Set 1 - Suggested Answers
QUESTION 1
Part A
a)
Audit Expectation Gap – the difference between the expectations of the users of the
financial statements and the opinion that the auditors can provide. For example,
users of financial statements expect auditors to guarantee the accuracy of financial
statements while the auditors can only provide reasonable assurance of financial
statements that are free from material misstatements
(2 marks)
b)
Deep pocket syndrome – the tendency of the injured party to sue the auditors
regardless whether they are at fault or not. This is because auditor is often time
perceived as the only one left with financial resources to compensate the users of
financial statements (plaintiff) in cases of business failure
(2 marks)
c)
Audit Oversight Board – it is established to oversee the auditors of Public Interest
Entities (PIEs) and to protect the interests of investors by promotiing confidence in
the quality and reliability of audited financial statements of PIEs
( 2 marks)
Part B
With reference to the code of professional conduct, ethics and practice, the following are
what the auditor should do in the cases below:
a)
The firm may provide such non-audit service but should avoid making the
management decisions as to whom to hire. The firm can assist in reviewing the
professional qualification of the applicants and provide advice on their suitability for
the position. The firm may also provide a short-list of candidates for interview
provided that the list is drawn up based on criteria specified by the client.
(3 marks)
b)
Tan & Company should explain to their client that they can generally perform the
financial due diligence. However, in respect of the valuation of the inventory, the firm
would not have the skills and competency to determine the value. The firm should
advice client to rely on expert who would have the skills to determine the value. If the
client does not appoint the expert, the firm should refrain from undertaking the
engagement.
(3 marks)
c)
KS & Company may receive a commission from the software developer in connection
with the sale of specific accounting software to client. The auditor could disclose to
client in advance about their commission arrangement with the software developer
and get agreement from the client.
(3 marks)
(Total: 15 marks)
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QUESTION 2
a)
Four types of property, plant and equipment transactions are:
1.
Acquisition of capital assets for cash or other non-monetary considerations.
2.
Disposition of capital assets through sale, exchange, retirement, or
abandonment.
3.
Depreciation of capital assets over their useful economic life.
4.
Leasing of capital assets.
(4 x 1/2 mark = 2 marks)
b)
Inherent risk factors that should be considered when assessing inherent risk for
property, plant, and equipment are:
1.
Complex accounting issues:
Lease accounting, self-constructed assets, and capitalized interest are
examples of transactions that involve complex accounting issues.
2.
Difficult-to-audit transactions:
The vast majority of property, plant, and equipment transactions are relatively
easy to audit. However, transactions involving donated assets, non-monetary
exchanges, and self-constructed assets are more difficult to audit because it
may be difficult to verify the value of such assets.
3.
Misstatements detected in prior audits:
If the auditor has detected misstatements in prior audits, the likelihood of
misstatements in the current year is higher.
(3 x 2 marks = 6 marks)
c)
Substantive audit procedures with related assertions that the auditors should use in
verifying the mobile construction equipment and related depreciation would include
the following:
Substantive Procedures
Determine that the equipment account is properly added.
Determine that the subsidiary accounts agree with
controlling accounts.
Obtain or prepare an analysis of changes in the account
during the year.
Determine that beginning-of-year balances agree with the
prior year's ending balances.
Inspect documents in support of additions during the year
Assertions
Valuation
Completeness
valuation
valuation
Completeness
and obligations
Inspect documents in support of disposals/retirements Completeness
during the year.
and obligations
Analyse repairs and maintenance for possible valuation
reclassifications
Determine the propriety of accounting for equipment not in valuation
current use.
2
/rights
/rights
Test the accuracy of equipment and accounting records by
(1) selecting items from the accounting records and
verifying their physical existence and (2) selecting items of
equipment and locating them in the accounting records
Evaluate the reasonableness of estimated lives and
methods of depreciation used.
Test the calculation of depreciation charges and
accumulated depreciation balance.
Perform analytical procedures such as comparing
depreciation charges to balance sheet accounts for proper
relationship and compare the current year's depreciation
charges with prior year's depreciation amounts
Evaluate the financial statement presentation and
disclosures for conformity with approved accounting
standards.
Review insurance coverage.
Existence/
Completeness
valuation
valuation
valuation
Presentation
Disclosure
and
Rights and Obligations
(any 6 x 2 marks = 12 marks)
d)
Five (5) substantive procedures that can be used to audit the impairment of PPE:
1.
Gather assurance on the valuation of PPE through a variety of procedures
such as understanding of the business and industry and current events that
may lead to impairment.
2.
Tests of controls over the client company’s impairment evaluation.
3.
Inquiry and observation regarding the condition and usefulness of long lived
assets.
4.
Substantive procedures on account balances.
5.
Gather evidences for substantial judgement and expertise required in
reviewing for recoverability and impairment test.
Note: MFRS 136 – Impairment of Assets defined an asset is impaired when its
recoverable amount is less than its carrying amount. Recoverable amount is
the higher of the fair value less costs to sell and value in use.
(5 x 1 mark = 5 marks)
(Total: 25 marks)
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QUESTION 3
The differences between review of financial information and due diligence engagement in
terms of the objective and review procedures are as follows:
Type of
Engagement
Objective
Review of Financial Information
Review
Procedures
1.
Due diligence
The practitioners perform limited
evidence gathering procedures to
obtain the moderate assurance
whether financial information or
financial statements present a true
and fair view in accordance with
the identified financial reporting
framework.
(1 mark)
2.
3.
4.
5.
6.
The appointed
practitioners are required
to ensure that the entity’s
submission to Securities
Commission does not
contain false, misleading
or omitted information (in
compliance with section
32B of the SCA 1993)
( 1 mark)
Understanding entity’s business 1. Review of information
and industry
on audited financial
Understanding entity’s
performance for the
accounting system and
past five years
financial statements
2. Review of
Inquiries on material assertions,
management system
recording of transactions,
and financial reporting
changes in accounting policies
3. Review of forecast and
and practices, subsequent
budget system in
events
comparison with the
Inquiries of significant issues
actual information
and actions taken by
4. Review of internal
management
control and financial
Perform analytical reviews
procedures
Obtain written management
5. Review of financial
representation
position, cash flow and
(any 4 x 1 mark = 4 marks)
bank loans
6. Review of profit and
cash flow forecast
7. Financial Statement
analysis and
comparison with
industry statistics
(any 4 x 1 mark = 4 marks)
[Total: 10 marks]
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QUESTION 4
A.
a)
b)
Tests of controls
1. Inquiries about internal controls (e.g determining who actually performs easy
described function)
2. Observation of controls (e.g. consider the manner in which the control is being
operated)
3. Inspection of documents supporting controls or events (e.g. verifying that a
transaction has been authorised)
4. Examination of evidence of management views (e.g. minutes of management
meetings)
5. Reperformance of control procedures to ensure they were correctly performed
(e.g. reconciliation of bank accounts)
6. Testing on internal controls operating on computer applications (e.g. access
controls)
(any 4 x 1 mark = 4 marks)
Types of substantive tests
i.
B.
Analytical procedures
The analysis of significant ratios and trends including the resulting
investigations of unusual fluctuations or items. The use of comparisons and
relationships in the analytical procedures can help determine whether the
account balances and other related financial or non – financial data are
appeared reasonable.
(2 marks)
ii.
Substantive test of transactions
This is to test the material errors or frauds in the individual transactions.
Examining individual transaction provides the auditor with evidence on the
validity, completeness, valuations, accuracy, and cut – off such as the
transaction related audit objectives.
(2 marks)
iii.
Tests of account balances
This is to test on the details of amounts contained in an account balance.
Audit procedures for evidence are testing the monetary misstatements in the
accounts presented in financial statements and also to ascertain whether the
balance related objectives have been satisfied for each significant account
balance.
(2 marks)
Elements of control environment
1. Communication and enforcement of integrity and ethical values
2. Commitment to competence
3. Participation by those charged with governance
4. Management’s philosophy and operating style
5. Organisational structure
6. Assignment of authority and responsibility
7. Human resource policies and practices
5
(any 4 x 1 mark = 4 marks)
C.
a)
Benefits and disadvantages of using CAAT.
Benefits
Audit time maybe save.
Disadvantages
The auditors need to have computer
proficiency.
Ability to scrutinize large volume of Can be expensive to set
data.
Eliminate manual casting, cross Detailed knowledge of systems and
casting.
programs is required
Less manual procedure.
CAATs are generally not designed to
detect frauds.
The auditor does not necessarily have To know the techniques of auditing using
to be present at client’s office.
CAATs.
(any 2 marks of each x 2 = 4 marks)
b)
Two (2) common types of CAATs
Audit software – is computer programs used for audit purposes to examine the
contents of the client’s computer files. e.g Package Programs or Generalised Audit
Software and Written Programs or Custom Audit Software.
(1 1/2 marks)
Test data – are data used by the auditors for computer processing to test the
operation of the client’s computer programs. E.g. Test data, Parallel Simulation,
Integrated test Facility & Concurrent Auditing techniques.
(1 1/2 marks)
c)
Four (4) major steps to be undertaken by the auditors in the application of CAAT.
1.
2.
3.
4.
5.
6.
Set the objectives of the CAAT application
Determine the content and accessibility of the entity’s files
Define the transaction types to be tested
Define the procedures to be performed on the data
Define the output requirements
Identify the audit and computer personnel who may participate in the design and
application of the CAAT
7. Refine the estimates of costs and benefits
8. Ensure the use of the CAATs is properly controlled and documented
9. Execute the CAAT application
10. Evaluate the result.\
(any 4 x 1 mark = 4 marks)
[Total: 25 marks]
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QUESTION 5
a) i)
The auditor primarily would be concerned with occurrence of sales transactions,
because of the large increase in sales, both in general and abroad.
(2 marks)
ii)
The auditor would be concerned with the existence of the accounts receivable
because there is some evidence that the increase in accounts receivable seemed to
be greater than the increase in sales (e.g. greater percentage increase in accounts
receivable than for sales, increase in average days outstanding).
The auditor also would be concerned with valuation or allocation (i.e. to what
extent are the receivables collectible).
(4 marks)
b)
Procedures the auditor should perform:Vouch sales and receivables. Specifically, to examine the occurrence and existence
assertions, auditors could choose a sample sales transactions and examine
supporting documents, perhaps paying particular attention to the existence of a valid
sales order as well as evidence that the products were shipped (i.e. shipping
documents).
(2 marks)
Confirm a sample of accounts receivable with customers, perhaps asking the
customers to fill in the monetary amount that they owe as of the balance sheet date.
This procedure would help verify existence or occurrence, rights and obligations, and
valuation or allocation.
(1 marks)
Prepare an aging schedule to check for the existence of a significant amount of old
receivables. This procedure would be useful primarily for valuation or allocation.
(1 mark)
[Total: 10 marks]
QUESTION 6
A.
a)
The auditor should issue an audit report with a “adverse” opinion.
Reason being the applicable financial reporting framework (MFRS) requires a
statement of cash flows included in the financial statements. The management is
required to prepare the statement of cash flows for inclusion in the financial
statement.
(2 marks)
7
b)
The auditor should issues audit report with a qualified or an adverse opinion,
depending on the pervasiveness of the item.
Reason being the approach is not in accordance with a financial reporting
framework (MFRS) because such contingencies must be disclosed in the notes to
the financial statements if the amount of the contingency cannot be measured
reliably. In this case the potential settlement is likely to be very large given the
proportions of the tragedy in terms of human loss and suffering. In addition, the
tragedy may well threaten the company’s ability to be involved in similar projects in
the future and perhaps its own survival. Thus, an adverse opinion is very likely the
most appropriate response.
(3 marks)
c)
The auditor should issues an audit report with qualified opinion or a disclaimer of
opinion.
Reason being because the client would not allow the confirmations to be sent, the
appropriate response would generally be either for a scope limitation imposed by the
client’s management, depending on the pervasiveness of the effect the possible
misstatements on accounts receivable and sales.
If in any situation when the auditor concludes that a qualification of the opinion will
be inadequate to communicate the gravity of the situation, the auditor should where
practicable and possible under applicable law or regulation withdraw from the audit.
(3 marks)
d)
The auditor should issues an audit report with an unmodified opinion.
Reason being the auditor is satisfied about the inventory balance using alternative
audit procedures. The alternative audit procedures would normally include a physical
count subsequent to year end and reconciliation to the balance at the end of the
reporting period.
(2 marks)
e)
The auditor should issues an audit report with a qualified or adverse opinion.
Reason being the client’s failure to disclose the related-party transaction means that
the financial statements do not comply with a financial reporting framework (MFRS).
(2 marks)
B.
Specific responsibilities of management
Designing, implementing and maintaining internal control
Preparation and fair presentation of financial statements that is free from material
misstatement either due to error or fraud.
(3 marks)
[Total: 15 marks]
END OF ANSWER PAPER
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