrum Limited,
Karachi.
Dear Sirs,
We have performed the procedures agreed with you and enumerated below with respect
to the verification of royalty. Our engagement was undertaken in accordance with the
International Standards on Related Services applicable to agreed upon procedures
engagements. The procedures were carried out solely to assist you in verification of the
royalty.
The procedures are summarised as follows:
(i)
(ii)
(iii)
We obtained the list of all invoices issued by the company and agreed the total with
the total sales reported in the financial statements.
We selected every 10th invoice and traced the sales (if any) of product X, from the
invoice onto the list of transactions and checked the price charged with the rate list
applicable to different customers.
For every selected invoice of product X, we checked that the royalty had been
recorded as per the agreed rates.
Findings
We report our findings below:
(i)
(ii)
(iii)
With respect to item (i) we found that the total list of all invoices was in agreement
with the total sales reported in the financial statements.
With respect to item (ii) we found that price charged was in agreement with the rate
list.
With respect to item (iii) we found that royalty had been recorded as per the agreed
rates.
Because the above procedures do not constitute an audit or a review in accordance with
International Standards on Auditing or International Standards on Review Engagements,
we do not express any assurance on the royalty.
Had we performed additional procedures or had we performed an audit or review of
financial statements in accordance with International Standards on Auditing or
International Standards on Review Engagements, other matters may have come to our
attention that would have been reported to you.
Our report is solely for the purpose set forth in the first paragraph of this report and for
your information and is not to be used for any other purpose or to be distributed to any
other parties. This report relates only to the accounts and items specified above and do
not extend to financial statements of LCL, taken as a whole.
AUDITOR
NAME
ADDRESS
Page 4 of 7
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2017
Ans.5







Ans.6
(a)
As the payroll is sent to MPL for authorization, therefore it implies that a high
degree of interaction exist between PayPro and MPL.
In these circumstances MPL can easily implement effective controls over those
transactions.
Accordingly, there is no limitation of scope because of our inability to visit PayPro.
We would test controls implemented by MPL for the authorization of payroll and
related data.
However, there is still a need to evaluate the controls applied by PayPro.
A type 1 report will not be helpful in evaluation of controls at PayPro. Though, it
includes the service auditor’s opinion on the description of the service organisation’s
system, control objectives and related controls and the suitability of the design of
the controls to achieve the specified control objectives, it does not provide any
evidence of the operating effectiveness of the relevant controls.
Since PayPro only provides type 1 report therefore, we may contact PayPro,
through MPL, to request that type 2 report should also be provided. Further, we
may also decide not to rely on the auditor giving the type 2 report. In that case, we
may appoint another auditor to perform procedures at PayPro i.e to test the
operating effectiveness of those controls.
Evaluation of the situation:

The debts should have been shown as current debts in accordance with the
terms of the loan agreements.

The verbal confirmation from the banks cannot be a replacement to avoid
showing loans as current liabilities as nothing is in writing.
Furthermore, even if the bank confirms it even then it is a subsequent
non-adjusting event as this has been done subsequent to year-end, and on the
balance sheet there was a breach of loan covenants.

In addition to this the period of grace should be atleast of twelve months after
the reporting date within which the Naveed Limited can rectify the breach.
Basis for qualified opinion
As more fully explained in note xx to the financial statements, the debt covenants of
the loans as at 30 June 20XX have been breached by the company. Accordingly, the
long term loans reflected in the statement of financial position of the company
amounting to Rs. XXX million should have been classified as “current liabilities” as
the terms of the loan require immediate repayment of loan in case of breach of debt
covenants.
(b)
Suggested controls for claim verification:
(i)
Employ a panel of qualified surveyors with good reputation.
(ii) Segregation of duties relating to the claim process.
(iii) Monitoring the time lag between policy issuance and claim reported and
between the claim lodge and settlement date, and investigate unusual cases.
(iv) A second survey may be conducted on a test basis especially in unusual cases.
(v) Surveyors should be required to submit pictures of the damaged assets
whenever possible.
(vi) Monitor which agent and insuree has the highest claim ratio.
(vii) Review the total claims verified by each surveyor and compare it with value of
assets insured to identify unusual ratio.
Page 5 of 7
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2017
Ans.7
Procedures:
(i)
Assess whether the degree of access to be provided to us by the component auditor
is sufficient.
(ii)
Assess the professional competence of Sun Limited’s (SL) auditor by obtaining
information about his membership with relevant professional bodies.
(iii) Obtain confirmations from professional bodies under which the auditor of SL is
registered with and his good standing etc.
(iv) Obtain a statement from the auditor of SL that it has complied with the relevant
ethical requirements.
(v)
Review the code of ethics followed by the auditor of SL, and assess whether ethical
requirements of that code are in agreement with the ethical requirements relevant
to the group audit.
(vi) Ascertain the competence and qualification of staff assigned by the auditor of SL to
assess whether they have necessary skills to address the issues related to the group
audit.
(vii) Ascertain the quality control policies and procedures used by the auditor of SL.
(viii) Determine whether the auditor of SL’s is a member of network of audit firms and
inquire whether the network firm carries out regular quality reviews.
(ix) Discuss the audit methodology to be used by SL’s auditor and whether it would be
sufficient for the group audit and determine the necessary audit instructions to be
issued.
(x)
Identify the differences in the applicable financial reporting framework of the group
and the component, if any and obtain a statement that the component auditor
understands the applicable financial reporting framework.
(xi) Request any results of monitoring or inspection visits conducted by the regulatory
authority.
Ans.8
Examination procedures should include the following:













Obtain an understanding of the business of DFL.
Discuss how the management has developed the significant assumptions and assess
the reasonableness thereof.
Inquire about the process of making the prospective information and the internal
controls over the system used to prepare prospective financial information.
Inquiry about the expertise and experience of those preparing the information.
Inquire about accuracy of previous prospective information made by the
management and the estimates and basis used.
Ensure that accounting policies used in preparing the prospective financial
information are consistent with those used in historical financial information and
comply with the applicable financial reporting framework.
Confirm expected timeframe for the import and installation of machinery by
referring to vendor quotations/communication.
Confirm that the sales of new flavours have been assumed from the date the
machine is ready for commercial production.
Verify the production capacity of the new plant to corroborate the projected
revenue.
Review market research documents to assess the reasonableness of projected sales
quantities and review prices charged by competitors for the premium flavors.
Assess the reasonableness of staff cost through average employee turnover rate and
the salary growth rates.
Discuss the expected decrease in production costs with the management and review
the information on which the projection is based.
Obtain information from management about major ingredients and wastage
percentages etc. to review the projected cost of raw material.
Page 6 of 7
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2017








Review how cost of repairs and maintenance has been projected and whether the
fact that it is a new plant has been considered.
Verify the cost of the new plant from supplier’s quote and bills related to import and
installation costs to calculate the depreciation expense.
Check how the management has accounted for the gain/loss on disposal of the old
plant and equipment.
Check whether projections related to juices segment are based on past trends and
discuss any major changes in the market, processes, etc. and the effect thereof on the
projections.
Recalculate the finance cost.
Review the tax workings.
Carry out analytical review.
Obtain written representations from the management regarding the assumptions
used intended use of prospective financial information and management’s
acceptance of its responsibility for the prospective comprehensive income.
(The End)
Page 7 of 7
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Audit, Assurance and Related Services
Examiners’ comments and Suggested answers
Certified Finance and Accounting Professional (CFAP) – Summer 2017
Examinations
Overall General Comments:
The overall performance was slightly better than the previous attempt as 14.07% students
secured passing marks as compared to 13.70% in the previous attempt. Performance
remained weak in those areas which have not been tested in the recent past like question
1(b) and question 2 and 5 and also where a slightly different style of testing was adopted
such as in question 1(a).
Question-wise comments:
Question 1
General comments:
02.59% candidates secured passing marks in this question.
Part (a)
Common errors:
1. Instead of stating the information which the auditor would like to obtain, students tried
to identify the risks and in some cases, the procedures which would need to be
performed.
2. Generally the students didn’t consider the need to obtain information about the
lawyer’s opinion. Probably they felt that the prices have been raised after consulting
the lawyer and therefore no further opinion was required. In fact, lawyer’s opinion on
both situations i.e. the basis on which he had allowed the company to proceed with the
price increase and his views on the notice received, were important for the auditor.
3. Some other key points such as grounds on the basis of which the notice was issued,
disposal of investment and the consequent issues, information regarding the events
occurring up to the date of the auditor’s report, assumptions used for projecting future
profitability and impairment testing, etc. were also not identified.
Suggested answer:
I would like to obtain the following information for evaluating the key issues arising from the
given scenario:
Going concern:
(i)
(ii)
Management’s assessment/future projections justifying the use of going concern
assumption.
Assumptions used therein.
Page 1 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017
Impairment of intangible assets:
(i)
(ii)
Patent agreement and the amortization policy.
Working related to impairment testing and the assumptions used there in.
Deferred tax asset:
(i)
(ii)
Projections of future profitability.
Assumptions used therein.
Show cause notice:
(i)
(ii)
(iii)
(iv)
Grounds on which RA has issued the notice.
Legal advisor’s opinion on the matter.
Details of previous price increases, their basis and whether any approval was sought
/taken.
Correspondence with the relevant regulatory authorities.
Investment in PCL:
(i)
(ii)
(iii)
(iv)
Reason for decrease in investment i.e. disposal, impairment, recording of loss/dividend
under equity method.
Gain/loss on such disposal and how was it accounted for.
Procedure followed to carry out the disposal.
In case of loss, impact on remaining investments, if any.
Other matters:
Information regarding the events occurring up to the date of the auditor’s report.
Part (b)
Common errors:
1. Students were unaware of what matters are to be reported to those charged with
governance. They only discussed the administrative matters relating to the conduct of
audit.
2. Instead of mentioning the specific information based on the given scenario, selected
contents of ISA 260 were reproduced.
3. Though it was clearly mentioned in the question that it may be assumed that all issues
have been satisfactorily resolved, matters relating to qualification of report were
commonly discussed.
4. A key point that the improved performance seemed mainly on account of price
increase and any adverse decision of the regulator with respect to price increase may
have serious consequences, was missed.
Suggested answer:
The following matters will be reported to those charged with governance:
Going concern:

The entity has significant brought forward losses.
Page 2 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017




Significant amount of liabilities are outstanding. The current liabilities exceed the current
assets of the company and the current ratio is only 0.68.
Long-term debt is 5.13 times the equity.
Although, the profitability, debt equity ratio and current ratio has improved this year, the
improvement is mainly due to the price increase. If the decision of the RA goes against
the company, the situation could become much worse.
Key assumptions of the future projections provided by the management.
Decrease in carrying value of investment in PCL:


Reason for the decrease and its implication (if any).
Significance of the matter and any defect in the process followed to carry out the
transaction.
Show cause notice by RA:


Details of the notice issued by RA, its significance to the financial statements.
Disclosure requirement in the financial statements.
Impairment of intangibles:

Results of impairment testing and the key assumptions used.
Deferred tax:


The recognition of deferred tax asset is subject to the availability of future taxable
benefits.
Key assumptions of the working provided by the management in respect of the above.
Question 2
General comments:
15.45% candidates secured passing marks in this question.
Part (a)
Common errors:
1. The poor performance was mainly because the candidates did not appreciate the fact
that the question was on planning rather than execution and/or because they had very
little knowledge of currency swaps.
2. In the planning stage the auditors are mainly concerned with assessing the risk of
material misstatement and in this regard they focus on gathering relevant information.
Generally the candidates could not explain this approach with confidence and
produced vague answers.
3. General issues concerning the planning were mentioned rather than issue specific to
foreign currency swap.
4. The candidates failed to understand that currency swap contracts represent a
significant accounting estimate, therefore the requirements of ISA-540, Auditing
Accounting Estimates, including fair value Accounting Estimate, and related
disclosure were mostly ignored.
Page 3 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017
Suggested answer:
While planning the audit of currency swap contracts, the auditor is required to obtain the
understanding of the following in order to provide a basis of the identification and assessment
of the risks of material misstatement for estimates used in the valuation of currency swap as
per the requirement of ISAs:
(i)
(ii)
(iii)
The requirements of the applicable financial reporting framework relevant to
accounting estimates, including related disclosures.
Management means / procedures for identification of transactions, events and
conditions that may give rise to new, or the need to revise existing, accounting
estimates.
How management makes the accounting estimates, and an understanding of the data
on which they are based, including:







The method used in making the accounting estimate.
The assumption underlying the accounting estimates.
Relevant controls.
Whether management has used an expert.
Consider the use of auditor’s expert.
Whether there has been or ought to have been a change from the prior period in the
methods for making the accounting estimates, and if so, why.
Whether and, if so, how management has assessed the effect of estimation
uncertainty.
Part (b)
Common errors:
Valuation of Currency Swap
Steps related to verification of the valuation rates were not mentioned.
Actuarial liability
1. Responsibilities of the actuary or the steps to be performed by him were stated instead
of the auditor.
2. Competence of the valuer was discussed in too much detail whereas other steps were
missed.
Suggested answer:
Audit procedures to be performed for valuation of currency swap contract:
(i)
(ii)
(iii)
(iv)
(v)
Obtain the details of the foreign currency swap contracts;
Assess the reasonableness of assumptions used in the foreign currency swap contracts;
Verify the valuation rates used, if available from authentic websites (e.g. Bloomberg);
Check subsequent settlement of contracts, if any, for verification of the valuation rates.
In case valuation methodologies have been used in valuation of derivative contracts
then apart from assessing the reasonableness of the assumptions, get the valuation reperformed for the contract by the auditor.
Page 4 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017
(vi)
Evaluate whether the auditor’s expert has the necessary competence, capabilities and
objectivity for the auditor’s purposes.
Audit procedures to be performed for actuarial liability:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
Assess that the management expert should have relevant competence and capable
enough of doing the tasks assigned.
Evaluate whether the auditor’s expert has the necessary competence, capabilities and
objectivity for the auditor’s purposes.
Obtain and ensure the completeness and accuracy of the data in respect of staff
retirement benefits provided by the management to the management and auditor’s
expert.
Independently assess the accuracy of the assumptions pertaining to salary increase
rate, discount rate, retirement age, pension indexation, if any on the basis of historical
trend and current status of the things.
Discuss and resolve the differences, if significant, between the report of the expert and
report of auditor’s expert.
Ensure that proper disclosure is given in the financial statements in respect of defined
benefit plan liability.
Question 3
General Comments:
50.95% candidates secured passing marks in this question.
Part (a)
Common errors
1.
2.
The students did not understand that the two firms were network firms and
therefore each firm would be subject to the same independence requirement while
accepting an assignment involving clients of the network firms, as would be
applicable in case of its own clients.
Those students who correctly identified that the two firms were network firm,
declared that internal audit assignment cannot be accepted which was not correct as
internal audit assignments pertaining to some areas may still be accepted. (Please
refer suggested answer for further guidance).
Suggested answer:
Our firm and Akbar Ali and Company are Network firms due to common quality control
department and common quality control policies and procedures.
The firm shall be independent of the audit client of the network firms, also.
Therefore, the provision of internal audit services will create a self-review threat to
independence, in the same manner, as if the assignment was taken by the firm itself.
Since our client is a public interest entity, we shall not provide the internal audit services
relating to the following:

A significant part of the internal controls over financial reporting.
Page 5 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017


Financial accounting systems that generate information that is significant to the client’s
accounting records or financial statements on which the firm will express an opinion: or
Amounts or disclosures that are material to the financial statements on which the firm
will express an opinion.
The firm may accept the engagement except for the above mentioned internal audit service
but it should ensure that it does not get involved in management decision making.
If the firm gets involved in management decision making, the threat created would be so
significant that no safeguards would reduce the threat to an acceptable level.
Part (b)
Common errors:
1.
2.
There were two reasons for concern in the given situation i.e. Sameer’s close
relationship with Saqib and their managerial positions. Mostly, the students did not
mention the second point.
Inappropriate safeguards were identified such as (i) ensure that Sameer does not
have close relations with any of the audit team members, (ii) ensure that other
senior managers are also assigned to the job along with Sameer, etc.
Suggested answer:
Due to close personal relationship between Sameer and Saqib, self-interest, familiarity and
intimidation threats may be created.
The threats are significant due to close personal relationship and managerial positions of
Saqib and Sameer. The significance will also depend on the interaction of Sameer with the
assurance team;
Safeguards may include:


structuring Sameer’s responsibilities to reduce any potential influence over the assurance
engagement; or
having the relevant assurance work reviewed by a chartered accountant.
Question 4
General comments:
80.79% candidates secured passing marks in this question.
Common errors:
1.
Totally incorrect procedures were observed such as obtaining confirmation from
selected customers, ensuring that credit notes have been issued in case of sales
returns, procedures to ensure that sales were not overstated, etc. Some of them even
mentioned about obtaining confirmation from Spectrum Limited who had
appointed them!
Page 6 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017
2.
Unrelated findings were reported i.e. which did not arise from the procedures which
had been carried out.
Suggested answer:
Report of Factual Findings
Board of Directors,
Spectrum Limited,
Karachi.
Dear Sirs,
We have performed the procedures agreed with you and enumerated below with respect to
the verification of royalty. Our engagement was undertaken in accordance with the
International Standards on Related Services applicable to agreed upon procedures
engagements. The procedures were carried out solely to assist you in verification of the
royalty.
The procedures are summarised as follows:
(i)
(ii)
(iii)
We obtained the list of all invoices issued by the company and agreed the total with
the total sales reported in the financial statements.
We selected every 10th invoice and traced the sales (if any) of product X, from the
invoice onto the list of transactions and checked the price charged with the rate list
applicable to different customers.
For every selected invoice of product X, we checked that the royalty had been
recorded as per the agreed rates.
Findings
We report our findings below:
(i)
With respect to item (i) we found that the total list of all invoices was in agreement
with the total sales reported in the financial statements.
(ii)
With respect to item (ii) we found that price charged was in agreement with the
rate list.
(iii)
With respect to item (iii) we found that royalty had been recorded as per the agreed
rates.
Because the above procedures do not constitute an audit or a review in accordance with
International Standards on Auditing or International Standards on Review Engagements, we
do not express any assurance on the royalty.
Had we performed additional procedures or had we performed an audit or review of financial
statements in accordance with International Standards on Auditing or International
Standards on Review Engagements, other matters may have come to our attention that
would have been reported to you.
Page 7 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017
Our report is solely for the purpose set forth in the first paragraph of this report and for your
information and is not to be used for any other purpose or to be distributed to any other
parties. This report relates only to the accounts and items specified above and do not extend
to financial statements of LCL, taken as a whole.
AUDITOR
NAME
ADDRESS
Question 5
General comments:
02.17% candidates secured passing marks in this question.
Common errors:
1.
Controls as mentioned in the question were stated, such as, payroll is sent to MPL
for authorization, PayPro shares type 1 report, etc., without any further comments,
whereas, the requirement was to specify the procedures to assess the effectiveness
of the controls.
2.
It was suggested that there was scope limitation and that the assignment should not
be accepted.
3.
General statements were produced such as when a control would be considered to
be operating effectively i.e. when it is expected to control misstatements,
importance of controls in the given situation, assess whether controls employed by
MPL are relevant (it was actually the question as to how to do it), etc.
Suggested answer:







As the payroll is sent to MPL for authorization, therefore it implies that a high degree
of interaction exist between PayPro and MPL.
In these circumstances MPL can easily implement effective controls over those
transactions.
Accordingly, there is no limitation of scope because of our inability to visit PayPro.
We would test controls implemented by MPL for the authorization of payroll and
related data.
However, there is still a need to evaluate the controls applied by PayPro.
A type 1 report will not be helpful in evaluation of controls at PayPro. Though, it
includes the service auditor’s opinion on the description of the service organisation’s
system, control objectives and related controls and the suitability of the design of the
controls to achieve the specified control objectives, it does not provide any evidence
of the operating effectiveness of the relevant controls.
Since PayPro only provides type 1 report therefore, we may contact PayPro, through
MPL, to request that type 2 report should also be provided. Further, we may also
decide not to rely on the auditor giving the type 2 report. In that case, we may appoint
another auditor to perform procedures at PayPro i.e. to test the operating effectiveness
of those controls.
Page 8 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017
Question 6
General comments:
14.55% candidates secured passing marks in this question.
Part (a)
Common errors:
1.
2.
3.
4.
5.
The type of modification drafted was different from the type of modification which
was recommended while evaluating the situation.
It was not clearly stated that the debt needed to be classified as a current liability.
It was suggested that a disclaimer should be given which was totally incorrect.
Basis of qualification was not drafted properly. Mostly, reference to the note to the
financial statements and the financial impact were missing.
Emphasis of matter paragraph was suggested and drafted which was not appropriate
in the given scenario.
Suggested answer:
Evaluation of the situation:

The debts should have been shown as current debts in accordance with the terms of the
loan agreements.

The verbal confirmation from the banks cannot be a replacement to avoid showing loans
as current liabilities as nothing is in writing.
Furthermore, even if the bank confirms it even then it is a subsequent non-adjusting event
as this has been done subsequent to year-end, and on the balance sheet there was a breach
of loan covenants.

In addition to this the period of grace should be atleast of twelve months after the
reporting date within which the Naveed Limited can rectify the breach.
Basis for qualified opinion
As more fully explained in note xx to the financial statements, the debt covenants of the loans
as at 30 June 20XX have been breached by the company. Accordingly, the long term loans
reflected in the statement of financial position of the company amounting to Rs. XXX million
should have been classified as “current liabilities” as the terms of the loan require immediate
repayment of loan in case of breach of debt covenants.
Part (b)
Common errors:
1. Irrelevant controls were specified which could not play any role in the identification of
frauds such as, controls over recording of claims and verification of payments, etc.
were specified which were totally irrelevant.
2. Students did not seem to have any idea about the working of an insurance company
and suggested totally irrelevant and impractical steps i.e. match external surveyor’s
report with internal surveyor’s report, ask the client to sign on the surveyor’s report,
etc.
Page 9 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017
Suggested answer:
Suggested controls for claim verification:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
Employ a panel of qualified surveyors with good reputation.
Segregation of duties relating to the claim process.
Monitoring the time lag between policy issuance and claim reported and between
the claim lodge and settlement date, and investigate unusual cases.
A second survey may be conducted on a test basis especially in unusual cases.
Surveyors should be required to submit pictures of the damaged assets whenever
possible.
Monitor which agent and insuree has the highest claim ratio.
Review the total claims verified by each surveyor and compare it with value of assets
insured to identify unusual ratio.
Question 7
General comments:
35.45% candidates secured passing marks in this question.
Common errors:
1.
The requirement of the question was not understood i.e. how to assess the extent
of reliance to be placed on the work of the component auditor and consequently,
procedures which would be performed as part of the audit were described such as
meeting with component auditor to obtain understanding of the component and
its environment, discussing with component auditor about risk of material missstatement, etc.
2.
Too much stress was laid on the qualification and experience of the auditor and
the remaining aspects were ignored.
Suggested answer:
Procedures:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
Assess whether the degree of access to be provided to us by the component auditor is
sufficient.
Assess the professional competence of Sun Limited’s (SL) auditor by obtaining
information about his membership with relevant professional bodies.
Obtain confirmations from professional bodies under which the auditor of SL is
registered with and his good standing etc.
Obtain a statement from the auditor of SL that it has complied with the relevant
ethical requirements.
Review the code of ethics followed by the auditor of SL, and assess whether ethical
requirements of that code are in agreement with the ethical requirements relevant to
the group audit.
Ascertain the competence and qualification of staff assigned by the auditor of SL to
assess whether they have necessary skills to address the issues related to the group
audit.
Ascertain the quality control policies and procedures used by the auditor of SL.
Determine whether the auditor of SL’s is a member of network of audit firms and
inquire whether the network firm carries out regular quality reviews.
Page 10 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017
(ix)
(x)
(xi)
Discuss the audit methodology to be used by SL’s auditor and whether it would be
sufficient for the group audit and determine the necessary audit instructions to be
issued.
Identify the differences in the applicable financial reporting framework of the group
and the component, if any and obtain a statement that the component auditor
understands the applicable financial reporting framework.
Request any results of monitoring or inspection visits conducted by the regulatory
authority.
Question 8
General comments:
21.32% candidates secured passing marks in this question.
Common errors:
1.
Steps relating to audit of historical financial statements were commonly included
along with steps related to report on the forecast.
2.
Important points were missed such as obtaining understanding of the business,
review of market research report to assess projected sales, tax working and
management representation.
Suggested answer:
Examination procedures should include the following:












Obtain an understanding of the business of DFL.
Discuss how the management has developed the significant assumptions and assess
the reasonableness thereof.
Inquire about the process of making the prospective information and the internal
controls over the system used to prepare prospective financial information.
Inquiry about the expertise and experience of those preparing the information.
Inquire about accuracy of previous prospective information made by the management
and the estimates and basis used.
Ensure that accounting policies used in preparing the prospective financial information
are consistent with those used in historical financial information and comply with the
applicable financial reporting framework.
Confirm expected timeframe for the import and installation of machinery by referring
to vendor quotations/communication.
Confirm that the sales of new flavours have been assumed from the date the machine
is ready for commercial production.
Verify the production capacity of the new plant to corroborate the projected revenue.
Review market research documents to assess the reasonableness of projected sales
quantities and review prices charged by competitors for the premium flavors.
Assess the reasonableness of staff cost through average employee turnover rate and
the salary growth rates.
Discuss the expected decrease in production costs with the management and review
the information on which the projection is based.
Page 11 of 12
Examiners’ comments and Suggested answers on Audit, Assurance and Related
Services, CFAP Examination Summer 2017









Obtain information from management about major ingredients and wastage
percentages etc. to review the projected cost of raw material.
Review how cost of repairs and maintenance has been projected and whether the fact
that it is a new plant has been considered.
Verify the cost of the new plant from supplier’s quote and bills related to import and
installation costs to calculate the depreciation expense.
Check how the management has accounted for the gain/loss on disposal of the old
plant and equipment.
Check whether projections related to juices segment are based on past trends and
discuss any major changes in the market, processes, etc. and the effect thereof on the
projections.
Recalculate the finance cost.
Review the tax workings.
Carry out analytical review.
Obtain written representations from the management regarding the assumptions used
intended use of prospective financial information and management’s acceptance of its
responsibility for the prospective comprehensive income.
(THE END)
Page 12 of 12
AUDIT, ASSURANCE AND RELATED SERVICES
Summary of Marking Key
Certified Finance and Accounting Professional Examination – Summer 2017
Note regarding marking scheme:
The marking scheme is given as a guide. However, markers also award marks for alternative
approaches to a question and relevant/well-reasoned comments/explanations. Moreover, the
available marks in a question may exceed the total marks.
A.1
A.2
Up to 0.75 mark for specifying each point for evaluating the key issues
(b)
01 mark for stating each significant matter to be included in the letter to those
charged with governance
10.0
Up to 01 mark for specifying each matter to be considered in planning the
audit of currency swap contract
6.0
(a)
(b)
A.3
A.5
A.6
01 mark for stating each procedure for defined benefit plan liability
01 mark for stating each procedure for valuation of currency swap
contract
4.0
5.0
Up to 02 marks for discussing the requirements of independence in the
network firms
Identification of threat
01 mark for stating each internal audit service not to be provided to a
public interest entity
Discussion on the need to avoid management responsibility
(b)
Up to 01 mark for discussing each threat and its significance
0.5 mark for stating each safeguard
Preparation of draft report layout and inclusion of standard statements
Up to 1.5 marks for each procedure which may be performed by the auditor
and its related finding
6.0
Evaluation of the situation
Description of the type 1 report and its limitation in the given situation
Up to 01 mark for each point related to how to test the operating effectiveness
of controls
4.5
3.0
(a)
A.4
Mark(s)
10.0
(a)
Evaluation of the situation
Drafting the qualification for inclusion in the audit report
(a)
(b)
01 mark for suggesting each control to be implemented
2.0
1.0
3.0
1.0
2.0
1.0
6.0
2.5
3.0
3.0
5.0
A.7
01 mark for each procedure which may be performed by the group auditor
10.0
A.8
0.75 mark for each procedure to be performed in respect of the forecast
12.0
(THE END)
Page 1 of 1
Certified Finance and Accounting Professional Stage Examination
The Institute of
Chartered Accountants
of Pakistan
7 December 2017
3 hours – 100 marks
Additional reading time – 15 minutes
Audit, Assurance and Related Services
Q.1
You are the audit manager of Mehmood Auto Limited (MAL), a listed company, for the
year ending 31 December 2017. MAL assembles and manufactures a wide range of motor
vehicles. All motor vehicles sold by MAL are under warranty up to a mileage of 50,000 km
and are also eligible for free service every quarter for two years.
The extracts from the draft financial statements prepared by the management are as follows:
Revenue from sales of motor vehicles
Revenue from sales of spare parts
Cost of sales
Gross profit
Assets
Property, plant and equipment
Deferred tax
Instalment sales receivables
Stock in trade
Other assets
2017
2016
------- Rs. in million ------54,000
70,000
1,500
1,000
(49,950)
(63,190)
5,550
7,810
2017
2016
------- Rs. in million ------6,600
4,510
233
194
1,200
700
16,000
13,000
13,817
15,476
37,850
33,880
During the course of the audit, you came to know that there have been 37 instances of
serious accidents involving newly manufactured cars where MAL had to pay compensation
aggregating Rs. 145 million plus cost of repairs amounting to Rs. 14 million.
An investigation into the matter has revealed that 15 such accidents were because of failure
of the brakes. The management has assured you that the fault has been identified and
appropriate corrective measures have been taken in this regard. However, you have noted
that the entire compensation amount is being shown as receivable from a supplier who has
provided the brake system.
Required:
Identify the audit risks in the above situation and specify the key audit steps which you will
perform in respect thereof.
Q.2
(a)
(20)
You have been the auditor of Venus Limited (VL) for past few years. During the
current year’s audit, the report of the valuation expert shows that the fair value of
buildings of VL is slightly above their carrying amount. However, during the course of
audit, you discovered a copy of a draft report by the same valuer in which the value
assigned to the buildings was lower by Rs. 20 million. While investigating the matter,
the audit senior has identified that had the assets been valued on the basis of the
unsigned valuation report, it would have resulted in breach of a loan covenant. You
have also noted that the same valuer has been used by VL for the last many years.
Required:
Specify the steps that you would take in the above situation and discuss the possible
effects on the audit report, if the materiality limit on this audit is Rs. 80 million.
(10)
Audit, Assurance and Related Services
(b)
Page 2 of 3
You are the audit manager at the client Lavender Product Limited (LPL). Your team
had proposed various adjustments including the impairment of a plant. LPL’s CFO
has agreed to record all the adjustments including the impairment loss. However, the
CFO is reluctant to disclose in the financial statements, the circumstances that lead to
the impairment of plant and machinery.
Required:
Evaluate the above situation and state the implications on the audit report, if any.
Q.3
(05)
You are the audit manager in GMP Chartered Accountants. The following matters are
under your consideration for the year ended 30 September 2017:
(i)
Kamran Limited (KL) is in the business of manufacturing generators. On
1 October 2016, KL acquired 750,000 ordinary shares of HL (which supplies generator
components to KL), constituting 75% of the issued, subscribed and paid-up capital
against a gross consideration of Rs. 700 million. KL paid Rs. 500 million on the date
of acquisition whereas Rs. 200 million was paid on 1 October 2017.
At the acquisition date, the identifiable net assets were recognized at their carrying
amount which was approximately equal to the fair value of Rs. 670 million, except the
building and leasehold land whose fair value was assessed at Rs. 130 million above
their carrying amount. The fair value of NCI at the date of acquisition was assessed at
Rs. 155 million.
KL recognised goodwill amounting to Rs. 45 million on acquisition of HL, under the
full goodwill method.
(ii)
Waris Limited has changed its accounting policy for property, plant and equipment
from historical cost to revaluation model.
Required:
Guide your audit team on key audit procedures with regard to the above information.
(Audit procedures related to verification of property, plant and equipment are not required)
Q.4
(15)
Aster Textile Limited (ATL) manufactures industrial grade safety garments. It uses certain
chemicals whose waste needs to be disposed of in a certain manner to prevent any harm to
the environment.
The government has prescribed the safety standards which are required to be adhered to,
with regard to disposal of these chemicals. ATL has its own internally developed standards
which have been approved by some of its international customers. These customers require
that ATL as well as all its suppliers should comply with these standards. However, the
standards set by the government are far more comprehensive and stringent as compared to
ATL’s internally developed standards.
ATL has approached your firm to report on compliance with its internally developed
standards. ATL has informed you that the report would be submitted to the concerned
international customers.
Required:
In the light of the relevant international standards on assurance engagements:
(a) Discuss what steps would you take before deciding to accept the above assignment.
(12)
(b) Assuming that you have accepted the engagement, what matters would you like to
include in your report to ensure that it is not misleading for the intended users.
(03)
Audit, Assurance and Related Services
Q.5
Page 3 of 3
You have recently completed the audit of the financial statements of Rose Limited (RL), a
listed company having a net profit of Rs. 1,500 million. You have identified following
matters which will be reported as key audit matters in the audit report:
(i)
RL has pending tax litigation in which tax department has raised demand aggregating
Rs. 175 million. The demand has been challenged by RL and the decision in respect of
this matter is currently pending. The amount is disclosed as a contingent liability in the
financial statements.
(ii) RL makes significant purchases from related parties and also incurs significant
advertising expenses through related parties. These transactions are properly disclosed
as related party transactions in the financial statements.
(iii) RL has decided to sell a manufacturing facility located in Faisalabad having a carrying
value of Rs. 300 million and would replace it with another facility in Gujranwala. The
manufacturing facility has been classified as non-current assets held for sale.
Required:
Draft the key audit matters section to be included in the audit report of RL relating to the
above matters. (You may assume necessary details where required)
Q.6
(15)
You are the quality control partner of Lotus & Co. Chartered Accountants. You have been
assigned additional responsibilities for assessment of risks associated with the firm’s clients.
At present, the following matters are under your consideration:
(a)
(b)
Clean Limited (CL) has failed to pay the fee for review of its half yearly accounts for
the six month ended 30 June 2017. The issue was discussed with the management in
the planning meeting for the audit of the year ending 31 December 2017. The
management has assured that the amount would be paid in about 30 days. During the
discussion, the audit manager was also informed that CL has been facing liquidity
issues and it has closed two of its plants. The management has also requested for a
reduction in the audit fee for the year ending 31 December 2018 because of the
decline in the volume of business. Further, the management has requested the firm to
consider some relief as regards audit fee for the current year.
(10)
During the review of working papers of Daffodil Limited (DL), the engagement
manager came to know that a large consignment of import of raw material is stuck
with the custom authorities. On his query he was informed that the DL’s clearing
agent was unable to resolve the matter. However, now DL has approached another
custom clearing agent for clearing the said consignment and the matter with the
custom authorities would be resolved shortly. DL has agreed to pay 1.4% of the value
of consignment to the clearing agent. A junior member of the team has informed the
engagement manager that clearing agent appointed by DL is the brother of the audit
senior.
(05)
Required:
Discuss the categories of threats involved in each of the above situations and advise the
possible course of action that may be followed.
Q.7
Bluebell Foundation (BF) is a non-profit organisation. It is in the process of receiving a grant
from the federal government. To receive such grant BF has to submit a report of factual
findings on the projects being run by BF. The trustees approached your firm and on their
request you provided a specimen of the report that may be issued in the given situation.
Subsequently, you have received a letter from the trustees in which they have requested to
remove the statement from the report, “this report is not to be distributed to any other parties other
than the federal government”, as BF also intends to distribute the report to its current corporate
donors.
Required:
Discuss how the firm should deal with the request of the trustees.
(THE END)
(05)
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2017
Ans.1
Following are the risks in the given situation and the related procedures which may be
undertaken:
(i)
Litigations and claims:
Risk:
 Even though the company has to pay Rs. 145 million in damages and
Rs. 14 million in repairs, there is still a risk that our audit team might not be
aware of further damage claims filed against MAL.
 There is also a risk that further accidents may occur or further cases are filed
against MAL after the balance sheet date.
Procedures:
 Send confirmation requests to MAL’s legal advisors.
 Consider engaging own legal counsel for assessing the impact of the cases filed
against the company.
 Inquire the management and MAL’s legal counsel about how the management
would deal if any further damage claims are filed against MAL.
 Assess the potential impact of recognizing a charge or disclosing a contingent
liability in the light of IAS 37.
 Assess whether a penalty may be imposed on MAL by any government
authority.
 Verify current and subsequent legal expenses incurred by MAL for
identification of any undisclosed damage claim.
(ii)
Impairment of plant and machinery
Risk:
 Sales of MAL has declined by 23% and is expected to remain under pressure in
the future also, because of the situation. Therefore, there is a risk that value in
use of the plant and machinery may have been reduced.
Procedures:
 Review the working prepared by the client relating to value in use.
 Assess the reasonableness of assumptions taken by the management and
discount rate used.
 Consider involving auditor’s expert and obtaining a report about the nature of
fault in the production process and whether the management’s claim, that it has
been fixed can be relied upon.
(iii)
Warranty provision
Risk:
 In the given scenario, the probability / size of warranty claims may exceed the
initial estimate and therefore the existing provision may not be adequate.
Procedures:
 Review warranty claims / payments after the balance sheet date.
 Review any revised working which the client may have prepared.
 Consider the appropriateness of the MAL’s model and assumptions used in the
light of current situation.
 Consider involving an expert to calculate the warranty provision to be included
in the financial statements.
Page 1 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2017
(iv)
Write down of inventory to NRV:
Risk:
 There is a risk that the company might not be able to sell the affected cars or
witness decline in its price, therefore there is a risk that net realizable value of
the inventory may be lower than its cost.
Procedures:
 Evaluate the cost of necessary changes required to be made in the current
inventory of the cars, to bring them in a saleable condition.
 Review and test the procedures in place for comparing NRV with cost for each
item of inventory and assess whether appropriate changes have been made in
the light of current situation.
(v)
Refund liability:
Risk:
 There is a risk that the customers might return back the cars or MAL may have
to recall the sold cars.
Procedures:
 Obtain management’s assessment and projections of the number of cars which
may be returned by the customer or MAL may have to call them back and
assess the adequacy of projections and assumptions used.
(vi)
Receivable from supplier:
Risk:
 MAL cannot record a receivable from the supplier until it is virtually certain
that the amount will received, therefore, there is a significant risk that the
receivable may need to be written off.
Procedures:
 Discuss with the client the basis on which it has decided to book the receivable.
 Obtain the legal advisor’s opinion on the matter and the notice issued to the
supplier.
 Review correspondence with the supplier.
 Review the contract with the supplier for identification of any clause related to
indemnification of damages
 Send confirmation request to the supplier with regard to the receivable balance.
(vii) Provision for doubtful installment sales receivable:
Risk:
 The sales for the year have decreased but the installments sales receivable has
increased. It indicates that there is a risk that more than usual number of
installments may have become overdue and might not be recoverable.
Procedures:
 Check aging of installments receivable and identify any overdue installments.
 Obtain confirmation from major debtors.
 Assess the adequacy of provision against overdue installments.
 Review the subsequent recovery of installment sales receivable.
Page 2 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2017
(viii) Separate revenue for free service:
Risk:
 Providing free service after a certain mileage is a separate performance
obligation. As it is provided to all customers, it’s revenue should be recorded
separately by appropriately bifurcating the revenue from sale of cars. There is a
risk that the revenue may have been included in the revenue from sale of motor
vehicles.
Procedures:
 Identify the price at which such services are regularly provided to the customers
to assess whether the bifurcation has been made appropriately.
 Ensure that revenue from sale of cars has been appropriately recognized by
excluding the amount pertaining to provision of services which should have
been recorded as a liability.
Ans.2
(a)








(b)
Although the amount of Rs. 20 million is not individually material, but, we
will need to discuss the values reported in the draft report with the
management and the valuer and why and on what basis the value was
changed.
We will have to consider the independence of the management’s expert due to
the long association with VL.
We may consider hiring our own expert for assessing the value.
If the value assigned by our expert is different from the value assigned by the
management’s expert, we will strive to resolve the differences through
discussions with both experts and the management.
We will have to reassess the risk of material misstatement due to fraud and its
impact on the nature, timing and extent of audit procedures.
If the adjustment would result in breach of loan covenants the consequence
may be qualitatively material due to conversion of long term loan into short
term.
If we are unable to resolve the differences, it will cause disagreement with the
management and although the amount is not material, however, due to
qualitative materiality, we may have to issue a qualified report. Moreover, we
will have to determine whether uncorrected misstatements are material, in
aggregate.
If the changes in the valuer’s report creates doubts as to the integrity of the
management, we may consider appropriate action which may include
withdrawing from engagement, disclaiming an opinion, etc. depending upon
the applicable laws and regulation.
These disclosures are mandatory as they are required by the applicable financial
reporting framework.
The misstatement in qualitative disclosure could be material, because the disclosure
of events that lead to impairment could influence the economic decision of the users
of the financial statements
Since non-disclosure would lead to a material misstatement of the financial
statements that relates to qualitative disclosures, we shall discuss the non-disclosure
with those charged with governance. If the disagreement persists, we shall qualify
our audit report and

Describe in the Basis for Opinion section the nature of the omitted
information; and
Page 3 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2017

Unless prohibited by law or regulation, include the omitted disclosures,
provided it is practicable to do so provided we are able to obtain sufficient
appropriate audit evidence about the omitted information.
However, if the CFO agrees to disclose the circumstances that led to the
impairment of plant and machinery, then we would need to include a key audit
matter paragraph in our audit report.
Ans.3
(i)
Kamran Limited:
Measurement of goodwill on acquisition

Agree the purchase consideration to the legal documentation pertaining to the
acquisition and review the documents to ensure that the figures included in the
goodwill calculation are complete.

Review due diligence report relevant to the acquisition, for confirmation of
acquired assets and liabilities and their fair values.

Verify and assess the reasonableness of the discount rate used for discounting
the purchase consideration received on 1 October 2017.

Evaluate the methods / assumptions used to determine the fair value of
acquired assets, including the property and liabilities, to confirm compliance
with IFRS 3 and IFRS 13.

Review of board minutes for discussions relating to the acquisition and for the
relevant minutes of board approval.

Verify and assess the reasonableness of the fair value of NCI.
Impairment of goodwill:

Discussion with management regarding potential impairment of Group assets
and confirmation as to whether an impairment review has been performed.

A copy of any impairment review performed by management, with scrutiny of
the assumptions used, and re performance of calculations.

Assess the reliability of cash flow forecasts through a review of actual past
performance and comparison to previous forecast

Involve our valuation specialist for evaluating the appropriateness of the fair
value of the building, leasehold land and also for the impairment testing of
goodwill.
Intercompany transactions:

Ensure the elimination of intercompany balances.

Ensure that profit included in inventory purchased from HL has been reversed.

Ensure that appropriate adjustments have been made for consistent
application of accounting policies across the group as required by IFRS 3.
(ii)
Waris Limited:

We need to assess, why the accounting policy was changed and the impact of
the change on the financial statements. We should also consider whether the
change in accounting policy is free from bias.

Evaluate whether the change in accounting policy has been properly
accounted for and adequately presented and disclosed.

The change of policy will be required to be reported to those charged with
governance and change in policy would also require board approval.

The opinion paragraph of our report will be altered to mention the fact about
change in accounting policy and whether we concur with it or not.
Page 4 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2017
Ans.4
(a)
Our firm shall only accept the engagement if we are satisfied that relevant ethical
requirements including those related to independence have been met. We need to
ensure that the basis upon which the engagement is to be performed has been
agreed i.e. there is a common understanding between our firm and ATL of the
terms of engagement. We would also need to ensure that our team have the
appropriate competence and capabilities.
One of the precondition for accepting an engagement is that the standard that will
be applied to evaluate the disposal of waste should be suitable for the engagement
circumstances i.e. it should exhibit the following characteristics.
(i)
(ii)
(iii)
(iv)
(v)
Relevance
Completeness
Reliability
Neutrality
Understandability
Although the standards have been developed internally, it exhibits the
characteristics of relevance, completeness and neutrality since these are agreed by all
the intended users.
The reliability of the criteria would have to be assessed by considering whether the
criteria is such that it would lead to a reasonably consistent measurement or
evaluation of the underlying subject matter when used in similar circumstances by
different practitioners. The understandability criteria would be considered to have
been met if it results in information that can be understood by the intended users.
Whether the criteria meet the requirement of reliability and understandability is a
matter of professional judgement and we would need to assess it accordingly.
It may be noted that the relevant auditing standard allow the use of internally
developed criteria for the purpose of preparing the subject matter information in the
particular circumstances of the engagement despite the existence of a different
criteria embodied in the law or regulation. However, we should seek
acknowledgement from all the intended users that the said criteria are suitable for
their purpose.
(b)
Though all the intended users agree on the use of internally developed standards,
the existence of more comprehensive standards issued by the government requires
that our assurance report:
(i) States that the criteria are not embodied in law or regulation, or issued by
authorized or recognized bodies of experts.
(ii) Alerts readers that the subject matter information is prepared in accordance
with special purpose criteria and as a result, the subject matter information
may not be suitable for other purposes; and
(iii) Indicates that the assurance report is intended solely for specific users and is
not to be distributed to any other parties other than the engaging parties.
Page 5 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2017
Ans.5
Key audit matter
How the matter was addressed in our audit
Tax Contingency
Refer note x to the financial statements
The company has significant tax We have obtained and assessed the management’s
contingencies which can have a contention against the demands made by the taxation
significant impact if materialized. authorities.
Due to the high level of judgment
required to assess the outcome of We also had a discussion with the tax advisor of the
tax litigations, we consider it to be Company and his rationale and justifications against the
a key audit matter.
demands made by the taxation authorities.
We used our own tax specialist to consider the level of
provision required in light of the nature of the
company’s exposure, applicable regulation and the
company’s correspondence with the tax authorities.
We have considered any legal precedent or case law by
assessing relevant historical and recent judgments passed
by the courts and other authorities in similar situation.
We evaluated the adequacy of the disclosure in the
financial statement.
Related Party Transactions
Refer note x to the financial statements
The company has significant We assessed the management controls over
purchases from related parties. identification and capturing and recording of related
Further, significant amount of party transactions.
advertising expenses are also paid
We also assessed how frequently the related party listing
to related parties.
is updated by the management and whether there are
Due to the large number of any time lags or not.
transactions with the related
parties, we consider it as an area of Reviewed filings with the regulatory authorities for the
significant risk, and hence this was names of related party in which officers and directors
occupy directorship or management position.
identified as a key audit matter.
Reviewed contract with related party for providing
advertising and other services.
Reviewed minutes of meeting of board of directors for
the discussion and authorization of related party
transaction.
Reviewed accounting record for large, unusual and nonrecurring transactions.
We circulated confirmation request to the related parties
regarding the transactions carried out with them and
their balances as at year end.
We evaluated the adequacy of the related party
disclosures in the financial statements.
Page 6 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2017
Non-Current Assets Held For Sale
Refer note x to the financial statements
The company is committed to a We assessed the company’s commitment to the sale
plan to sell part of a plan through understanding the status of the sales
manufacturing facility.
process and reviewing correspondence from
purchasers and prospective purchasers.
This part of the manufacturing
facility has been classified as We involved our own valuation specialist to assist in
non-current assets held for sale evaluating the fair value of the plant.
and written down to its fair value
less costs to sell.
We evaluated the adequacy of the financial statement
disclosures, including disclosures of key assumptions,
Due to the high level of judgment and sensitivities.
judgment involved in estimating
the fair value and the significant
carrying amounts of the assets
and liabilities associated with it,
we considered it to be a key audit
matter.
Ans.6
(a)
The discussion in the meeting with the management of Clover Limited (CL)
highlights two aspects which would have an impact on the ethical considerations:
(i) Outstanding fee
(ii) Reduction in fee
(i)
Outstanding fee:
A self-interest threat may be created if fees due from an audit client remain
unpaid for a longtime, especially if the review fee is not paid before the
issuance of the audit report for the year ended 31 December 2017.
Our firm should ensure that the outstanding fee is received as early as possible
to avoid the above threat. In this regard we should consider discussing this
matter with the audit committee or those charged with governance.
If the fee remains unpaid, the existence and significance of any threat shall be
evaluated and safeguards applied when necessary to eliminate the threat or
reduce it to an acceptable level. Such a safeguard is, having an additional
chartered accountant who did not take part in the audit engagement provide
advice or review the work performed.
According to Code of Ethics, the overdue fee might even be regarded as being
equivalent to a loan to the client and in case the amount is considered
significant, we may consider whether it is appropriate to continue the audit
engagement.
(ii)
Reduction in fee:
A self-interest threat to professional competence and due care is created if the
fee quoted is so low that it may be difficult to perform the engagement with
applicable technical and professional standards in that price.
Even though CL has closed one of its major product lines, it does not
necessarily mean that quantum of work will materially differ from the
Page 7 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2017
quantum of work carried out by us previously. Instead, because of the weak
financial position of the company, we may encounter more challenging audit
areas that would require additional work and more extensive areas of
professional judgement and greater skepticism such as for determining
impairment of assets and going concern, etc.
In view of the above, we may agree to a reduction in fee only if we are
satisfied that we would be able to perform all the necessary procedures and
there would be no undue pressure in this regard because of the reduction in
fee.
Moreover, regardless of the audit fee, we should ensure that:
 adequate time is spent on the assignment; and
 audit personnel with sufficient expertise and experience are assigned to
the job.
We should only accept management’s request of a reduction in fee, if we are
able to ascertain that the quantum of work will reduce accordingly.
(b)
Self-interest threat or intimidation threat may be created due to a close business
relationship between a member of the audit team’s immediate family and the audit
client. The relationship of the audit senior and the clearing agent comes under the
definition of close family member instead of immediate family member. However,
the code recognizes the fact that it is impossible to define every situation, and there
could be many variation in circumstances that create threats to independence and
can deter a Chartered Accountant from concluding that a situation is permitted if it
is not specifically prohibited.
Therefore, even though the clearing agent is not an immediate family member of
the audit senior, our firm should consider the possibility and significance of threats
to the independence of the audit senior.
Depending upon the significance, we may also consider:
Removing the audit senior from the engagement team.

Having a chartered accountant review the work of the audit senior.

Ans.7





The report is restricted to those parties that have agreed to the procedures to be
performed.
The reason for restricting the AUP report in this manner is to prevent readers who
are unaware of the context for the AUP from misinterpreting the results of those
procedures.
However, if BF intends to share the report with persons other than the federal
government, BF should agree with the firm, the specific donors to whom the report
would be available and such parties should be disclosed in the engagement letter.
Furthermore, BF should ensure that the said donors are aware and understand the
procedures which will be performed by the firm.
If disclosure to the other parties is agreed as discussed above, the report would still
include a statement to the effect that the AUP report is restricted to the specified
users and is not to be used for any other purpose.
(The End)
Page 8 of 8
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Audit, Assurance and Related
Services
SESSION
Certified Finance and Accounting Professional
(CFAP) Examination - Winter 2017
General:
The overall performance in this attempt was much below expectation as the passing
percentage was only 11.2% as compared to 16% in the previous attempt. The
disappointing factor was that the overall performance remained poor in all the questions.
The major reason for the poor performance was lack of knowledge, failure to give due
attention to the requirement of the question and answering in light of the given scenario
and poor writing skills.
Question-wise comments:
Question 1
This question required identification of audit risks in a given scenario and the key audit
steps to be performed to address the identified risks. Though it was a standard question
which is tested in almost the same manner in every examination, the performance
remained poor as only 15% of the candidates secured passing marks. The only
consolation was that a further 40% of the students scored 7 to 9 marks.
Major errors were as follows:




Majority of the candidates could not identify more than three or four risks. Mostly,
the risk related to installments receivable, write down of inventory, impairment of
plant and proper segregation of revenue between revenue from sale of cars and
services revenue could not be identified.
Issue of going concern and deferred tax were identified as the risks which was
inappropriate as the company was still earning substantial profits.
In respect of audit procedures, the requirement was to specify key audit procedures
whereas a number of students identified the simpler procedures such as casting,
agreeing with ledger, etc.
Audit steps aimed at obtaining evidence to support completeness assetion were
mostly missed. For example, most of the students specified steps to verify the list of
litigation and claims but did not specify steps which could ensure that all litigations
and claims are recorded on the list.
Page 1 of 5
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Winter 2017
Question 2
This question consisted of two parts. The overall performance was below average as only
25% of the candidates secured passing marks. However, like in question 1, a further 30%
of the students scored more than 40% marks. Performance in each part is discussed
below:
Part (a)
According to the scenario given in this question, an audit team member had discovered a
draft report issues by a valuer appointed by the company. In the draft report, the value
assigned to the buildings was lower than the amount which was mentioned in the final
report. It was also noted by the auditor that in case of valuation as per draft report,
certain loan covenants may have been breached. The requirement was to specify the steps
to be taken in the given situation and the possible impact on the audit report.
The overall performance was satisfactory. However, very few students scored full or high
marks. The major issues observed were as follows:



The issue of overall materiality was ignored in most of the cases. Despite the fact that
materiality limit mentioned in the question was Rs. 80 million and the amount in
doubt was only Rs. 20 million, which was much below the materiality level, most of
the candidates stated that the matter is material and pervasive and discussed the
possibility of giving an adverse opinion. In such cases, the auditor considers the
impact of all material misstatements in aggregate, in order to decide the impact on
audit report. This aspect was rarely mentioned.
Breach of loan covenant usually entitles the bank to demand an immediate repayment
and therefore the loan is converted into a short-term liability. Moreover, other terms
of loan may also change requiring revision in certain disclosures. In such situation, in
case of disagreement with the management, auditor has to qualify the report despite
the amount not crossing the materiality threshold, because, such disclosure is
qualitatively material. This aspect was seldom discussed.
While discussing the issue of management integrity, only two alternatives were
mostly discussed i.e. disclaiming an opinion and withdrawal. These are relevant but
extreme steps. An important step which the auditor takes in such situations i.e. where
there is a doubt but no conclusive evidence is to reassess the risk of material
misstatement due to fraud and its impact on nature, timing and extent of audit
procedures. This aspect was not covered by many candidates.
Part (b)
The performance in this part was quite poor. Only about 50% of the students were able to
explain correctly that matter discussed in the scenario was qualitatively material and
should be disclosed. However, very few could specify the impact on audit report if the
client refuses to make the disclosure (For details, refer ICAP’s suggested answer).
Moreover, the fact that if the disclosure is given, the matter may form part of the Key
Audit Matter section of the audit report was rarely mentioned.
Page 2 of 5
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Winter 2017
Question 3
The overall performance in this question was very poor as only 6% candidates secured
passing marks, though a further 30% of the candidates scored more than 40% marks. The
requirement was to specify key audit procedures related to two issues as discussed below:
(i)
This contained a short scenario whereby a subsidiary had been acquired during the
relevant accounting year. According to the given information, three issues should
have been addressed i.e. measurement of goodwill, impairment of goodwill and
inter-company transactions. The major reason for poor performance was that
majority of the students ignored either one or both of the last two issues. Other
common mistakes were as follows:



(ii)
Verification of discount rate used to discount the purchase consideration
received after one year of the acquisition and the methods / assumptions used to
determine the fair value of the assets and liabilities were mostly ignored.
Many students only mentioned that impairment of goodwill should be tested.
No further steps were specified in this regard.
While discussing steps related to inter-company transactions, reversal of profit
on intercompany stocks was mostly missed.
This part was based on a very simple scenario whereby a company had changed its
accounting policy for property, plant and equipment from historical cost to
revaluation model. The overall performance was average as most of the students
mentioned about inquiring the reasons for change and whether it was free from bias
and ensuring proper disclosure. However, only few students mentioned about
modifying the opinion paragraph to mention about the change and whether the
auditor concurs with it or not. Moreover, while discussing the accounting treatment
and the disclosure requirements, it was mentioned that being a change in
accounting policy, the effect would be taken retrospectively which was incorrect as
change in accounting policy from historical cost to revaluation method does not
require restatement of financial statements.
Further, the question explicitly stated that routine verification steps of property
plant and equipment were not required but many students kept wasting their time
on these steps.
Question 4
According to the scenario in this question, the auditor had been asked to report on
compliance with internally developed safety standards related to disposal of waste
chemicals and the report was to be issued to the customers of the company. The key issue
was that the government had also issued its own safety standards which were more
comprehensive and stringent.
The performance remained below average as only 19% candidates secured passing
marks. Moreover, about 40% of the candidates were totally unaware of the related
auditing standard and scored less than 25% marks.
Page 3 of 5
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Winter 2017
Some of the better students who scored passing or near passing marks made two types of
errors which resulted in loss of marks, as discussed below:


They failed to offer any comments regarding the use of internally developed
standards in the presence of more comprehensive standards issued by the
government.
It was mentioned that the auditor should assess that the standards to be applied are
suitable but failed to specify how the auditor would ensure them.
Question 5
This question was based on Key Audit Matters (KAM) section of the audit report.
According to the question, the auditors had identified three matters for inclusion in the
KAM section. The requirement was to draft the relevant KAM section. The overall
performance was below average as only 20% candidates could secure passing marks. The
major errors were as follows:



About 50% of the candidates were totally unaware of how to handle this question and
obtained four or less marks. Answers of most such students were restricted to
specifying the audit verification steps.
While discussing the reasons for inclusion of a particular matter in the KAM section,
many candidates only discussed materiality of the matter. Other reasons such as high
level of judgment involved and existence of risks, etc. were not mentioned.
Many key steps which the auditor performs were not listed. Especially, in the case of
related party transactions, only the audit procedures related to verification of
transactions listed by the client were mentioned, whereas procedures for ensuring
completeness of the disclosure were not stated.
Question 6
This question contained two independent scenarios and the candidates were required to
identify the threats involved and the possible course of action to be adopted in each case.
Though this should have been an easy question as this part of the syllabus is regularly
tested, yet the performance was even worse as only 18% of the candidates secured
passing marks. Comments on each scenario are given below:
(i)
According to this scenario, a client which was in a weak financial position had failed
to pay the audit fee for review of half yearly accounts and the management had also
requested the audit firm to give some relief as regards audit fee of current year.
The performance remained below average mainly because the students could not
give appropriate comments on some of the main issues as discussed below:

With regard to non-payment of audit fee, the candidates generally could not
specify an important step that the auditor should bring the matter to the
knowledge of the audit committee and/or those charged with governance.
Moreover, it was also important to assess the significance of the threat which
was also missed by the majority. Furthermore, many candidates mentioned about
declining the engagement whereas according to the scenario it had already been
accepted.
Page 4 of 5
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Winter 2017


With regard to reduction in fee, many students did not make any comment on the
management’s contention that work would reduce as a result of closure of plants.
On the other hand, many students were completely in agreement with the
management’s view in this regard. They did not consider the other aspect of the
situation i.e. closure of factories is also an indication of weakening financial
position because of which the auditor may have to face more challenges such as
risk of intentional misstatement and more issues involving professional
judgment, such as impairment of assets and going concern and therefore it was
not necessary that closure of plants may result in reduction in work.
A large number of students were of the incorrect view that audit fee cannot be
reduced under any circumstances.
Question 7
This question was based on a simple scenario according to which a not-for-profit
organisation required a report of factual findings about its projects, in order to receive
certain grant from the federal government. However, since the trustees want to distribute
the report to other donors also, they have requested the auditor to not to include any
condition in the report regarding its non-distribution to parties.
The performance in this question was poor and only 12% of the candidates secured
passing marks. Almost 11% of the candidates had no idea whatsoever and preferred not
to attempt the question altogether. A further 27% of the candidates scored zero marks as
they believed that the request of the trustees cannot be accepted.
(THE END)
Page 5 of 5
AUDIT, ASSURANCE AND RELATED SERVICES
Summary of Marking Key
Certified Finance and Accounting Professional Examination – Winter 2017
Note regarding marking scheme:
The marking scheme is given as a guide. However, markers also award marks for alternative
approaches to a question and relevant/well-reasoned comments/explanations. Moreover, the
available marks in answer may exceed the total marks of a question.
Mark(s)
8.0
12.0
A.1
01 mark for identification of each relevant audit risk
0.5 mark for each key audit step/procedure against the identified risk
A.2
(a)
Discussion on important issues in the given scenario
Audit procedure/steps to deal with the situation
Impact on the audit report
3.0
5.0
2.0
(b)
Evaluation of the situation and the possible course of action
Impact on the audit report and the information to be included therein
2.0
3.0
A.3
A.4
01 mark for each key audit procedure/step to be performed as follows:
measurement of goodwill
impairment of goodwill
intercompany transactions
change from historical cost to revaluation
(a)
01 mark for each acceptance procedure to be performed
Discussion on the suitability of the criteria
Discussion on the use of internally developed criteria despite the
existence of a different criteria embodied in law and regulation
4.0
4.0
3.0
4.0
4.0
6.0
2.0
(b)
01 mark for each matter to be included in the report
3.0
A.5
01 mark for discussing why the matter was determined to be a key audit matter
01 mark for each audit procedure for addressing the key audit matter
3.0
12.0
A.6
(a)
Identification of threats
Evaluation of the situation and significance of the threat
Discussion on available safeguards
2.0
6.0
2.0
(b)
Identification of threats
Evaluation of the situation and significance of the threat
Discussion on available safeguards
1.0
3.0
1.0
Discussion on the reason for placing restriction on the distribution of report
Discussion on the firm’s response to the trustees’ request
A.7
2.0
3.0
(THE END)
Page 1 of 1
Certified Finance and Accounting Professional Stage Examination
7 June 2018
3 hours – 100 marks
Additional reading time – 15 minutes
The Institute of
Chartered Accountants
of Pakistan
Audit, Assurance and Related Services
Q.1
You are the audit manager of Saqib Shaukat and Company, Chartered Accountants,
responsible for the audit of Modern Electronics Limited (MEL) for the year ended
31 May 2018. MEL is a listed company and is engaged in manufacture of wearable sports
sensors, smart watches, GPS navigation systems, vehicle cameras and fleet management
system, and sells it through a chain of distributors throughout the country.
The extracts of segment information as disclosed in the draft financial statements for the
year ended 31 May 2018 is as follows:
Revenue
Cost of sales
Gross profit
Net profit
Fixed assets
Debtors
Inventory
GPS navigation
Wearable sports
All other segments
Total
system
sensors
2018
2017
2018
2017
2018
2017
2018
2017
------------------------------------------- Rs. in million ------------------------------------------6,323
7,978
4,119
5,319
3,480
2,346
13,922
15,643
(3,830)
(5,158)
(3,234)
(4,149)
(2,749)
(1,643)
(9,813) (10,950)
2,493
2,820
885
1,170
731
703
4,109
4,693
1,141
1,244
257
351
133
282
1,531
1,877
1980
633
640
2,329
685
665
2,395
361
378
2,661
488
444
2,777
334
294
1,662
196
196
7,152
1,328
1,312
6,652
1,369
1,305
The following information is also available:
(i)
MEL was witnessing a shift of customers from wearable sports sensors to smart
watches which have additional features as compared to the features being offered by
wearable sports sensors. Therefore, to maintain its customer base MEL started
developing its own smart watch and successfully launched it in 2018. MEL intends to
expand its product range in the smart watch segment by expanding its manufacturing
facility which would be financed through a right issue.
(ii)
On 10 April 2018 MEL publicly announced that it was closing an old (fully
depreciated) plant which was used to manufacture a component used in the wearable
sports sensors and will instead import it from China at cheaper rates. The
management is considering various options in respect of this plant. However, the
affected employees were communicated about the decision on the same date and
negotiations with the labour union were started for agreeing on the termination
payments.
(iii)
A significant portion of the sale of GPS navigation system consists of sale to the
tourism industry. The government had made it mandatory for all tour operators to
install GPS navigation system. The compliance has to be made by all tour operators
over a period of four years. Association representing the country’s tour operators had
signed a four-year agreement in April 2016 with MEL under which discounted sale
price has been offered to the tour operators which cannot be raised. A natural disaster
destroyed the supplier’s plant which supplied several components of the GPS
navigation system and consequently MEL has to import these components from
Malaysia at twice the cost of local purchase. At the year-end 200 contracts for supply
of 4,000 GPS navigation systems are still pending.
Required:
Identify the audit risks in the above situation and specify the key audit steps which you will
perform in respect thereof.
(20)
Audit, Assurance and Related Services
Q.2
Page 2 of 4
Your firm has been approached by Eagle Courier Limited (ECL) to provide due diligence
review on a potential acquisition. ECL is a leading courier service company having a
network of offices throughout the country. ECL has a vast fleet of delivery vans and
motorcycles.
ECL intends to use its courier industry experience and expand into food delivery business by
using its current fleet of motorcycles. However, it would require bringing on board a vast
number of restaurants and build its own online food ordering website, of which they do not
have any expertise and experience.
For this purpose, ECL has identified an online food ordering business Foodi.com (FC) for
acquisition. FC is a partnership concern and was set up by three college friends in 2014. FC
received the best ‘start-up business’ award in 2015. Founders of FC had borrowed funds
from two individual investors, which are to be repaid in 10 years.
IT, restaurant relation, customer support and administrative departments are led by the
partners. Being an online service business, the only major assets of FC are a fleet of
motorcycles obtained on an operating lease of 5 years and computers.
Apart from 500 riders, FC employs 30 staff, out of which 10 are related to IT department,
10 belong to customer support, 5 belong to restaurant liaison and the remaining 5 are
responsible for the accounts, HR and administration of the business.
Extracts from audited profit or loss statement for four years are as follows:
Revenue
Operating expenses
Lease rentals
Operating profit/(loss)
Finance cost
Profit/(loss) for the year
2017
2016
2015
2014
-------------------- Rs in million -------------------55,000
50,000
20,000
10,000
(34,650)
(30,000)
(16,000)
(15,000)
(5,750)
(4,600)
(2,875)
(1,150)
14,600
15,400
1,125
(6,150)
(3,075)
(3,155)
(1,615)
(1,615)
11,525
12,245
(490)
(7,765)
Required:
Identify and explain the matters you would focus on in your due diligence review. Also
identify any additional information / document you would require during the review.
Q.3
You are the audit manager of Zia Yaqoob & Company Chartered Accountants. You have
asked Aslam, one of the team members assigned on the audit of Black Sugar Limited to
draft the audit report for the year ended 31 May 2018. The extracts from the draft report are
as follows:
Adverse Opinion
In our opinion, except for the effects of the matter described in the Basis for Adverse
Opinion section of our report, the accompanying financial statements present fairly, in all
material respects the financial position of the Company as at 31 May 2018, and its financial
performance and its cash flows for the year then ended.
Basis for Adverse Opinion
The Company’s stores and spares consist of capital spares of machineries for smooth and
uninterrupted production of sugar during the crushing season. These are carried at lower of
cost and net realisable value as per IAS–2. The Company’s Chief Financial Officer has
refused to reclassify it as capital stores and spares as per IAS–16 as it would adversely affect
the current ratio, as prescribed by the financial institutions. We verified the Company’s
records and ascertained conclusively the value of the capital spare at Rs. 100 million. Had
the management stated them as capital spares, Non–Current assets would have increased by
Rs. 100 million and consequently Current Assets would have reduced by the same amount.
(15)
Audit, Assurance and Related Services
Page 3 of 4
Emphasis of Matter Paragraph
We draw attention to note 2 to the financial statements, which describes the early adoption
of IFRS–2. However, due to time limitation, certain disclosures required by IFRS–2 could
not be provided in the financial statements. Our opinion is not modified in this respect.
Required:
Critically analyse the audit report drafted by Aslam.
Q.4
(11)
Chester Limited (CL) has introduced an equity settled share based payment plan for its
executives on 1 April 2017. Under the plan, 50 of its executives have received 100 share
options each, which will vest on 31 May 2022 if the executives remain in employment at
that date and CL’s share price increases to Rs. 180 at 31 May 2022.
Required:
Mention the key audit procedures for share based payment options described above,
assuming that evaluation of the competency and integrity of the management expert has
already been tested.
Q.5
(06)
Nisar Khalid & Co. Chartered Accountants (NKC) has been approached by Hector Limited
(HL) a listed company, for appointment as HL’s auditors for the year ending 30 April 2019.
The core departments of NKC along with the names of the partners are as follows:
Assurance
Department
Nisar
Hashmat
Moin
Rashid
Arif
Quality Control
Department
Ali
Usman
Tax & Corporate
Advisory Department
Khalid
Ovais
Hasan
NKC intends to appoint Rashid as the engagement partner. As part of the client acceptance
procedures, an email was circulated to all the staff of the firm to disclose any investment in
HL and its related parties by any partner/employee or their family member(s).
A summary of response of Rashid and his staff is as follows:
Rashid has confirmed that he does not hold any shares in HL although his wife has
invested Rs. 2 million in a mutual fund. The mutual fund has invested 14% of its total
investment in shares of HL.
Zahid has been working as an audit manager with Rashid. Zahid has disclosed that he
has invested Rs. 50,000 in the shares of Troy Limited (TL). HL owns 20% shareholding
in TL.
Response by other partners of the firm are as follows:
Ali has invested Rs. 45,000 in the shares of Achilles Limited, which is the holding
company of HL.
Ovais has confirmed that his son has invested Rs. 500,000 in the debentures issued by
HL.
Response by other staff of the firm:
Some of the junior audit staff who are not working with Rashid and the staff of the
firm’s accounts department have confirmed holding in shares of HL of nominal
amounts ranging from Rs. 5,000 to Rs. 60,000.
Required:
In the light of Code of Ethics for Chartered Accountants, evaluate the above situation and
discuss the threats (if any) in each case along with the available safeguards if NKC decides
to accept the assignment.
(15)
Audit, Assurance and Related Services
Q.6
(a)
Page 4 of 4
The following information relates to the audit of Apex Fertilizer Limited (AFL) for
the year ended 31 March 2018:
AFL has incurred gross loss which is mainly because AFL’s plant was not running
on optimum capacity due to severe shortage of gas supply from the government.
However, AFL has recently made arrangements with a privately owned company
for supply of gas. Management expects that continuous supply of gas would help
AFL to convert its gross loss into gross profit, although achieving net profit would
require more efforts.
Several instalments of the long term loan appearing on the balance sheet were
overdue. AFL entered into a restructuring agreement with the bank on
7 April 2018 whereby the outstanding interest has been converted into a loan of
three years and principal payments have also been relaxed. The first payment of
principal is now due in July 2019 and the amounts have been reclassified on the
basis of the restructuring agreement.
The method for the depreciation of plant and machinery has been changed from
straight line to units of production method.
The directors’ report includes the following information:
“We have entered into a gas supply arrangement with Karim Gas Limited from
August 2018. A continuous gas supply will help us to attain the optimum
production level and record profits in the next financial year. Furthermore, several
cost saving measures have been taken, as a result of which fixed costs have reduced by
15%.
The company has entered into a restructuring agreement whereby the lenders
considering the potential of the company’s vision and strategies have further
extended and relaxed the terms of future payments. As a result, our liquidity position
has improved which is depicted by a much improved current ratio.”
Required:
As the audit manager what issues would you like to discuss with the
(i)
management in respect of the above (other than the issue of going concern)?
(ii) What could be the possible impact on the audit report if the management does
not agree with your point of view about the issues raised in (a) above?
(b)
(10)
(04)
During the audit of a listed client Pixel Limited (PL), you became aware that a legal
action has been instituted against PL by a competitor, on account of infringement of
patent rights. The company’s lawyer was not able to give any estimate about the
outcome of the case.
No provision was made in the financial statements for the possible loss as a result of
the claims (which are considered to be material), although details of those legal claims
were fully disclosed in the notes.
Required:
Draft how the above matter would be reported in the key audit matter section of the
audit report. (You may assume necessary details)
Q.7
(05)
Kiran is the audit senior responsible for the audit of Xengen Limited. She has noticed that a
large number of journal entries were processed near the year end.
Required:
(a) What controls should she expect to be in place for recording and processing of journal
entries?
(b) What course of action should the audit team take if serious deficiencies are identified
during the control testing process?
(THE END)
(07)
(07)
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2018
A.1
Following are the risks in the given situation and the related procedures which may be
undertaken:
(i)
Impairment of plant and machinery of wearable sports sensors
Risk:
 A continuous decline in sales of this segment and the shift of customers towards smart
watches is an indicator of impairment of the plant and machinery of the wearable
sports sensors segment. Therefore, there is a risk that value in use of the plant and
machinery may have been reduced.
Procedures:
 Ask the management to carry out an impairment review (if not done already) and
obtain the working prepared by the management.
 Obtain an understanding of management process related to identifying, estimating and
recording impairments for PPE
 Review the source data used by the management for impairment testing.
 Assess the reasonableness of assumptions taken by the management and discount rate
used.
 Consider involving auditor’s expert.
(ii)
Overstatement of revenue / understatement of expenses:
Risk:
 MEL may be inclined to show better results so that it would be able to issue right
shares at a much higher premium.
Procedures:
 Understand and evaluate MEL’s financial reporting process and the controls over
journal entries and other adjustments.
 Review accounting estimates for consistency/reasonableness/unbiasness
 Evaluate business rationale for significant transaction outside the normal course of
business
 Evaluate the selection and application of accounting policies by the entity, particularly
those related to subjective measurements.
 Perform analytical review of revenue and expenses.
 Perform cut-off test to check that the vouchers have been completely recorded.
 Perform extensive substantive testing in areas with low control reliance.
(iii)
Segment reporting:
Risk:
 The assets of all other segments are 34% of the total assets. There is a risk that fleet
management system, vehicle cameras or smart watches may fulfill the quantitative
criteria of being reported as a separate segment and management may not have
disclosed it as per IFRS 08.
Procedures:
 Inquire the total assets and revenues of each regularly reviewed segment of MEL and
verify the quantitative thresholds of being reported as a separate segment.
 Ensure that any segment meeting the criteria specified by IFRS is separately disclosed.
 Review the reconciliations between segment information and consolidated information
to assess whether significant items are properly disclosed.
(iv)
Assets held for sale
Risk:
 There is a risk that the criteria for classification of non-current assets as held for sale are
met after the reporting period but disclosures in this respect are not made in the
financial statements.
Page 1 of 9
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2018
Procedures:
 Inquire management if any decision has been finally made for sale of the plant.
 Read the minutes of the board of director’s meeting subsequent to the year end.
 Inspect the correspondence file or agreement if any with the prospective buyer.
 Assess whether plant is available for immediate sale and disposal within 12 months is
highly probable.
 If the criteria for classification of non-current assets as held for sale are met
subsequently, ensure that it is adequately disclosed in the financial statements.
(v)
Provision for staff termination
Risk:
 Since MEL has made a public announcement of closure of the plant and has also
communicated the affected employees, a constructive obligation exists for recognizing
a restructuring provision. As the negotiations with the labor union has not yet been
concluded, there exist a risk that restructuring provision might not be appropriately
recorded.
Procedures:
 Obtain any working prepared by the client for restructuring provision.
 Ensure that the restructuring provision has been recorded in accordance with IAS-37
and cost related to retraining & relocating of continuing staff has not been included in
the provision.
 Obtain a list of all employees who have been made redundant and ensure that all of
them are included in the calculation.
 Review correspondence with employees to establish the date, when the closure of the
facility was communicated to them in order to establish if this was before the year-end.
 With the permission of the client, inquire from the terminated employees regarding
any agreed termination payments.
 Obtain the minutes of meeting held with the labor union to identify whether any
agreement has been reached subsequent to year end.
 Obtain management representation in respect of agreement with the labor union.
(vi)
Onerous contract
Risk:
 There is a risk that due to the increased cost, the pending orders of GPS navigation
systems may result in an onerous contract and MEL would have to recognize a
provision for the present obligation.
Procedures:
 Inspect the Purchase agreement to identify the purchase cost. Also assess whether all
cost has been included that are part of inventory as per IAS-2.
 Check whether the revised landed cost exceeds the agreed sale price.
 If yes then review the assumptions made by the management for the calculation of
expected future sales.
 Ensure onerous contracts are appropriately recorded and disclosed in the financial
statements.
 Review the agreement and assess, whether MEL has a right to cancel the current or
future orders and any cancellation clause or penal provision for exiting the agreement.
 Ensure that penalties if any and other legal costs etc. and duly considered in
determining the amount of provision required.
(vii) Inventory
Risk:
There is a risk that that due to the increased cost of manufacturing GPS navigation system,
the cost of inventory in hand may exceed it’s selling price and would require to be written
down to it’s net realizable value.
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Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2018
Procedures:
 Review and test the procedures in place for comparing NRV with cost for each item of
inventory and assess whether appropriate changes have been made in the light of
current situation.
(viii) Development cost
Risk:
Due to launch of smart watches, there is a risk that cost incurred for research and
development may not have been appropriately accounted for.
Procedures:
 Ensure that all research has been recorded as period cost.
 Ensure that the criteria mentioned by IAS – 38 for capitalization of development cost
has been met.
 Inquire from management about the ending of research phase and commencement of
the development phase and evaluate it’s appropriateness.
(ix)
Foreign exchange translation risk
Risk:
Since the company is exposed to foreign exchange risk due to significant imports, there
is a risk that gains and losses on translation of foreign currencies are wrongly
credited/debited to purchases instead of charging to profit and loss account.
Procedures:
 Check on a sample basis that any gains/losses arising on the translation of foreign
currency are correctly recognized as per the requirements of International Financial
Reporting Standards.
 Check that appropriate exchange rates are used in translation of foreign currency.
(x)
Other risk
The gross profit of all other segments has declined from significantly from 31% to 21%.
Procedures:
 Inquire from management and evaluate the reasons for such a decline.
A.2
(i)
FC being a partnership business is not subject to regulation and oversight of corporate
regulatory authorities and we would need to inquire about the financial reporting
framework used for the preparation of the financial statements and whether it is acceptable.
Documents/information required:
 Audited financial statements of four years
 Any regulatory returns filed by FC
(ii)
It is crucial to identify the role of other 2 persons who have financed the business of FC. It
is important to determine whether the partners can sell their business without the consent of
the lenders.
Documents/information required:
 Copy of partnership deed
 Copy of agreement with the lenders
Page 3 of 9
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2018
(iii)
Evaluate why the finance cost remained the same and then increased when business
became profitable i.e. assess whether there is any profit sharing agreement with the lenders.
Documents/information required:
 Balance of the outstanding loan
 Terms of repayment of loan
 Copy of agreement with the lenders
(iv)
Evaluate the reasons for significant improvement in revenue/profits in 2016.
Evaluate whether the levels of revenue/profits of 2016 and 2017 are sustainable.
Documents/information required:
 Forecast profit and loss account for next three years should be obtained
 Reasonableness of assumptions on which they are based should be evaluated
 Number of active customers registered with FC
 Contracts with restaurants
(v)
Though the increase in expenses appears reasonable on an overall basis i.e. based on the
increased activities (revenue). However, to assess whether the change is reasonable we have
to obtain details/breakup of major expenses.
(vi)
All the partners are crucial to the success of FC, as the business relies heavily on them. We
would have to see whether ECL would be able to find adequate replacement for the
expertise of the partners. Moreover, continuity of other key staff should also be ascertained
for smooth operation of the business.
Documents/information required:
 Names of the key staff
 Job description of the staff
 Offering letter / employment agreement
(vii) ECL plans to use their own delivery riders for the business. It therefore needs to be
ascertained whether the riders are employed on a fixed salary or commission plus fixed
salary and are they entitled to any redundancy payments. The same also needs to be
ascertained for other staff of FC who would not be retained.
Documents/information required:
 Contract with the employees/appointment letters.
(viii) FC fleet of delivery bikes have been acquired on a five-year lease. It seems that it is a
finance lease as the useful life of the bikes is also five years. ECL plans to use its own fleet
for food delivery, so it needs to be ascertained that whether the lease agreement contains
any clause of early exit and its associated cost.
Documents/information required:
 Lease agreement
 Valuation
V
of motor cycles and the lease liability
(ix)
The valuation of the website should also be taken into consideration. Since ECL intends to
use the online system developed by FC, the systems should be tested for security and
should be considered in valuation of the website.
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Audit, Assurance and Related Services
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Certified Finance and Accounting Professional Examination – Summer 2018
Documents/information required:
 Security certificates obtained by FC
 Detail of amounts paid to developer for constructing the web site
 Any other certificates obtained by FC
(x)
All off balance sheet items should also be taken into consideration along with the
assessment of it’s probable outcome.
Documents/information required:
 Names and addresses of the legal advisors of FC
 Names and addresses of all banks of FC
 Details of any pending cases against FC
 Details of future contracts with suppliers
(xi)
The applicability of the income tax and sales tax on the business of FC should also be
considered. It should also be ensured that the tax return have been filed appropriately and
would not result in any future claims by the tax authorities.
Documents/information required:
 Tax returns
(xii) It also needs to be ensured that whether the information systems of FC and ECL could be
integrated.
Documents/information required:
 System specification of both the companies
A.3
Adverse opinion:
 When the auditor expresses an adverse opinion, due to the significance of the matter the
auditor states, that financial statements do not present fairly or give a true and fair view. The
“except for” phrase is used when the auditor expresses a qualified opinion due to material
misstatement.
 The auditor also needs to mention the applicable framework, which have not been complied
with.
 Apparently it seems that in this situation a qualified opinion would have been more
appropriate, since the value of capital spare parts and their depreciation may never represent
a substantial portion of the financial statements.
Basis of adverse opinion:
 Reference of the notes to the financial statements where the relevant information is
disclosed/discussed is missing.





Aslam has stated that the auditors have conclusively assessed the value of stores at Rs. 100
million which is inappropriate. Audit procedures provide reasonable assurance, which is less
than the absolute assurance implied by the word “conclusively”.
Instead of mentioning the audit procedure performed, only mentioning the value of capital
stores would have been sufficient. The description of audit procedures is only provided in the
key audit matter section.
It is not appropriate to give the argument offered by the CFO and use his designation in the
audit report.
Mentioning the CFO may lead to litigations against the firm for defamation. The word
management or company may have been used instead of CFO.
The financial effect of the misstatement has also not been completely discussed. If the capital
stores and spares would have been reclassified as per IAS – 16 then they may have been
subject to depreciation resulting in impact on profit after tax and equity.
Page 5 of 9
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2018

Reference to International Accounting Standards has been made in an inappropriate manner
which is against the best practices being followed almost universally. It should have been
ensured that full name of those standards are given rather than their acronyms.
Emphasis of matter paragraph:
 As per ISA 706 early application (where permitted) of a new accounting standard that has a
material effect on the financial statements may be considered as emphasis of matter
paragraph. However, information related to non-disclosure of information which results in
material misstatement in the financial statements shall not be included in emphasis of matter
paragraph.
 A qualified opinion on the basis of inability to obtain sufficient appropriate audit evidence
should be expressed and in the ‘Basis for opinion section’ the nature of the omitted
information should have been described if practicable.
A.4
(i)
Verify the following information to be used in the calculation of the amount of expense
from Board Minutes and other records of the company:





The grant date and vesting date
The number of executives to whom options are awarded
The number of share options awarded to each individual
The required conditions attached to the options
The number of executives who have accepted share based payment options
(ii)
Agree the fair value of share options with valuer’s report and evaluate whether it is a reliable
source of evidence.
(iii) Test the operating effectiveness of the controls over how management made the accounting
estimate.
(iv) The relevance and reasonableness of management expert findings or conclusion and their
consistency with other audit evidence and whether they have been appropriately reflected
in the financial statement.
(v) If management expert work involves significant use of source data, the relevance,
completeness and accuracy of source data.
(vi) Obtain and review the forecast of staffing levels or employee turnover rates relevant to
executives over the vesting period and consider whether assumptions used for the forecast
appear reasonable.
(vii) Ensure that share based payment options have been accounted for and disclosed as per
IFRS – 2.
(viii) Consider the use of auditor’s expert.
A.5
Holding a financial interest in an audit client may create a self-interest threat. However, the
significance of the threat may vary in different circumstances, each of which is discussed below:
Rashid
Even though Rashid does not have any financial interest in HL. However, his wife being an
immediate family member holds an indirect financial interest, since she beneficially owns shares
in HL through a collective investment trust.
It needs to be assessed whether the amount invested in the mutual fund is material to her. If yes, a
self-interest threat would be created. Then the firm should not accept the assignment unless the
units of mutual fund are disposed of or a sufficient amount is disposed of so that the remaining
amount is no longer material.
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Audit, Assurance and Related Services
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Certified Finance and Accounting Professional Examination – Summer 2018
Zahid
Since HL owns 20% shares in TL, HL can exercise significant influence over TL. However, the
materiality of the interest both for HL in TL and Zahid in TL needs to be evaluated. In case the
financial interest is material to any of the parties the threat created would be so significant that it
can only be reduced if Zahid disposes of his entire shareholding or reduces it to such an extent
that it no longer remains material.
Ali & Ovais:
Persons performing quality control for the engagement or providing consultation regarding
technical issues for the engagement are also included in the audit team.
A self-interest threat may be created due to Ali’s holding of shares in the holding company of HL
if the investment in HL is material to AL. If the investment are material to AL then firm should
not appoint Ali as the engagement quality control partner unless he disposes of his entire
investment.
If Ovais’s son is not dependent on him, then NKC can accept the assignment. However, if Ovais
is to be considered as the tax advisory partner, then his son being a close family member, would
have to dispose of all of his holding or a sufficient amount is disposed of so that the remaining
amount is no longer material, even if he is not dependent on Ovais. However, if his son intends to
retain the investment, then NKC should consider to have a chartered accountant review the work
performed by Ovais or remove Ovais from the team.
If Ovais’s son is dependent on him, then it would be a direct investment in an audit client by an
immediate family member and NKC could not accept the assignment, unless he disposes of all
his investment.
Other employees:
Self-interest threat may be created, but it’s significance would depend on whether any of these
individuals have any relationship with the audit team and the firm’s organizational, operating and
reporting structure.
Depending upon the significance of the threat, NKC may:

remove any audit team member who have any relationship with such an employee;

exclude any such employee from any significant decision making; or

have a chartered accountant review the work of such member of the audit team
A.6
(a)
(i)






We will inform the management that the financial liabilities need to be classified
as current when they are due to be settled with in twelve months after the
reporting period. Agreement to reschedule the loan has been completed after the
reporting period and hence classification between short and long term portions
should still be based on the position prior to restructuring.
The signing of the restructuring agreement after the reporting date, would needs
to be disclosed as a non-adjusting event.
It also needs to be discussed how the management has calculated the expected
units to be produced by the plant and whether the change in the depreciation
would result in a more fair presentation of the plant’s utilization. Also ask the
management that whether the change in the depreciation method has been
applied prospectively.
We will also need to discuss with the management, the need to provide
disclosures in the financial statements with respect to change in accounting
estimates.
It also needs to be brought in the management’s information that any
depreciation method once adopted, needs to be consistently applied.
Due to the gross loss and the uncertainty of gas supply, we will also have to ask
the management, that whether any exercise for determination of impairment has
been carried out.
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Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2018





(ii) 

(b)
We will also inquire whether arrangement of gas with privately owned company
requires any investment (such as construction of pipeline.
The directors’ report state that fixed costs have been decreased by 15% due to
measures taken by the management, whereas, a significant portion thereof is due
to change in depreciation method. Hence, it needs to be discussed what measures
were taken by AFL which led to reduction in fixed cost by 15%.
The directors’ report (other information) states the gas supply arrangement with
Karim Gas Limited will help AFL to attain optimum production level and record
profits in next financial year. However, as per management explanation, it would
only help the company to record gross profit rather than recording net profit.
Therefore, there is an inconsistency between Directors report (other information
and management explanation. If other information is materially misstated we will
request management to amend the directors’ report in this regard.
We may have to ask the management to change the directors’ report regarding
the improvement of current ratio, as it was because of the restructuring
arrangement which now needs to be classified as a current liability.
We will have to inform the management that if the identified material
misstatement of other information is not corrected, it may undermine the
credibility of the financial statements and the auditor’s report thereon. Such
material misstatements may inappropriately influence the economic decisions of
the users for whom the auditor’s report is prepared.
If the loan is not classified as a current liability we will have to express a qualified
opinion and we will also have to describe the financial effects of the material
misstatement in the basis of opinion section of the report.
Since the directors’ report forms part of the annual report, a statement that
describes the uncorrected material misstatement of the other information should
be included in a separate section under the heading of “Other information”.
Contingent liabilities
Refer note x to the financial statements.
How our audit addressed the key audit
matter
The assessment of the existence of the Our audit procedures included the
present legal obligation, analysis of the following:
probability of the related payment and
determining a reliable estimate, requires We had discussions with the Company’s
significant management’s judgment to legal advisors in respect of the outcome of
assess whether it should be recognized as the case and reasonableness of the
provisions or disclosing it as a contingent disclosure.
liability.
We inquired the management and those
Due to the level of judgement relating to charged with governance and also
valuation and presentation of contingent reviewed the subsequent correspondence
liabilities, this is considered to be a key with the competitor.
audit matter.
We also involved our legal expert to assess
We have also assessed it as an area of the outcome of the case.
higher
assessed
risk
of
material
misstatement as it could not be measured We evaluated the adequacy of the
reliably.
disclosure in the financial statements, in
particular the disclosure of the uncertainty
in estimation and its quantification.
Key audit matter
Page 8 of 9
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2018
A.7
(a)
(i)
Policies and procedures involving journal entries and other adjustments should be
documented and available to personnel involved in initiating the entries to the general
ledger/transaction processing systems.
(ii) Entries should be identified with adequate descriptions and/or supporting
documentation including calculations.
(iii) Each entry should be signed by the preparer and approved by the authorized
personnel.
(iv) Authority limits for approval of journal entries should be well defined.
(v) Each entry should be sequentially numbered and dated.
(vi) Standardized forms should be used for standard journal entries (e.g. forms containing
the account numbers of ledgers in which the entry is to be posted)
(vii) Automated exception reports of entries such as amounts in excess of certain limits,
credit entries in accounts where only debit entries are posted, entries in rarely used
accounts, etc. should be regularly generated and reviewed.
(b)
Reassess the risk of material misstatement and modify the nature timing and extent of
further audit procedures, such as:







Identify the ledger accounts in which most of the journal entries were processed, for
e.g. (revenue or fixed assets).
Inquire accounting and data entry personnel whether they were requested to make
any unusual entries during the period.
Introduce an element of unpredictability regarding the amount and types of journal
entries and other adjustments tested.
Computer assisted audit techniques may be used to identify the journal entries and
other adjustments to be tested or to detect unusual entries or entries made at unusual
time or by unusual users.
Increase the extent of substantive procedures.
Focus on journal entries posted at quarter-end and year-end.
Assess whether the control weakness identified represents management override of
control and represents a fraud risk.
If the management integrity or competence is not in doubt the auditor shall communicate
to management at an appropriate level of responsibility significant deficiencies in internal
control it intends to communicate to those charged with governance along with the
description of the deficiencies and an explanation of their potential effects.
If the findings appear to call management’s integrity or competence in doubt the auditor
shall communicate the significant deficiencies to those charged with governance and
consider resigning from the assignment and obtain legal opinion in this regard and shall
determine whether there is a responsibility to report to the regulatory authorities.
(The End)
Page 9 of 9
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Audit, Assurance and Related
Services
SESSION
Certified Finance and Accounting Professional
(CFAP) Examination - Summer 2018
General:
The overall performance in this attempt with passing ratio of 12.5% was slightly better
than the previous attempt where the passing ratio was 11.2%. However, such low passing
percentages are a matter of concern especially in a subject in which all the students are
obtaining extensive training. The matter of concern is that the performances were poor in
all the questions except one, with passing percentages ranging between 7 to 17%.
Further, in all these questions, between 25 to 60 percent of the candidates could not even
score 25% marks.
Question wise comments are given below:
Question 1
This was a standard question on identification of risks and the key audit procedures to be
performed in respect thereof. Despite the fact that questions in this area appear in every
attempt, the performance of the students was very poor as only 14% of the candidates
secured passing marks. A significant number of students were totally unprepared as about
40% of the candidates secured 5 or less marks in this 20 mark question.
Majority of the candidates were able to identify some of the risks but were unable to
identify the relevant audit procedures. Further, risks related to segment reporting,
onerous contract and foreign exchange translation were identified by few students only.
A major issue with many students was that they gave generalized steps such as “ensure
that appropriate provision has been made” instead of specifying what steps have to be
taken in this regard. Some of the other common issues are discussed below:



With regard to overstatement of revenue / understatement of expenses, hardly any
student mentioned that the intention may be to show better results to be able to issue
right shares at a much higher premium. Moreover, the students seemed to be unaware
of the areas which should be scrutinized when such a risk is identified and only few
could mention steps related to review of journal entries, accounting estimates,
transactions outside the normal course of business, etc.
With regard to assets held for sale the review of board minutes and criteria for
classification of non-current assets as held for sale were rarely discussed.
Somehow, a number of students wasted a lot of time in discussing the issue of going
concern which was hardly relevant as the company had earned substantial profits this
year as well as in the past also.
Page 1 of 4
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Summer 2018

With regard to segment reporting procedures for ascertaining whether any other
segment had fulfilled the criteria for being reported as a separate segment was
mentioned by few students only.
Question 2
This was a scenario based question in which the candidates were required to discuss the
matters which they would focus while performing a due diligence review under the given
scenario. They were also supposed to identify any additional information which they may
require during the review. The performance in this question was extremely poor and only
7% could secure passing marks. About 62% of the candidates secured three or less marks
in this 15 mark question.
Majority of the students seemed to have very little idea of the important aspects which
are considered in a due diligence review. Accordingly, most of the answers revolved
around analyzing the data given in the question irrespective of the significance of each
type of information. Moreover, very little or no emphasis was placed on other important
areas such as (i) role of partners and in the absence of any experience of similar business,
how would the acquirer manage the business (ii) is there any key staff and would they
continue (iii) terms of employment of the existing delivery staff who would have to be
relieved, (iv) are the financial statements audited and (v) other off balance sheet items.
Even the analysis of data was weak in many cases as the following matters were
discussed by few students only:




Why the finance cost remained constant in 2014 and 2015
Which assets have been leased and would the lease continue
Why there is no provision for taxation
What are the details of operating expenses
While discussing the other important information/documents required, items like bank
details, legal advisor’s details, contracts with restaurants and suppliers, etc. were mostly
ignored.
Question 3
In this question an audit report drafted by an audit team member was given and the
candidates were required to critically analyse the audit report i.e. identify the apparent
errors. This was expected to be a high scoring question but even in this question, the
performance was very poor as only 13% candidates secured passing marks. About 30%
of the candidates secured two or less marks in this 11 mark question.
Majority of the students identified only two or three mistakes in the draft report, which
were definitely not enough to justify a question worth eleven marks. Some very basic
statements were incorrectly phrased in the draft report but they were picked up by only a
handful of students like the words “conclusively” and “CFO has refused” and use of
acronyms for international accounting standards were very obvious mistakes.
Page 2 of 4
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Summer 2018
Question 4
This question required the candidates to mention the key audit procedures for share based
payment option described in the given scenario. The performance in this part was quite
satisfactory as 48% of the candidates secured passing marks. However, about 25% of the
candidates were totally unaware of this area and obtained one or less mark in this six
mark question.
Though many of the students performed very well; yet there were several others who had
no idea of the key issues involved such as the vesting period, fair value of share options
and the assumptions used, forecast of employee turnover rates, etc. Many candidates
produced lengthy discussion on the competency and integrity of the management expert
although it was mentioned in the question that this aspect was not required to be
discussed.
Question 5
Code of Ethics is considered a favourite area of the students; however, in this attempt the
performance was poor in this area also. Only 17% of the candidates secured passing
marks and about 20% of the candidates secured three or less marks in this 15 marks
question.
Majority of the students were only able to obtain a few marks on the basis of their
comments on shareholding of the engagement partner’s wife’s. Most of the candidates
tried to give generalised comments on the scenario as a whole instead of analyzing each
situation separately.
Many students did not consider the partners giving non-audit services as part of audit
team and hence made incorrect conclusions. Similarly, only a few students touched on
the threats arising due to holdings of other employees as majority concluded that no
threats would arise due to holdings of other employees.
Question 6
This question consisted of two independent parts. Only 15% of the candidates could
secure passing marks in this question. Part wise comments are given below:
Question 6(a)
According to the scenario given in the question the following matters were highlighted
with regards to a listed company AFL:
1. It had incurred gross loss as because of shortage of gas supply, its plant could not run
on optimum capacity.
2. AFL had made arrangements with a gas supply company which is expected to
convert gross loss into gross profit.
3. Long-term loan had been restructured and classified as a short term loan.
4. Method of recording depreciation has been changed.
5. A paragraph from the directors’ report was reproduced.
Page 3 of 4
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Summer 2018
The requirement was to discuss what matters the auditor would need to discuss with the
management (other than going concern issues) and the possible impact on audit report if
the management does not agree with the auditor’s point of view.
Most of the students picked up the obvious points but failed to identify the non-obvious
ones. Some of the errors also resulted because of not reading the question carefully.
Some such issues are discussed below:




It was clearly mentioned in the question that the restructuring of loan has been agreed
after year-end. Therefore, they should have mentioned that restructuring of loan is a
non-adjusting event and that any change in the classification of liability from current
to non-current would not be done this year. Instead, most of them mentioned that the
auditor needs to consider whether it is an adjusting or a non-adjusting event.
No questions were raised as to how total number of units which the plant would
produce has been estimated.
Regarding the change in depreciation method, a lot of students perceived it as a
change in accounting policy and discussed about its retrospective application whereas
under IAS 16 change in depreciation method is to be accounted for as a change in
accounting estimate.
Regarding inconsistencies between auditor’s information and director’s report, only
few students raised question regarding director’s claim that the company would be
able to record profits in the next year and their claim regarding improvement in
current ratio which could even reverse after appropriate classification of long term
loan.
Question 6(b)
In this question, the candidates were required to draft how the given matter would be
reported in the key audit matter section. The issue pertained to petition filed by a
competitor where the client’s legal advisor was unable to give any estimate about the
outcome and consequently no provision had been made but full disclosure had been
given. The candidates were allowed to assume further details if necessary.
The performance of the students in this part was much better. However, in many cases
the answers suffered on account of poor english as the candidates produced meaningless
sentences.
Question 7
In this question the candidates were required to specify the controls which they would
expect with regard to processing of journal entries and what action should the auditor
take if serious deficiencies are identified during the control testing process.
Some basic controls and consequent actions were pointed out by majority of the students
but only 17% could secure passing marks.
Controls like documented policies and procedures, standardized forms for standard
journal entries, automated exception reports for un-usual entries were hardly discussed.
Similarly, auditors’ actions like use of computer assisted audit techniques, increasing the
extent of substantive testing and assessing risk of management override of controls were
rarely mentioned.
(THE END)
Page 4 of 4
AUDIT, ASSURANCE AND RELATED SERVICES
Summary of Marking Key
Certified Finance and Accounting Professional Examination – Summer 2018
Note regarding marking scheme:
The marking scheme is given as a guide. Markers also award marks for alternative approaches to
a question and relevant/well-reasoned comments/explanations. Moreover, the available marks in
answer may exceed the total marks of a question.
A.1
01 mark for identification of each relevant audit risk
0.5 mark for each key audit step/procedure to be performed against the
identified risks
01 mark for explanation of each matter to be focused in due diligence review
0.5 mark for identification of each additional document/information
Mark(s)
8.0
12.0
A.2
A.3
Up to 02 marks for analysis of each error in the given extract of the audit report
11.0
A.4
01 mark for each key audit procedure
6.0
A.5
A.6
A.7
Identification of threats
Evaluation of the situation and significance of the threat in the case of:
–
Rashid
–
Zahid
–
Ali & Ovais
–
Other employees
Discussion on available safeguards
(a)
(i)
10.0
5.0
1.0
2.5
2.5
2.5
1.5
5.0
Up to 02 marks for identification of each issue to be discussed with the
management
10.0
(ii) Brief explanation of the impact of the identified issues on the audit report
4.0
(b)
Discussing why the matter was determined to be a key audit matter
Drafting of extract of key audit matter section of the audit report
1.0
4.0
(a)
01 mark for mentioning each control for recording and processing of journal
entries
7.0
01 mark for each key step to be taken in the given situation
7.0
(b)
(THE END)
Page 1 of 1
Certified Finance and Accounting Professional Stage Examination
The Institute of
Chartered Accountants
of Pakistan
6 December 2018
3 hours – 100 marks
Additional reading time – 15 minutes
Audit, Assurance and Related Services
Q.1
You are the engagement manager in Hasan Abdali and Company, Chartered Accountants.
One of your clients is Falcon Limited (FL) which owns six shopping malls and four office
building complexes in different cities for rental purposes. FL also constructs and sells
residential apartments in major cities of Pakistan.
The following matters were discussed in the planning meeting of the audit for the year
ending 31 December 2018:
(i)
CFO informed that FL has implemented a new enterprise resource planning system
(ERP). He stated that FL has successfully revamped the entire accounting system
through this new ERP.
(ii) A shopping mall located in Multan has been witnessing low turnout of customers. FL
has been trying to persuade its tenants for not vacating their shops and have offered
that they pay 50% of the rent and pay the remaining amount when conditions improve.
Some of the tenants have accepted FL’s offer and have formally negotiated a two-year
relaxation period.
(iii) FL’s head office was shifted to a central location in a newly constructed building. Two
floors of the building which were surplus to FL’s need have been rented out to
MM Limited (MML) which is owned by a director of FL. MML provides maintenance
services to various building projects. FL and MML have agreed that FL will not charge
any rent for the two floors in consideration for free maintenance of Multan shopping
mall and the head office.
(iv) Construction of four residential projects started during the year. The projects are in
various stages of completion. About 70% of the apartments have already been booked.
FL offers different terms to its customers depending upon which option they choose.
(v) The balcony of one of the apartments constructed in 2012 fell off, severely injuring
three persons. The news surfaced in the media and caused severe criticism on FL and a
show-cause notice was also received by FL from a regulatory authority. FL’s
management is of the view that the construction was up to the required standards and
the residents had made some modifications which caused this incident.
Required:
Discuss the audit risks that exist in the above scenario and suggest the key audit procedures
to be performed in respect of the identified risks.
Q.2
(23)
During the audit of Leather Goods Limited (LGL), it came to the knowledge of the audit
team that LGL has been dumping its chemical waste in an open area outside the city,
without proper treatment as per the required standards. When confronted, the Chief
Financial Officer did not consider it a serious issue and informed that LGL has managed to
receive the required certificate from the relevant regulatory authority.
Required:
Evaluate the above situation and explain what course of action the auditor would need to
take.
(14)
Audit, Assurance and Related Services
Q.3
Page 2 of 3
You are the audit partner of Mansoor Noorani and Company, Chartered Accountants.
Following are the audit issues being faced on different clients:
(a) The previous year’s audit report of RP Limited was qualified by the predecessor auditor
for not recording impairment loss of Rs. 67 million on plant and machinery. However,
the management has recorded the impairment in the current year. Profit before tax for
current and prior year is Rs. 500 million and Rs. 300 million respectively.
(b) The management of DC Limited has informed you that they have not disclosed a
material litigation relating to an oil spill from its vessel as the disclosure would be
detrimental to the legal defence of the entity.
Required:
Discuss the auditor’s course of action along with implications on the audit report.
Q.4
(12)
Dildar Textile Limited (DTL) has a factory situated in Faisalabad. DTL has been facing
acute shortage of power supply, due to which it has not been able to fulfil its orders within
the committed time. Directors of DTL have decided to install gas driven power plant, to
resolve the issue of power breakdown and has approached its bank for a loan of
Rs. 500 million to finance the required expenditure.
To meet the bank’s requirement, DTL has prepared a forecast cash flow for the next three
years. The following further information is available:
(i)
DTL intends to supply the surplus electricity produced to the national grid. Directors
expect an increase in the cash flow due to the proceeds of sale of electricity.
(ii) DTL plans to procure a vacant plot next to its facility for installation of the plant.
(iii) The installation of plant is expected to be completed by 30 June 2019.
(iv) Currently, 40% of the production is exported and the rest is sold locally. DTL is
expecting a rise in export as well as local orders by 30% and 20% respectively.
(v) Other major outflows pertain to raw material, payroll cost and marketing costs.
Required:
DTL has asked your firm of chartered accountants to provide a report on the forecast. State
the key examination procedures to be used in respect of the cash flow forecast.
Q.5
(a)
(10)
You are the quality control partner in a firm of chartered accountants. Your firm has
been approached by Beta (Private) Limited (BPL) for appointment as the auditors for
the year ending 30 June 2019.
Your firm was also hired by BPL for valuation of its investment in an unlisted
company on August 2018. The valuation engagement had concluded in
September 2018 and the amount of investment is material to BPL’s financial
statements.
Required:
Being the quality control partner, advise whether the audit of BPL could be accepted by
the firm. Also discuss the relevant threats, if any.
(b)
(06)
You are the statutory auditor of two listed companies, Alpha Limited and Gama
Limited. Both the companies are in conflict with each other and involved in two major
litigations.
Required:
Identify the threats involved in the above situation and also suggest related safeguards,
if any.
(06)
Audit, Assurance and Related Services
Q.6
Page 3 of 3
(a) Explain the difference between:
(i) Type 1 report and type 2 report.
(ii) Scope of assurance engagement under the ‘Inclusive Method’ and under the
‘Carve out Method’
(03)
(03)
(b) You have been assigned the area of related parties in an audit of the financial
statements of a listed company where there are significant related party transactions.
Required:
Highlight what controls would you expect to be present in the company for the related
party transactions.
Q.7
(a)
(05)
Your firm Gul Khan and Company, Chartered Accountants (GK) is the auditor of
Yameen Corporation Limited (YCL), a listed company which has three subsidiaries. In
the planning meeting, the Chief Financial Officer of YCL informed you about the
following developments which took place during the year ending 31 December 2018:
(i)
Asia Power Limited (APL) was incorporated in a foreign country named Blueland
in January 2018. YCL is the main sponsor and holds 75% shares in APL. Rest of
the shares are held by a local sponsor. APL is being audited by a firm in Blueland.
APL is providing project management services to a power plant in Blueland. The
fee for project management services is agreed at USD 30 million while the
expected cost is USD 22.5 million. The revenue is being recognized on identified
milestone basis in the books of APL.
(ii) There was a major reshuffle in one of the business segments of YCL which
resulted in several employees being laid off. The reshuffling was carried out when
several ghost employees were identified by the internal audit department.
Consequently, the management of YCL decided to outsource its payroll
processing department along with few other activities related to the finance
department to another company.
Required:
In light of the above mentioned information what considerations should be taken into
account while devising the over-all audit strategy.
Note: Audit procedures are not required
(b)
(13)
You are the audit manager in a firm of chartered accountants. The audit of a client
TC Limited (TCL) is in the finalisation stage. TCL has a foreign subsidiary, WCL.
The financial statements of WCL are not in compliance with IFRS-15 as the regulator
in foreign country has deferred adoption of IFRS-15. Your audit team has asked TCL’s
management to assess the impact due to non-adoption of IFRS-15 and revise the
financial statements accordingly. According to the management of TCL, the local
auditor of WCL has expressed an unqualified audit report on WCL’s financial
statements. They believe that the auditor should rely on the report issued by WCL’s
auditor. In this respect they have referred to previous year’s audit report which clearly
states that the firm’s opinion was based solely on the report issued by the subsidiary’s
auditor.
Required:
Discuss how you will respond to the argument presented by TCL’s management.
(THE END)
(05)
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2018
Ans.1
(i)
Risk of improper implementation of ERP:
Improper implementation of new ERP system creates the risk of generating incorrect
financial information and records.
There is a risk of improper capitalization of the cost of new ERP or the useful live for
calculating the amortization may not be appropriate.
Audit procedures:
 Check whether appropriate user testing was performed.
 Ensure that necessary action was taken on the basis of users’ testing results.
 Ensure that system was retested after incorporation of changes, if any, on the
basis of users’ testing.
 Ensure whether appropriate training was provided to users.
 Ensure that account balances have been properly brought forward in the ERP.
 Perform walkthrough and test of controls of the ERP.
 Involve the firm’s IT team for assessing the implementation and proper
functionality of the ERP.
 Ensure that criteria mentioned by IAS 38 for capitalization of cost has been met.
 Assess the reasonableness of the useful life of the new ERP.
(ii)
Risk of decrease in fair valuation of investment property:
 There is an inherent risk in the fair valuation of investment property because of
the estimates and judgements involved.
Audit procedures:
 Obtain an understanding of management process related to valuation of
investment property.
 Review the source data used by the management for the valuation.
 Assess the reasonableness of assumptions taken by the management.
 Assess the competence and objectivity of external valuers appointed by the
management.
 Consider involving auditor’s expert.
(iii)
Risk of classification and impairment of receivables:
There is a risk that amounts due from tenants who have not availed the offer may
have incorrectly been classified as non-current assets and vice versa.
Furthermore, due to low turnout of customers and the fact that the tenants won’t be
paying 50% of the rent for two years, a provision of doubtful receivables may need to
be made against rent receivable.
Audit procedures:
 Inquire from the management how many tenants have agreed on the revised
terms and obtain the new agreements.
 Ensure that 50% of the amount agreed to be paid after one year is re-classified as
non-current assets.
 Ensure that long term receivables have been recorded at the discounted amount.
 Consider the reasonableness of the discount rate used.
 Ensure that appropriate provision has been made for doubtful receivables.
 Confirm the outstanding balance from the tenants.
 Ensure the reasonableness of the assumption used by the management for
forecasting the improvement.
Page 1 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2018
(iv)
Risk of related party transactions:
There is a risk of inappropriate classification of the two floors given to MML. The
two floors could be classified as PPE as well as investment property, depending upon
the conditions specified in the IFRS.
Letting out two floors to MML is a related party transaction. There is a risk that the
transaction with MML may have not been made on arm’s length. Moreover, the way
the agreement has been made poses a risk of incorrect determination of the amount
of revenue and expenses to be recognized.
Audit procedures:
 Obtain the agreement made with MML and evaluate whether the terms of the
contract are consistent with the management’s explanation.
 Consider whether the two floors are capable of being leased or sold separately to
assess that these have been classified correctly.
 If these floors are classified as investment property, assess whether the fair value
of the property has been determined appropriately. In this regard, assess the
competence and objectivity of the valuer, appropriateness of the assumptions
used and also consider hiring the services of auditor’s expert.
 Assess whether the transaction has been recorded at an appropriate amount.
 Consider whether the transaction has been made at arms-length and where these
are not at arms-length, appropriate disclosure is given.
 Ensure that the consideration in kind has been accounted for as per the
requirements of IFRS-15
 Ensure that proper disclosures are made in the financial statements, in respect of
this transaction.
(v)
Risk of revenue recognition:
There is a risk of error in recognizing the revenue from the construction of residential
apartments as different basis of recognition have been specified by the IFRS i.e. it is
either recognized at a point in time or over the period of completion. In case the
terms of sale agreement suggest that revenue should be recognized over the period
then there is a risk that the stage of completion may not be correctly assessed, resulting
in over or under statement of revenue.
Audit procedures:
 Review the sale agreement and check that the basis of recording of revenue is
correct.
 Where the revenue is being recognized over the period of completion:




Obtain an understanding of management process related to assessing the
stage of completion.
Assess the reasonableness of assumptions taken and estimates made by the
management expert.
Assess the competence and objectivity of the management expert.
Consider engaging the auditor’s expert to assess the stage of completion.
Ensure correct accounting and disclosure of the revenue, costs, assets and
liabilities.
Litigation and claim
There is a risk that a provision for damages may be required to be made in the
financial statements for injuries caused by fall of the balcony.

(vi)
Further, if fault in construction is proved, a provision for repair cost/fine related to
other apartments may also be required.
Page 2 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2018
Audit procedures:
 Send confirmation requests to FL’s legal advisors.
 Review the correspondence with the regulators and the minutes of the meeting
to gain an insight in the matter.
 Consider engaging own legal counsel.
 Ensure appropriate disclosure or provision in the financial statements, as the case
may be.
(vii) Risk related to negative publicity:
Due to the falling of balcony and the resultant media criticism, there is a risk of serious
damage to the reputation of the company.
Audit procedures:
 Discuss with the management, the impact of this event on the marketability of
the company’s existing projects.
 Review subsequent events to see whether there are any unreasonably high
number of cancellations or decline in bookings.
 Assess the impact of the above on the financial statements.
Ans.2
Evaluation of the situation:
Even though LGL manages to get its required certificate, the same could have significant
implications on LGL as any mishap may lead to severe legal action in future. Furthermore,
violation of laws and regulations is a fraud risk factor and also brings in doubt the ethical
values and the attitude of the management towards the conduct of business.
Course of action:
(i)
Auditor should inquire how the management has obtained the certificate despite of
not disposing the waste as per the required standards and consider the possibility that
the certificate was obtained illegally.
(ii) Audit team should critically inspect cash payments and any unexplained payments
made during the year.
(iii) Auditor should assess the risk of material misstatement due to fraud and it’s
implication on nature, timing and extent of audit procedures.
(iv) Due to the non-compliance of laws and regulation and the attitude of management
towards its compliance, auditor should also consider the reliability of written
representation provided by the management.
(v) Auditor should discuss the matter with those charged with governance and advise
them to take necessary steps to avoid future non-compliances.
(vi) Auditor should consult the legal advisor about the laws and regulations and the
possible impact of the non-compliance on the client. If auditor is not satisfied with
the opinion of LGL’s legal advisor it should consult with its own lawyer, relating to
possible legal consequences.
(vii) If those charged with governance agree to rectify the situation, the auditor need to
consider:
 the cost of cleaning up the site and ask the client to make necessary provision.
 the possibility of similar non-compliance in other areas.
(viii) In case no action is taken by those charged with governance, the partner must
consider:
 the impact on the audit report.
 withdrawing from the engagement.
 including a key audit matter section regarding the risk of fraud, bribery and
corruption.
(ix)
Auditor should consider the legal responsibilities to report the non-compliance to the
authorities.
Page 3 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2018
Ans.3
(a)
The auditor will include other matter paragraph in his audit report mentioning the
fact that the previous year’s financial statements were audited by another firm of
chartered accountants and they had expressed a qualified opinion along with the
reasons of qualification and the date of the audit report.
Management of RPL has accounted for an impairment of Rs. 67 million in the
financial statements of the current year, whereas it should have been provided in the
previous year. Hence the current year’s profit is understated by the same amount and
corresponding figures/opening balances also contain a material misstatement of Rs.
67 million.
The auditor should ask the management and those charged with governance to restate
the comparative figures and take the effect of the impairment retrospectively.
If the management agrees to make the adjustment retrospectively, an unqualified
opinion will be expressed with an emphasis of matter paragraph giving reasons for
restatement of figures and a reference to the notes to the financial statements.
If the management does not agree then the auditor’s report will be qualified due to
the misstatement in current year as well as the corresponding figures/opening
balances.
(b)
In extremely rare cases, if disclosure of some or all of the information required by
IFRS can be expected to prejudice seriously the position of the entity in a dispute with
other parties then in such cases, an entity need not disclose the information.
In the given situation, the auditor should assess whether he agrees with the
management’s point of view in the light of the above guideline. If the auditor does
not agree, he should qualify the audit report. However, if the auditor agrees, he needs
to ensure that the management discloses the general nature of the dispute, together
with the fact, and reason why, the information has not been disclosed, as is further
provided in the IFRS. If the directors do not agree to disclose the general nature of
the dispute together with the fact and reason why the information has not been
disclosed, the auditor would need to express a qualified opinion. In case of either type
of disagreement, the auditor needs to describe the nature of the omitted information
in the basis for opinion section.
Moreover, unless prohibited by law or regulation, include the omitted disclosures,
provided it is practicable to do so and the auditor has obtained sufficient appropriate
audit evidence about the omitted litigation.
If proper disclosures are made in the financial statements, auditor should consider
including it in the key audit matter section of the audit report.
Ans.4
(i)
Confirm expected timeframe for the import and installation of machinery by referring
to vendor quotations/communication.
(ii) Obtain the pro forma invoice / quotation for the procurement and installation of the
generators.
(iii) Confirm the cost purchase of land with agreement made with the seller.
(iv) Obtain the bids received from the contractors for estimating the amount of
expenditure required for the construction of the building in which the generator
would be installed.
(v) Inquire from management whether necessary approvals have been obtained from the
government for the installation of power plant.
(vi) Assess the amount of gas available by reviewing the communication with the
government, and whether it corroborates with management’s expectations.
(vii) Review the payment terms with the government for the supply of extra electricity.
Page 4 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2018
(viii) Inquire management about basis of increases in export and local sales.
(ix) Review the foreign exchange rates used for translating the exports sales.
(x) Purchase of raw material, staff cost and marketing expense corroborates with
expected increase in sales.
(xi) Inquire with the marketing department whether any new campaigns would be
required to meet the expected rise in sales and its estimated cost.
(xii) Consider whether fuel costs have been revised in line with the specifications provided
by the generator supplier.
(xiii) Inquire about the interest rates and the repayment terms of the loan and ensure that
they have been appropriately incorporated in the cash flow.
(xiv) Assess management competence regarding the preparation of the cash flow forecast.
Ans.5
(a)
Under the code of ethics, the firm could not have accepted the valuation service, had
the valuation service been requested after the appointment as auditors, However,
since the valuation service was provided prior to appointment as auditors, the audit
engagement could be accepted.
A self-review threat would be created because the amount is material to the financial
statements, is highly subjective and is included in the financial statements of the
period which the firm will subsequently audit.
In order to reduce the threat to an acceptable level the following safeguards should be
applied:



(b)
Not including personnel who provided the non-assurance service in the audit
team.
Having a chartered accountant to review the audit and the valuation as
appropriate
Engaging another firm to evaluate the results of the valuation engagement or
having another firm to re-perform the non-assurance service to the extent
necessary to enable it to take responsibility for the service.
A threat to objectivity or confidentiality may be created when a chartered accountant
in practice performs services for clients that are in dispute with each other.
Following safeguards should be considered and applied as necessary to eliminate or
reduce the threats to an acceptable level:








The use of separate engagement teams.
Procedures to prevent access to information (e.g., strict physical separation of
such teams, confidential and secure data filing).
The use of confidentiality agreements signed by employees and partners of the
firm.
Regular review of the application of safeguards by a senior individual not
involved with relevant client engagement.
Having a chartered accountant who is not involved in providing the service
review the work performed to assess whether the key judgements and
conclusions are appropriate.
Consulting with third parties, such as professional body, legal counsel, etc.
Disclose the nature of conflict of interest and the related safeguards to the clients
in litigation.
Where a conflict of interest poses a threat to one or more of the fundamental
principles, including objectivity, confidentiality or professional behavior, that
cannot be eliminated or reduced to an acceptable level through the application
of safeguards, the chartered accountant may withdraw from the engagement.
Page 5 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2018
Ans.6
(a)
(i)
Type 1 report
Type 2 report
(i)
It gives reasonable assurance about It gives reasonable assurance about
the suitability of design and the suitability of design and
implementation of controls.
implementation of controls and
their operating effectiveness.
(ii) Type 1 report is at a specified date. Type 2 report is for a specified
period.
(iii) In type 1 report, service auditor Type 2 report, includes the
mentions that the he has not following:
performed
any
procedures  a summary of the service
regarding
the
operating
auditor’s procedures to obtain
effectiveness of controls and
reasonable assurance.
therefore no opinion is expressed  A statement, that the evidence
thereon.
obtained is sufficient and
appropriate to provide a basis for
the service auditor’s opinion
 a separate section after the
opinion, or an attachment, that
describes the tests of controls that
were performed and the results of
those tests.
(ii)
(b)
Inclusive method
Carve-out method
(i)
Service organization’s description Service organization’s description
of its system includes the control of its system excludes the control
objectives and related controls at objectives and related controls at
the sub-service organization.
the sub-service organization.
(ii) Scope of the service auditor Scope of the service auditor
includes
the
subservice excludes
the
subservice
organization’s relevant control organization’s relevant control
objectives and related controls.
objectives and related controls.
(iii) Service auditor mention’s in his Service auditor mention’s in his
report that his procedures extend to report that his procedures do not
controls
at
the
subservice extend to controls at the subservice
organization.
organization.
(iv) In the description of system, In the description of system, there is
detailed processing or controls at no need to describe detailed
the subservice organization shall be processing or controls at the
described.
subservice organization.
Ability of entity’s information systems to record, process and summarize related
(i)
party relationships and transactions to meet the accounting and disclosure
requirements of the framework;
(ii) Appropriateness of internal ethical codes communicated to the entity’s
personnel and their enforcement. They should also govern the circumstances in
which the entity may enter into specific types of related party transactions.
(iii) Policies and procedures for open and timely disclosure of the interests that
management and those charged with governance have in related party
transactions.
(iv) Timely disclosure and discussion between management and those charged with
governance of significant related party transactions outside the entity’s normal
course of business, including whether those charged with governance have
appropriately challenged the business rationale of such transactions (for
example, by seeking advice from external professional advisors).
Page 6 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2018
Clear guidelines for the approval of related party transactions involving actual
or perceived conflicts of interest, such as approval by a subcommittee of those
charged with governance comprising individuals independent of management.
(vi) Periodic reviews by the internal audit function.
(vii) Proactive actions taken by management to resolve related party disclosure
issues, such as by seeking advice from the auditor or external legal counsel.
(viii) The process for assessing whether the transaction is at arm’s length price or not.
(v)
Ans.7
(a)
Consideration related to audit of component:
The financial reporting framework used by APL to prepare the financial
(i)
statements, including any need for reconciliation to another reporting
framework.
(ii) The size of operation of APL, it’s materiality for YCL and who are the auditors.
(iii) The extent of involvement in the audit of APL and whether the working papers
will be available to the firm.
(iv) The nature of the business of APL and whether any specialized knowledge is
required for the component.
(v) Expected types and timing of reports to be issued by the auditor and the
component auditor.
(vi) How the competence of the component auditors would be confirmed along with
the acceptability of the ethical standards and quality control policies followed
by them.
(vii) The preliminary identification of material classes of transactions, account
balances and disclosures of APL.
Consideration for engaging expert:
Audit team should consider whether they have the expertise of calculating or
(i)
estimating the agreed milestones or would they require the services of an expert.
Consideration related to fraud risk:
The reliance placed on internal control and increasing the extent of substantive
(i)
testing.
(ii) Identification of fraud by the payroll department indicates that there might be
other instances of fraud even though there is a functioning internal audit
department, therefore team members need to maintain a questioning mind and
to exercise professional skepticism in gathering and evaluating audit evidence.
(iii) Even though an internal audit department exist, but due to the emergence of
fraudulent activity we need to consider the management commitment to design,
implementation and maintenance of sound internal control.
(iv) The selection of the engagement team and the assignment of audit work in light
of fraud risk and the complexity of the group and its operations.
Consideration related to service organisation:
YCL’s use of service organizations and how the audit team will obtain evidence
(i)
concerning the design or operation of controls performed by them, i.e will the
type 2 reports be available.
(ii) Significance of those services to YCL and materiality of the transactions
processed or accounts or financial reporting processes affected by the service
organization.
(iii) The nature of the relationship between the user entity and the service
organization, including the relevant contractual terms for the activities
undertaken by the service organization.
Page 7 of 8
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Winter 2018
Identification of high risk areas:
Identify areas of higher risk of material misstatement such as, staff lay-off,
(i)
recognition of revenue from project management services, related party
transactions and business combination along with the appropriate audit
approach.
(b)
Even though regulators of foreign subsidiary have granted relaxation for the
implementation of IFRS-15 but still, the financial statements need to be converted as
per financial reporting framework of the group.
Since the group auditor is responsible for obtaining sufficient appropriate audit
evidence regarding the financial information of the entities within the group to express
an opinion on the consolidated financial statements, we would need to verify the
impact of IFRS-15.
Furthermore, if the impact is material to the group financial statements then it would
need to be adjusted otherwise we would express a qualified opinion.
With regards to audit report, issuance of 2018 Regulations eliminates the previous
concept of division of responsibilities, thus making the group auditor responsible for
the audit opinion on the consolidated financial statements, without making reference
in the audit report to any other auditor involved in the audit of subsidiaries.
(The End)
Page 8 of 8
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
EXAMINERS’ COMMENTS
SUBJECT
Audit, Assurance and Related
Services
SESSION
Certified Finance and Accounting Professional
(CFAP) Examination - Winter 2018
General:
The overall performance in this paper was better than the previous attempt as 21%
candidates secured passing marks as compared to 13% in the previous attempt. Still the
passing ratio was among the lowest in this attempt’s CFAP examination papers.
The most prominent reason for poor performance is that most students try to write as
many points as they could think of irrespective of their relevance. In the process they also
write the same points in different words. Such wastage of time affects their performance
as they are unable to allocate sufficient time to consider the exact requirement of the
question and frame their answers in a logical manner.
Question 1
It was a standard sort of a question where the candidates were required to identify audit
risks in the given scenario and suggest key audit procedures to be performed in respect of
each identified risk.
The performance remained mixed. Though passing ratio was only 29% yet average
marks obtained by the candidates were 9.3 which showed that even those students who
could not secure passing marks were able to secure some marks.
Majority of the students were able to identify the risks correctly but a common error was
the identification of going concern issue as a risk as there was no indication in the
question which could lead to doubt over the going concern status of the company. This
error had serious repercussions for the erring students as all their focus got shifted to this
risk and they wasted time in mentioning a number of audit procedures related to this risk
and ignored some very pertinent issues.
Majority of the students showed lack of clarity in identifying the audit procedures. At this
stage the students should realize that when they have identified any particular risk, they
need to list down discrete, appropriate and relevant audit steps to address the risk. For
example, if a risk of under provisioning for a specific obligation is present, the audit step
can’t just say that auditor will ensure that proper provision has been made by the client.
Page 1 of 5
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Winter 2018
A common error was with regard to implementation of ERP. The risk of improper
implementation was identified by almost all the students but procedures to address this
risk were not up to the mark. Many answers listed procedures to be done during testing
phase of the new ERP ignoring the fact that the system was already live and operational.
Associated risk of incorrect capitalization and amortization were also missed out
generally.
Many students appeared confused about correct accounting treatment of the given
situations. The candidates cannot suggest appropriate audit procedures unless they clearly
understand the correct accounting treatment of a given scenario. This was obvious in case
of revenue recognition especially where company had offered tenants to pay 50% of the
rent at a later time. Most of the students failed to realise that this would give rise to longterm receivables which would have to be classified as non-current asset and would also
need recognition after discounting. Majority of the students were of the view that only
50% of the rent which is actually paid would be recognised as revenue.
Majority of the candidates were also not clear about the accounting issues to be faced
where two floors of the building were rented out to a related party i.e. that these floors
could be classified as property plant and equipment or as investment property, depending
upon certain conditions.
Question 2
This question was based on a short scenario according to which a company had been
dumping its waste without appropriate safeguards but had somehow managed to obtain
the required certificate from relevant regulatory authority. The candidates were required
to explain what course of action the auditor would need to adopt in the given situation.
It was a low-scoring question as only 14% of the candidates secured passing marks. Most
of the answers revolved around analyzing the possible penalties through legal advice and
their provision and disclosures. They failed to realize that the main point of concern for
auditor was assessing the attitude of management towards compliance of laws and
regulations necessary for conduct of business which entailed a big question mark on the
management’s concern for ethical values and also indicated a fraud risk factor. This, in
turn, required a review of the audit approach with regard to nature, timing and extent of
audit procedures. Possibility of similar non-compliances and unexplained cash payments
needed to be critically inspected also. Most of the students missed these critical points.
Question 3
This question consisted of two independent situations (parts) and the candidates were
required to discuss the auditor’s course of action along with implications on the audit
report. The overall performance was poor as only 13% candidates secured passing marks.
Performance in each part is discussed below:
Page 2 of 5
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Winter 2018
Question 3(a)
According to the scenario, previous year’s audit report had been qualified by the
predecessor auditor for not recording impairment of plant and machinery. However, the
impairment loss relating to previous year had been recorded in the current year.
About 50% of the students knew that by making the adjustment in the current year, the
current year’s profit has been under stated and also that the corresponding figures are
also misstated and that if the necessary correction is not made, a qualified report would
have to be issued. However, they failed to specify that even if the management agrees to
make the correction, an emphasis of matter paragraph would have to be given giving
reasons for restatement and reference to the relevant note to the financial statements. The
remaining 50% of the students suggested incorrect approach. According to most such
students the management was correct and the auditor needed to issue an unmodified
report. Some of them were of the view that the matter can only be rectified by asking the
previous auditor to revise the audit report. Some of them were totally confused and
narrated the procedures to verify the amount of impairment.
Question 3(b)
According to the situation in this part, the management had informed the auditor that they
have not disclosed a material litigation as the disclosure would be detrimental to the legal
defense of the entity. Only few students knew that according to IAS-37, in extremely rare
circumstances, this can be allowed. Consequently, the auditor needed to assess the
validity of the management’s point of view.
Instead, answers kept orbiting around legal confirmations, assessments of amount to be
provided in financial statements, conclusions that management has to disclose it in any
case and even doubts on integrity of management in case of non-disclosure.
Question 4
This was a simple question requiring steps to verify cash flow forecast. The performance
was satisfactory as 47% candidates secured passing marks. The common mistake was
that students copied exact wording from the standard and did not structure their answers
according to the scenario. Most of the students mentioned steps like checking the
reliability of data and reasonableness of assumptions but missed specific steps such as
those related to draft loan agreement, vendor quotations for machinery, cost and time
frame for installation of generators, foreign exchange rates and bids received for
construction of building for installation of generators.
Question 5
This question was based on code of ethics for Chartered Accountants. The question
consisted of two parts. The overall performance was satisfactory as 50% candidates
secured passing marks. Part wise performance is discussed below:
Page 3 of 5
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Winter 2018
Question 5(a)
According to the given scenario, a firm of chartered accountants was offered appointment
as auditors by a company whereas the firm had been previously involved in the valuation
of the company’s investment in an unlisted company. The requirement was to discuss
whether the firm could accept the appointment and the threats involved.
The performance in this part was not satisfactory as majority of the students did not pay
attention to the fact that valuation service was provided prior to appointment as auditor
so the appointment could have been accepted. Consequently, they also did not mention
the correct safeguards as they concluded that no safeguards can reduce the threat to an
acceptable level.
Question 5(b)
According to the given scenario, two clients of an audit firm were involved in major
litigations. The requirement was to identify the threats in the given situation and the
related safeguards.
This part was attempted well as most of the students mentioned the correct threats i.e.
objectivity and confidentiality; and the related safeguards.
Question 6
This question consisted of two parts. The overall performance was good as 62%
candidates secured passing marks. Part wise performance is discussed below:
Question 6(a)
In sub-part (i), almost all of the students were able to point out two basic differences
between type 1 report and type 2 report; however, most of them missed an important
point i.e. that in type 1 report, no opinion is expressed whereas type 2 report includes an
opinion, summary of procedures carried out and results of tests of controls also. Same
was the case in sub-part (ii) which required differentiating between inclusive method and
carve out method. An important difference i.e. in inclusive method the service auditor
mentions that his procedures extend to controls at subservice organization whereas in
carve-out method it’s the opposite; was normally missed out.
Question 6(b)
This part was also well attempted as majority of the candidates were able to correctly
identify the controls for identification and reporting of related party transactions.
Question 7
This question consisted of two parts. The performance was very poor as only 10%
candidates secured passing marks. Part wise performance is discussed below:
Page 4 of 5
Examiners’ Comments on Audit, Assurance and Related Services – CFAP Examination
Winter 2018
Question 7(a)
According to the scenario given in this part, a company had three subsidiaries. One of the
subsidiaries had been incorporated in the current year, in a foreign country. Further,
ghost employees had been identified by the internal audit in one of the company’s
business segment and as a result, a major reshuffle had been carried out and payroll
processing department had been outsourced. The requirement was to discuss the matters
which needed to be considered while devising the overall audit strategy.
Though this part of the question was attempted by almost all the students and some basic
factors to be considered for devising the overall audit strategy of a group audit were
pointed out by majority of the students, only a few secured passing marks. The main
reason was that candidates produced answers based on general factors that are to be
considered in any group audit. There was very little focus on the fact that one new
subsidiary was added to the group during this year and several ghost employees were
identified in the parent company.
Considerations like requirement of any specialized knowledge especially the expertise
needed for calculating or estimating the agreed milestones to ensure correct revenue
recognition were hardly discussed. Similarly, actions like less reliance on internal
controls and increasing the extent of substantive testing along with need to exercise
professional skepticism were rarely touched upon.
Question 7(b)
According to the given scenario, the financial statements of a client’s foreign subsidiary
were not in compliance with IFRS 15 as the regulator there had deferred the adoption of
IFRS 15. The management does not agree that any change is necessary as the previous
year’s audit report stated that in giving the opinion the auditor had relied solely on the
report issued by subsidiary’s auditor.
The performance remained below average as majority of the students missed the point
that Auditors (Reporting Obligations) 2018 Regulations have eliminated the previous
concept of division of responsibilities, thus making the group auditor solely responsible
for the audit opinion on the consolidated financial statements.
(THE END)
Page 5 of 5
AUDIT, ASSURANCE AND RELATED SERVICES
Summary of Marking Key
Certified Finance and Accounting Professional Examination – Winter 2018
Note regarding marking scheme:
The marking scheme is given as a guide. However, markers also award marks for alternative
approaches to a question and relevant/well-reasoned comments/explanations. Moreover, the
available marks in answer may exceed the total marks of a question.
A.1
A.2
A.3
Up to 01 mark for discussing each relevant audit risk
Up to 01 mark for each key audit procedure to be performed against the
identified risks
Mark(s)
11.0
12.0
Evaluation of the situation
Discussion on auditor’s course of action related to:
− suspected malpractice and/or fraud by the management along with its
implications
− determination of the possible impact on the financial statements
− impact on the auditor’s report
2.0
7.0
3.0
2.0
(a)
Discussion regarding the adjustments required in the financial statements
Discussion regarding the impact on the audit report
1.5
4.5
(b)
Evaluation of the need and extent of disclosures required in the financial
statements
Discussion regarding the impact on the audit report
3.0
3.0
A.4
Up to 01 mark for each key examination procedure
A.5
(a)
Discussion regarding acceptability of the engagement
Identification of the relevant threat
Evaluation of the significance of threat
01 mark for each related safeguard
1.5
0.5
1.0
3.0
(b)
Identification of threat
Up to 01 mark for each related safeguard
1.0
5.0
(a)
(i)
Up to 1.5 marks for each difference
3.0
(ii) Up to 01 mark for each difference
3.0
(b)
Up to 01 mark for each control
5.0
(a)
Up to 01 mark for each consideration to be taken into account while devising
the over-all audit strategy
13.0
01 mark for each valid discussion point in response to the argument
presented by the management
Discussion on reporting implication
4.0
1.0
A.6
A.7
(b)
10.0
(THE END)
Page 1 of 1
Certified Finance and Accounting Professional Stage Examination
The Institute of
Chartered Accountants
of Pakistan
13 June 2019
3 hours – 100 marks
Additional reading time – 15 minutes
Audit, Assurance and Related Services
Q.1
Your firm has been appointed as the auditor of Best Industries Limited (BIL) for the year
ending 30 June 2019. BIL is a listed company and has three production plants. Plants A and
B manufacture industrial chemicals whereas Plant C is used in manufacturing of various
cosmetic and skin care products.
The following information has been gathered by the audit team:
(i)
Ghufran is the CEO and holds, directly and indirectly, majority of the shareholdings
in BIL. There are seven other directors on the board who meet four times a year to
approve the quarterly financial statements and endorse the decisions taken by Ghufran
during the quarter.
(ii)
Considering the decline in demand of the products, BIL has taken the following
decisions during the year:
Close Plant B with effect from 31 August 2019. The public announcement of this
decision was made on 15 April 2019.
Introduce a new incentive package for distributors in January 2019 to boost the
sales of industrial chemicals. The sales commission rate is dependent on achieving
the various annual target levels set by the BIL’s management.
Launch a customer loyalty program in February 2019 in which customers are
awarded loyalty points on each purchase of cosmetic and skin care products from
selected retail outlets and online stores. The management believes that this
initiative would increase the demand of cosmetic and skin care products.
(iii)
Staff at production and marketing departments are hired at low salaries but they are
given high annual bonuses on achieving their targets.
(iv)
Last year, BIL was selected for tax audit in which the income tax department had
disallowed certain business expenditures. BIL filed an application against the order
issued by the income tax department. However, it lost the first appeal and has recently
filed a second appeal to the relevant income tax authority.
Required:
Discuss the audit risks that exist in the above scenario and suggest the key audit procedures
that you would perform to address those risks.
Q.2
(a)
(24)
Your firm has been hired by Pedro Limited to assist the management in preparation of
certain financial information. You are in disagreement with some of the adjustments
made by the management in the financial information and consider these to be
inaccurate.
Required:
Discuss how you would resolve the disagreement along with the implication, if any,
on the report.
(05)
Audit, Assurance and Related Services
(b)
Page 2 of 3
You are the audit manager of a listed company, Brace Limited (BL). During your
discussion with the audit team deputed on the review assignment of BL’s interim
financial statements for the half year ended 31 May 2019, the following matters are
highlighted:
(i)
Auditor was not asked to attend the stock count at the end of the period.
Consequently, the audit team relied on the physical count sheets provided by the
management.
(ii)
BL has significant accumulated losses and its current liabilities exceed the
current assets.
(iii) Provision for bad debts is in line with the prior period. However, age-analysis of
debtors has not been used.
(iv)
Due to time constraints, the review of subsequent events has not been carried
out by the audit team.
Required:
Discuss how you would deal with the above matters and the possible implications of
each of the above matters on the review report.
Q.3
(10)
You are a partner in a firm of chartered accountants. Your firm has recently been
approached by an off-shore entity incorporated in British Virgin Island for appointment as
an auditor for the year ending 30 September 2019. The entity is following locally developed
accounting standards in the preparation of its financial statements.
On your query regarding availability of records and information, the entity has informed
you that they will electronically send the scanned copies of the records/information required
for the audit purpose.
Required:
Discuss the matters that your firm should consider before accepting the above audit
engagement.
Q.4
Alpha Textile Limited (ATL) is a long standing listed audit client of your firm. Haris has
been the audit engagement partner of ATL for the last five years. The firm is considering to
appoint Munir as ATL’s engagement partner and Haris either as ATL’s quality control
review partner or client relationship partner.
Required:
In the light of Listed Companies (Code of Corporate Governance) Regulation, 2017 and
ICAP’s Code of Ethics, discuss the validity of Haris’s appointment either as ‘quality control
review partner’ or ‘client relationship partner’.
Q.5
(11)
(a)
(08)
On 25 March 2019, your firm issued the audit report on the financial statements of
Noor Limited (NL) for the year ended 31 December 2018. During the first week of
June 2019, NL’s management has requested you to issue the report on summarized
financial statements for the year ended 31 December 2018 for the use of its potential
investor after incorporating the effect of a material litigation decided in favor of NL on
31 May 2019.
Required:
Discuss your firm’s responsibility in respect of gathering the audit evidence and
issuing a report on summarized financial statements.
(05)
Audit, Assurance and Related Services
(b)
Page 3 of 3
The following situations have arisen at different audit clients of your firm. The
year-end in each case is 31 March 2019:
(i)
Afzal Limited is a listed company. During its audit of financial statements, the
provincial sales tax authority has seized the accounting records of the company
on the charges of tax evasion.
(05)
(ii) Gems Limited (GL) is a leading manufacturer of jewelry made from precious
stones. GL sources the stones from three suppliers located in
Khyber Pakhtunkhwa (KPK). On 10 May 2019, a severe earthquake struck KPK
destroying the mines and the stone extraction units located in KPK. GL’s plant
was also partially damaged due to the earthquake.
Upon discussion with the management, you came to know that one of the GL’s
plants was affected by the earthquake and due to adequate insurance, they would
be able to claim the loss amount from insurance company. They further informed
that GL could continue to use the other plants for production.
(10)
Required:
Discuss your firm’s course of action along with the implications on the audit report.
Q.6
During the audit of Shahid Limited, your IS audit team has reported the following issues:
(i)
(ii)
(iii)
The client did not have an approved business continuity plan.
There were several program changes made during the year which were not approved
by the higher management. However, a complete log of program changes was
maintained.
IDs of the employees who have left the company are not deleted on a timely basis.
Required:
Discuss the possible course of action that you may take in respect of the above identified
issues. (Reporting implications are not required)
Q.7
(12)
During the audit of consolidated financial statements of Voltage Limited (VL), for the year
ended 31 May 2019, you have identified the following matters which will be reported as key
audit matters in the audit report:
(i)
(ii)
VL has acquired 65% shares in Pyrus Limited.
VL has entered into a major project in relation to the development and maintenance
of its electricity transmission infrastructure which is expected to be completed over a
three year period.
Required:
Draft the key audit matters section to be included in the audit report of VL’s consolidated
financial statements. (You may assume necessary details where required)
(THE END)
(10)
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2019
A.1
(i)
Opening balances
It is the first year audit and there is the possibility that prior year balances are
materially misstated, are not correctly brought forward and the accounting policies are
not consistently applied.
Procedures:



(ii)
Review the previous period’s accounting records and schedules to ensure that
opening balances have been correctly brought forward to the current period.
If the predecessor auditor permits, review his working papers to ensure the
correctness of the opening balances.
Obtain evidence from the procedure performed in the current period to provide
evidence relating to the correctness of opening balances and the consistent
application of accounting policies.
Ineffective governance structure
Ghufran being the majority shareholder and taking all the decisions, which are later on
endorsed by the board indicates that the board may be overly influenced by Ghufran.
This ineffectiveness may affect the company’s operational efficiency, control
environment, exposure towards legal and regulatory risks, etc.
The Board of Directors meets four times only for approving the accounts, there is a risk
that BIL may be in non-compliance of Code of Corporate Governance which require the
board to have other sub-committees of HR, risk, etc. and their related meetings.
Procedures:





(iii)
Inquire whether there is a formal and effective mechanism for an annual
evaluation of the board’s own performance, members of board and of its
committees.
Obtain the meeting minutes and evaluate involvement of other directors in the
decision making process.
Obtain minutes of the different committees such as audit committee, HR
committee, etc., and evaluate their effectiveness in the strategic and operational
decision making.
Inquire about the independent directors and their role on the board of directors.
Inquire about the competencies, skills, knowledge and experience of the board of
directors.
Fraudulent financial reporting / management override of controls
Due to the dominant nature of Ghufran and ineffective governance structure there is a
risk of management override of controls.
Furthermore, there is an increased risk of fraudulent financial reporting as the staff in
production and marketing department receive low salaries but are given high annual
bonuses on achieving their annual targets.
Procedures:






Understand and evaluate BIL’s financial reporting process and the controls over
journal entries and other adjustments.
Evaluate business rationale for significant transaction outside the normal course
of business.
Perform analytical review of revenue.
Perform cut-off test to check that the vouchers have been completely recorded.
Evaluate the selection and application of accounting policies by the entity,
particularly those related to subjective measurements.
Obtain the details of sales return after the year end.
Page 1 of 10
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2019
(iv)
Assets held for sale
There is a risk that the criteria for classification of non-current assets as held for sale
is not met resulting in in-appropriate accounting and disclosures.
In case the criteria for recognition as held for sale is met there is an inherent risk, due
to the high level of judgment, involved in estimating the fair value and the significant
carrying amounts of the assets and liabilities associated with it.
Procedures:

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

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(v)
Inquire from the management if any decision has been finally made for sale of the
plant.
Read the minutes of the board meetings for confirmation of the above.
Inspect the correspondence file or agreement if any with the prospective buyer.
Assess whether plant is available for immediate sale and disposal within
12
months is highly probable.
Involve our own valuation expert to assist in evaluating the fair value of the plant.
Evaluate the adequacy of the accounting and financial statement disclosures,
including disclosures of key assumptions, judgment and sensitivities.
Restructuring costs and liabilities
Since BIL has decided to close one of the chemical production plant and public
announcement has been made in this regard, there exists a risk that restructuring
provision might not be appropriately recorded and disclosed.
There is also a risk that the criteria for recognition of restructuring provision is not
met resulting in in-appropriate accounting and disclosures.
Procedures:






(vi)
Inquire from the management whether it has a detailed formal plan for
restructuring.
Inquire whether the main features of the plan have been communicated to the
affected employees/parties.
Inquire from the management whether they have started to implement the
restructuring plan.
Review the working prepared by the client for restructuring provision and ensure
it has been prepared in accordance with IAS-37 along with the related
assumptions.
Obtain a list of all employees who have been made redundant and ensure that all
of them are included in the calculation.
With the permission of the client, inquire from the terminated employees
regarding any agreed termination payments.
Sales commissions
Since the commission paid to distributors depends on achievement of annual targets,
judgement would be required in assessing whether they would be able to meet their
targets and accruing the sales commission accordingly.
Procedures:



Obtain an understanding of the contracts with the distributors.
Observe the sales made subsequent to the year end.
Inquire the process being followed by the management for recording sales
commission and assessing the reasonableness of management assumptions.
Page 2 of 10
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2019
(vii) Loyalty programs
There is significant judgement involved in determining whether customers would
make future purchases and redeem their loyalty points. Therefore, there is a risk of
material misstatement in recoding revenues and associated liabilities resulting from
such transactions.
Procedures:

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

(viii)
Obtain an understanding the of the customer loyalty program and the management
process for recording revenues and the related obligations.
Evaluate reasonableness of management assumption regarding the expectation of
point redemptions.
Ensure that accounting has been done in accordance with IFRS-15.
Consider using an expert for calculating the liability related to points redemption.
Tax liabilities
There is a risk of material misstatement due to the high level of judgment required to
assess the outcome of tax litigations.
Procedures:

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
(ix)
Obtain the opinion of Company’s tax advisor about the allowability of such
disallowances.
Consider involvement of own tax specialist to understand the nature of these
disallowances and their point of view about the success in such type of cases.
Evaluate the nature of disallowances and compare it with the company’s historical
track record in such types of cases.
Evaluate the adequacy of the accounting / disclosure in the financial statement.
Impairment of plant and machinery
Decline in demand of BIL’s products is an indicator of impairment of the plant and
machinery. Therefore, there is a risk that the plant and machinery may have been
impaired.
Procedures:




(x)
Obtain an understanding of management process related to identifying, estimating
and recording impairments for PPE
Review the source data used by the management for impairment testing.
Assess the reasonableness of assumptions taken by the management and discount
rate used.
Consider involving auditor’s expert.
Inventory
There is a risk that that due to decline in the demand of BIL’s product, there may be
obsolete inventory which require to be written down to net realizable value.
Procedures:


Obtain the aging analysis of inventory to identify any obsolete inventory which
needs to be written down to its NRV.
Review and test the procedures in place for comparing NRV with cost for each item
of inventory and assess whether appropriate changes have been made in the light
of current situation.
Page 3 of 10
Audit, Assurance and Related Services
Suggested Answers
Certified Finance and Accounting Professional Examination – Summer 2019
A.2
(a)
Since the assignment involves assisting the management in preparation of financial
information, it should be considered as ‘compilation engagement’. In such an
engagement, no opinion can be formed.
Considering the scenario, if your firm becomes aware that compiled financial
information is misleading, appropriate amendments in this regard should be proposed
to the management.
However, if the management declines, or does not permit your firm to make the
amendments to the compiled financial information, your firm shall withdraw from the
engagement and inform management and those charged with governance.
If withdrawal from the engagement is not possible, your firm shall determine the
professional and legal responsibilities applicable in the circumstances.
(b)
(i)
Ordinarily an auditor is not required to perform the procedure of observation for
obtaining evidence in a review engagement. However, only relying on the count
sheets provided by management is not sufficient and we will have to perform
analytical procedure.
Considering this, there will be no implication on review report.
(ii)
Existence of accumulated losses and adverse ratio indicates that BL may not be a
going concern. Therefore, we will have to inquire management as to its plans for
future actions, feasibility of future plans and whether outcome of the plans would
improve the situation.
Consider the adequacy of the disclosures about such matters in the interim