2015
AUDIT AND
ASSURANCE
QUESTION BANK
ICAP
Question
Bank
P
Audit and Assurance
Second edition published by
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The Institute of Chartered Accountants of Pakistan
Certificate in Accounting and Finance
Audit and Assurance
C
Contents
Page
Question and Answers Index
v
Questions
Section A
Multiple choice questions
1
Section B
Objective test and long-form questions
17
Section C
Multiple choice answers
71
Section D
Objective test and long-form answers
77
Answers
© Emile Woolf International
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The Institute of Chartered Accountants of Pakistan
Audit and Assurance
© Emile Woolf International
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The Institute of Chartered Accountants of Pakistan
Certificate in Accounting and Finance
Audit and Assurance
I
Index to Objective test and long-form
questions and answers
Question
page
Answer
page
Audit framework, regulation and ethics
1
ICAP Code of Ethics
17
77
2
Levels of assurance
18
79
3
Shamsuddin
18
79
4
Core concepts
18
80
5
Threats
19
81
6
Burewala and Kamal
19
82
7
Zaman and Bilal
19
83
8
Audit process
19
84
9
Regulatory and professional
requirements
20
85
10
Fundamental principles
20
87
11
Oops
20
87
12
Independence of external auditors
20
88
13
Tahira and Parvez
21
88
Planning and risk assessment
14
Saad Co
21
89
15
Alpha
21
90
16
Engagement letter and documentation
22
90
17
Shahid Corporation
22
91
18
Assertions
22
91
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Audit and Assurance
Question
page
Answer
page
19
Companies Ordinance 1984
23
93
20
ASPL
23
93
21
AMF
24
94
22
Acceptance and planning
24
95
23
SPL
25
95
24
Fruit and nuts
25
96
25
Discussions and judgment
26
97
26
Dynamic
26
98
27
Changing Terms
26
99
28
EL
27
99
29
Calm Co
27
100
30
Azam
27
100
31
Hurricane
27
102
32
Zakir Co
29
104
33
Hajira
30
106
34
Tahir Co
30
108
Internal control
35
Controls
31
110
36
Shahzad
31
111
37
Waheed Engineering
32
112
38
Danish
33
113
39
Roses Anytime
34
115
40
Trade Receivables
35
117
41
Granger
35
119
Audit evidence
42
Nobel
36
122
43
Masoom Limited
37
122
44
Sky Blue
37
123
45
Direct confirmations 1
37
123
46
Chill
37
124
47
Sales sampling
38
124
48
PQR
38
125
49
Hard Stone Limited
39
126
50
Related parties
39
127
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Index to questions and answers
Question
page
Answer
page
51
Direct confirmations 2
39
127
52
Working papers
39
128
53
Al-Shams
39
128
54
Auditor’s expert
40
129
55
ADL
40
130
56
Guava & Co
40
131
57
RP Planning
41
132
58
Manufacturing inventories
41
132
59
Wedge & Co
41
135
60
MWL
41
136
61
BPR
42
137
62
Taskeen Co
42
138
63
Wings
43
140
64
Glasses2Go
43
142
65
ISA 620
44
144
66
Cuddly World
45
144
67
Analytical procedures and materiality
45
146
68
Tahira Transporters
46
148
69
Willow
47
150
70
Sparkle Forever
48
152
71
Bubbles
48
154
72
ISA 500
49
156
73
Javeria Co
49
157
74
Porridge
50
158
75
Trembridge Engineering
51
160
76
ISA 620: Using the Work of an Auditor’s
Expert
51
162
77
Heidi Co
52
163
Scenarios
78
Zeedin Co
52
165
79
Sahito Co
54
168
80
Bashir Co
55
170
57
173
Completion
81
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Analytical Procedures
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The Institute of Chartered Accountants of Pakistan
Audit and Assurance
Question
page
Answer
page
82
Auditor Responsibility
57
175
83
Al-Badr
57
175
84
Shahrukh and Company
58
176
85
The engagement partner
59
177
86
Different audit clients
60
177
87
Situations have arisen on different
clients
60
178
88
Hafiz Limited
61
179
89
An ‘emphasis of matter’ paragraph and
an ‘other matter’ paragraph
61
180
90
MM Electronics (Private) Limited
61
180
91
Ranjha Limited
62
181
92
Pervasive effects
63
182
93
Audit report at the end of the audit
63
183
94
Iqra Industries Limited
64
184
95
Blue Sky Limited
64
184
96
Form 35A in the Companies
64
185
97
Written Representations
65
185
98
Shahrukh and Co
65
186
99
Kazmi-Wassan
66
186
100
RK Resourcing
67
188
101
Rake Enterprises
67
191
Review engagements
102
ISRE 2400
68
192
103
Karim
68
193
104
IFI
69
194
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SECTION
Certificate in Accounting and Finance
Audit and Assurance
A
Multiple choice questions
CHAPTER 1 – CONCEPT AND NEED FOR ASSURANCE
1
2
3
The fundamental objective of the audit of a company is to
A
Protect the interests of the minority shareholders
B
Detect and prevent errors and fraud
C
Assess the effectiveness of the company’s performance
D
Attest to the credibility of the company’s accounts
The concept of stewardship means that a company’s directors
A
Are responsible for ensuring that the company complies with the law
B
Are responsible for ensuring that the company pays its tax by the due date
C
Safeguard the company’s assets and manage them on behalf of the
shareholders
D
Report suspected fraud and money laundering to the authorities
Why do auditors concentrate their efforts on material items in accounts?
A
Because they are easier to audit
B
Because it reduces the audit time
C
Because the risk to the accounts of their being incorrectly stated is greater
D
Because the directors have asked for it
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Audit and Assurance
4
5
Which of the following is NOT the responsibility of a company’s directors?
A
Reporting to the shareholders on the accuracy of the accounts
B
Establishment of internal controls
C
Keeping proper accounting records
D
Supplying information and explanations to the auditor
International auditing standards are issued by the:
A
International Accounting Standards Board
B
Financial Accounting Standards Board
C
International Audit and Assurance Standards Board
D
Auditing Practices Board
CHAPTER 2 – OBTAINING AN ENGAGEMENT
6
7
8
9
When an auditor is proposed for removal from office, which one of the following is he
NOT permitted to do?
A
Circulate representations to members
B
Apply to the court to have the proposal removed
C
Speak at the AGM/EGM where the removal is proposed
D
Receive notification of the AGM/EGM where the removal is proposed
Which one of the following is NOT a duty of the auditor?
A
Duty to report to the company’s bankers
B
Duty to report to the members
C
Duty to sign the audit report
D
Duty to report on any violation of law
Assuming that it is not the first appointment of the auditor, who is responsible for the
appointment of the auditor?
A
The shareholders in a general meeting
B
The managing director
C
The board of directors in a board meeting
D
The audit committee
The independent auditor's primary responsibility is to:
A
the directors
B
the company's creditors (payables)
C
the company's bank
D
the shareholders
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Question bank: Multiple choice questions
10
How long is the auditor’s term of office?
A
Until the audit is complete
B
Until the financial statements are complete
C
Until the next AGM
D
Until the directors remove them
CHAPTER 3 – PLANNING AND RISK ASSESSMENT
11
12
13
14
15
Which of the following is correct in relation to materiality?
A
A matter is material only if it changes the audit report
B
A matter is material if the auditor and the directors both decide that further work
needs to be done in the area under question
C
A matter is material only if it affects directors’ emoluments
D
A matter is material if its omission or misstatement would reasonably influence
the decisions of an addressee of the auditors’ report
Which one of the following is NOT considered to be part of planning?
A
Background i.e. industry
B
Previous year’s audit i.e. any qualifications in the report
C
Considering the work to be done by the client staff e.g. internal audit
D
Considering whether the financial statements show a true and fair view
Audit risk is composed of 3 factors. Which of the following is NOT one of those factors?
A
Compliance risk
B
Detection risk
C
Control risk
D
Inherent risk
Which of the following should NOT be considered at the planning stage?
A
The timing of the audit
B
Analytical review
C
Last year’s written representation letter
D
Obtaining written representations
At the planning stage you would NOT consider:
A
the timing of the audit
B
whether corrections from the inventory count have been implemented
C
last year's audit
D
the potential use of internal audit
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Audit and Assurance
CHAPTER 4 – EVIDENCE AND SAMPLING
16
17
18
19
20
Which of the following describes sampling risk?
A
The risk of the auditor carrying out a test the wrong way round
B
The risk of reliance on unsuitable audit evidence
C
The risk that the sample does not reflect the population
D
The risk of the auditor reaching the wrong conclusions from testing
Which of the following is NOT an accepted method of selection in sampling?
A
Systematic selection
B
Pervasive selection
C
Random selection
D
Haphazard selection
Which of the following are you unlikely to see in the current file of auditors’ working
papers?
A
Memorandum & articles of association
B
Audit planning memorandum
C
Summary of unadjusted errors
D
Details of the work done on the inventory count
According to ISA 500, the strength of audit evidence is determined by which two
qualities?
A
Appropriateness & competence
B
Sufficiency & appropriateness
C
Reliability & extensiveness
D
Objectivity & independence
Which of the following is normally the most reliable source of audit evidence?
A
Internal audit
B
Suppliers’ statements
C
Board minutes
D
Analytical review
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Question bank: Multiple choice questions
CHAPTER 5 – INTERNAL CONTROL
21
22
23
24
25
The degree of effectiveness of an internal control system depends on:
A
The design of the internal control system and the implementation of the controls
B
The design of the internal controls and the implementation of the control system
C
The implementation of the controls and the correctness of the accounting records
D
The design of the internal control system and the correctness of the accounting
records
According to ISA 315, which of the following is NOT an element of the control
environment?
A
Participation of management
B
Information processing
C
Commitment to competence
D
Human resource policies and practices
According to ISA 315, which of the following is NOT a control activity?
A
Performance reviews
B
Physical controls
C
Organisational structure
D
Segregation of duties
Which of the following is NOT an internal control?
A
Authorising purchase orders
B
Ensuring cash is locked away
C
Performing external confirmation of receivables
D
The opening of the post should not be the same person who banks the cheques
A walk-through test is designed to do what?
A
To check that materiality levels are acceptable
B
As a checklist to see if all substantive tests have been performed
C
To provide assurance within a letter of representation
D
To confirm that the auditor’s understanding of the internal control system is
correct
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Audit and Assurance
CHAPTER 6 – FLOWCHARTS AND IT CONCEPTS
26
27
28
29
Which of the following descriptions is correct?
A
An internal control evaluation questionnaire is circulated to staff within the
internal control function of an organisation to ask for feedback about their job
satisfaction and targets for the coming year.
B
Narrative notes are a list of questions about controls in a particular aspect of
operations or accounting. They are designed to establish whether appropriate
controls exist that meet specific control objectives.
C
An internal control questionnaire is sent from the internal auditors to the external
auditors during the audit to request ideas for improving the internal control
system.
D
A systems flowchart provides a logical representation of an accounting system
(or part of a system) in the form of a diagram representing documents generated,
processes applied and the flow of documents between departments.
Which of the following are levels within a systems flowchart?
A
Top, middle, lower
B
Mini, micro, macro
C
Executive, managerial, operational
D
Strategic, tactical, factory
Which of the following descriptions for flowchart symbols is correct?
A
A circle is used to indicate the starting and ending points of the process.
B
An oval represents an individual activity or step in the process
C
Triangles are used to show decision points. Each path emerging from the triangle
must be labelled with one of the potential answers.
D
A pentagon is used to link a particular step of the process to another page or part
of the flowchart. Letters are placed in the pentagon to clarify continuation.
Which of the following is not a type of physical access control?
A
Taking a weekly backup of data
B
Surveillance video
C
Fingerprint readers for system log-in
D
Fences, doors and door-locks
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Question bank: Multiple choice questions
30
Which of the following descriptions of ciphers is correct?
A
Asymmetric key ciphers – these use related (often identical) keys to both encrypt
and decrypt information. This is sometimes called ‘shared secret’ between two or
more parties
B
Block ciphers – data is encrypted one ’data unit’ (typically 1 byte) at a time in the
same order it was received. The simplest method is to use translation tables
which offset the input blocks across an array of the table. Enhanced encryption
can be achieved by combining two or more tables
C
Symmetric key ciphers – these use related (often identical) keys to both encrypt
and decrypt information. This is sometimes called ‘shared secret’ between two or
more parties
D
Stream ciphers – this is where fixed length blocks are encrypted and streamed
across the network with a high speed connection
CHAPTER 7 – TESTS OF CONTROLS
31
32
33
34
Which one of the following is NOT an internal control you would expect to see in a
sales system?
A
All goods received notes are authorised by the customer
B
All orders are checked against credit limits
C
All invoices are recorded on pre-numbered sequential documents
D
All cash is banked on the same day as it was received
Which one of the following is NOT an internal control you would expect to see in a
purchases system?
A
Preferred suppliers are used
B
All invoices are grid-stamped to create the company’s own invoice system
C
Employees are only paid for work done
D
There is a list of authorised cheque signatories
Which of the following is NOT a main element of a sales system?
A
Receiving orders from customers
B
Marketing
C
Despatching the goods and invoicing customers
D
Recording sales and debtors in the accounts
Which of the following is NOT a test of control?
A
Checking that all purchase invoice are authorised by the proper people
B
Test checking from purchase invoices to goods received notes
C
Where a list of approved suppliers exists, checking that orders are placed only
with suppliers on such a list
D
Checking for sequential numbering by the client of purchase invoices received
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Audit and Assurance
35
Which of the following is NOT a main element of a purchases system?
A
Placing orders
B
Receiving purchase invoices
C
Goods received
D
Decisions at board level on whether to incur capital expenditure
CHAPTER 8 – INTRODUCTION TO SUBSTANTIVE PROCEDURES
36
37
38
39
40
Which of the following is NOT a financial statement assertion?
A
Completeness
B
Occurrence
C
Cash flow
D
Existence
Which of the following is NOT an accepted means of obtaining audit evidence?
A
Inspection
B
Enquiry
C
Analytical procedures
D
Estimates
Which one of the following types of evidence is the most reliable?
A
The client's sales invoices
B
Report obtained from a client’s bank confirming balances
C
The written representation letter
D
Confirmation during a telephone call with the Managing Director that there are no
loans outstanding
At what stage of the audit do ISAs 315 and 520 require the auditor to use analytical
procedures?
A
When tendering for the audit of a new client
B
During the planning stage and the review stage
C
At the report writing stage
D
When deciding whether to rely on the evidence of an expert
Which of the following is not an accounting estimate?
A
Depreciation
B
Provision for claims under a law suit
C
Price paid for a new non-current asset
D
Accrued revenue
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Question bank: Multiple choice questions
CHAPTER 9 – SUBSTANTIVE PROCEDURES: NON-CURRENT ASSETS
41
42
43
44
45
Which tangible non-current assets are normally not depreciated?
A
Land and buildings
B
Land only
C
Buildings only
D
All tangible non-current assets are depreciated
Which of the following should not be shown as an intangible non-current asset?
A
Purchased goodwill
B
Non-purchased goodwill
C
Development costs meeting the criteria in IAS 38
D
Other intangible assets having a readily ascertainable market value
A non-current asset register holds details of non-current assets.
These details will include:
A
Cost, depreciation, service details, location, disposal proceeds
B
Service details, serial number, capital allowances, net book value
C
Capital allowances, disposal proceeds, supplier, location
D
Cost, depreciation, asset number, serial number, location
Which of the following is NOT a substantive test for the audit of non-current assets?
A
Reconcile the non-current assets register to the receivables ledger control
account
B
Consider the reasonableness of any revaluations
C
Physically check a sample of non-current asset additions
D
Vouch disposal proceeds to the bank statement
Which term would you NOT associate with non-current assets?
A
Net realisable value
B
Goodwill
C
Investments
D
Net book value
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Audit and Assurance
CHAPTER 10 – SUBSTANTIVE PROCEDURES: CURRENT ASSETS
46
47
48
49
50
The principal audit procedure at the inventory count is?
A
Analytical review
B
Computation
C
Observation
D
Delegation
Which of the following is NOT a substantive test for the audit of inventories?
A
Test the updating of all inventory count differences to inventory records
B
Test the accuracy of net realisable value through the review of post year-end
sales
C
Have satisfactory explanations been explained for all material inventory count
differences
D
Check that all administrative overheads have been correctly accrued for in the
valuation of inventories
Which of the following are acceptable valuation methods under IAS 2?
A
LIFO and weighted average
B
FIFO and base
C
LIFO and base
D
FIFO and weighted average
Which of the following is NOT a substantive test for the audit of receivables?
A
Test cash received after the end of the reporting period
B
Check adequate provision for doubtful debts
C
Check reasons for debit balances (and ensure they are disclosed under
payables)
D
Check brought forward balance
What is NOT true about bank reconciliations?
A
Reconciling items must be followed through to the bank statement
B
An error, if below materiality, is acceptable
C
If the client has performed the reconciliation, the auditor must cast the whole
reconciliation
D
It is the primary substantive test for cash
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Question bank: Multiple choice questions
CHAPTER 11 – SUBSTANTIVE PROCEDURES: OTHER AREAS
51
52
53
54
55
A good way to authenticate sales is to view the authorisation of?
A
Goods received notes
B
Sales orders
C
Goods despatch notes
D
Supplier statements
Which of the following audit procedures is primarily intended to provide audit evidence
as to existence?
A
Matching sales invoices to goods despatch notes
B
Casting the sales ledger
C
Confirming receivables balances with customers
D
Checking the dating of outstanding cheques
Which of the following is NOT normally a non-current liability?
A
Corporation tax payable
B
Debentures
C
Bank loans
D
Finance lease obligations
Which of the following does not appear in IAS 37?
A
Deferred income
B
Contingent assets
C
Provisions
D
Contingent liabilities
Suppliers’ statements are reconciled in order to:
A
verify the completeness of payables
B
ensure cut-off is correct
C
vouch the authorisation of purchase orders
D
verify the existence of payables
CHAPTER 12 – RELATED PARTY TRANSACTIONS
56
An example of an external business risk is:
A
The existence of related parties
B
Having a small customer database
C
A customer's insolvency
D
Process of dealing with customer relations
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Audit and Assurance
57
58
Which of the following statements about the audit of related parties is correct?
A
The materiality of related parties is judged by reference to the company being
audited, not the individual related party.
B
The main audit concern in relation to related parties is the adequacy of the
disclosures of the related parties that have been identified.
C
It is usually considered unnecessary to obtain written representations from
management about related parties.
D
A company should disclose both the nature of related party relationships and the
amount of related party transactions.
Which of the following statements are correct?
1
With related party transactions, there is some risk of collusion and fraud.
2
A focus of audit attention with regard to related party transactions should be on
significant non-routine transactions.
A
Statement 1 only is correct.
B
Statement 2 only is correct.
C
Both statements are correct.
D
Neither statement is correct.
CHAPTER 13 – RELIANCE ON OTHERS
59
60
The auditor may work with a specialist. What effect does this have on the auditor’s
responsibilities?
A
The client must take full responsibility for the specialist
B
The auditor’s responsibilities are not diminished in any way
C
The auditor and client have joint responsibility for the specialist
D
All 3 are equally responsible
Which of the following statements is correct?
A
Responsibility for a group audit is shared by the group auditor and any
component auditors.
B
An audit firm may accept an engagement as group auditor even if it is
insufficiently involved in the audit of significant components to obtain audit
evidence about them.
C
A group auditor may rely on the work done by a component auditor without the
need to assess its quality.
D
The group auditor sets the group materiality level for the financial statements as
a whole and component materiality levels for components audited by component
auditors.
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Question bank: Multiple choice questions
61
62
63
Which of the following statements about the principal auditor in a group audit is
INCORRECT?
A
The principal auditor is responsible for the opinion on the group financial
statements as a whole.
B
The principal auditor can demand information and explanations from the
secondary auditor.
C
The principal auditor needs to consider the materiality of the portion of the group
audited by him.
D
The principal auditor can demand co-terminus year-ends for all group companies.
Which of the following statements is correct?
A
A component auditor should provide the group auditor with access to its relevant
auditing documentation.
B
A component auditor should provide the group auditor with a report of work
performed unless the group auditor specifically states that this is not necessary.
C
When there is a joint audit, one of the firms must act as the senior firm in the
audit.
D
When a component within a group is significant, the audit of the component
should use group materiality.
Which of the following items should be communicated by a group auditor to the group
management?
1
material weaknesses in group-wide controls
2
material weaknesses discovered by the group auditor in any component of the
group
3
material weaknesses discovered by any component auditor in any component of
the group
4
Any fraud or suspected fraud
A
1, 2, 3 and 4
B
1 only
C
1 and 4 only
D
1, 2 and 4 only
CHAPTER 14 – PROFESSIONAL ETHICS AND CODES OF CONDUCT
64
You have been proposed as auditor of a company. What is the first step that you
should take?
A
Obtain the client’s permission to communicate with the existing auditor
B
Obtain the existing auditor’s working papers
C
Obtain a copy of the company’s most recent board minutes
D
Obtain a copy of the existing auditor’s letter of engagement
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Audit and Assurance
65
66
67
68
Which one of the following may auditors NOT perform for their client?
A
Taking management decisions
B
Preparation of accounting records
C
Preparing tax computations
D
Advising on weaknesses in the internal control systems
Which of the following are fundamental ethical principles for professional accountants?
1
Competence
2
Compliance
3
Integrity
4
Objectivity
A
1, 2 and 3 only
B
1, 3 and 4 only
C
2, 3 and 4 only
D
1, 2 and 4 only
An auditor should not accept a loan on favourable commercial terms from an audit
client because of the threat to his or her independence. The threat would be a:
A
Self-interest threat
B
Self-review threat
C
Advocacy threat
D
Familiarity threat
Which of the following statements is INCORRECT?
A
An auditor may serve on the board of directors of an audit client.
B
An auditor who is an immediate family member of the director of an audit client
must not be assigned to the audit team.
C
Purchasing goods from an audit client on normal commercial terms does not
create a threat to the auditor’s independence.
D
An auditor who was recently a director of an audit client must not be assigned to
the audit team for that client.
CHAPTER 15 – AUDIT FINALISATION AND REPORTING
69
Which of the following is true about written representations?
A
They are the best source of audit evidence
B
They should be used only when there is a lack of other substantive audit
evidence
C
They should be used only when there is other substantive audit evidence to
complement it
D
Shareholders receive a copy of all material written representations
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Question bank: Multiple choice questions
70
71
72
73
Which of the following would you not use as a benchmark for comparison when
undertaking analytical procedures?
A
Other audit clients
B
Previous years
C
Other companies in the same industry
D
Budget
What is meant by the expression ‘expectation gap’?
A
The gap between how the directors of a company perform their duties and how
the shareholders expect them to perform
B
The gap between how the directors of a company perform their duties and how
the general public expects them to perform
C
The gap between the public perception of the role of company auditors and their
statutory role and responsibilities
D
The gap between the auditors’ own perception of their duties and how they are
set out in the Companies Act
Which of the following does NOT belong in the auditors’ report?
A
Introductory paragraph specifying the pages to which the report relates and the
accounting convention adopted
B
Basis of the opinion
C
Involvement of any specialist
D
Statement of responsibilities of directors and auditors
Which one of the following is part of the auditor’s function?
A
Conducting the inventory count
B
Obtaining and evaluating audit evidence on the financial statements
C
Calculating the year-end accruals figure for inclusion in the accounts
D
Providing representations to management
CHAPTER 16 – INTERNATIONAL STANDARDS ON REVIEW ENGAGEMENTS
74
What sort of assurance is provided in a review engagement?
A
Positive assurance
B
Negative assurance
C
High level of assurance
D
No assurance
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Audit and Assurance
75
76
77
Which of the following statements is correct?
A
When a company negotiates a ‘friendly’ takeover, it usually appoints a firm of
accountants to carry out due diligence on the takeover target.
B
In an attestation engagement, the accountant is required to report on the quality
of work performed.
C
In a review engagement, evidence is gathered mainly by means of computation
and inspection.
D
In an engagement to review financial statements, the amount of work required is
the same as for an audit.
For companies required to produce interim financial statements (IFI):
A
one audit firm should audit the IFI and a different firm should audit the financial
statements for the year as a whole.
B
one accountancy firm should review the IFI and a different firm should audit the
financial statements for the year as a whole.
C
the same firm should audit the IFI and the financial statements for the year as a
whole.
D
the same firm should review the IFI and the financial statements for the year as a
whole.
What is meant by negative assurance?
A
The auditor cannot give an opinion due to lack of evidence.
B
The client's financial statements were found to be materially misstated.
C
The auditor could not conduct any tests due to lack of controls.
D
The auditor did not find anything to indicate that a material misstatement exists.
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SECTION
Certificate in Accounting and Finance
Audit and Assurance
B
Objective test and
long-form questions
AUDIT FRAMEWORK, REGULATION AND ETHICS
1
ICAP Code of Ethics
(a)
ICAP’s code of ethics has specified five principles of professional ethics for
chartered accountants. The circumstances in which a chartered accountant
operates may give rise to specific threats to compliance with these principles.
Required:
(b)
(i)
Briefly describe each of the fundamental principles of professional ethics.
(7)
(ii)
Briefly describe different categories of the threats to compliance with
the fundamental principles.
(5)
Mustansar is the audit manager of a team engaged on the audit of a listed
company. During his initial discussion with the chief executive officer (CEO) of
the company, he was informed that depressed economic conditions have badly
affected the company and its liquidity. Due to uncertainty about the future of the
company, certain key employees have left including several staff members of
accounting and finance department. Consequently, the accounting records are in
a bad shape and the management is making efforts to complete the draft
accounts quickly. He therefore requested Mustansir to carry out necessary
accounting work and to help prepare the annual financial statements at a fee to
be agreed mutually.
Required:
Briefly describe the guidelines contained in the ICAP’s Code of Ethics and the
extent of support that can be offered by the auditors, in the above situation.
(6)
(Total: 18 marks)
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2
Levels of assurance
Distinguish between absolute and reasonable assurance. Identify the type of
assurance that is expected in an audit of the financial statements, clearly outlining the
reasons to justify your point of view.
(8)
3
Shamsuddin
Shamsuddin a newly qualified chartered accountant has recently established his
practice in the name of Shamsuddin & Co., Chartered Accountants. He is continuously
trying to expand his practice and in this process he came across the following
situations:
(i)
One of his friends, who is the owner of an advertising agency, has offered to
provide significant discount for publicity of his new practice.
(ii)
Fashion Limited, a private limited company, which has suffered heavily on
account of recent financial turmoil, has informed him that it is willing to appoint
him in the forthcoming annual general meeting (AGM) of the company in place of
the existing auditors, if he can quote a fee below the existing audit fee.
(iii)
Design Limited has contacted Shamsuddin and informed him that they are willing
to appoint him as their external auditor in the next AGM at a fee of Rs. 200,000 if
he completes the audit in a month. However, in case of delay in the audit work
the audit fee will be reduced to Rs.150,000.
(iv)
Shamsuddin receives an offer of appointment as auditors from Style Enterprises,
a sole proprietorship, who wants to remove the existing auditors before
completion of their term of office.
Required:
Shamsuddin is inclined to accept the above offers. Discuss the options available with
him in each of the above situations.
(10)
4
Core concepts
(a)
(b)
Briefly highlight the management’s responsibilities relating to the financial
statements?
(7)
During the audit team planning meeting, a member of the audit team passed a
comment that based on past experience with the client, he was confident that the
management of the client was honest and there was no issue as regards
management integrity or risk of fraud in the Company. The audit manager
responded that the auditor should always maintain an attitude of professional
scepticism throughout the audit.
Required:
Briefly describe ‘Audit Scepticism’ and elaborate on the response of the audit
manager.
(8)
(Total: 15 marks)
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Question bank: Objective test and long-form questions
5
Threats
A chartered accountant is required to comply with five fundamental principles
specified by ICAP’s Code of Ethics. However, compliance with the fundamental
principles may potentially be threatened by a broad range of circumstances.
Required:
Briefly describe the categories of threats that may potentially affect
compliance with the fundamental principles. Give two examples for each category.
(10)
6
Burewala and Kamal
Discuss the categories of threats that may be involved in each of the following
independent situations and advise the partners of the concerned firm with regard to the
possible course of action that may be followed, in each case.
(a)
Burewala Bank Limited (BBL) is a listed audit client of Umer and Company,
Chartered Accountants (UCC). BBL has granted a house loan of Rs. 5 million to a
partner in UCC.
(4)
(b)
Kamal was the audit manager during the last year’s annual audit of Faisalabad
Textile Mills Limited (FTML). He has joined FTML as their Manager Finance,
prior to the commencement of the current year’s audit.
(8)
(Total: 12 marks)
7
Zaman and Bilal
Comment on each of the following independent situations with reference to the
applicable rules and regulations.
(a)
Zaman is a partner in a firm of Chartered Accountants and holds 5,000 shares
in Mardan Limited (ML). His firm has received an offer for appointment as
auditors of Khanewal Limited (KL). ML and KL are subsidiaries of Dera Khan
Limited (DKL).
(3)
(b)
Bilal and Company has received an offer for appointment as auditors of IJK
Limited. The total paid up capital of the company is Rs. 990 million whereas its
ordinary share capital is Rs. 130 million.
Faryal, the wife of a partner in Bilal and Company, is a director in LMN
Limited which holds 50 million non-voting preference shares and 2 million
ordinary shares in IJK Limited. Faryal also holds 10,000 shares in LMN Limited.
The par value of both types of shares is Rs. 10 each.
(4)
(Total: 7 marks)
8
Audit process
The purpose of an external audit and its role are not well understood. You have been
asked to write some material for inclusion in your firm’s training materials dealing with
these issues in the audit of large companies.
Required:
(a)
Draft an explanation dealing with the purpose of an external audit and its role in
the audit of large companies, for the inclusion in your firm’s training materials.
(7)
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(b)
The external audit process for the audit of large entities generally involves two or
more recognisable stages. One stage involves understanding the business and
risk assessment, determining the response to assessed risk, testing of controls
and a limited amount of substantive procedures. This stage is sometimes known
as the interim audit. Another stage involves further tests of controls and
substantive procedures and audit finalisation procedures.
This stage is
sometimes known as the final audit.
Describe and explain the main audit procedures and processes that take place
during the interim and final audit of a large entity.
(7)
(Total: 14 marks)
9
Regulatory and professional requirements
The profession has been criticised recently by politicians for its role in monitoring
potential corporate failure. Radical reforms have been called for in the way the audit is
regulated. For example, politicians have stated that there should be a change of
legislation in the following ways:
Auditing standards
Auditing standards should be set and enforced independently from the accounting
profession.
Fraud
Auditing firms should have a duty to detect and report fraud.
Non audit services
Non auditing services supplied to an audit client should be stopped.
The duration of the appointment of auditors
The appointment of auditors should be for a maximum period of seven years.
Required:
(a)
(b)
10
Describe the current regulatory and professional requirements relating to each of
the headings listed above.
(12)
Discuss the reasons why you feel the audit profession has been criticised over
the current regulations in the above areas.
(8)
(Total: 20 marks)
Fundamental principles
Explain each of the FIVE fundamental principles of ICAP’s Code of Ethics
11
(5)
Oops
Explain the situations where an auditor may disclose confidential information about a
client.
(8)
12
Independence of external auditors
The responsibilities of external auditors are not always well understood. When external
auditors provide non-audit services to their audit clients, it is essential that the auditors
make a clear distinction between their audit and non-audit responsibilities.
Required:
Explain why it is essential for external auditors to be independent of their clients
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
13
Tahira and Parvez
Your firm is the external auditor to two companies. One is a hotel, Tahira, the other is a
food wholesaler, Parvez, which supplies the hotel. Both companies have the same
year-end. Just before the year end, a large number of guests became ill at a wedding
reception at the hotel, possibly as a result of food poisoning.
The guests have taken legal action against the hotel and the hotel has taken action
against the food wholesaler. Neither the hotel nor the food wholesaler has admitted
liability. The hotel is negotiating out-of-court settlements with the ill guests, the food
wholesaler is negotiating an out-of-court settlement with the hotel. At the year end, the
public health authorities have not completed their investigations.
Lawyers for both the hotel and the food wholesaler say informally that negotiations are
‘going well’ but refuse to confirm this in writing. The amounts involved are material to
the financial statements of both companies.
Required:
Assuming that your firm continues with the audit of both companies, for each company,
describe the difficulties you foresee in obtaining sufficient audit evidence for potential
provisions, contingent liabilities and contingent assets.
(4)
PLANNING AND RISK ASSESSMENT
14
Saad Co
You are a manager in the audit firm of Ajmal & Co; and this is your first time you have
worked on one of the firm’s established clients, Saad Co. The main activity of Saad Co
is providing investment advice to individuals regarding saving for retirement, purchase
of shares and securities and investing in tax efficient savings schemes. Saad is
regulated by the relevant financial services authority.
You have been asked to start the audit planning for Saad Co, by Mr Sher, a partner in
Ajmal & Co. Mr Sher has been the engagement partner for Saad Co, for the previous
nine years and so has excellent knowledge of the client. Mr Sher has informed you that
he would like his daughter Zhura to be part of the audit team this year; Zhura is
currently studying for her first set of exams for her ICAP qualification. Mr Sher also
informs you that Mr Faisal, the audit senior, received investment advice from Saad Co
during the year and intends to do the same next year.
Required:
(a)
Explain the ethical threats which may affect the auditor of Saad Co.
(3)
(b)
For each ethical threat, discuss how the effect of the threat can be mitigated.
(3)
(Total: 6 marks)
15
Alpha
The following three entities have approached Alpha & Company, Chartered
Accountants (the firm) for appointment as their statutory auditors. In each case there
are following issues which need to be considered before the firm decides to accept the
assignments.
(i)
Client: Safe Bank Limited
Issue: the firm has acquired office equipment from the bank under finance lease
arrangements. In addition, some partners of the firm are also using the bank’s
credit card facility.
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(ii)
Client: Pride Communication Limited (PCL):
Issue: One of the firm’s partners had remained the director of PCL for many
years, as a nominee of Federal Government.
(iii)
Client: Gama Limited
Issue: A partner of the firm holds shares in Beta Limited which is an associated
company of Gama Limited.
Required:
In each case specify the minimum conditions specified by Companies Ordinance,
1984, which should be fulfilled in order to accept the audit engagement.
16
(9)
Engagement letter and documentation
(a)
List down the principal contents of an audit engagement letter.
(7)
(b)
Audit documentation facilitates understanding of the nature, timing and extent of
audit procedures; the results of audit procedures and significant matters arising
during the audit.
Discuss briefly:
(i)
What are the “significant matters” which are required to be documented?
(ii)
In how many days after the date of auditor’s report, the auditor is required
to complete the assembly of his final audit file?
(7)
(Total: 14 marks)
17
Shahid Corporation
Azeem and Company have been the auditors of Shahid Corporation Limited, a
listed company, for the past many years. You have been appointed as the audit
engagement manager.
Briefly explain the matters which you would consider while assessing the following:
(a)
acceptance and continuance of client relationship.
(5)
(b)
need to send a new engagement letter.
(3)
(Total: 8 marks)
18
Assertions
(a)
(b)
“The auditor shall perform risk assessment procedures to provide a basis
for the identification and assessment of risks of material misstatement at the
financial statement and assertion levels.”
(i)
Briefly explain what you understand by the risk of material misstatement at
financial statement level.
(4)
(ii)
List down the risk assessment procedures as referred above.
(2)
“The auditor’s assessment of materiality and audit risk may be different at the
time of initially planning the engagement from at the time of evaluating the results
of audit procedures.”
Briefly describe the reasons which may lead to such a change in the
auditor’s assessment.
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(3)
The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
(c)
Briefly describe the assertions used by the auditors in respect of the following:
(i)
account balances
(ii)
classes of transactions; and
(iii)
presentation and disclosures
(7)
(Total: 16 marks)
19
Companies Ordinance 1984
Comment on each of the following situations with reference to the appointment of
external auditors in accordance with the requirements of the Companies Ordinance,
1984:
20
(a)
Farrukh & Co., Chartered Accountants, has received an offer to be appointed as
the external auditor of Ebrahim Gas Company. The firm is indebted to the
company as it has not paid the last two months’ bills amounting to Rs. 4,860.
(b)
After seventy days of incorporation, the directors of Rahman Limited (RL)
decided to appoint Mr Shahid as the company’s statutory auditor. Mr Shahid was
employed by RL before he started his own practice.
(c)
The directors of Fazal Limited (FL) have decided to appoint Syed & Company,
Chartered Accountants, as external auditor of the company. One of the partner’s
spouse holds 1,000 shares in the subsidiary of FL.
(d)
The directors of Najam (Pvt.) Limited having paid-up capital of Rs. 4.5 million
have appointed Mr Dawood to act as the external auditor of the company. Mr
Dawood has been awarded a diploma in International Financial Reporting
Standards by the Institute of Chartered Accountants of Pakistan and has
completed the mandatory period of training from a leading firm of chartered
accountants.
(e)
All directors of Hussain Associates (Pvt.) Limited are chartered accountants. The
company has recently received an offer for appointment as the external auditor of
Masood (Pvt.) Limited which has a paid-up share capital of Rs. 1,000,000.
(10)
ASPL
You are the Audit Manager on the audit of Al-Salam Pakistan Limited (ASPL) for the
year ended June 30, 20X3. ASPL is engaged in the manufacture of a wide range of
plastic products. While reviewing the initial work performed by the audit team, the
following matters have come to your notice:
(i)
The quantity of material scrapped during the year is materially different from the
quantity of scrap sold. The company’s records show nil balance both at the
beginning and at the close of the year. No reconciliation for the difference has
been provided by the company.
(ii)
Sales for the year have increased by 7% over the previous year. However, it
has been noted that sales in the last two weeks of June 2010 have been
exceptionally high and represent 15% of the annual sales. The audit working
papers carry the following observations in respect of the above:
‰
70% of the sales in the last two weeks of June were made to two new
customers whose credit assessment has not been formally documented;
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Audit and Assurance
(iii)
‰
a significant portion of the goods sold to the above referred customers
were returned in the first week of July 2010; and
‰
management bonuses are linked to the operating performance of the
company.
During the year, ASPL purchased a machine for Rs. 25 million. The payment
voucher is duly supported by the invoice from the supplier. However, the fixed
assets schedule provided by the client shows the amount capitalized as Rs. 2.5
million. Depreciation has been charged on this amount. The difference of Rs.
22.5 million is appearing in the Bank Reconciliation Statement.
Required:
(a)
Analyse each of the above situations and assess whether it represents a fraud or
an error.
(6)
(b)
What action would you take to deal with the above matters?
(9)
(Total: 15 marks)
21
AMF
Al-Madad Foundation (AMF) is a charitable organization. It receives donations which
are utilized to help the destitute persons in accordance with the rules and regulations
prescribed by the AMF’s Trust Deed.
The donations are received from the following sources:
(i)
Cash collected from the general public through charity boxes placed at
key points in hospitals, airports, superstores etc.,
(ii)
cash and cheques received from individuals and institutions at AMF’s office; and
(iii)
cash from generous individuals who prefer to remain anonymous.
Donations received in case of (ii) and (iii) above, often contain specific instructions for
utilisation of the donated amount for specific purposes e.g. for education of orphan
children.
Required:
(a)
Identify the inherent risks in the operations of AMF.
(3)
(b)
Briefly discuss the effect of each of these risks on the audit of AMF.
(3)
(Total: 6 marks)
22
Acceptance and planning
(a)
What is the difference between audit strategy and audit plan?
(4)
(b)
You have been appointed as the auditor of a company which was previously
audited by another auditor. Being a new client, what additional considerations
would you take into account while performing the preliminary engagement
activities prior to commencement of the audit?
(5)
(Total: 9 marks)
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Question bank: Objective test and long-form questions
23
SPL
Strawberry Pakistan Limited (SPL) was incorporated on March 1, 20X3. The directors
of SPL are in the process of appointing the first statutory auditor of the company. They
have requested your firm to submit a proposal for the statutory audit assignment. A
partner of your firm has asked you to draft the proposal after assessing whether the
preconditions for the audit exist.
Required:
(a)
Briefly discuss the term ‘preconditions for an audit’.
(b)
What are the steps that you would perform in order to ensure that preconditions
for the audit exist?
(c)
Discuss whether your firm may or may not accept the assignment if one of the
preconditions for the audit is not present.
(Total: 15 marks)
24
Fruit and nuts
Comment on each of the following independent situations in respect of appointment of
auditors, with reference to the applicable rules and regulations:
(a)
Guava and Company, Chartered Accountants, have received a request for
appointment as auditor of Orange Bank Limited (OBL). Most of the partners of
Guava and Company maintain their accounts with OBL and are enjoying credit
card facilities from them. The maximum outstanding balance on the credit card
facility, due from any partner is Rs.399,000.
(b)
Apricot and Company, Chartered Accountants, have received an offer for
appointment as auditor of Banana Limited. Mr Pumpkin who is a nominee
director of the Government on the Board of Directors of Banana Limited holds
25% shares in Water Melon Limited. The spouse of a partner also holds shares in
Water Melon Limited.
(c)
Mr Zaheer, a legal practitioner, has received an offer for appointment as external
auditor of Lychee (Private) Limited (LPL). The paid up capital of LPL is Rs.
1,500,000 of which 40% is owned by Blue Black Limited, a listed company.
(d)
Walnut and Company, Chartered Accountants, have received an offer for
appointment as external auditors of Wasim (Private) Limited (WPL), in place of
the previous auditors, who were removed before the completion of their term.
You may assume that WPL has completed all the legal formalities before
removing the previous auditors.
(e)
Mr Sadiq has recently joined your firm as a partner. He has served on the
Board of Directors of Strawberry Limited (SL) until 30 June 20X0, as a
Government nominee. In the Annual General Meeting of SL held on 31 August
20X2, a shareholder has proposed the name of your firm for appointment as the
external auditors for the year ending 30 June 20X3.
(Total: 11 marks)
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25
Discussions and judgment
(a)
List the benefits associated with holding timely discussion among the team
members in respect of matters susceptible to material misstatements.
(5)
(b)
Quite often, the risk of material misstatement is greater in case of non-routine
transactions and judgmental matters.
Required:
(i)
What do you understand by non-routine transactions and judgmental matters?
(ii)
State the reasons on account of which risk of material misstatement is increased
in case of:
‰
Non-routine transactions
‰
Judgmental matters
(6)
(Total: 11 marks)
26
Dynamic
In the planning phase of the audit of Dynamic Limited for the year ending 30 June
20X3, you have calculated the following ratios from the management accounts of
the company for the eight months ended 29 February 20X3:
Gross profit percentage
Inventory turnover days
Current ratio
Quick asset ratio
Times interest earned
Debtors turnover days
Eight months
period ended
29 February 20X3
Year ended
30 June 20X2
Year ended
30 June 20X1
35%
120
1.5
0.78
0.91
132
40%
105
2.3
1.6
1.67
86
40%
78
2.6
1.7
2.1
68
Required:
Identify the prospective audit risks which the auditor should consider while planning the
audit.
(9)
27
Changing terms
An auditor may agree to a change in the terms of engagement provided there is a
reasonable justification for doing so.
Required:
(a)
List the circumstances in which the management may request the auditor to
change the terms of an audit engagement.
(b)
What factors should be considered by the auditor before accepting a change in
the terms of the engagement?
(c)
List the steps that the auditor should consider, if he is unable to agree to a
change in the terms of engagement.
(Total: 9 marks)
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
28
EL
List the important matters that are required to be included in an audit engagement letter.
(6)
29
Calm Co
ISA 315 Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and its Environment deals with the auditor’s responsibility to
identify and assess the risks of material misstatement in the financial statements,
through understanding the entity and its environment, including the entity’s internal
control.
Required:
30
(i)
Explain the purpose of risk assessment procedures.
(3)
(ii)
Outline the sources of audit evidence the auditor can use as part of risk
assessment procedures.
(3)
(Total: 6 marks)
Azam
Azam is a charity whose constitution requires that it raises funds for educational
projects. These projects seek to educate children and support teachers in certain
countries. Charities in the country from which Azam operates have recently become
subject to new audit and accounting regulations.
Charity income consists of cash collections at fund raising events, telephone appeals,
and bequests (money left to the charity by deceased persons). The charity is small and
the trustees do not consider that the charity can afford to employ a qualified
accountant. The charity employs a part time book-keeper and relies on volunteers for
fund raising.
Your firm has been appointed as accountants and auditors to this charity because of
the new regulations. Accounts have been prepared (but not audited) in the past by a
volunteer who is a recently retired Chartered Accountant.
Required:
(a)
Describe the risks associated with the audit of Azam under the headings inherent
and control risks and detection risk and explain the implications of these risks for
overall audit risk.
(10)
(b)
List and explain the audit tests to be performed on income and expenditure from
fund raising events.
(10)
Note: In part (a) you may deal with inherent risk and control risk together. You are not
required to deal with the detail of accounting for charities in either part of the question.
(Total: 20 marks)
31
Hurricane
You are the audit manager in charge of the audit of Hurricane, a limited liability
company. The company’s year-end is 31 December, and Hurricane has been a client
for seven years. The company purchases and resells fittings for ships including
anchors, compasses, rudders, sails etc. Clients vary in size from small businesses
making yachts to large companies maintaining large luxury cruise ships. No
manufacturing takes place in Hurricane.
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Audit and Assurance
It is now early in 20X4. Information on the company’s financial performance is available
as follows:
20X4
20X3
Forecast
Actual
Rs m
Rs m
Revenue
45,928
40,825
Cost of sales
(37,998) (31,874)
―――
―――
Gross profit
7,930
8,951
Administration costs
(4,994)
(4,758)
Distribution costs
(2,500)
(2,500)
―――
―――
Net profit
436
1,693
―――
―――
Non-current assets (at net book value)
Current assets
Inventory
Receivables
Cash and bank
Total assets
Capital and reserves
Share capital
Accumulated profits
Total shareholders’ funds
Non-current liabilities
Current liabilities
3,600
4,500
200
6,000
500
―――
10,300
―――
1,278
4,052
1,590
―――
11,420
―――
1,000
5,300
―――
6,300
1,000
3,000
―――
10,300
―――
1,000
5,764
―――
6,764
2,058
2,598
―――
11,420
―――
Other information
The industry that Hurricane trades in has seen moderate growth of 7% over the last
year.
„
Non-current assets mainly relate to company premises for storing inventory. Ten
delivery vehicles are owned with a net book value of Rs 30m
„
One of the directors purchased a yacht during the year.
„
Inventory is stored in ten different locations across the country, with your firm
again having offices close to seven of those locations.
„
A computerised inventory control system was introduced in August Year
Inventory balances are now obtainable directly from the computer system. The
client does not intend to count inventory at the year end but rely instead on the
computerised inventory control system.
„
Required:
(a)
ISA 300 Planning an Audit of Financial Statements, states that an auditor must
plan the audit.
Explain why it is important to plan an audit.
(b)
(5)
Using the information provided above, prepare the audit strategy for Hurricane for
the year ending 31 December 20X4.
(15)
(Total: 20 marks)
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
32
Zakir Co
(a)
With reference to ISA 520 Analytical Procedures explain
(i)
what is meant by the term ‘analytical procedures’;
(2)
(ii)
the different types of analytical procedures available to the auditor; and (3)
(iii)
the situations in the audit when analytical procedures can be used.
(3)
Zakir Co sells garden sheds and furniture from 15 retail outlets. Sales are made to
individuals, with income being in the form of cash and debit cards. All items purchased
are delivered to the customer using Zak’s own delivery vans; most sheds are too big for
individuals to transport in their own motor vehicles. The directors of Zak indicate that
the company has had a difficult year, but are pleased to present some acceptable
results to the members.
The income statements for the last two financial years are shown below:
Income statement
31 March
20X4
31 March
20X3
Rs m
Rs m
7,482
6,364
(3,520)
––––––
(4,253)
––––––
3,962
2,111
(1,235)
(1,320)
Selling and distribution
(981)
(689)
Interest payable
(101)
(105)
Revenue
Cost of sales
Gross profit
Operating expenses
Administration
Investment income
145
––––––
Profit/(loss) before tax
1,790
–
––––––
(3)
‗‗‗‗‗‗
‗‗‗‗‗‗
––––––
––––––
Financial statement extract
Cash and bank
253
‗‗‗‗‗‗
(950)
‗‗‗‗‗‗
Required:
(b)
As part of your risk assessment procedures for Zakir Co, identify and provide a
possible explanation for unusual changes in the income statement.
(9)
(c)
Confirmation of the end of year bank balances is an important audit procedure.
Required:
Explain the procedures necessary to obtain a bank confirmation letter from Zakir Co.’s
bank.
(3)
(Total: 20 marks)
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Audit and Assurance
33
Hajira
(a)
Explain the term ‘audit risk’ and the three elements of risk that contribute to total
(4)
audit risk.
The Hajira charity was established in 1960. The charity’s aim is to provide
support to children from disadvantaged backgrounds who wish to take part in
sports such as tennis, badminton and football.
Hajira has a detailed constitution which explains how the charity’s income can be
spent. The constitution also notes that administration expenditure cannot exceed
10% of income in any year.
The charity’s income is derived wholly from voluntary donations. Sources of
donations include:
(i)
Cash collected by volunteers asking the public for donations in shopping
areas,
(ii)
Cheques sent to the charity’s head office,
(iii)
Donations from generous individuals. Some of these donations have
specific clauses attached to them indicating that the initial amount donated
(capital) cannot be spent and that the income (interest) from the donation
must be spent on specific activities, for example, provision of sports
equipment.
The rules regarding the taxation of charities in the country Hajira is based are
complicated, with only certain expenditure being allowable for taxation purposes
and donations of capital being treated as income in some situations.
Required:
34
(b)
Identify areas of inherent risk in the Hajira charity and explain the effect of each
(12)
of these risks on the audit approach.
(c)
Explain why the control environment may be weak at the charity Hajira.
(4)
(Total: 20 marks)
Tahir Co
One of your audit clients is Tahir Co a company providing petrol, aviation fuel and
similar oil based products to the government of the country it is based in. Although the
company is not listed on any stock exchange, it does follow best practice regarding
corporate governance regulations. The audit work for this year is complete, apart from
the matter referred to below.
As part of Tahir Co.’s service contract with the government, it is required to hold an
emergency inventory reserve of 6,000 barrels of aviation fuel. The inventory is to be
used if the supply of aviation fuel is interrupted due to unforeseen events such as
natural disaster or terrorist activity.
This fuel has in the past been valued at its cost price of Rs.150 a barrel. The current
value of aviation fuel is Rs.1,200 a barrel. Although the audit work is complete, as
noted above, the directors of Tahir Co have now decided to show the ‘real’ value of this
closing inventory in the financial statements by valuing closing inventory of fuel at
market value, which does not comply with relevant accounting standards. The draft
financial statements of Tahir Co currently show a profit of approximately Rs.5m with net
assets of Rs.1.7 billion.
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Question bank: Objective test and long-form questions
Required:
(a)
List the audit procedures and actions that you should now take in respect of the
above matter.
(6)
(b)
For the purposes of this section assume from part (a) that the directors have
agreed to value inventory at Rs.150/barrel.
Having investigated the matter in part (a) above, the directors present you with
an amended set of financial statements showing the emergency reserve stated
not at 6,000 barrels, but reported as 60,000 barrels. The final financial
statements now show a profit following the inclusion of another 54,000 barrels of
oil in inventory. When queried about the change from 6,000 to 60,000 barrels of
inventory, the finance director stated that this change was made to meet
expected amendments to emergency reserve requirements to be published in
about six months’ time. The inventory will be purchased this year, and no liability
will be shown in the financial statements for this future purchase. The finance
director also pointed out that part of Tahir Co.’s contract with the government
requires Tahir Co to disclose an annual profit and that a review of bank loans is
due in three months. Finally the finance director stated that if your audit firm
qualifies the financial statements in respect of the increase in inventory, they will
not be recommended for re-appointment at the annual general meeting. The
finance director refuses to amend the financial statements to remove this
‘fictitious’ inventory.
Required:
(i)
State the external auditor’s responsibilities regarding the detection of fraud;
(4)
(ii)
Discuss to which groups the auditors of Tahir Co could report the ‘fictitious’
(6)
aviation fuel inventory;
(iii)
Discuss the safeguards that the auditors of Tahir Co can use in an attempt
to overcome the intimidation threat from the directors of Tahir Co.
(4)
(Total: 20 marks)
INTERNAL CONTROL
35
Controls
(a)
If the auditor plans to rely on controls that have not changed since they were last
tested, the auditor should test the operating effectiveness of such controls at
least once in every third audit. Identify the situations in which the auditor may
(4)
decide to test the controls again, in the very next audit.
(b)
Briefly describe the components of internal control.
(10)
(Total: 14 marks)
36
Shahzad
(a)
Briefly explain the components of internal control as referred to in the
International Standards on Auditing.
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The Institute of Chartered Accountants of Pakistan
Audit and Assurance
(b)
Your firm is the auditor of Shahzad Limited (SL), a listed company, which is a
wholesaler of consumable products. SL records its sale on delivery of goods and
maintains up to date computerised inventory records.
A full inventory count was conducted at the year end. The senior who attended
the physical stocktaking at the central warehouse has observed the following
matters:
(i)
The inventory count took place on January 1, 20X3 under the supervision
of the Inventory Controller. No movement of inventory took place on that
day.
(ii)
Four counting teams were formed. Each team comprised of two
persons. The floor area was allocated by the teams among themselves.
(iii)
Each team was instructed by the Inventory Controller to remember
which inventory had been counted.
(iv)
Pre-numbered count sheets were provided to the staff involved in the
inventory count. The count sheets showed the inventory ledger balances,
to facilitate reconciliation.
(v)
Old, slow-moving or already sold inventories were highlighted on the
count sheets at the time of counting.
(vi)
Items not located on the pre-numbered inventory sheets were
recorded on separate sheets which were numbered by the staff.
(vii) At the end of the count, all inventories against which advances from
customers had been received were removed from the physical inventory
on the instruction of the Inventory Controller.
Required:
Identify the weaknesses in the system of inventory count. Give appropriate
explanations to support your point of view.
(9)
(Total: 18 marks)
37
Waheed Engineering
Your firm is the external auditor of Waheed Engineering, a listed company, which has
revenue of Rs100 million. The head office site includes the manufacturing unit, the
accounting functions and main administration. There are a number of sales offices in
different parts of the country. Waheed Engineering does not have an internal audit
department.
At the interim audit you have been assigned to the audit of the wages system. This will
involve obtaining an understanding of the wages system, testing the controls and
performing substantive procedures in order to verify wages transactions.
The wages records are maintained on a computer and all the wages information is
processed at the head office. Some of the employees in the manufacturing unit are
paid in cash, and all other employees have their wages paid directly into their bank
account.
Manufacturing employees are paid their wages a week in arrears. All other employees
are paid at the end of each week or month.
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
There is a personnel department which is independent of the wages department. The
personnel department maintain records of the employees, including their starting date,
grade, current wage rate and leaving date (if appropriate).
Previous years' audits have revealed frauds by wages department staff facilitated by
weaknesses in controls in the wages system. These frauds have included:
„
paying employees after appointment but before they commenced work;
„
paying employees after they have left; and
„
paying fictitious employees.
A check of current controls in the wages system has revealed that the company has
failed to instigate controls to prevent these types of fraud recurring. So the audit
programme requires extensive substantive procedures to be carried out to ensure that
recorded wages transactions have not been misstated by similar frauds taking place in
the current year.
The existence of employees at the head office site can be verified by physical
inspection. From a cost effectiveness point of view, only a small sample of sales offices
will be visited. The audit manager has asked you to consider the audit procedures you
would carry out to obtain sufficient appropriate evidence of the existence of employees
at sales offices not visited by the audit staff.
The audit manager has explained that 'unclaimed wages' (in part (c) below) arise when
manufacturing employees are not present to collect their wages (when they are paid
out in part (b)). The unclaimed wage packets are given to the cashier who records their
details in the unclaimed wages book and is responsible for their custody. Any
employee who has not received his/her wage packet at the pay-out can obtain it from
the cashier. You have ascertained that there is no system of checking the operation of
the unclaimed wages system by a person independent of the cashier and the wages
department.
Required:
(a)
Describe the normal controls you would expect to see in a wages system and
explain their purpose.
(10)
(b)
Describe how you would verify that employees are not paid before they
commenced work for the company.
(5)
(c)
Describe the audit procedures you would carry out in connection with attending a
pay out of wages in cash to manufacturing employees.
(5)
(d)
Describe the substantive procedures on transactions you would carry out on the
unclaimed wages system.
(5)
(e)
Describe the evidence you would obtain to verify the existence of employees
whose wages are paid directly into their bank account, including those at sales
offices.
(5)
(Total: 30 marks)
38
Danish
Your firm has recently been appointed as auditor to Danish, a private company that
runs a chain of small supermarkets selling fresh and frozen food, and canned and dry
food. Danish has very few controls over inventory because the company trusts local
managers to make good decisions regarding the purchase, sale and control of
inventory, all of which is done locally. Pricing is generally performed on a cost-plus
basis.
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Audit and Assurance
Each supermarket has a stand-alone computer system on which monthly accounts are
prepared. These accounts are mailed to head office every quarter. There is no
integrated inventory control, sale or purchasing system and no regular system for
inventory counting. Management accounts are produced twice a year.
Trade at the supermarkets has increased in recent years and the number of
supermarkets has increased. However, the quality of staff that has been recruited has
fallen. Senior management at Danish are now prepared to invest in more up-to-date
systems.
Required:
(a)
Describe the problems that you might expect to find at Danish resulting from poor
internal controls.
(8)
(b)
Make FOUR recommendations to the senior management of Danish for the
improvement of internal controls, and explain the advantages and disadvantages
of each recommendation.
(12)
(Total: 20 marks)
39
Roses Anytime
(a)
ISAs identify a number of key procedures which auditors should perform if they
wish to rely on internal controls and reduce the level of substantive testing they
perform. These include:
(i)
documentation of accounting and internal control systems;
(ii)
walk-through tests;
(iii)
audit sampling;
(iv)
testing internal controls;
(v)
dealing with deviations from the application of control procedures.
Required:
Briefly explain each of the procedures listed above.
(b)
(10)
Roses Anytime sells Roses wholesale. Customers telephone the company and
their orders are taken by clerks who take details of the Roses to be delivered, the
address to which they are to be delivered, and account details of the customer.
The clerks input these details into the company's computer system (whilst the
order is being taken) which is integrated with the company's inventory control
system. The company's standard credit terms are payment one month from the
order (all orders are despatched within 48 hours) and most customers pay by
bank transfer, An accounts receivable ledger is maintained and statements are
sent to customers once a month. Credit limits are set by the credit controller
according to a standard formula and are automatically applied by the computer
system, as are the prices of Roses.
Required:
Describe and explain the purpose of the internal controls you might expect to see
in the sales system at Roses Anytime over the:
(i)
receipt, processing and recording of orders;
(6)
(ii)
collection of cash.
(4)
(Total: 20 marks)
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
40
Trade Receivables
There are many reasons for maintaining internal control systems. These include the
need to ensure that:
(i)
transactions are properly authorised;
(ii)
transactions are promptly and accurately recorded;
(iii)
access to assets and records is properly authorised;
(iv)
recorded assets represent actual assets.
In the absence of internal controls, errors, omissions and misappropriation of assets
are likely and external and internal auditors pay particular attention to both the design
and operation of internal control systems.
Receivables is an area in which most organisations expect internal controls to be
operating effectively.
Required:
(a)
In the context of receivables, list and describe the types of error, omission and
misappropriation of assets that can occur in practice where internal controls are
weak or non-existent.
(8)
(b)
Explain why even a good system of internal control will not necessarily prevent or
detect errors, omissions and the misappropriation of assets in a receivables
system, and explain why a good system of internal control is important to
auditors.
(4)
(c)
List the main internal controls that you would expect to be in operation in the
receivables system at a small manufacturing company with a computerised
(7)
accounting system.
(d)
Explain why external auditors seek to rely on the proper operation of internal
controls wherever possible.
(5)
(Total: 24 marks)
41
Granger
Granger is a privately owned incorporated business that operates a garage which
repairs and services motor vehicles. Most customers are required to pay by cash or
cheque on collecting their vehicle. Credit accounts are available to business
customers, These customers sign the invoice on collection of the vehicle and their
business is billed monthly. Separate series of pre-numbered invoices are drawn up by
the foreman for cash sales and for credit sales. All customer accounts are maintained
by the receptionist. His duties include the following:
Cash sales
Collect cash or cheques from customers on collecting their vehicle.
At the end of the day, check the numerical sequence of cash sales invoices, add the
sales total and agree the total to the amount of cash and cheques received.
Record the total cash sales in the cash receipts book.
Credit sales
Obtain the customer's signature on the copy invoice of business account customers.
Enter the invoices in numerical sequence in the sales journal and post the customer's
account in the accounts receivable ledger.
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The Institute of Chartered Accountants of Pakistan
Audit and Assurance
Send monthly statements to credit account customers and follow up overdue accounts.
List the balances on the accounts receivable ledger at the end of the month and
reconcile the total with the control account in the general ledger.
Write off uncollectible balances to bad debts.
Cash receipts
Open the mail, extract cheques from credit account customers, record them in the cash
receipts book and post the accounts receivable ledger,
Make up the day's banking of cash (and cheques) from both cash and credit sales,
prepare the deposit slip and bank the cash (and cheques).
All other accounting duties are the responsibility of two further accounts clerks and all
are subject to supervision by the garage manager.
Required:
(a)
(i)
Explain why the functions assigned to the receptionist result in an
inadequate segregation of duties. Your explanation should identify
misstatements that could occur and indicate how those duties could be
reassigned to other staff members.
(8)
(ii)
Identify other control procedures you would consider necessary to ensure
the completeness of the recorded cash receipts and accounts receivable.
(4)
(b)
As a member of the audit staff of the company's external auditors, you visit the
garage and make a count of cash on hand. You subsequently compare details of
unbanked cash receipts that you counted with the entry in the cash receipts
boots for that date. Although the total in the cash receipts book is the same, the
amount of banknotes and coins is less and there is a cheque from a business
customer that you did not record.
Required:
(i)
(ii)
Explain the procedures to be followed in making a cash-count for audit
purposes.
(4)
Explain the irregularity that the discrepancy between the cash count and
cash receipts book might lead you to suspect, and describe how you would
investigate the discrepancy.
(4)
(Total: 20 marks)
AUDIT EVIDENCE
42
Nobel
You are the manager on the audit of Nobel Limited, a listed company, which
manufactures automotive parts and air-conditioners for motor vehicle assemblers.
Annual sale of the Company is Rs. 850 million and profit before tax is Rs. 60 million.
Your review of the audit working paper file has disclosed the following outstanding
issues:
(i)
The company is facing a potential legal claim from Mehran Motors Limited
(MML) in respect of defective air conditioners supplied to them. A claim for Rs.
25 million being the cost of replacement of air conditioners and lost production
time has been lodged with the Company by MML. The management is of the
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
view that the claim is not justified, as the air conditioners were properly
functioning and had been tested for quality and that the defects have arisen
because of the negligence of MML and its technicians. However, a provision of
Rs. 2 million has been made in the financial statements in this respect.
(ii)
Depreciation on certain equipment has been charged at 10% per annum on
reducing balance method. This rate is consistent with prior years and the same
rate is being used by most other companies, in the automobile industry.
However, significant losses have recently been recorded on the disposal of
similar equipment.
Management has provided written representations in respect of the above matters.
Required:
What audit evidence will you gather to address the above issues?
43
(6)
Masoom Limited
As the manger on the audit of Masoom Limited you want the management to appoint
experts to assist you on certain matters.
Explain the circumstances where auditor may use the work of an expert and the
auditor’s responsibilities in this regard.
(7)
44
Sky blue
Mr Mubarak is the audit senior on the audit of Sky Blue Limited. While comparing the
draft financial statements with the previous year, he noted many unusual fluctuations.
Briefly explain the procedure he should follow, in the above situation.
(6)
45
Direct confirmations 1
Direct confirmations from third parties provide independent audit evidence that
certain account balances and items in the financial statements are properly recorded
and disclosed.
Required:
(a)
Distinguish between positive and negative confirmations.
(2)
(b)
Briefly describe the risks associated with each of the above type of confirmation
and the steps that an auditor usually takes to avert such risks.
(5)
(c)
Explain why and under what circumstances an auditor may decide to use
negative confirmation requests. Also, identify the circumstances where the
auditor may use a combination of positive and negative confirmations.
(6)
(Total: 13 marks)
46
Chill
You are the engagement manager on the audit of Chill Limited. During the course of
audit, you have been provided an Actuarial Valuation Report on the Company’s
Employees Retirement Benefits Scheme. You have noted that the report has
been prepared by M/s Saleem and Company which is not well known to you.
Required:
Briefly describe the matters that you would consider before using the report prepared
by Saleem and Company.
(5)
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The Institute of Chartered Accountants of Pakistan
Audit and Assurance
47
Sales sampling
(a)
You are the audit manager on a client where an annual sale is Rs. 640 million.
During the course of annual audit the following table was developed by an
audit team member, to categorize the annual sales:
Rs.
Category A
50 sales transactions to different customers
300 million
Category B
100 transactions to different customers
200 million
Category C
500 transactions to different customers
140 million
Total
640 million
Sohail, a team member, is of the view that if verification of all the transactions in
category A is carried out, there is no need to perform further procedures.
However, other team members do not agree and consider that proper sampling
should be carried out from the total population and categorization should be
ignored.
Required:
As an audit manager of the job, you are required to:
(b)
(i)
Explain how audit efficiency could be improved by using the above table.
(ii)
List other ways in which the sales population may be categorized and what
precaution should be taken while carrying out such categorization.
(iii)
Give your opinion on the views expressed by:
x
Sohail
x
Other audit team members.
(11)
Describe the circumstances in which an auditor may decide to examine entire
population of items that make up an account balance.
(3)
(Total: 14 marks)
48
PQR
During the audit of PQR Limited you have been assigned the task of evaluating the
work performed by the internal audit department of the company on certain specific
areas.
Required:
(a)
Describe how you would evaluate the work performed, in order to determine the
extent of reliance that may be placed thereon.
(6)
(b)
List the important differences between internal and external audit with respect
to the following:
‰
Independence
‰
Objectives
‰
Reporting
(8)
(Total: 14 marks)
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
49
Hard Stone Limited
You are the senior member of the audit engagement team, auditing the financial
statements of a manufacturing company, Hard Stone Limited. List down the primary
substantive procedures, which you would carry out in the verification of:
(a)
trade debts (excluding receipts from customers).
(6)
(b)
stores and spares.
(6)
(Total: 12 marks)
50
Related parties
Describe the procedures that the auditor may perform, in order to ensure the
completeness of the information provided by the management, about related parties.
(6)
51
Direct confirmations 2
Direct confirmations of balances due from customers are obtained to satisfy the
objective of ensuring that the customer exists and owes the specified amount to the
company at a certain date.
Required:
(a)
State the circumstances in which an auditor may decide not to circulate the
requests for direct confirmation.
(5)
(b)
What are the factors that an auditor considers while designing the requests for
direct confirmation?
(5)
(c)
Describe the alternative audit procedures which may be conducted if the
customer does not reply to a request for confirmation.
(6)
(Total: 16 marks)
52
Working papers
The preparation of working papers is an integral part of the auditor’s responsibilities.
Identify the factors that the auditor should consider while determining the form, content
and extent of audit working papers.
(7)
53
Al-Shams
Al-Shams Limited is an unquoted public company. A large part of its business is
carried out with persons / organisations related to the management or the
shareholders.
Required:
(a)
State any eight procedures which an auditor may perform for determining the
existence of related parties or related party transactions.
(8)
(b)
Give four examples of situations that may be indicative of dominant influence
exerted by a related party.
(4)
(Total: 12 marks)
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Audit and Assurance
54
Auditor’s expert
When expertise in a field other than accounting or auditing is necessary to
obtain sufficient appropriate audit evidence, the auditor has to determine whether to
use the work of an auditor’s expert.
Required:
List down the sources from where the auditor may get the information regarding
the expert’s competence, capabilities and objectivity.
(6)
55
ADL
(a)
(b)
Differentiate between the following:
(i)
Statistical and non-statistical sampling
(ii)
Sampling and non-sampling risk
(5)
You are the audit manager on Apple Distribution Limited (ADL). While reviewing
the audit planning documentation, you found that the audit team has selected
100 out of a total of 2,550 debtors for balance confirmation. The details are as
follows:
‰
50 largest debtors constitute approximately 40% of total debtors. Out of
these, 10 have been selected.
‰
90 other debtors were selected through haphazard sampling.
‰
All debtors below Rs. 5,000 were ignored as immaterial.
‰
Balances due from government and some of the related parties were
ignored as prior years working papers showed that they never responded to
requests for confirmation.
Required:
(i)
Comment on the sampling approach adopted by the audit team.
(ii)
Suggest alternative means of selecting the sample in which the material
balances have a greater probability of selection.
(8)
(Total: 13 marks)
56
Guava & Co
You are the training manager at Guava & Co., Chartered Accountants. Some
trainees in the firm have requested you to clarify the following issues:
(a)
Can the auditor discard any audit document, forming part of his opinion, after
the issuance of the auditor’s report?
(b)
The changes that can be incorporated during the final file assembly process
citing three such examples.
(c)
The circumstances under which it becomes necessary to modify the existing audit
documents or add new audit documents after the issuance of the auditor’s report
and the matters that should be documented in such a situation.
Required:
Offer appropriate explanations for each of the above issues.
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(11)
The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
57
RP planning
As the auditor of a listed company with a number of related parties, what steps
would you consider as part of your audit planning to ensure that all related party
relationships and transactions are identified and disclosed in the financial statements.
(13)
58
Manufacturing inventories
List the substantive procedures that may be performed by the auditor to verify the
amount of inventories as appearing in the financial statements of a manufacturing
concern.
(15)
59
Wedge & Co
(a)
You are the audit manager of W edge & Co, a firm of Chartered Accountants.
The audit seniors on various jobs have sought your advice in respect of the
following independent situations:
(i)
The expected rate of deviation based on the auditor’s understanding of
controls has increased to an extent which is unacceptably high.
(ii)
Number of debtors has increased from 4,500 to 5,000 and the amount of
debtors as a percentage of total assets has also increased.
(iii) The expected amount of misstatement has decreased from Rs. 300,000
to Rs. 200,000 whereas the monetary amount in respect of which an
appropriate level of assurance is required has increased by Rs. 50,000.
Required:
State with reasons, the effect of each of the above issues on the sample size of:
(i)
Tests of controls; and
(b)
(ii) substantive procedures.
(7)
While determining the sample size for tests of controls, the auditor takes into
account the expected rate of deviation. State the factors that are relevant to the
auditor’s consideration of the expected rate of deviation.
(4)
(c)
Differentiate between the following:
(i)
(ii)
Fair presentation framework and compliance framework
Tolerable misstatement and performance materiality
(9)
(Total: 20 marks)
60
MWL
You are currently in the planning phase of the audit of Mineral Water Limited (MWL) for
the year ended 30 June 2012. The following information is available to you:
Customer
Segment
Super
markets
Wholesalers
Retailers
Five star
hotels
© Emile Woolf International
No. of
Balance
Customers outstanding
12
20,014
10
10-20 21-30
days
days
days
Rs. in thousand…
8,125
5,053
6,396
31-90
days
> 90
days
311
129
65
553
7
14,910
4,743
7,694
5,078
1,756
2,805
454
278
201
209
187
111
――― ――― ――― ――― ―――
47,361 17,764 15,663 12,054 1,244
――― ――― ――― ――― ―――
――
636
――
41
6,019
1,798
2,793
3,150
724
1,784
The Institute of Chartered Accountants of Pakistan
Audit and Assurance
50% provision for doubtful debts has been made by MWL against balances
outstanding for more than 30 days whereas the balances outstanding for more than 90
days have been fully provided.
Required:
(a)
Indicate what would be the basis for selecting debtors for circularising positive
and negative requests for confirmations.
(6)
(b)
Briefly explain as to how you would deal with a situation where a debtor confirms
a balance which is different from the amount appearing in the confirmation
request.
(8)
(Total: 14 marks)
61
BPR
List the substantive procedures that may be performed by an auditor to verify the
following:
(a)
Bank reconciliation statements
(6)
(b)
Payroll
(8)
(c)
Raw material purchases
(6)
(Total: 20 marks)
62
Taskeen Co
(a)
(b)
(i)
In the context of ISA 530 Audit sampling, explain and provide examples of
the terms ‘sampling risk’ and ‘non-sampling’ risk.
(4)
(ii)
Briefly explain how sampling and non-sampling risk can be controlled by
the audit firm.
(2)
Taskeen Co is owned and managed by two brothers with equal shareholdings.
The company specialises in the sale of expensive motor vehicles. Annual
revenue is in the region of Rs70,000,000 and the company requires an audit
under local legislation. About 500 cars are sold each year, with an average value
of Rs140,000, although the range of values is from Rs130,000 to Rs160,000.
Invoices are completed manually with one director signing all invoices to confirm
the sales value is correct. All accounting and financial statement preparation is
carried out by the directors. A recent expansion of the company’s showroom was
financed by a bank loan, repayable over the next five years.
The audit manager is starting to plan the audit of Taskeen Co. The audit senior
and audit junior assigned to the audit are helping the manager as a training
exercise.
Comments are being made about how to select a sample of sales invoices for
testing. Audit procedures are needed to ensure that the managing director has
signed them and then to trace details into the sales day book and sales ledger.
‘We should check all invoices’ suggests the audit manager.
‘How about selecting a sample using statistical sampling techniques,’ adds the
audit senior.
‘Why waste time obtaining a sample?’ asks the audit junior. He adds ‘taking a
random sample of invoices by reviewing the invoice file and manually choosing a
few important invoices will be much quicker.’
© Emile Woolf International
42
The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
Required:
Briefly explain each of the sample selection methods suggested by the audit
manager, audit senior and audit junior, and discuss whether or not they are
appropriate for obtaining a representative sample of sales invoices.
(9)
(c)
Define ‘materiality’ and explain why the auditors of Taskeen Co must form an
opinion on whether the financial statements are free from material misstatement.
(5)
(Total: 20 marks)
63
Wings
Wings is an airline. The company owns some of its fleet of aircraft. Other aircraft are
leased from third parties. Wings has an internal audit function that has recently
expanded. Your firm is the external auditor to Wings. Your firm has been asked to
investigate the extent of which it may be able to rely on the work of internal audit in the
following areas:
„
Sales and ticketing;
„
Fleet acquisition and maintenance;
„
Trade payables and long-term debt financing (borrowings).
The company outsources its in-flight catering and payroll functions to different service
organisations.
Required:
(a)
Explain why the work of internal auditors, in the three areas noted above, is likely
to be useful to you as the external auditor.
(9)
(b)
Explain how the quality of the internal audit function is likely to influence the
extent of your reliance on internal audit work.
(5)
(c)
Describe the audit evidence you will seek relating to internal controls over the
out-sourced functions (in-flight catering and payroll).
(6)
(Total: 20 marks)
64
Glasses2Go
ISA 230 Audit Documentation establishes standards and provides guidance regarding
documentation in the context of the audit of financial statements.
Required:
(a)
List the purposes of audit working papers.
(3)
(b)
You have recently been promoted to audit manager in the audit firm of Sadia &
Co. As part of your new responsibilities, you have been placed in charge of the
audit of Glasses2Go, a long established audit client of Sadia & Co. Glasses2Go
sells spectacles; the company owns 42 stores where customers can have their
eyes tested and choose from a range of frames.
Required:
List the documentation that should be of assistance to you in familiarising
yourself with Glasses2Go. Describe the information you should expect to obtain
from each document.
(8)
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The Institute of Chartered Accountants of Pakistan
Audit and Assurance
(c)
The time is now towards the end of the audit, and you are reviewing working
papers produced by the audit team. An example of a working paper you have just
reviewed is shown below.
Client name: Glasses2Go
Year end: 30 April 20X3
Working paper: Payables transaction testing
Audit assertion: To make sure that the purchases day book is correct.
Method: Select a sample of 15 purchase orders recorded in the purchase
order system. Trace details to the goods received note (GRN), purchase
invoice (PI) and the purchase day book (PDB) ensuring that the quantities
and prices recorded on the purchase order match those on the GRN, PI
and PDB.
Test details: In accordance with audit risk, a sample of purchase orders
were selected from a numerically sequenced purchase order system and
details traced as stated in the method. Details of items tested can be found
on another working paper.
Results: Details of purchase orders were normally correctly recorded
through the system. Five purchase orders did not have any associated
GRN, PI and were not recorded in the PDB. Further investigation showed
that these orders had been cancelled due to a change in spectacle
specification. However, this does not appear to be a system weakness as
the internal controls do not allow for changes in specification.
Conclusion: Purchase orders are completely recorded in the purchase day
book.
Required:
Explain why the working paper shown above does not meet the standards
normally expected of a working paper.
Note: You are not required to reproduce the working paper.
(9)
(Total: 20 marks)
65
ISA 620
ISA 620 Using the work of an auditor’s expert contains guidance where the auditor uses
the work of an expert to provide knowledge relevant to the audit, which the audit firm itself
does not possess. Before the firm can rely on the work of the expert, ISA 620 requires the
firm to assess that work.
Required:
(i)
Set out FOUR examples of financial statement areas where the audit firm might
be likely to rely upon the work of an expert employed by the audit firm.
(2)
(ii)
Set out the main procedures an audit firm should apply before relying on the work
of such an expert.
(4)
(Total: 6 marks)
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
66
Cuddly World
You are the auditor of Cuddly World, a company which manufactures and sells small
cuddly toys by mail order. The company is managed by Mr Kabir and two assistants.
Mr Kabir authorises important transactions such as wages and large orders, one
assistant maintains the payables ledger and orders inventory and pays suppliers, and
the other assistant receives customer orders and despatches cuddly toys. Due to other
business commitments Mr Kabir only visits the office once a week.
At any time, about 100 different types of cuddly toys are available for sale. All sales are
made cash with order – there are no receivables. Customers pay using credit cards
and occasionally by sending cash. Revenue is over Rs 5.2 million.
You are planning the audit of Cuddly World and are considering using some of the
procedures for gathering audit evidence recommended by ISA 500 as follows:
(1)
analytical procedures;
(2)
inquiry;
(3)
inspection;
(4)
observation;
(5) recalculation.
Required:
(a)
(b)
For each of the above procedures:
(i)
explain its use in gathering audit evidence;
(5)
(ii)
describe one example for the audit of Cuddly World.
(5)
Discuss the suitability of each procedure for Cuddly World, explaining the
limitations of each.
(10)
(Total: 20 marks)
67
Analytical procedures and materiality
(a)
Analytical procedures are an important and powerful tool for auditors in
explaining the performance of a business. ISAs 315 and 320 require the auditor
to apply analytical procedures at the planning and overall review stages of the
audit.
Required:
Explain the possible reasons for the following changes in accounting ratios found
at the planning stage of the audit:
(i)
an increase in the current ratio;
(ii)
a decrease in the gross profit margin; and
(iii)
an increase in the inventory holding period;
(6)
Note: No marks will be awarded for showing the calculation of the ratio, all parts
carry equal marks.
(b)
The concept of materiality is fundamental to the work of auditors and is covered
by ISA 320 Materiality in planning and performing an audit. Matters that are
immaterial are not reported in financial statements.
Required:
Explain the concept of materiality and describe how materiality affects the audit
work performed by auditors.
(4)
(Total: 10 marks)
© Emile Woolf International
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The Institute of Chartered Accountants of Pakistan
Audit and Assurance
68
Tahira Transporters
You are the external auditor of Tahira Transporters, a public limited company (TT). The
company's year-end is 11 March. You have been the auditor since the company was
formed 24 years ago to take advantage of the increase in goods being transported by
road. Many companies needed to transport their products but did not always have
sufficient vehicles to move them. TT therefore purchased ten vehicles and hired these
to haulage companies for amounts of time ranging from three days to six months.
The business has grown in size and profitability and now has over 550 vehicles on hire
to many different companies. At any one time, between five and 20 vehicles are
located at the company premises where they are being repaired; the rest could be
anywhere on the extensive road network of the country it operates in. Full details of all
vehicles are maintained in a non-current asset register.
Bookings for hire of vehicles are received either over the telephone or via e-mail in TT's
offices. A booking clerk checks the customer's credit status on the receivables ledger
and then the availability of vehicles using the Vehicle Management System (VMS)
software on TT's computer network. E-mails are filed electronically by customer name
in the e-mail program used by TT. If the customer's credit rating is acceptable and a
vehicle is available, the booking is entered into the VMS and confirmed to the customer
using the telephone or e-mail. Booking information is then transferred within the
network from the VMS to the receivables ledger programme, where a sales invoice is
raised. Standard rental amounts are allocated to each booking depending on the
amount of time the vehicle is being hired for. Hard copy invoices are sent in the post for
telephone orders or via e-mail for e-mail orders.
The main class of asset on TT's statement of financial position is the vehicles. The net
book value of the vehicles is Rs6 million out of total shareholders' funds of Rs15 million
as at 31 March 20X3.
Required:
(a)
List and explain the reason for the audit tests you should perform to check the
completeness and accuracy of the sales figure in TT's financial statements.
(10)
(b)
List and describe the audit work you should perform on the statement of financial
position figure for vehicles in TT's financial statements for the year ended 31
March 20X3.
(10)
(Total: 20 marks)
© Emile Woolf International
46
The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
69
Willow
As a staff member of R and A Chartered Certified Accountants you are assigned to the
audit of tangible non-current assets of Willow for the year ended 31 March 20X3. R and
A have been the auditors of Willow for many years. You obtain the following schedule
of movements on property, plant and equipment and analysis of additions from the
company’s accountant.
Property
Rs m
Cost or valuation
1 April 20X2
Additions
Disposals
Revaluations
31 March 20X3
Accumulated depreciation
1 April 20X2
Provision
Written back on disposal
Adjustment on revaluation
31 March 20X3
Carrying amount
31 March 20X3
31 March 20X2
Plant and machinery
Rs m
Total
Rs m
340
–
–
120
––––
460
––––
275
123
(72)
–
––––
326
––––
615
123
(72)
120
––––
786
––––
24
5
–
(24)
––––
5
––––
213
30
(65)
–
––––
178
––––
237
35
(65)
(24)
––––
183
––––
455
––––
316
––––
148
––––
62
––––
603
––––
378
––––
Schedule of additions (plant and machinery)
Supplier
Description
Cost
Rs m
New Models
Milling machine Model 38
55
Drill Suppliers
Power drill Type 45C
34
Hoist Co
Electric hoist no 722
18
Sundry below Rs 1m
16
–––––––
123
–––––––
The company’s accountant also advises you that the property was revalued following a
valuation by the company’s property manager who is a professionally qualified valuer.
During your verification of depreciation you discover that most plant and machinery is
fully depreciated. Moreover you discover that, due to oversight, depreciation has
continued to be provided on fully depreciated items. As at the beginning of the year the
amount of overstatement was Rs 43m. The accountant suggests the correction be
made by reducing the current year’s charge for depreciation.
© Emile Woolf International
47
The Institute of Chartered Accountants of Pakistan
Audit and Assurance
Required:
(a)
State, with reasons, the initial audit procedures you would perform on the
schedules provided by the company’s accountant.
(3)
(b)
Outline the substantive audit procedures you would apply in verifying additions to
plant and machinery. Your answer should identify procedures applicable to each
of the financial statement assertions.
(8)
(c)
Describe the audit procedures applicable to verifying the revaluation of property.
(5)
(d)
With respect to the correction to accumulated depreciation, and assuming the
amount to be material, discuss the accountant’s proposed treatment. If you
disagree with the accountant’s proposal, state, with reasons, the correct
accounting treatment.
(4)
(Total: 20 marks)
70
Sparkle Forever
You are the audit manager in the firm of Dandy & Co, an audit firm with ten national
offices. One of your clients, Sparkle Forever, purchases diamond jewellery from three
manufacturers. The jewellery is then sold from Sparkle Forever’s four shops. This is the
only client your firm has in the diamond industry.
You are planning to attend the physical inventory count for Sparkle Forever. Inventory
is the largest account on the statement of financial position with each of the four shops
holding material amounts. Due to the high value of the inventory, all shops will be
visited and test counts performed.
With the permission of the directors of Sparkle Forever, you have employed JJ, a firm
of specialist diamond valuers who will also be in attendance. JJ will verify that the
jewellery is, in fact, made from diamonds and that the jewellery is saleable with respect
to current trends in fashion. JJ will also suggest, on a sample basis, the value of
specific items of jewellery. Counting will be carried out by shop staff in teams of two
using pre-numbered count sheets.
Required:
71
(a)
List and explain the reason for the audit procedures used in obtaining evidence in
relation to the inventory count of inventory held in the shops.
(10)
(b)
Explain the factors you should consider when placing reliance on the work of UJ.
(5)
(c)
Describe the audit procedures you should perform to ensure that jewellery
inventory is valued correctly.
(5)
(Total: 20 marks)
Bubbles
Bubbles manufactures and distributes soft drinks. Its inventories are controlled using a
real-time system which provides accurate records of quantities and costs of inventories
held at any point in time. This system is known within the company as the 'Stockpop'
system and it is integrated with the purchases and sales system. Bubbles has an
internal audit department whose activities encompass inventories.
No year-end inventory count takes place Inventories are held in several large
warehouses where non-stop production takes place.
© Emile Woolf International
48
The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
Your firm is the external auditor to Bubbles and you have been asked to perform the
audit of inventories, Inventories include finished goods and raw materials (water, sugar,
sweeteners, carbonating materials, flavourings, cans, bottles, bottle tops, fastenings
and packaging materials).
Your firm, which has several offices, wishes to rely on the 'Stockpop' system to provide
the basis of the figure to be included in the financial statements 'for inventories. Your
firm does not wish to ask the company to conduct a year-end inventory count.
Required:
(a)
Describe the audit tests that you would perform on the `Stockpop' system during
the year in order to determine whether to rely on it as a basis for the raw
materials and finished goods figures to be included in the financial statements.
(11)
Note: You are not required to deal with work in progress.
(b)
Describe the audit tests you would perform on the records held by Bubbles at the
year end to ensure that raw materials and finished goods are fairly stated in the
financial statements.
(9)
(Total: 20 marks)
72
ISA 500
ISA 500 Audit evidence identifies seven main testing procedures. One of these is
external confirmation.
Required:
(a)
List FOUR examples of external confirmations.
(b)
For EACH of the examples in (a) above explain:
(2)
ONE audit assertion that the external confirmation supports, and
ONE audit assertion that the external confirmation does NOT support.
(8)
(Total: 10 marks)
73
Javeria Co
Javeria Co has a significant number of cash transactions and recent non-current asset
purchases have been financed by a bank loan. This loan is repayable in equal annual
instalments for the next five years.
Required:
(a)
Explain the procedures to obtain a bank report for audit purposes from Javeria
Co.’s bank and the substantive procedures that should be carried out on that
report.
(5)
(b)
List the further substantive procedures that should be carried out on the bank
balances in Javeria Co.’s financial statements.
(5)
(Total: 10 marks)
© Emile Woolf International
49
The Institute of Chartered Accountants of Pakistan
Audit and Assurance
74
Porridge
Porridge is a small manufacturing company of which your firm of Chartered Certified
Accountants is the external auditor. You have been assigned to the audit of trade
payables.
The audit file indicates that control risk for purchases and payments transactions is
assessed as slightly less than high because of limitations in the extent of segregation
of duties due to the small number of accounts personnel. There are no other identified
control problems or prior year audit problems.
Narrative notes on the accounting system contain the following descriptions.
‰
Purchases are requisitioned by the user department and ordered, using
prenumbered order forms, by the purchasing manager.
‰
Raw materials and manufacturing supplies are delivered to the receiving
department of the factory where the receiver issues prenumbered goods inward
notes (GINs).
‰
Purchases of other goods and services are delivered directly to the requisitioning
department and no GINs are issued.
The accounts department checks suppliers' invoices with purchase orders, and
‰
x
for production department purchases, with GINs
x
‰
‰
for other purchases, sends the invoices to the requisitioning department
manager who initials the invoice to indicate that it is appropriate to pay.
Invoices are then processed to the accounting records using proprietary
software.
All suppliers are paid at the end of the month following the month of receipt of the
invoice.
Payables at 31 October 20X3 therefore represent goods and services invoiced in
October. In addition, invoices received between 1 and 15 November were divided into
those relating to goods received or services provided before and after 31 October, the
former being recorded in the accounting records before the October trial balance was
produced. On 15 November, any unmatched GINs relating to deliveries before 31
October were posted to the accounts as at 31 October at the estimated amounts of the
invoices.
Suppliers' invoices are filed alphabetically with supporting documentation, all of which
is cancelled with the date of payment when the cheque is issued. Suppliers' monthly
statements are also filed with the invoices. These are scrutinised by the accounts
department for unusual items, such as overdue invoices, but are not regularly
reconciled with the company's own records.
Required:
(a)
In your audit of trade payables in the 31 October 20X3 financial statements
explain which of the financial statement assertions you would regard as
presenting the greatest inherent risk.
(4)
(b)
Discuss the reasons for undertaking or not undertaking
circularisation.
(c)
Outline substantive procedures you would apply in your audit of trade payables
relating to production department purchases.
(6)
(d)
Explain additional procedures you would perform in verifying the completeness of
non-production department payables.
(6)
a payables’
(4)
(Total: 20 marks)
© Emile Woolf International
50
The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
75
Trembridge Engineering
Your firm is the auditor of Trembridge Engineering, and you have been asked to
suggest the audit work you will carry out in verifying accounts payable and purchase
accruals at the company's year end of 30 September 20X3. You attended the inventory
count at the year end.
The company operates from a single site and all raw materials for production are
received by the goods inwards department. When the materials are received they are
checked for quantity and quality to the delivery note and purchase order, and a multipart goods received note is made out and signed by the storekeeper. If there are any
problems with the raw materials, a discrepancy note is raised which gives details of the
problems (e.g. incorrect quantities or faulty materials).
The purchase accounting department receive the purchase invoices, check them to the
purchase order and goods received note and post them to the purchase ledger. At the
end of each month, payments are made to suppliers. The purchase ledger is
maintained on a PC.
The main sundry payables and accruals at the year end include:
(i)
wages accruals and associated taxes payable;
(ii)
sales taxes payable;
(iii)
time dependent accruals, such as interest on loans and overdrafts, telephone,
heat and light, and other expenses paid in arrears.
Most employees' wages are paid weekly in arrears.
Required:
Describe in detail the audit work you will carry out to:
(a)
(b)
(c)
check suppliers' statements to the balances on the purchase ledger;
verify that purchases cut-off has been correctly carried out at the year end;
ensure that sundry payables and accruals are correctly stated.
(8)
(5)
(7)
(Total: 20 marks)
76
ISA 620: Using the Work of an Auditor’s Expert
(a)
ISA 620 Using the Work of an auditor’s Expert explains how an auditor may use
an expert to obtain audit evidence.
Required:
Explain THREE factors that the external auditor should consider when assessing
the competence and objectivity of the expert.
(3)
(b)
(c)
Auditors have various duties to perform in their role as auditors, for example, to
assess the truth and fairness of the financial statements.
Required:
Explain THREE rights that enable auditors to carry out their duties.
(3)
List FOUR assertions relevant to the audit of tangible non-current assets and
state one audit procedure which provides appropriate evidence for each
assertion.
(4)
(Total: 10 marks)
© Emile Woolf International
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The Institute of Chartered Accountants of Pakistan
Audit and Assurance
77
Heidi Co
Following a competitive tender, your audit firm Cal & Co has just gained a new audit
client Heidi Co. You are the manager in charge of planning the audit work. Heidi Co.’s
year end is 30 June 20X3 with a scheduled date to complete the audit of 15 August
20X3. The date now is 3 June 20X3.
Heidi Co provides repair services to motor vehicles from 25 different locations. All
inventory, sales and purchasing systems are computerised, with each location
maintaining its own computer system. The software in each location is the same
because the programs were written specifically for Heidi Co by a reputable software
house. Data from each location is amalgamated on a monthly basis at Heidi Co.’s head
office to produce management and financial accounts.
You are currently planning your audit approach for Heidi Co. One option being
considered is to re-write Cal & Co.’s audit software to interrogate the computerised
inventory systems in each location of Heidi Co (except for head office) as part of
inventory valuation testing. However, you have also been informed that any computer
testing will have to be on a live basis and you are aware that July is a major holiday
period for your audit firm.
Required:
(a)
(b)
(i)
Explain the benefits of using audit software in the audit of Heidi Co;
(4)
(ii)
Explain the problems that may be encountered in the audit of Heidi Co and
for each problem, explain how that problem could be overcome.
(10)
Following a discussion with the management at Heidi Co you now understand
that the internal audit department are prepared to assist with the statutory audit.
Specifically, the chief internal auditor is prepared to provide you with
documentation on the computerised inventory systems at Heidi Co. The
documentation provides details of the software and shows diagrammatically how
transactions are processed through the inventory system. This documentation
can be used to significantly decrease the time needed to understand the
computer systems and enable audit software to be written for this year’s audit.
Required:
Explain how you will evaluate the computer systems documentation produced by
the internal audit department in order to place reliance on it during your audit. (6)
(Total: 20 marks)
SCENARIOS
78
Zeedin Co
Zeedin Co assembles fridges, microwaves, washing machines and other similar
domestic appliances from parts procured from a large number of suppliers. As part of
the interim audit work two weeks prior to the company year-end, you are testing the
procurement and purchases systems and attending the inventory count.
Procurement and purchases system
Parts inventory is monitored by the stores manager. When the quantity of a particular
part falls below re-order level, an e-mail is sent to the procurement department
detailing the part required and the quantity to order. A copy of the e-mail is filed on the
store manager’s computer.
© Emile Woolf International
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The Institute of Chartered Accountants of Pakistan
Question bank: Objective test and long-form questions
Staff in the procurement department check the e-mail, allocate the order to an
authorised supplier and send the order to that supplier using Electronic Data
Interchange (EDI). A copy of the EDI order is filed in the order database by the
computer system. The order is identified by a unique order number.
When goods are received at Zeedin, the stores clerk confirms that the inventory agrees
to the delivery note and checks the order database to ensure that the inventory were in
fact ordered by Zeedin. (Delivery is refused where goods do not have a delivery note.)
The order in the order database is updated to confirm receipt of goods, and the
perpetual inventory system updated to show the receipt of inventory. The physical
goods are added to the parts store and the paper delivery note is stamped with the
order number and is filed in the goods inwards department.
The supplier sends a purchase invoice to Zeedin using EDI; invoices are automatically
routed to the accounts department. On receipt of the invoice, the accounts clerk checks
the order database, matches the invoice details with the database and updates the
database to confirm receipt of invoice. The invoice is added to the purchases database,
where the purchase day book (PDB) and suppliers individual account in the payables
ledger are automatically updated.
Required:
(a)
(b)
(c)
(d)
List SIX audit procedures that an auditor would normally carry out on the
purchases system at Zeedin Co, explaining the reason for each procedure. (12)
List FOUR audit procedures that an auditor will normally perform prior to
attending the client’s premises on the day of the inventory count.
(2)
(i)
State the aim of a test of control and the aim of a substantive procedure. (5)
(ii) In respect of your attendance at Zeedin Co.’s inventory count, state one
test of control and one substantive procedure that you should perform. (4)
On the day of the inventory count, you attended depot nine at Zeedin. You
observed the following activities:
1.
Pre-numbered count sheets were being issued to client’s staff carrying out
the count. The count sheets showed the inventory ledger balances for
checking against physical inventory.
2.
All count staff were drawn from the inventory warehouse and were counting
in teams of two.
3.
Three counting teams were allocated to each area of the stores to count,
although the teams were allowed to decide which pair of staff counted
which inventory within each area. Staff were warned that they had to
remember which inventory had been counted.
4.
Information was recorded on the count sheets in pencil so amendments
could be made easily as required.
5.
Any inventory not located on the pre-numbered inventory sheets was
recorded on separate inventory sheets – which were numbered by staff as
they were used.
6.
At the end of the count, all count sheets were collected and the numeric
sequence of the sheets checked; the sheets were not signed.
Required:
(i)
(ii)
List the weaknesses in the control system for counting inventory at depot
nine.
(3)
For each weakness, explain why it is a weakness and state how that
weakness can be overcome.
(9)
(Total: 35 marks)
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Audit and Assurance
79
Sahito Co
Introduction – audit firm
You are an audit senior in Bachani & Co, a firm providing audit and assurance
services. At the request of an audit partner, you are preparing the audit programme for
the income and receivables systems of Sahito Co.
Audit documentation is available from the previous year’s audit, including internal
control questionnaires and audit programmes for the despatch and sales system. The
audit approach last year did not involve the use of computer assisted audit techniques
(CAATs); the same approach will be taken this year. As far as you are aware, Sahito’s
system of internal control has not changed in the last year.
Client background – sales system
Sahito Co is a wholesaler of electrical goods such as kettles, televisions, MP3 players,
etc. The company maintains one large warehouse in a major city. The customers of
Sahito are always owners of small retail shops, where electrical goods are sold to
members of the public. Sahito only sells to authorised customers; following appropriate
credit checks, each customer is given a Sahito identification card to confirm their
status. The card must be used to obtain goods from the warehouse.
Despatch and sales system
The despatch and sales system operates as follows:
1.
Customers visit Sahito’s warehouse and load the goods they require into their
vans after showing their Sahito identification card to the despatch staff.
2.
A pre-numbered goods despatch note (GDN) is produced and signed by the
customer and a member of Sahito’s despatch staff confirming goods taken.
3.
One copy of the GDN is sent to the accounts department, the second copy is
retained in the despatch department.
4.
Accounts staff enter goods despatch information onto the computerised sales
system. The GDN is signed.
5.
The computer system produces the sales invoice, with reference to the inventory
master file for product details and prices, maintains the sales day book and also
the receivables ledger. The receivables control account is balanced by the
computer.
6.
Invoices are printed out and sent to each customer in the post with paper copies
maintained in the accounts department. Invoices are compared to GDNs by
accounts staff and signed.
7.
Paper copies of the receivables ledger control account and list of aged
receivables are also available.
8.
Error reports are produced showing breaks in the GDN sequence.
Information on receivables
The chief accountant has informed you that receivables days have increased from 45
to 60 days over the last year.
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Question bank: Objective test and long-form questions
The aged receivables report produced by the computer is shown below:
Number of
Range of debt
receivables
15
Less than Rs 0
Total debt
Rs
(87,253)
Current Rs
1 to 2
months
old Rs
More than 2
months old
Rs
(87,253)
197
Rs 0 to Rs 20,000
2,167,762
548,894
643,523
975,345
153
Rs 20,001 to
50,000
5,508,077
2,044,253
2,735,073
728,751
1,495,498
––––––––––
9,084,084
––––––––––
750,235
–––––––––
3,256,129
–––––––––
23
––––
388
––––
Rs 50,001 or more
672,750
72,513
––––––––– ––––––––––
4,051,346
1,776,609
––––––––– ––––––––––
In view of the deteriorating receivables situation, a direct confirmation of receivables
will be performed this year.
Required:
(a)
(b)
80
Explain the steps necessary to check the accuracy of the previous year’s internal
control questionnaires.
(4)
Using information from the scenario, list SIX tests of control that an auditor would
normally carry out on the despatch and sales system at Sahito Co and explain
the reason for each test.
(12)
(c)
State and explain the meaning of FOUR assertions that relate to the direct
confirmation of receivables.
(4)
(d)
(i)
Describe the procedures up to despatch of letters to individual receivables
in relation to a direct confirmation of receivables.
(5)
(ii)
Discuss which particular categories of receivables might be chosen for the
(5)
sample.
(Total: 30 marks)
Bashir Co
Introduction
Bashir Co assembles specialist motor vehicles such as lorries, buses and trucks. The
company owns four assembly plants to which parts are delivered and assembled into
the motor vehicles.
The motor vehicles are assembled using a mix of robot and manual production lines.
The ‘human’ workers normally work a standard eight hour day, although this is
supplemented by overtime on a regular basis as Bashir has a full order book. There is
one shift per day; mass production and around the clock working are not possible due
to the specialist nature of the motor vehicles being assembled.
Wages system – shift workers
Shift-workers arrive for work at about 7.00 am and ‘clock in’ using an electronic
identification card. The card is scanned by the time recording system and each
production shift-worker’s identification number is read from their card by the scanner.
The worker is then logged in as being at work. Shift-workers are paid from the time of
logging in. The logging in process is not monitored as it is assumed that shift-workers
would not work without first logging in on the time recording system.
Shift-workers are split into groups of about 25 employees, with each group under the
supervision of a shift foreman. Each day, each group of shift-workers is allocated a
specific vehicle to manufacture. At least 400 vehicles have to be manufactured each
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Audit and Assurance
day by each work group. If necessary, overtime is worked to complete the day’s quota
of vehicles. The shift foreman is not required to monitor the extent of any overtime
working although the foreman does ensure workers are not taking unnecessary or
prolonged breaks which would automatically increase the amount of overtime worked.
Shift-workers log off at the end of each shift by re-scanning their identification card.
Payment of wages
Details of hours worked each week are sent electronically to the payroll department,
where hours worked are allocated by the computerised wages system to each
employee’s wages records. Staff in the payroll department compare hours worked from
the time recording system to the computerised wages system, and enter a code word
to confirm the accuracy of transfer. The code word also acts as authorisation to
calculate net wages. The code word is the name of a domestic cat belonging to the
department head and is therefore generally known around the department.
Each week the computerised wages system calculates:
(i)
gross wages, using the standard rate and overtime rates per hour for each
employee,
(ii) statutory deductions from wages, and
(iii) net pay.
The list of net pay for each employee is sent over Bashir’s internal network to the
accounts department. In the accounts department, an accounts clerk ensures that
employee bank details are on file. The clerk then authorises and makes payment to
those employees using Bashir’s online banking systems. Every few weeks the financial
accountant reviews the total amount of wages made to ensure that the management
accounts are accurate.
Termination of employees
Occasionally, employees leave Bashir. When this happens, the personnel department
sends an e-mail to the payroll department detailing the employee’s termination date
and any unclaimed holiday pay. The receipt of the e-mail by the payroll department is
not monitored by the personnel department.
Salaries system – shift managers
All shift managers are paid an annual salary; there are no overtime payments.
Salaries were increased in July by 3% and an annual bonus of 5% of salary was paid in
November.
Required:
(a)
(b)
(c)
(d)
List FOUR control objectives of a wages system.
(2)
As the external auditors of Bashir Co, write a management letter to the directors
in respect of the shift-workers’ wages recording and payment systems which:
(i)
Identifies and explains FOUR weaknesses in that system;
(ii) Explains the possible effect of each weakness;
(iii) Provides a recommendation to alleviate each weakness.
(14)
List THREE substantive analytical procedures you should perform on the shift
managers’ salary system. For each procedure, state your expectation of the
result of that procedure.
(6)
Audit evidence can be obtained using various audit procedures, such as
inspection.
APART FROM THIS PROCEDURE, in respect of testing the accuracy of the time
recording system at Bashir Co, explain FOUR procedures used in collecting audit
evidence and discuss whether the auditor will benefit from using each procedure.
(8)
(Total: 30 marks)
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Question bank: Objective test and long-form questions
COMPLETION
81
Analytical procedures
(a)
Analytical procedures are an important part of the audit process and a tool
which the auditor uses during the various phases of an audit.
Required:
(i)
Describe the nature and purpose of analytical procedures used during an
audit.
(6)
(ii)
Describe the factors that the auditor needs to consider while designing
and performing analytical procedures as substantive procedures.
(4)
(iii)
(b)
Describe the objectives which an auditor expects to achieve while applying
analytical procedures at the overall review stage of an audit.
(4)
Representations by management are considered as audit evidence. Describe
the basic elements of a management representation letter.
(4)
(Total: 18 marks)
82
Auditor responsibility
The auditor is required to issue an audit report at the end of the audit, which sets out
his opinion on the financial statements. An important element of the audit report is
the statement of auditor’s responsibility.
Required:
Narrate the matters that should be contained in the statement of auditor’s responsibility
as included in an audit report issued under ISA-700 ‘The Independent Auditor’s Report
on a Complete Set of General Purpose Financial Statements’.
(8)
83
Al-Badr
Al-Badr & Company, Chartered Accountants, have conducted the statutory audit of the
financial statements of Al-Qasim Limited, a listed company, for the year ended June
30, 20X3 under the requirements of the Companies Ordinance, 1984. The job in
charge has drafted the following audit report:
Auditors’ Report to the Directors
We have audited the annexed balance sheet of Al-Qasim Limited as at June 30, 20X3
and the related profit and loss account and statement of changes in equity together
with the notes forming part thereof, for the year then ended and we state that we have
obtained all the information and explanations which, to the best of our knowledge and
belief, were necessary for the purposes of our audit.
We conducted our audit in accordance with the auditing standards. These standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the above said statements are free of any material misstatement. An audit
includes examining evidence supporting the amounts and disclosures in the above said
statements. An audit also includes assessing the accounting policies and all estimates
made by management, as well as, evaluating the overall presentation of the above said
statements. We believe that our audit provides a reasonable basis for our opinion and,
after due verification, we report that:
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Audit and Assurance
(a)
in our opinion:
(i)
the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies Ordinance,
1984, and are in agreement with the books of account and further in
agreement with accounting policies consistently applied;
(ii)
the expenditure incurred during the year was for the purpose of the
company’s business;
and
(iii)
the business conducted, investments made and the expenditure incurred
during the year were in accordance with the objects of the company;
(b)
in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, profit and loss account and
statement of changes in equity together with the notes forming part thereof
conform with International Financial Reporting Standards, and give the
information required by the Companies Ordinance, 1984, in the manner so
required and respectively give a true and fair view of the state of the company’s
affairs as at June 30, 20X3 and of the profit and changes in equity for the year
then ended; and
(c)
in our opinion, no zakat was deductible at source under the Zakat and Ushr
Ordinance, 1980 (XVIII of 1980).
Al-Badr & Company
Chartered Accountants
Karachi
Dated: September xx, 20X3
Required:
Identify and explain (where necessary) the errors in the above audit report.
(Note: You are not required to redraft the report.)
84
(Total: 12 marks)
Shahrukh and Company
Shahrukh and Company, Chartered Accountants, have conducted the statutory audit of
the financial statements of Karim Limited, a listed company, for the year ended 30 June
2012 under the Companies Ordinance, 1984. The job incharge has drafted the
following audit report:
Auditors’ Report to the Members
We have audited the annexed balance sheet of Karim Limited (the Company) as at 30
June 2012, and the related Income and Expenditure Account, Statement of
Comprehensive Income, Cash Flow Statement and Statement of Changes in Equity
together with the notes forming part thereof, for the year then ended and we state that
we have obtained all the information and explanations which were necessary for the
purposes of our audit.
It is the responsibility of the company’s management to establish and maintain a
system of internal control and prepare and present the above said statements in
conformity with the approved auditing standards and the requirements of the fourth
schedule to the Companies Ordinance, 1984. Our responsibility is to audit these
statements.
We conducted our audit in accordance with the auditing standards as applicable in
Pakistan. These standards require that we plan and perform the audit to obtain
reasonable and limited assurance about whether the above statements are free of any
misstatement. An audit includes examining evidence supporting the amounts and
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Question bank: Objective test and long-form questions
disclosures in the above said statements. An audit also includes assessing the
accounting policies and significant estimates made by management, as well as,
evaluating the overall presentation of the above said statements. We believe that our
audit provides a reasonable basis for our opinion and, after due verification, we report
that:
(a)
in our opinion, proper books of accounts have been kept by the company.
(b)
in our opinion:
(i)
the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies Ordinance
1984, and are in agreement with the books of account and are further in
accordance with accounting policies consistently applied;
(ii)
the expenditure incurred during the year was in accordance with the objects
of the Company; and
(iii)
the business conducted, investments made and the expenditure incurred
during the year were for the purpose of the Company’s business;
(c)
in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, profit and loss account, statement of
comprehensive income, cash flow statement and statement of changes in equity
together with the notes forming part thereof, on form with the approved
accounting standards as applicable in Pakistan and give the information required
by the Companies Ordinance, 1984, in the manner so required and respectively
give a true and fair view of the state of the Company’s affairs as at 30 June 2012;
and
(d)
in our opinion, no zakat was deductible at source under the Zakat and Ushr
Ordinance, 1980.
Chartered Accountants
Date: 01 September 2012
Required:
Identify the errors in the above report vis-à-vis a standard statutory audit report
(Note: You are not required to redraft the report.)
(Total: 15 marks)
85
The engagement partner
As the engagement partner, you have reviewed the audit working papers of
Samarkand Limited (SL). The audit team has highlighted the following matters in the
working papers.
(a) Twenty percent of the company’s recorded turnover (revenue) comprises of cash
sales.
Proper records of cash sales have not been maintained. Consequently, the audit team
was unable to design audit procedures to verify the cash sales.
(b) During the current year, the company changed the method of charging depreciation
on its fixed assets from the straight line to the diminishing balance method.
However, all the required disclosures have been included in the notes to the
financial statements.
(c) The previous year’s financial statements were audited by another firm of chartered
accountants which has issued an un-modified opinion on those financial
statements.
Required:
Discuss the impact of each of the above matters on your audit report.
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(10 marks)
The Institute of Chartered Accountants of Pakistan
Audit and Assurance
86
Different audit clients
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.
(08)
(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.
(05)
(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.
(07)
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.
(Total: 20 marks)
87
Situations have arisen on different clients
The following situations have arisen on different clients being audited by your firm. The
year end in each instance is 31 December 2011.
(a) The management of Dir Limited intends to present certain unaudited
supplementary information, with the audited financial statements, in order to comply
with the requirements of the parent company. Before signing the audit report, it has
been determined that some of the information is inconsistent with the information in
the draft financial statements.
(04)
(b) Malakand Industries Limited (MIL) is engaged in the supply of customised
machinery to textile manufacturers. On 18 February 2012 one of its customers, who
owed Rs. 9.6 million, went into voluntary liquidation. In addition to the above
amount, a job was in progress on behalf of that customer and on which MIL had
already spent Rs. 13.9 million.
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Question bank: Objective test and long-form questions
The directors have refused to make a provision against the debt on the grounds
that the liquidator was appointed after the balance sheet date. They have also
refused to make any provision in respect of the work in process as they are
planning to sell the machinery being manufactured to another customer for Rs. 15.7
million.
The profit after tax of MIL is Rs. 85 million. The materiality level is 10% of profit
after tax.
(06)
(c) Swat Limited has invested Rs. 150 million in a business which is not mentioned in
the object clause of its Memorandum of Association. However, the object clause
was amended a week before the signing of the audit report.
(05)
Required:
In the light of the relevant requirements, discuss how should the auditor deal with the
above situations and describe the impact thereof on the audit report. (Total: 15 marks)
88
Hafiz Limited
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.
(05)
(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.
(05)
Required:
Discuss how would you deal with each of the above issues and what may be the
implications thereof on your audit report.
(Total: 10 marks)
89
An ‘emphasis of matter’ paragraph and an ‘other matter’ paragraph
(a)
Differentiate between an ‘emphasis of matter’ paragraph and an ‘other matter’
paragraph.
(04)
(b)
Give three examples each of circumstances which may necessitate the inclusion
of the following in the auditor’s report:
(i)
An ‘emphasis of matter’ paragraph; and
(03)
(ii)
An ‘other matter’ paragraph.
(03)
(Total: 10 marks)
90
MM Electronics (Private) Limited
You are the audit manager of MM Electronics (Private) Limited. The company markets
its products through retail outlets in nine major cities. The draft financial statements for
the year ended 30 June 2011 show a profit after tax of Rs. 20 million and net assets of
Rs. 150 million.
The audit team has noted the following matters for your consideration:
(a)
During the year the company has changed its policy of valuation of property,
plant and equipment from historical cost to revalued amount. For this purpose,
the services of Professional Valuers (Private) Limited were hired. They have
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issued valuation reports of three outlets indicating a revaluation surplus of Rs. 10
million, which has been recognised in the financial statements. The management
has informed you that the valuation reports of the remaining properties are
expected to be issued in December 2011.
(06)
(b)
The company was sued for breach of contract by a customer claiming damages
of Rs. 10 million. The legal advisor has confirmed the management’s assertion
that no liability existed at the balance sheet date. However, while reviewing the
customers’ files, you found an email from the Manager (Legal Department)
addressed to the Chief Executive in which he has opined that the company will
have to pay atleast 50% of the damages claimed.
(04)
(c)
With effect from 01 July 2010, the company has introduced a policy of providing
one year warranty on its television sets. No warranty is provided on the other
products. Sales of television sets aggregated Rs. 20 million, whereas the total
sales for the year amounted to Rs. 80 million.
(07)
The company has a customer support department which provides after sales services
on all products. For defects not covered under the warranty, the company bills the
customers at
25% above cost. The management has included a note in the draft financial statements
stating that no provision has been made in respect of the warranty, as the amount
cannot be measured reliably.
(d) The directors have decided not to disclose earnings per share as the same had
reduced significantly on account of issuance of 100% bonus shares. The disclosure
was however made in all previous financial statements.
(03)
Required:
Express your views on each of the above situations and discuss the impact thereof on
the audit report.
(Total: 20 marks)
91
Ranjha Limited
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, along with 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.
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Question bank: Objective test and long-form questions
(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)
92
Pervasive effects
(a)
Briefly explain the term ‘pervasive effects on the financial statements’. (04 marks)
(b)
As the engagement partner, you have reviewed the audit working papers of
Apricot Engineering Limited (AEL). The audit team has highlighted the following
matters in the working papers.
(i)
The company has issued a bank guarantee to one of its related parties
after the balance sheet date. No disclosure in this regard has been made in
the draft financial statements.
(ii)
AEL has paid a dividend after many years. Zakat has been appropriately
deducted and deposited in the Central Zakat Fund.
(iii)
Subsequent to the year end, a major debtor has declared bankruptcy. The
company expects to recover only 20% of the outstanding amount. The
management has refused to make a provision but is ready to disclose the
fact by way of a note.
(iv)
With effect from January 1, 2010, AEL has:
x
changed the method of charging depreciation on its fixed assets from
the ‘straight line’ to the ‘diminishing balance’; and
x
revised its estimate of useful lives of vehicles from 6 years to 4 years.
Required:
Discuss the impact of each of the above matters on your audit report.
93
(10 marks)
Audit report at the end of the audit
(a)
The auditor is required to issue an audit report at the end of the audit, which sets
out his opinion on the financial statements. An important element of the audit
report is the statement of auditor’s responsibility.
Required:
Narrate the matters that should be contained in the statement of auditor’s responsibility
as included in an audit report issued under ISA-700 ‘The Independent Auditor’s Report
on a Complete Set of General Purpose Financial Statements’.
(b)
Identify the situations in which an auditor may modify his report without affecting
his opinion. Also explain how such a modification should be presented in the
audit report.
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94
Iqra Industries Limited
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.
95
(04)
Blue Sky Limited
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)
96
(11)
Form 35A in the Companies
The auditor’s report as specified in form 35A in the Companies (General Provisions
and Forms) Rules, 1985 includes the auditor’s opinion on certain matters which have
not been specified in the format of auditor’s report given in the International Standards
on Auditing.
Required:
List the additional reporting responsibilities of the auditor, as discussed in the
preceding paragraph.
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97
Written representations
One of the objectives of obtaining a written representation from management is to
ensure that the management knows and acknowledges its responsibility for the
preparation of the financial statements and for the completeness of the information
provided to the auditor.
Required:
Specify the situations which may create doubts as to the reliability of written
representations. What course of action would the auditor take in such a situation? (7)
98
Shahrukh and Co
Shahrukh and Company, Chartered Accountants, have conducted the statutory
audit of the financial statements of Karim Limited, a listed company, for the year
ended 30 June 20X3 under the Companies Ordinance, 1984. The job in charge has
drafted the following audit report:
Auditors’ Report to the Members
We have audited the annexed balance sheet of Karim Limited (the Company) as at 30
June 20X3, and the related Income and Expenditure Account, Statement of
Comprehensive Income, Cash Flow Statement and Statement of Changes in Equity
together with the notes forming part thereof, for the year then ended and we state that
we have obtained all the information and explanations which were necessary for the
purposes of our audit.
It is the responsibility of the company’s management to establish and maintain a
system of internal control and prepare and present the above said statements in
conformity with the approved auditing standards and the requirements of the fourth
schedule to the Companies Ordinance, 1984. Our responsibility is to audit these
statements.
We conducted our audit in accordance with the auditing standards as applicable in
Pakistan. These standards require that we plan and perform the audit to obtain
reasonable and limited assurance about whether the above statements are free of any
misstatement. An audit includes examining evidence supporting the amounts and
disclosures in the above said statements. An audit also includes assessing the
accounting policies and significant estimates made by management, as well as,
evaluating the overall presentation of the above said statements. We believe that our
audit provides a reasonable basis for our opinion and, after due verification, we report
that:
(a)
in our opinion, proper books of accounts have been kept by the company.
(b)
in our opinion:
(i)
(ii)
(iii)
(c)
the balance sheet and profit and loss account together with the notes
thereon have been drawn up in conformity with the Companies Ordinance
1984, and are in agreement with the books of account and are further in
accordance with accounting policies consistently applied;
the expenditure incurred during the year was in accordance with the objects
of the Company; and
the business conducted, investments made and the expenditure incurred
during the year were for the purpose of the Company’s business;
in our opinion and to the best of our information and according to the
explanations given to us, the balance sheet, profit and loss account, statement of
comprehensive income, cash flow statement and statement of changes in equity
together with the notes forming part thereof, conform with the approved
accounting standards as applicable in Pakistan and give the information required
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by the Companies Ordinance, 1984, in the manner so required and respectively
give a true and fair view of the state of the Company’s affairs as at 30 June 20X3;
and
(d)
in our opinion, no zakat was deductible at source under the Zakat and Ushr
Ordinance, 1980.
Chartered Accountants
Date: 01 September 20X3
Required:
Identify the errors in the above report vis-à-vis a standard statutory audit report.
(12)
(Note: You are not required to redraft the report.)
99
Kazmi-Wassan
You are the manager in charge of the audit of Kazmi-Wassan, a listed company which
manufactures specialist cars and other motor vehicles for use in films. Audited revenue
is Rs 140 million with profit before tax of Rs 7.5 million.
All audit work up to, but not including, the obtaining of written representations has been
completed. A review of the audit file disclosed the following outstanding points:
Tiger’s Purr
The company is facing a potential legal claim from the Tiger’s Purr company in respect
of a defective vehicle that was supplied for one of their films. Tiger’s Purr maintains that
the vehicle was not built strongly enough while the directors of Kazmi-Wassan argue
that the specification was not sufficiently detailed. Dropping a vehicle 50 metres into
the river and expecting it to continue to remain in working condition would be unusual,
but this is what Tiger’s Purr expected. Solicitors are unable to determine liability at the
present time. A claim for Rs 4 million being the cost of a replacement vehicle and lost
production time has been received by Kazmi-Wassan from Tiger’s Purr. The directors’
opinion is that the claim is not justified.
Depreciation
Depreciation of specialist production equipment has been included in the financial
statements at the amount of 10% pa based on reducing balance. However, the
treatment is consistent with prior accounting periods (which received an unmodified
auditors’ report) and the companies in the same industry and sales of old equipment
show negligible profit or loss on sale. The audit senior, who is new to the audit, feels
that depreciation is being undercharged in the financial statements.
Required:
(a)
(b)
(c)
Explain the purpose of a written representation letter.
(5)
For each of the above matters:
(i)
discuss whether or not a paragraph is required in the representation letter;
and
(ii) if appropriate, draft the paragraph for inclusion in the representation letter.
(10)
A suggested format for the letter of representation has been sent by the auditors
to the directors of Kazmi-Wassan. The directors have stated that they will not
sign the letter of representation this year on the grounds that they believe the
additional evidence that it provides is not required by the auditor.
Required:
Discuss the actions the auditor may take as a result of the decision made by the
directors not to sign the letter of representation.
(5)
(Total: 20 marks)
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100 RK Resourcing
You are the auditor of RK Resourcing, a limited liability company which extracts,
refines and sells oil and petroleum related products.
The audit of RK Resourcing for the year ended 30 June 20X3 had the following events:
Date (20X3)
Event
15 August
Bankruptcy of major customer representing 11% of the trade
receivables on the statement of financial position.
Financial statements approved by directors.
Audit work completed and auditor’s report signed.
Accidental release of toxic chemicals into the sea from the
company’s oil refinery resulting in severe damage to the
environment. Management had amended and made adequate
disclosure of the event in the financial statements.
Financial statements issued to members of RK Resourcing.
A fire at one of the company’s oil wells completely destroys the well.
Drilling a new well will take ten months with a consequent loss in oil
production during this time.
21 September
22 September
1 November
23 November
30 November
Required:
(a)
International Standard on Auditing 560 Subsequent Events explains the audit
work required in connection with subsequent events.
List the audit procedures that can be used prior to the auditor’s report being
signed to identify events that may require adjustment or disclosure in the financial
statements.
(5)
(b)
For each of the following three dates:
„
„
15 August 20X3
1 November 20X3, and
„
30 November 20X3:
(i)
State whether the events occurring on those dates are adjusting or nonadjusting according to IAS 10 Events After the Reporting Period, giving
reasons for your decision.
(6)
Explain the auditor’s responsibility and the audit procedures that should be
carried out.
(9)
(ii)
Note: Marks are allocated evenly across the three dates.
(Total: 20 marks)
101 Rake Enterprises
You are the audit manager of Rake Enterprises, a limited liability company. The
company’s annual revenue is over Rs 100 million.
Required:
(a)
(b)
Compare the responsibilities of the directors and auditors regarding the published
financial statements of Rake Enterprises.
(6)
An extract from the draft audit report produced by an audit junior is given below:
Auditor’s responsibility
'We conducted our audit in accordance with Auditing Standards. An audit
includes examination, on a test basis, of evidence relevant to the amounts and
disclosures in the financial statements. It also includes an assessment of all the
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estimates and judgements made by the directors in the preparation of the
financial statements, and of whether the accounting policies are appropriate to
the company's circumstances, consistently applied and adequately disclosed.
'We planned and performed our audit so as to obtain as much information and
explanation as possible given the time available for the audit. We confirm that the
financial statements are free from material misstatement, whether caused by
fraud or other irregularity or error. The directors however are wholly responsible
for the accuracy of the financial statements and no liability for errors can be
accepted by the auditor. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the company's annual report.'
Required:
Identify and explain the errors in the above extract.
Note: You are not required to redraft the report.
(10)
(Total: 16 marks)
REVIEW ENGAGEMENTS
102 ISRE 2400
(a)
Explain the meaning of “assurance” and give two examples of types of assurance
which can be provided, distinguishing between the two in terms of the level of
assurance offered by each of them.
(4)
(b)
ISRE 2400 Engagements to review financial information sets out the objective,
general principles and procedures to be applied to a review engagement.
Required:
Set out the main types of procedures which an accountant should perform when
carrying out a review engagement.
(4)
(Total: 8 marks)
103 Karim
Karim & Company, Chartered Accountants are engaged in the review of interim
financial information of Babar Textiles Mills Limited for the half year ended June 30,
20X3. The increase in oil and energy prices and current inflationary trend prevailing in
the country has resulted in substantial losses and the Company’s outlook is negative.
Moreover, in view of recessionary pressures being faced by the US and many of the
EU economies, some of the large customers in those countries have not renewed their
orders and many others are expected to follow. Consequently, the company has
decided to lay off 40 percent of its workforce gradually, over the next few months.
The company’s management acknowledges the severity of the situation but is
reluctant to provide specific details in the interim financial information. However, it has
given a note containing general indications about the future prospects of the company.
Required:
Describe how the auditor should address the above issue and the implications it may
have on the review report of interim financial information.
(9)
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104 IFI
The auditor should have an understanding of the entity and its environment to enable
him to plan the engagement and select the inquiries, analytical and other review
procedures.
Required:
State the procedures which an auditor may perform, to update his understanding of the
entity and its environment, while carrying out an engagement to review interim financial
information.
(10)
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SECTION
Certificate in Accounting and Finance
Audit and Assurance
C
Multiple choice answers
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CHAPTER 1 – CONCEPT AND NEED FOR ASSURANCE
1
D
2
C
3
C
4
A
5
C
CHAPTER 2 – OBTAINING AN ENGAGEMENT
6
B
7
A
8
A
9
D
10
C
CHAPTER 3 – PLANNING AND RISK ASSESSMENT
11
D
12
D
13
A
14
D
15
B
CHAPTER 4 – EVIDENCE AND SAMPLING
16
C
17
B
18
A
19
B
20
B
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Answer bank: Multiple choice answers
CHAPTER 5 – INTERNAL CONTROL
21
A
22
B
23
C
24
C
25
D
CHAPTER 6 – FLOWCHARTS AND IT CONCEPTS
26
D
27
B
28
D
29
A
30
C
CHAPTER 7 – TESTS OF CONTROLS
31
A
32
C
33
B
34
B
35
D
CHAPTER 8 – INTRODUCTION TO SUBSTANTIVE PROCEDURES
36
C
37
D
38
B
39
B
40
C
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CHAPTER 9 – SUBSTANTIVE PROCEDURES: NON-CURRENT ASSETS
41
B
42
B
43
D
44
A
45
A
CHAPTER 10 – SUBSTANTIVE PROCEDURES: CURRENT ASSETS
46
C
47
D
48
D
49
C
50
B
CHAPTER 11 – SUBSTANTIVE PROCEDURES: OTHER AREAS
51
C
52
A
53
A
54
A
55
A
CHAPTER 12 – RELATED PARTY TRANSACTIONS
56
C
57
D
58
C
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Answer bank: Multiple choice answers
CHAPTER 13 – RELIANCE ON OTHERS
59
B
60
D
61
D
62
A
63
D
CHAPTER 14 – PROFESSIONAL ETHICS AND CODES OF CONDUCT
64
A
65
A
66
B
67
A
68
A
CHAPTER 15 – AUDIT FINALISATION AND REPORTING
69
B
70
A
71
C
72
C
73
B
CHAPTER 16 – INTERNATIONAL STANDARDS ON REVIEW ENGAGEMENTS
74
B
75
A
76
D
77
D
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SECTION
Certificate in Accounting and Finance
Audit and Assurance
D
Objective test and
long-form answers
1
ICAP Code of Ethics
(a) (i)
The fundamental principles of professional ethics for chartered accountants
are as follows:
‰ Integrity:
A chartered accountant should be straightforward and honest in all
professional and business relationships.
‰ Objectivity:
A chartered accountant should not allow bias, conflict of interest or undue
influence of others to override professional or business judgments.
‰ Professional competence and due care:
A chartered accountant has a continuing duty to maintain the required
professional knowledge and skill to ensure that a client or employer
receives competent professional service based on current developments
in practice, legislation and techniques. A chartered Accountant should act
diligently and in accordance with applicable technical and professional
standards when providing professional services.
‰ Confidentiality:
Confidential information acquired as a result of professional and business
relationships should not be disclosed to third parties without proper and
specific authority unless there is a legal or professional right or duty to
disclose. Confidential information acquired as a result of professional and
business relationships should not be used for personal advantage of the
chartered accountant or third parties.
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‰ Professional Behaviour:
A chartered accountant should comply with relevant laws and regulations
and should avoid any action that discredits the profession.
(ii) The threats to compliance with the fundamental principles may be
categorized as follows:
‰
Self-interest threats:
These may occur as a result of the financial or other interests of a
chartered accountant or of an immediate or close family member.
‰
Self-review threats:
These may occur when a current assignment requires re-evaluation of
the opinion previously expressed by the same chartered accountant.
‰
Advocacy threats:
These may occur when a chartered accountant promotes a position or
opinion to the point that subsequent objectivity may be compromised.
‰
Familiarity threats:
These may occur when, because of a close relationship, a chartered
accountant becomes too sympathetic to the interests of others.
‰
Intimidation threats:
These may occur when a chartered accountant may be deterred from
acting objectively by threats, actual or perceived.
(b)
Assisting financial statement audit client in matters such as preparing accounting
records or financial statements may create a self-review threat when the financial
statements are subsequently audited by the firm.
It is the client’s management responsibility to ensure that accounting records are
kept and financial statements are prepared.
In the above case, the firm can provide assistance provided it does not involve
taking management decisions. Such management decisions include:
‰ Determining or changing journal entries, or the classifications for accounts or
transaction or other accounting records without obtaining the approval of the
audit client;
‰ Authorizing or approving transactions; and
‰ Preparing source documents or originating data (including decisions on
valuation assumptions), or making changes to such documents or data.
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2
Levels of assurance
Reasonable assurance is a concept relating to the accumulation of the audit
evidence necessary for the auditor to conclude that there are no material
misstatements in the financial statements taken as a whole.
Whereas absolute assurance provides a guarantee that the financial statements are
free from material misstatements.
An audit carried out in accordance with ISAs is designed to provide reasonable
assurance that the financial statements taken as a whole are free from material
misstatement, whether due to fraud or error. In an audit-engagement, the auditor
provides a higher, but not absolute, level of assurance that the information subject to
audit is free of material misstatements.
An auditor cannot obtain absolute assurance because there are inherent limitations in
an audit that affect the auditor’s ability to detect material misstatements. These
limitations result from factors such as:
(i)
The use of testing;
(ii)
The inherent limitations of any accounting and internal controls system (for
example, the possibility of collusion);
(iii)
The fact that most audit evidence is persuasive rather than conclusive.
Also, the work undertaken by the auditor to form an opinion is permeated by
judgment, in particular regarding:
(i)
the gathering of audit evidence, for example, in deciding the nature, timing
and extent of audit procedures; and
(ii)
the drawing of conclusions based on the audit evidence gathered, for
example, assessing the reasonableness of the estimates made by
management in preparing the financial statements.
Further, other limitations may affect the persuasiveness of evidence available to draw
conclusions on particular financial statement assertions (for example, transactions
between related parties)
3
Shamsuddin
(i)
As per the “Code of Ethics” for Chartered Accountants issued by ICAP, the
practicing chartered accountants are not allowed to publicize their services in
a manner as is done by other normal businesses.
Appropriate newspaper/magazine may be used to inform the public of the
establishment of a new practice. But such announcements should be limited
to a bare statement of facts giving due consideration to the appropriateness
of the area of distribution of the newspaper/magazine and number of
insertions.
What practicing members write or say should not be promotional of
themselves or their firm.
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Thus, Mr Shamsuddin can accept a discount offer provided he ensures
compliance to the above.
(ii)
The Code of Ethics for Chartered Accountants issued by ICAP states that:
“Chartered Accountants in practice should be careful not to quote fee lower
than that charged by the chartered accountants in practice previously
carrying out the audit unless scope and quantum of work materially differs
from the scope and quantum of work carried out by the previous auditor.”
Keeping in view of the above, it is not advisable for Shamsuddin to accept
the audit unless the reduction in fee is on account of the reason discussed
above.
(iii)
As per the Code of Ethics for Chartered Accountants, issued by ICAP, the
professional fees should not be contingent upon the findings or results of
such services.
Condition imposed by Design Limited impairs the objectivity of the auditor on
account of self-interest threat. Therefore, Shamsuddin should not accept
such a proposal.
(iv)
4
Being a sole proprietorship the existing and proposed auditors should
immediately communicate the fact to ICAP and the proposed auditor should
not accept the offer without clearance from ICAP and the existing auditor.
Core concepts
(a) The management’s responsibilities in relation to the financial statements
include the following:
‰ The overall responsibility for the preparation and presentation of the
financial statements.
‰ Identifying the financial reporting framework to be used in the preparation
and presentation of the financial statements.
‰ Designing, implementing and maintaining internal controls relevant to the
preparation and presentation of financial statements that are free from
material misstatement whether due to fraud or error.
‰ Selecting and applying appropriate accounting policies.
‰ Making accounting estimates that are reasonable in the circumstances.
(b) Audit Scepticism
Audit scepticism is an attitude of professional scepticism which means that the
auditor should recognize the fact that circumstances may exist that may cause
the financial statements to be materially misstated. Consequently, he should
make a critical assessment with a questioning mind of the validity of audit
evidence obtained. He should remain alert to audit evidence that contradicts or
brings into question the reliability of documents and responses to inquiries and
the reliability of other information obtained from management and those
charged with governance.
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Elaboration on the response of the audit manager that auditor should always
maintain an attitude of professional scepticism throughout the audit:
Although the auditor cannot be expected to disregard past experience of the
honesty and integrity of the entity’s management and those charged with
governance, the auditor’s attitude of professional scepticism is particularly
important in considering the risks of material misstatement on account of
changes in circumstances.
5
Threats
Following are the categories of threats that may potentially affect the fundamental
principles:
(i)
Self-interest threats
This may occur as a result of the financial or other interests of a chartered
accountant or of an immediate or close family member.
‰ A financial interest in a client or jointly holding a financial interest with a
client.
‰ Undue dependence on total fees from a client.
‰ Having a close business relationship with a client.
‰ Concern about the possibility of losing a client.
‰ Potential employment with a client.
‰ Contingent fees relating to an assurance engagement.
‰ A loan to or from an assurance client or any of its directors or officers.
(ii)
Self-review threat
This may occur when a previous judgment needs to be re-evaluated by the
chartered accountant responsible for that judgment.
‰ The discovery of a significant error during a re-evaluation of the work of the
chartered accountant in practice.
‰ Reporting on the operation of financial systems after being involved in their
design or implementation.
‰ Having prepared the original data used to generate records that are the
subject matter of the engagement.
‰ A member of the assurance team being, or having recently been, a director
or officer of that client.
‰ A member of the assurance team being, or having recently been, employed
by the client in a position to exert direct and significant influence over the
subject matter of the engagement.
‰ Performing a service for a client that directly affects the subject matter of the
assurance engagement.
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(iii)
Advocacy threats
This may occur when a chartered accountant promotes a position or opinion to
the point that subsequent objectivity may be compromised.
‰ Promoting shares in a listed entity when that entity is a financial statement
audit client.
‰ Acting as an advocate on behalf of an assurance client in litigation or
disputes with third parties.
(iv)
Familiarity threats
This may occur when, because of a close relationship, a chartered accountant
becomes too sympathetic to the interests of others.
‰ A member of the engagement team having a close or immediate family
relationship with a director or officer of the client
‰ A member of the engagement team having a close or immediate family
relationship with an employee of the client who is in a position to exert direct
and significant influence over the subject matter of the engagement.
‰ A former partner of the firm being a director or officer of the client or an
employee in a position to exert direct and significant influence over the
subject matter of the engagement.
‰ Accepting gifts or preferential treatment from a client, unless the value is
clearly insignificant.
‰ Long association of senior personnel with the assurance client.
(v)
Intimidation threats
This may occur when a chartered accountant may be deterred from action
objectively by threats, actual or perceived.
‰ Being threatened with dismissal or replacement in relation to a client
engagement.
‰ Being threatened with litigation.
‰ Being pressured to reduce inappropriately the extent of work performed in
order to reduce fees.
6
Burewala and Kamal
(a)
Burewala Bank Limited:
Threats
(i)
A threat to independence may be created if the loan is made under
abnormal lending procedures, terms and requirements and the loan is
material to both the firm and the BBL.
(ii)
A self-interest threat may be created if the loan amount is material to the
firm/ partner.
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Safeguards:
As the Companies Ordinance, 1984, restricts a person who is indebted to the
company from being auditor of the said company, therefore the course of
action available to the partners of UCC is to withdraw from the engagement or
repayment of the loan by the partner concerned.
(b)
Faisalabad Textile Mills Limited:
Threats:
It has created self-interest, familiarity and intimidation threats.
The assurance team’s independence is threatened, on account of the fact that
Kamal is in a position to exert direct and significant influence over the
assurance engagement as Kamal was a member of the assurance team
during the previous year audit.
Safeguards:
The safeguards might include:
7
(i)
Consider the appropriateness or necessity of modifying the assurance
plan for the assurance engagement;
(ii)
Assigning an assurance team that is of sufficient experience in relation
to the individual who has joined the assurance client;
(iii)
Involve an additional chartered accountant who was not a member of the
assurance team to review the work or advise as necessary; or
(iv)
Quality control review of the assurance engagement.
(v)
Ensuring that the individual concerned is not entitled to any benefits or
payments from the firm unless these are made in accordance with fixed
pre-determined arrangements. In addition, any amount owed to the
individual should not be of such significance to threaten the firm’s
independence.
(vi)
Ensuring that the individual does not continue to participate or appear to
participate in the firm’s business or professional activities.
Zaman and Bilal
(a)
‰
As per the Companies Ordinance, 1984 a person shall not be appointed
as auditor of a company, if he is disqualified for appointment of any other
company, which is that company’s subsidiary or a holding company or a
subsidiary of that holding company.
‰
Therefore, the firm cannot be appointed as an auditor of KL as Mr Zaman
holds 5,000 shares in ML which together with KL is a subsidiary of DKL.
‰
For appointment as the auditor of the company, Mr .Zaman is required to
dispose of the shares in ML.
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(b)
8
‰
Bilal and Company, Chartered Accountants are eligible to act as the
auditor of IJK Limited.
‰
IJK Limited is not an associated company of LMN Limited as LMN
Limited holds 15.4% shares of IJK Limited. Therefore the wife of the
partner is not required to dispose of the shares in LMN Limited.
‰
Holding of non-voting shares is not relevant in determining the status of
the company.
Audit process
(a)
(b)
Training materials: purpose of external audit and its role
(i)
The external audit has a long history that derives largely from the
separation of the ownership and management of assets. Those who own
assets wish to ensure that those to whom they have entrusted control are
using those assets wisely. This is known as the 'stewardship' function.
(ii)
The requirement for an independent audit helps to ensure that financial
statements are free of bias and manipulation for the benefit of users of
financial information.
(iii)
Companies are owned by shareholders but they are managed by directors
(in very small companies, owners and managers are the same, but many
such companies are not subject to statutory audit requirements).
(iv)
The requirement for a statutory audit is a public interest issue: the public is
invited to invest in enterprises, it is in the interests of the capital markets
(and society as a whole) that those investing do so in the knowledge that
they will be provided with 'true and fair' information about the enterprise,
This should result in the efficient allocation of capital as investors are able
to make rational decisions on the basis of transparent financial information.
(v)
The requirement for an audit can help prevent investors from being
defrauded, although there is no guarantee of this because the external
audit has inherent limitations. Reducing the possibility of false information
being provided by managers to owners is achieved by the requirement for
external auditors to be independent of the managers upon whose financial
statements they are reporting.
(vi)
The purpose of the external audit under International Standards on Auditing
is for the auditor to obtain sufficient appropriate audit evidence on which to
base the audit opinion. This opinion is to the effect that the financial
statements give a 'true and fair view' (or 'present fairly in all material
respects') of the position, performance (and cash flows) of the entity. This
opinion is prepared for the benefit of shareholders.
Main audit procedures and processes: interim and final audit
Interim
(i)
The interim audit generally involves risk assessment, the testing of internal
controls, and certain analytical and other substantive procedures. Many of
these procedures are often performed concurrently.
(ii)
Risk assessment involves gathering information about the business,
inquiries, analytical procedures and determining the response to assessed
risk. In practice it also involves the determination of materiality and
tolerable error.
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(iii)
Risk assessment also involves evaluating the design of internal controls
and determining whether they have been implemented.
Final
(iv)
Final audit procedures involve further tests of controls, substantive
procedures and audit finalisation procedures.
(v)
Further tests of controls are designed to test transactions occurring
between the date of the interim audit and the period-end. This is to
ascertain whether the conclusions from controls testing during interim work
remain valid for the full period.
(vi)
Substantive procedures may involve a blend of substantive analytical
procedures plus tests of detail. The tests of detail typically involve selecting
a sample from a source, for example a collection of purchase transactions,
and tracing the transactions through to originating evidence, for example
purchase invoices. Tests of detail are also carried out in the opposite
direction by selecting from the external source (e.g. supplier invoices) then
tracing entries through to the books and records
(vii) Audit finalisation procedures involve a review of the financial statements as
a whole to ensure that they are internally consistent and presented in
accordance with the relevant financial reporting framework (and the
auditor's knowledge of the business). This phase includes the Partner’s
review of significant matters raised by the audit team during the audit.
9
Regulatory and professional requirements
(a)
Current regulatory and professional requirements
(i)
Auditing standards
Both national and international bodies produce Auditing Standards.
International Standards on Auditing (ISAs) are produced by the
International Audit and Assurance Standards Board (IAASB), a committee
of the International Federation of Accountants (IFAC). IFAC is an
international organisation of professional accountancy bodies, including
ICAP.
National standard-setters are expected to aim for compatibility with ISAs as
far as possible and some (for example the UK) issue their own version of
ISAs. National accountancy bodies will then adopt all of the auditing
standards produced by their own standard setting body. Failure by auditors
to comply with auditing standards will then lend them open to disciplinary
action by their own accountancy body.
Local legislation will usually require recognised supervisory bodies to have
rules and practices as to the manner in which these standards are to be
applied in practice. Each supervisory body will adopt auditing standards in
order to meet local legislation and each body will be required to have
arrangements in place for the effective monitoring and enforcement of
compliance with those standards. Failure to apply relevant auditing
standards is a factor which a supervisory body will take into account when
deciding whether persons are fit and proper to be eligible for appointment
as company auditor.
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(ii)
Fraud
Currently the responsibility within a company for the prevention and
detection of fraud rests with management. The auditor is not responsible for
preventing fraud but audit procedures should be designed to give the
auditor a reasonable expectation of detecting any material misstatements,
whether intentional or unintentional, in a company’s financial statements.
(iii)
Non-audit services
There is no objection in principle to a practice providing non-audit services
but care must be taken not to perform management functions or make
management decisions. The key factor is that there is no conflict of interest
between audit and the other services provided.
Accountancy work, however, should not be performed for a public company
except in emergency situations. The scale and nature of such work should
be regularly reviewed.
In all cases in which a practice is concerned in the preparation of
accounting records for an audit client, the following safeguards should be
observed:
‰
the client should accept responsibility for the records as its own;
‰
the practice should not assume the role of management conducting
the operations of an enterprise;
‰
the practice should make appropriate audit tests even where it has
processed or maintained certain records.
Other types of non-audit work such as valuation services and internal audit
services are prohibited where the management threat or self-review threats
are too great.
Local legisalation will also usually provide that an auditor may not be an
officer or employee of a client company. Thus it is necessary for the auditor
to ensure that he does not make executive decisions.
(iv)
Duration of appointment
Local legislation usually provides that a company shall at each general
meeting appoint an auditor to hold office from the conclusion of that
meeting until the conclusion of the next general meeting at which accounts
are laid. Although the ICAP Code does not specifically deal with the length
of audit appointments it recognises that using the same senior personal on
an engagement over a long period of time may create a familiarity threat.
Safeguards might include rotating senior staff or review by an independent
party.
(b)
Reasons for criticism in the above areas
(i)
Auditing standards
ISAs are set by the IAASB whose members are mainly drawn from the
members of the auditing profession. The local disciplinary procedures
applied against an auditor for non-compliance with an auditing standard are
enforced by the professional bodies of accountants. Thus politicians have
criticised this self-regulatory procedure believing it to be open to abuse and
lacking independence. The argument put forward is that auditing standards
should be set by an independent body.
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(ii)
Fraud
It is quite apparent from the press and audit research that the public believe
that the auditor should and in fact does search for fraud during the conduct
of an audit. In view of the scandals over the years, the public expectation of
the extent of an audit has increased. The public finds it difficult to accept
that an auditor has no responsibility for the detection and reporting of fraud,
especially when one sees the high social cost of recent scandals.
(iii)
Non-audit services
Audit firms do not act exclusively in the capacity of auditors for their clients.
Audit work is in some cases, not the main business of audit firms. Auditors
provide many other services to their clients including tax advice, brand
name valuation and recruitment advice. Audit firms are dependent upon the
fees earned from non-audit services, and this dependency can affect the
auditors’ attitude to the audit. If an audit firm loses the audit, the financial
loss to the auditors can be significantly more than just the audit fee if he
provides other services to the client.
(iv)
Duration of appointment
It has been argued that the long-term nature of the company audit
engagement can lead to a loss in auditor independence due to an
increasing familiarity with the company’s management. In many countries
the audit appointment has to be terminated after a fixed number of years. If
the audit appointment was for a fixed maximum period, then auditors would
not be under the same pressure to maintain their client base if they know
that their relationship with the company was for a limited period, and that
audit appointments would be rotated.
10
Fundamental principles
Fundamental principles
Integrity. A professional accountant should be honest and straightforward in performing
professional services.
Objectivity. A professional accountant should be fair and not allow personal bias,
conflict of interest or influence of others to override objectivity.
Professional competence and due care. When performing professional services, a
professional accountant should show competence and duty of care by keeping up-todate with developments in practice, legislation and techniques.
Confidentiality. A professional accountant should respect the confidentiality of
information acquired during the course of providing professional services and should
not use or disclose such information without obtaining client permission.
Professional behaviour. A professional accountant should act in a manner consistent
with the good reputation of the profession and refrain from any conduct which might
bring discredit to the profession.
11
Oops
Confidential information
General rules
Information obtained during an audit is normally held to be confidential; that is it will not
be disclosed to a third party.
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However, client information may be disclosed where:
„
consent has been obtained from the client
„
there is a public duty to disclose or
„
there is a legal or professional right or duty to disclose.
However, these rules are general principles only; more detailed guidance is also
available to accountants, as explained below.
ICAP’s Code of Ethics and Conduct – obligatory disclosure
As noted above, ICAP’s Code of Ethics and Conduct confirms that when a member
agrees to work for a client in a professional capacity, it is an implied term of that
agreement that the member will not disclose a client’s affairs to any other person.
The recognised exceptions to this rule are where a member knows or suspects that his
client has committed treason, or is involved in drug trafficking or terrorist offences. In
these situations, information must be disclosed to a competent authority. The actual
disclosure will depend on the laws of the jurisdiction where the auditor is located.
The auditor may also be obliged to provide information where a court demands
disclosure. Refusal to provide information is likely to be considered contempt of court
with the auditor being liable for this offence.
ICAP Code of Ethics and Conduct – voluntary disclosure
A member may also disclose client confidential information voluntarily, that is without
client permission, in a limited number of situations.
12
„
To protect a member’s interests e.g. to allow a member to sue a client for unpaid
fees or defend an action for negligence.
„
Where there is a public duty to disclose e.g. the client has committed an action
against the public interest such as unauthorised release of toxic chemicals.
Independence of external auditors
External auditor independence
13
(i)
External auditors are unable to fulfil their duties to shareholders if they are not
independent of the entity on which they are reporting.
(ii)
If external auditors have an interest in the financial statements on which they are
reporting, they may not be objective. For example, if, in the case of a listed
company, they have prepared the financial statements on which they are
reporting, their view may not be considered objective.
(iii)
If they have financial or employment connections with the company on which
they are reporting they will not be objective.
(iv)
If they provide a significant level of additional services to the entity, some argue
that they cannot report objectively as auditors to shareholders.
Tahira and Parvez
Sufficient audit evidence and audit reports
(i)
The main problem for the auditors will be gaining sufficient evidence to
determine whether any amounts should be provided for and/or disclosed in
the financial statements of the two companies.
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14
(ii)
The lawyers refuse to provide anything other than informal evidence and
this will almost certainly not be sufficient to form an audit opinion.
(iii)
Unless audit evidence can be obtained elsewhere – a qualified opinion may
be needed for both companies as the amounts involved are material.
(iv)
It may be possible for the auditors to suggest to the companies that it would
be very helpful for the lawyers to provide some indication as to their view of
the likely outcome and the amounts involved, in order to avoid a modified
opinion.
(v)
The auditors should also take note of the progress of any legal proceedings
and any proceedings that may be instigated by the public health authorities
as such authorities might impose significant fines, and they might even
close the businesses down, which has implications for the going concern
status of both.
(vi)
The auditors may also seek written representation under ISA 580 from the
management about the likely outcome of the case to be obtained.
Saad Co
(a) Ethical threat
(b) Mitigation of threat
Mr Sher, the engagement partner has Mr Sher should be rotated from being
been involved with the client for the last engagement partner. He can still contact
nine years.
the client but should not be in the
This means he may be too familiar with position of signing the audit report.
the client to be able to make objective
decisions due to this long association.
There is no ethical rule which stops Mr
Sher recommending Zhura for the audit,
or letting Zhura take part in the audit,
providing Zhura has the appropriate
skills. If she does not have the
appropriate skills then there could be a
breach of the need for an audit team to
demonstrate professional competence
and due care.
To show complete independence, Zhura
should not be part of the audit team.
However, if Mr Sher is no longer the
engagement partner then this removes
the ethical threat and Zhura could be
included in the audit team so long as she
possesses the appropriate skills.
There may also be the impression of lack
of independence as Zhura is related to
the engagement partner. Zhura could be
tempted not to identify errors in case this
prejudiced her father’s relationship with
the client.
As long as Mr Faisal paid a full fee on
normal commercial terms to Saad Co for
the investment advice, then there is no
ethical threat. This would be a normal
commercial transaction and Mr Faisal
would not gain any benefit.
To show independence from the client,
Mr Faisal could be asked not to use the
services of Saad Co again unless this is
first agreed with the engagement
partner.
However, continued use of client
services could imply a lack of
independence especially if Mr Faisal is
not paying a full fee and therefore
receiving a benefit from the client.
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15
Alpha
(i)
The firm is not qualified for appointment as auditor of Safe Bank because it is
indebted to the bank.
The firm may accept appointment by terminating the lease agreement and
reducing the credit card balance to Rs 500,000.
(ii)
The firm is not qualified for appointment as auditor of PCL as one of the firm’s
partners had been a director of PCL during the past three years.
There is no way for the firm to accept the appointment except that the partner
resigns from the firm.
(iii)
The firm is not qualified for appointment as auditor of Gama Limited, as a
partner of the firm holds shares in Beta Limited, the associated company of GL.
Firm can accept appointment if the partner disposes off the shares of Beta
Limited within ninety days of appointment.
16
Engagement letter and documentation
(a)
The form and content of audit engagement letters may vary from client to client,
but they would generally include reference to:
‰
The objective of the audit of financial statements.
‰
Management’s responsibility for the financial statements.
‰
‰
The financial reporting framework applicable to financial statements.
The scope of the audit, including reference to applicable legislation,
regulations, or pronouncements of professional bodies to which the
auditor adheres.
‰
The form of any reports or other communication.
‰
The fact that because of the test nature and other inherent limitations of
an audit, together with the inherent limitation of internal control, there is
an unavoidable risk that even material misstatements may remain
undiscovered.
‰
(b)
Management’s responsibility to provide unrestricted access to whatever
records, documentation and other information that may be required in
connection with the audit.
‰
Management’s responsibility for establishing and maintaining effective
internal controls.
i) Significant Matters to be documented
‰
Matters that give rise to significant risk;
‰
Results of audit procedures indicating (a) that the financial
information could be materially misstated, or (b) a need to revise the
auditor’s previous assessment of the risks of material
misstatements and the auditor’s responses to those risks;
‰
Circumstance that cause the auditor significant difficulty in applying
necessary audit procedures;
‰
Findings that could result in a modification to the auditor’s report.
ii) Completion of assembly of final audit report
The auditor is required to complete the assembly of his final audit file within
60 days of the date of the audit report.
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17
Shahid Corporation
(a)
Acceptance and continuance of client relationships and specific audit
engagements include considering:
The integrity of the principal owners, key management and those charged
‰
with governance of the entity;
‰
Whether the engagement team is competent to perform the audit
engagement and has the necessary time and resources; and
‰
Whether the firm and the engagement team can comply with ethical
requirements
Deciding whether to continue a client relationship includes consideration of
significant matters that have arisen during the current or previous audit
engagement, and their implications for continuing the relationship.
(b)
18
For example, a client may have started to expand its business operation into an
area where the firm does not possess the necessary knowledge or expertise.
The auditor may decide not to send a new engagement letter for each period.
However, under the following situation it may be appropriate to send a new
engagement letter:
‰
Any indication that the client misunderstands the objective and scope of
the audit
‰
Any revised or special terms of the engagement
‰
A recent change of senior management or those charged with governance.
‰
A significant change in nature or size of the client’s business
‰
A significant change in ownership
‰
Legal or regulatory requirements.
Assertions
(a)
(i)
(ii)
‰
Risks of material misstatement at the financial statement level refer
to risks that relate pervasively to the financial statements as a whole
and potentially affect a number of assertions.
‰
They are not necessarily identifiable with specific assertions at the
class of transactions, account balance, or disclosure level. Rather,
they represent circumstances that may increase the risks of material
misstatement at the assertion level. For example, through
management override of internal control.
‰
Financial statement level risks mostly relate to situations arising
from fraud.
‰
Risks at the financial statement level may derive in particular from a
weak control environment. For example, weaknesses such as
management’s lack of competence.
The risk assessment procedures related to the risk of material
misstatement at the financial statement/assertion level are as follows:
‰
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Inquiries of management and of others within the entity who in the
auditor’s judgment may have information that is likely to assist in
identifying risks of material misstatement due to fraud or error.
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(b)
(c)
‰
Analytical procedures.
‰
Observation and inspection.
The auditors assessment of materiality and audit risk at the planning stage may
change later i.e. at the time of evaluating the results of audit procedures, on
account of the following:
‰
change in circumstances
‰
change in auditors knowledge as a result of performing audit procedures
‰
because the auditor may have intentionally set the materiality at a lower
level, to reduce the likelihood of undiscovered misstatement and hence
provide a margin of safety.
(i)
(ii)
(iii)
Assertions about account balances at the period end:
‰
Existence – assets, liabilities and equity interest exist.
‰
Rights and Obligations - The entity holds or controls the rights to
assets, and liabilities are the obligation of the entity.
‰
Completeness – all assets, liabilities and equity interest that should
have been recorded have been recorded.
‰
Valuation and allocation – assets, liabilities and equity interests are
included in the financial statements at appropriate amounts.
Assertions about classes of transactions:
‰
Occurrence – transactions and events that have been recorded
have occurred and pertain to the entity.
‰
Completeness – all transactions and events that should have been
recorded have been recorded.
‰
Accuracy – amounts and other data relating to recorded
transactions and events have been recorded appropriately.
‰
Cut-off – transactions and events have been recorded in the correct
accounting period.
‰
Classification – transactions and events have been recorded in the
proper accounts.
Assertions about presentation and disclosure:
‰
Occurrence and rights and obligations – disclosed events,
transactions and other matters have occurred and pertain to the
entity.
‰
Completeness – all disclosures that should have been included in
the financial statements have been included.
‰
Classification and understandability – financial information is
appropriately presented and described.
‰
Accuracy and valuation – financial and other information are
disclosed fairly and at appropriate amounts.
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19
20
Companies Ordinance 1984
(a)
The appointment of Farrukh & Co. will be in order because the firm would not
be considered indebted to the company as the period for which the utility dues
are unpaid does not exceed 90 days.
(b)
Mr Shahid cannot be appointed as statutory auditor of Rehman Limited
because of the following:
(i)
Mr Shahid is not eligible for appointment as statutory auditor since only
70 days have passed since the company’s incorporation and therefore
obviously less than three years have elapsed since he left the
employment of the company.
(ii)
Directors have lost their authority to appoint external auditors after the
expiry of 60 days from date of incorporation.
(c)
Syed & Co. shall not be appointed as auditor of the company because his
spouse holds shares in its associated company. However, the firm can be
appointed as auditor of Fazal Limited if the spouse of the partner disinvests the
shares within 90 days of appointment.
(d)
Mr Dawood’s appointment shall be void because only a chartered accountant
can be appointed as auditor of a private limited company having share capital
of Rs. 3 million or more.
(e)
Hussain Associates (Pvt.) Ltd. being a body corporate cannot be appointed as
external auditor of any company.
ASPL
(a) (i)
In the absence of any valid explanations from the management, it would be
considered as misappropriation of assets i.e. fraud as it seems to involve
the theft of an entity's assets.
(ii)
It is a case of fraudulent financial reporting as it seems that management
has tried to inflate the sales in order to deceive financial statement users.
An apparent intention behind this action is the management bonuses which
are linked to the operating performance of the company.
(iii)
It is an error on the part of accountant. The underlying records such as the
invoice etc. have not been altered and even the voucher has been prepared
with the correct amount which shows that it is an unintentional
misstatement.
(i)
If we have identified a fraud or has obtained information that indicate that a
fraud may exist, we should communicate these matters on a timely basis to
the appropriate level of management. This is so even if the matter might be
considered immaterial.
(b)
We should consider whether there are matters related to fraud to be
discussed with those charged with governance of the entity. Matters may
include:
‰
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Concerns about the nature, extent and frequency of management's
assessments of the controls in place to prevent and detect fraud and
of the risk that the financial statements may be misstated.
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‰
(iii)
21
A failure by management to appropriately address identified
significant deficiencies in internal control, or to appropriately respond
to an identified fraud.
‰
Our evaluation of ASPL’s control environment, including questions
regarding the competence and integrity of management.
‰
Actions by management that may be indicative of fraudulent financial
reporting, such as management's effort to manage earnings in order
to deceive financial statement users by influencing their perceptions
as to the entity's performance and profitability.
‰
Concerns about the adequacy and completeness of the authorization
of transactions that appear to be outside the normal course of
business.
Based on the discussion and our overall understanding of the matter, we
should:
‰
ask the management to reverse the sales made;
‰
revise its risk assessment of the entity’s control environment and
modify the further planned audit procedures accordingly.
‰
Consider the impact on audit report.
Since this seems to be an error, the appropriate level of management
should be informed about it and the relevant adjustments in fixed assets
and depreciation account should be made.
AMF
(a) Areas of Inherent Risk
(i)
Donations
‰ Donations may fall, especially where donors’ own income is limited or
declining, or there is a change in the circumstances.
‰ No control over the completeness of donations (especially over the cash
donations).
(ii) Expenses
‰ Donations are spent outside the aims and objectives of AMF.
‰ Donations are not spent in accordance with donors’ instructions.
(b) Effect on the audit approach
(i)
It is difficult to estimate that income in the future will be sufficient to meet the
expenditure of the AMF. Audit of the going concern concept (as in ensuring
that the AMF can still operate) will therefore be quite difficult.
(ii) Audit tests are unlikely to be effective to meet the assertion of completeness.
The audit report may need to be modified and qualified to explain the lack of
evidence stating that completeness of income cannot be confirmed.
(iii) Careful review of expenditure will be necessary to ensure that expenditure is
not ‘ultra vires’ the objectives of the AMF. The auditor will need to review the
trust deed and other documents of the AMF carefully in this respect.
(iv) The use of donations received for specific purposes would have to be
checked to ensure that instruction of donors has been followed.
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22
Acceptance and planning
(a) The audit strategy sets the scope, timing and direction of the audit. It also
provides guidance for the development of audit plan.
The audit plan is more detailed than the audit strategy and it includes the nature,
timing and extent of audit procedures to be performed by the engagement team
members. The planning for these audit procedures takes place over the course of
audit as the audit plan for the engagement develops.
(b) The auditor should perform the following activities prior to starting an initial audit
engagement:
(i)
Performing procedures regarding the acceptance of the client relationship
and the specific audit engagement.
(ii) Unless prohibited by law, arrangements to be made with the predecessor
auditor, for example, to review the predecessor auditor’s working papers.
(iii) Any major issues discussed with management in connection with the initial
selection as auditor, the communication of these matters to those charged
with governance, and how these matters affect the audit strategy and audit
plan.
(iv) The audit procedures necessary to obtain sufficient appropriate audit
evidence regarding opening balances.
(v) Other procedures required by the firm’s system of quality control for initial
audit engagements.
23
SPL
(a)
(b)
Preconditions for an audit are as follows:
(i)
An acceptable financial reporting framework has been used by the
management in the preparation of the financial statements; and
(ii)
the management and, where appropriate, those charged with governance
agreed on the premise on which the audit is to be conducted.
In order to establish whether the preconditions for an audit are present, we will:
(i)
determine whether the financial reporting framework to be applied in the
preparation of financial statements is acceptable;
(ii)
obtain the agreement of management that it acknowledges and
understands its responsibility:
‰
for the preparation of the financial statements in accordance with the
applicable financial reporting framework.
‰
for such internal control as management determines is necessary to
enable the preparation of financial statements that are free from
material misstatement, whether due to fraud or error.
‰
to provide us with
x
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access to all information of which management is aware, that
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may be relevant to the preparation of the financial statements;
(c)
x
additional information that the auditor may request from
management for the purpose of the audit; and
x
unrestricted access to persons within the entity from whom the
auditor determine it necessary to obtain audit evidence.
If a precondition for an audit is not present, the matter would be discussed with
the management. Unless required by law or regulation to do so, we will not
accept the proposed audit engagement, if the pre-conditions are not met.
However, if the financial reporting framework is prescribed by law or regulation
and it would have been unacceptable but for the fact that it is prescribed by law
or regulation, the audit engagement will be accepted only if the following
conditions are met:
(i)
Management agrees to provide additional disclosures in the financial
statements to avoid the financial statements being misleading;
(ii)
It is recognized in the terms of the audit engagement that:
‰
Our report on the financial statements will incorporate an Emphasis of
Matter paragraph, drawing users’ attention to the additional
disclosures.
‰
Our opinion on the financial statements will not include such phrases
as "present fairly, in all material respects," or "give a true and fair
view" unless it is expressively required to be stated under the law or
regulation.
If the above conditions are not present and still we are required by law or
regulation to undertake the audit engagement, we shall:
24
(i)
evaluate the effect of the misleading nature of the financial statements on
report; and
(ii)
include appropriate reference to this matter in the terms of the audit
engagement.
Fruit and nuts
(a)
(i)
The appointment of Guava and Company, Chartered Accountants, will be in
order.
(ii) The firm would not be deemed indebted to the company as the amount of
debt is not exceeding Rs. 500,000.
(b)
(i)
The Appointment of Apricot and Company, Chartered Accountants will be in
order.
(ii) Banana Limited and Water Melon Limited are not associated companies as
the common director is a Government nominee.
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(c)
(i)
Mr Zaheer can be appointed as the Auditor of Lychee (Private) Limited
(ii)
There is no specific qualification requirement for auditors of companies
having paid-up capital of less than Rs. 3 million.
(iii) The fact that 40% of the shareholding is owned by Blue Black Limited does
not disqualify Mr Zaheer as the auditor of LPL.
25
(d)
Before accepting the offer Walnut and Company, Chartered Accountants, apart
from obtaining professional clearance from the existing auditor is also required to
inform the ICAP (Institute) and obtain prior clearance from the Institute.
(e)
(i)
Since the three year period has not been lapsed,
(ii)
Our firm cannot be appointed as the auditor of Strawberry Limited,
(iii)
The fact that Mr Sadiq was serving on the board as a Government
nominee does not make any difference, in this case.
Discussions and judgment
(a)
Benefits of discussion among the engagement team about the susceptibility of
the entity’s financial statements to material misstatement are as follows:
(i)
Provides an opportunity for more experienced engagement team members
to share their insights based on their knowledge of the entity.
(ii) Allows the engagement team members to exchange information about the
business risks to which the entity is subject to and about how and where the
financial statements might be susceptible to material misstatement, due to
fraud or error.
(iii) Assists the engagement team members to gain a better understanding of
the potential for material misstatement in the areas assigned to them.
(iv) Develop an understanding; about the results of the audit procedures that
they perform on specific areas may affect other aspects of the audit
including the decisions about the nature, timing and extent of further audit
procedures.
(v) Provides a basis upon which engagement team members communicate and
share new information obtained throughout the audit that may affect the
assessment of risks of material misstatement or the audit procedures
performed to address these risks.
(b)
(i)
Non routine transactions:
Non-routine transactions are transactions that are unusual, due to either
size or nature, and that therefore occur infrequently.
Judgmental matters:
Judgmental matters may include the development of accounting estimates
for which there is significant measurement uncertainty.
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(ii) Reasons on account of which risk of material misstatement is
increased on account of Non routine transactions:
(1)
Greater management intervention to specify the accounting treatment.
(2)
Greater manual intervention for data collection and processing.
(3)
Complex calculations or accounting principles.
(4)
The nature of non-routine transactions, which may make it difficult for
the entity to implement effective controls over the risks.
Reasons on account of which risk of material misstatement is
increased on account of Judgmental matters:
26
(1)
Accounting principles for accounting estimates or revenue recognition
may be subject to differing interpretation.
(2)
Required judgment may be subjective or complex, or require
assumptions about the effects of future events, for example, judgment
about fair value.
Dynamic
The prospective audit risks are as follows:
Overstatement of Debtors:
Average period for outstanding debtors has reached to four months which is
indicative of a risk of inadequate provision against doubtful debts.
Overstatement/ Understatement of Inventories:
The inventories turnover rate has decreased to 3 times per year from 5 times in 20X1.
It is indicative of the following types of risks:
(a)
Obsolescence of inventories.
(b)
Improper valuation of inventories.
Overstating of income as well as understating of expenses:
The income position has weakened and the company has suffered losses as the
interest coverage has moved below 1.0. In such a situation there is a risk that the
management may like to overstate its revenue, and understate its expenses.
Liquidity Problems:
The company is experiencing liquidity problems as are evidenced from the decline in
current ratio and quick asset ratio.
Decline in Gross Profit %:
The decline in GP % needs to be justified. The absence of an appropriate explanation
may be indicative of:
(a) Improper pricing and discounting policies
(b) Improper purchasing policies
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(c) Other irregularities like unauthorized spending, intentional manipulation of
profitability etc.
Going Concern:
Losses/significant decline in profitability and fast deteriorating liquidity position are
financial indicators of going concern issues, which should not be overlooked.
27
Changing terms
(a)
(b)
(c)
Circumstances in which the management can request the auditor to
change the terms of audit engagement:
(i)
Change in circumstances affecting the need for the service.
(ii)
A misunderstanding as to the nature of an audit as originally requested.
(iii)
A restriction on the scope of an audit engagement, whether caused by
management or caused by other circumstances.
Factors that are to be considered by the auditor before accepting the
change in terms of engagement:
(i)
Justification provided for changing the terms of engagement.
(ii)
The information in respect of which the change is requested by the
management.
(iii)
Legal or contractual implications of the change.
Steps that the auditor can take, if he is unable to agree to a change in
terms of engagement:
If the auditor is unable to agree to a change in the terms of the audit
engagement and is not permitted by management to continue the original
engagement, the auditor shall:
28
(i)
Withdraw from the audit engagement where possible under applicable law
or regulation; and
(ii)
Determine whether there is any obligation, either contractual or otherwise,
to report the circumstances to other parties, such as those charged with
governance, owners or regulators.
EL
Key Components of Audit engagement letter:
‰
The objective and scope of the audit of financial statements;
‰
The responsibilities of the auditor;
‰
The responsibilities of management;
‰
Identification of the applicable financial reporting framework for the preparation
of the financial statements;
‰
Reference to the expected form and content of any reports to be issued by the
auditor and;
‰
A statement that there may be circumstances in which a report may differ from
its expected form and content.
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29
Calm Co
Risk assessment procedures
(i)
Purpose
The main purpose of risk assessment procedures is to help the auditor
obtain an understanding of the audit client.
The procedures will provide audit evidence relating to the auditor’s risk
assessment of a material misstatement in the client’s financial statements.
The auditor will also obtain initial evidence regarding the classes of
transactions at the client and the operating effectiveness of the client’s
internal controls.
Finally, the auditor may identify risks in other areas such as being
associated with a particular client or not being able to follow ethical
guidelines of ICAP.
(ii)
Sources of audit evidence
The auditor may obtain evidence from:
30
‰
Enquiries of management and others connected with the entity such
as external legal counsel or valuation experts
‰
Analytical procedures including ratio analysis to obtain high level data
on the client
‰
Observation of entity activities and inspection of documents, etc.
Azam
(a)
Risks and implications for audit risk
Inherent and control risks
(i)
Charities such as Azam can be viewed as inherently risky because they are
often managed by non-professionals and susceptible to fraud. In Azam’s
case inherent risk is likely to be high as there is no full-time accountant and
volunteers are used to raise funds.
(ii)
As Azam is staffed mainly by volunteers the inherent risk also increases
that transactions are not properly recorded. Volunteers are often more
enthusiastic as to what they typically perceive as the ‘value add’ and
‘making a difference’ activities and hence paperwork can be overlooked.
(iii)
Azam’s small size also reduces the opportunity for segregation of duties
and thus increases control risk and susceptibility to fraud.
(iv)
Azam may be at risk of being in violation of its constitutions which is
important where funds are raised from public or private donors who may
well object strongly if funds are not applied in the manner expected. The
question states that funds are required for educational projects so this
could be a problem if funds have been used for other purposes.
(v)
Azam is likely to have a high level of control risk because formal internal
controls are expensive and unlikely to be in place. This means that
donations are susceptible to misappropriation and Azam will have had to
rely heavily on the trustworthiness of volunteers.
(vi)
Inherent risk is also increased due to the fact that Azam has not been
audited previously which could lead to a greater risk of misstatement of
opening balances.
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Detection risk
(vii) Detection risk comprises sampling risk and non-sampling risk. It is possible
with Azam that all transactions will be tested and therefore sampling risk
(the risk that samples are unrepresentative of the populations from which
they are drawn) eliminated.
(viii) Non-sampling risk is the risk that auditors will draw incorrect conclusions
because, for example, mistakes are made, or errors of judgement are made
in interpreting results, or because the auditors are unfamiliar with the client.
As this is Azam’s first audit non-sampling risk is increased.
Audit risk
(ix)
(b)
Audit risk is the product of inherent risk, control risk and detection risk that
the auditors will issue an inappropriate audit opinion. This risk can be
managed by decreasing detection risk by altering the nature, timing and
extent of audit procedures applied. As inherent risk is high and controls
likely weak (as is likely to be the case with Azam) more audit work will be
performed in appropriate areas in order to reduce audit risk to an
acceptable level by reducing detection risk.
Audit tests – fund raising events
(i)
Attend fund raising events and observe the procedures employed in
collecting, counting, banking and recording the cash. This will help provide
audit evidence that funds have not been misappropriated and that all
income from such events has been recorded. Sealed boxes or tins that are
opened in the presence of two volunteers are often used for these
purposes.
(ii)
Perform cash counts at the events to provide evidence that cash has been
counted correctly and that there is no collusion between volunteers to
misappropriate funds.
(iii)
Examine bank paying in slips, bank statements and bank reconciliations
and ensure that these agree with records made at events. This also
provides evidence as to the completeness of income.
(iv)
Examine the records of expenditure for fund raising events (hire of
equipment, entertainers, purchase of refreshments etc.) and ensure that
these have been properly authorised (where appropriate) and that receipts
have been obtained for all expenditure. This provides evidence as to the
completeness and accuracy of expenditure.
(v)
Review the income and expenditure of fund raising events against any
budgets that have been prepared and investigate any significant
discrepancies.
(vi)
Ensure that all the necessary licenses (such as public entertainment
licences) have been obtained by the trustees for such events in order to
ensure that no action is likely to be taken against the charity or volunteers.
(vii) Obtain representations from the trustees to the effect that there are no
outstanding unrecorded liabilities for such events – again for completeness
of expenditure and liabilities.
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31
Hurricane
(a)
Importance of audit planning
According to ISA 300, the auditor should plan the audit work so that the
engagement will be performed in an effective manner. Specifically, planning is
required for the following reasons:
(b)
‰
To develop a general strategy and detailed approach for the specific
nature, timing and extent of the audit work. This will help to ensure that the
audit is carried out in an efficient and timely manner.
‰
So that attention is devoted to the important areas of the audit. Planning will
also help to identify problem areas so they can be addressed in a timely
fashion.
‰
To determine the amount of work to be carried out and therefore assist in
determining the number of staff required to perform the audit work.
‰
To provide a document as a reference for an initial discussion of the
approach to the audit with the company’s audit committee. The plan will
also help ensure that audit work is co-ordinated with client staff: e.g. for
production of specific documentation to assist the auditor.
‰
To act as a basis for the production of the audit program.
Audit strategy
Client:
Hurricane
Year ended: 31 December 20X4
Prepared by: A Manager
Characteristics of entity
Hurricane requires a normal statutory audit – there are no audit or filing
exemptions available.
The financial reporting framework is the International Accounting Standards and
there are no industry specific reporting requirements.
Hurricane buys and then resells all types of fixtures and fittings for ships from
yachts through to large cruise ships. The company has ten warehouses, seven of
which are located near to branches of our audit firm.
Key dates
Key dates in the audit timetable are:
‰
Interim audit
‰
Final audit
‰
Meeting with audit committee
‰
Financial statements approved by management
Specific dates are to be confirmed.
Overview of audit approach
The shipping supply industry has grown by 7% during the last year. Hurricane’s
sales increase is 12% indicating that the company continues to perform well
within the industry.
There have been no changes to the accounting policies of Hurricane during the
year.
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This is the first year that International Standards on Auditing (ISAs) are relevant
to this company. A detailed check will be required to ensure that no changes are
required to the audit plan.
The overall audit approach will be to use tests of control where possible.
However, the fall in gross profit indicates that sales may be understated or cost of
sales (COS) overstated, so additional substantive procedures may be required in
this area.
Materiality determination
Materiality will initially be set at ½ to 1% of revenue as this figure appears to be
more accurate than gross profit.
Materiality on the statement of financial position will be based on net asset
values.
Performance materiality will be set for specific areas.
Identification of risk areas with a higher risk of misstatement
A review of the draft financial statements for the company shows the following
risks:
‰
Sales have increased by 12% but COS by 19%. There is a risk of COS
being overstated.
‰
Inventory on the statement of financial position is down significantly on last
year indicating that there may be valuation or quantity errors.
‰
Trade receivables have increased by about 50%, significantly more than
the increase in sales. This indicates that the company may have debt
collection problems. Additional testing may be required on after date cash
collections to check for bad debts.
‰
Non-current assets have fallen by Rs. 900m, which is significant given that
most non-current assets are land and buildings. The reason for sale must
be ascertained.
‰
Non-current liabilities have also fallen by Rs1 billion. While not necessarily
linked to the fall in non-current assets, there is a possibility that non-current
assets have been sold to pay off the liabilities.
Audit approach – extent of controls testing
Audit testing will focus on the use of tests of controls where possible. However,
changes have been made to the inventory system during the year, limiting the
extent of testing of controls. Client systems have changed in the year with a new
computerised inventory control system. Unfortunately, the change was not
identified until audit planning started. Three actions are necessary in respect of
this system:
‰
Audit initial installation of the system including transfer of balances. One of
the reasons for the low inventory value could be omission of inventory
balances on transfer.
‰
Test count inventory at the year end and agree to the computerised
inventory records (and vice versa) to test their accuracy. Note that the client
will not be counting inventory at the year end but relying on the
computerised system.
‰
Test check bookings into and out of inventory from the purchases and sales
systems.
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Other risk areas
32
‰
The client appears to be a going concern, although the fall in gross profit
must be investigated. Cash and profit forecasts for the next 12 months
must also be obtained to confirm ongoing profitability and that the fall in
cash balances will not continue.
‰
There is the possibility of related party transactions. One of the directors
purchased a yacht during the year. Checks to be made to determine
whether company products were purchased, and if so whether these were
in the normal course of business.
‰
A new engagement letter is required in ISA format.
‰
Assistance may be required on the inventory count; three warehouses are
located away from our offices.
Zakir Co
(a)
(i)
Explanation of analytical procedures
Analytical procedures are used in obtaining an understanding of an entity
and its environment and in the overall review at the end of the audit.
‘Analytical procedures’ actually means the evaluation of financial and other
information, and the review of plausible relationships in that information.
The review also includes identifying fluctuations and relationships that do
not appear consistent with other relevant information or results.
(ii)
Types of analytical procedures
Analytical procedures can be used as:
(iii)
–
Comparison of comparable information to prior periods to identify
unusual changes or fluctuations in amounts.
–
Comparison of actual or anticipated results of the entity with budgets
and/or forecasts, or the expectations of the auditor in order to
determine the potential accuracy of those results.
–
Comparison to industry information either for the industry as a whole
or by comparison to entities of similar size to the client to determine
whether receivable days, for example, are reasonable.
Use of analytical procedures
Risk assessment procedures
Analytical procedures are used at the beginning of the audit to help the
auditor obtain an understanding of the entity and assess the risk of material
misstatement. Audit procedures can then be directed to these ‘risky’ areas.
Analytical procedures as substantive procedures
Analytical procedures can be used as substantive procedures in
determining the risk of material misstatement at the assertion level during
work on the income statement and statement of financial position (balance
sheet).
Analytical procedures in the overall review at the end of the audit
Analytical procedures help the auditor at the end of the audit in forming an
overall conclusion as to whether the financial statements as a whole are
consistent with the auditor’s understanding of the entity.
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(b)
Net profit
Overall, Zak’s result has changed from a net loss to a net profit. Given that sales
have only increased by 17% and that expenses, at least administration
expenses, appear low, then there is the possibility that expenditure may be
understated.
Sales – increase 17%
According to the directors, Zak has had a ‘difficult year’. Reasons for the increase
in sales income must be ascertained as the change does not conform to the
directors’ comments. It is possible that the industry as a whole, has been growing
allowing Zak to produce this good result.
Cost of sales – fall 17%
A fall in cost of sales is unusual given that sales have increased significantly.
This may have been caused by an incorrect inventory valuation and the use of
different (cheaper) suppliers which may cause problems with faulty goods in the
next year.
Gross profit (GP) – increase 88%
This is a significant increase with the GP% changing from 33% last year to 53%
in 20X3. Identifying reasons for this change will need to focus initially on the
change in sales and cost of sales.
Administration – fall 6%
A fall is unusual given that sales are increasing and so an increase in
administration to support those sales would be expected. Expenditure may be
understated, or there has been a decrease in the number of administration staff.
Selling and distribution – increase 42%
This increase does not appear to be in line with the increase in sales – selling
and distribution would be expected to increase in line with sales. There may be a
misallocation of expenses from administration or the age of Zak’s delivery vans is
increasing resulting in additional service costs.
Interest payable – small fall
Given that Zak has a considerable cash surplus this year, continuing to pay
interest is surprising. The amount may be overstated – reasons for lack of fall in
interest payment e.g. loans that cannot be repaid early, must be determined.
Investment income – new this year
This is expected given cash surplus on the year, although the amount is still very
high indicating possible errors in the amount or other income generating assets
not disclosed on the balance sheet extract.
(c)
Obtaining a bank letter
–
–
Review the need to obtain a bank letter from the information obtained from
the preliminary risk assessment of Zak.
Prepare a standard bank letter in the format agreed with banks in your
jurisdiction.
–
Obtain authorisation on that letter from a director of Zak for the bank to
disclose information to the auditor.
–
Where Zak has provided their bank with a standing authority to disclose
information to the auditors, refer to this authority in the bank letter.
–
The auditor sends the letter directly to Zak’s bank with a request to send
the reply directly back to the auditors.
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33
Hajira
(a)
Audit risk
Audit risk is the risk that an auditor gives an inappropriate opinion on the financial
statements being audited.
Inherent risk is the susceptibility of an assertion to a misstatement that could be
material individually or when aggregated with misstatements, assuming that there
are no related controls. The risk of such misstatement is greater for some
assertions and related classes of transactions, account balances, and
disclosures than for others.
Control risk is the risk that a material error could occur in an assertion that could
be material, individually or when aggregated with other misstatements, will not be
prevented or detected on a timely basis by the company’s internal control
systems.
Detection risk is the risk that the auditors’ procedures will not detect a
misstatement that exists in an assertion that could be material, individually or
when aggregated with other misstatements.
(b)
Inherent risks in charity
Area of inherent risk
Effect on audit approach
Income is from voluntary donations
only. There is a risk that donations will
fall, especially where donors’ own
income is limited by the ‘credit crunch’
etc.
It is difficult to estimate that income in
the future will be sufficient to meet the
expenditure of the charity.
Completeness of income – where
there are no controls to ensure income
is complete for example sales invoices
are not raised to obtain donations and
donations could be stolen by staff.
Audit tests are unlikely to be effective
to meet the assertion of completeness.
The audit report may need to be
modified and qualified to explain the
lack
of
evidence
stating
that
completeness of income cannot be
confirmed.
Funds can only be spent in
accordance with the aims of the
charity. There is a risk that funds are
spent outside the aims of the charity.
Careful review of expenditure will be
necessary to ensure that expenditure
is not ‘ultra vires’ the objectives of the
charity.
Audit of the going concern concept (as
in ensuring that the charity can still
operate) will therefore be quite difficult.
The auditor will need to review the
constitution of the Hajira charity
carefully in this respect.
Taxation rules relevant to charities.
There is a risk that the rules will be
broken due to lack of correct analysis
of income/expenditure.
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The auditor will need to ensure that
staff familiar with the taxation rules
affecting the charity are on the audit
team.
The Institute of Chartered Accountants of Pakistan
Answer bank: Objective test and long-form answers
(c)
Area of inherent risk
Effect on audit approach
Requirement to report expenditure in
accordance with the constitution –
administration expenditure can be no
more than 10% of total income. Risks
here include income being overstated
to allow expenditure to be overstated.
The trustees may attempt to hide
‘excessive’
expenditure
on
administration under other expense
headings.
Donations to charity for specific
activities for example provision of
sports equipment. There is a risk that
donations are not spent in accordance
with donors’ instructions.
Documentation for any donation will
need to be obtained and then
expenditure agreed to the terms of the
documentation. Any discrepancies will
have to be reported to management
As the auditor has to report on the
accuracy of income and expenditure
then audit procedures must focus on
the
accuracy
of
recording
of
expenditure.
Weak control environment
Lack of segregation of duties/responsibilities
There is normally a limited number of staff working in the charity meaning that a
full system of internal control including segregation of duties cannot be
implemented. Staff are likely to be unclear as to their exact responsibilities as
they are not formal ‘employees’ and are not part of the formal authority structure
in the charity.
Volunteer staff
Many staff are volunteers and so will only work at the charity on an occasional
basis. Controls will be performed by different staff on different days making the
system unreliable.
Lack of qualified staff (human resource issues)
Selection of staff is limited – people tend to volunteer for work when they have
time – and so they are unlikely to have professional qualifications or experience
to implement or maintain good control systems.
No internal audit department (lack of organisational structure)
Any control system will not be monitored effectively, mainly due to the lack of any
internal audit department. The charity will not have the funds or experience to
establish internal audit.
Attitude of the trustees
It is not clear how the charity’s trustees view risk. However, where trustees are
not professionally trained or have little time to devote to the charity, then there
may be an impression that controls are not important. The overall control
environment may therefore be weak as other charity workers do not see the
importance of maintaining good controls.
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34
Tahir Co
(a)
(b)
Valuation of aviation inventory
–
Review GAAP to ensure that there are no exceptions for aviation fuel or
inventory held for emergency purposes which would suggest a market
valuation should be used.
–
Calculate the difference in valuation. The error in inventory valuation is
Rs.1,050 * 6,000 barrels or Rs.6.3m, which is a material amount compared
to profit.
–
Review prior year working papers to determine whether a similar situation
occurred last year and ascertain the outcome at that stage.
–
Discuss the matter with the directors to obtain reasons why they believe
that market value should be used for the inventory this year.
–
Warn the directors that in your opinion, aviation fuel should be valued at the
lower of cost or net realisable value (that is Rs.150/barrel) and that using
market value will result in a modification to the audit report.
–
If the directors now amend the financial statements to show inventory
valued at cost, then consider mentioning the issue in the weakness letter
and do not modify the audit report in respect of this matter.
–
If the directors will not amend the financial statements, quantify the effect of
the disagreement in the valuation method – the sum of Rs.6.3m is material
to the financial statements as Tahir Co.’s income statement figure is
converted from a profit to a loss of Rs.1.3m although net assets decrease
by only about 0·3%.
–
Obtain a written representation letter from the directors of Tahir Co
confirming that market value is to be used for the emergency inventory of
aviation fuel.
–
If the directors will not amend the financial statements, draft the relevant
sections of the audit report, showing a qualification on the grounds of
disagreement with the accounting policy for valuation of inventory.
(i)
External auditor responsibilities regarding detection of fraud
Overall responsibility of auditor
The external auditor is primarily responsible for the audit opinion on the
financial statements following the international auditing standards (ISAs).
ISA 240 (Redrafted) The Auditor’s Responsibilities Relating to Fraud in an
Audit of Financial Statements is relevant to audit work regarding fraud.
The main focus of audit work is therefore to ensure that the financial
statements show a true and fair view. The detection of fraud is therefore not
the main focus of the external auditor’s work. An auditor is responsible for
obtaining reasonable assurance that the financial statements as a whole
are free from material misstatement, whether caused by fraud or error.
The auditor is responsible for maintaining an attitude of professional
scepticism throughout the audit, considering the potential for management
override of controls and recognising the fact that audit procedures that are
effective for detecting error may not be effective for detecting fraud.
Materiality
ISA 240 states that the auditor should reduce audit risk to an acceptably
low level.
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Therefore, in reaching the audit opinion and performing audit work, the
external auditor takes into account the concept of materiality. In other
words, the external auditor is not responsible for checking all the
transactions. Audit procedures are planned to have a reasonable likelihood
of identifying material fraud.
Discussion among the audit team
A discussion is required among the engagement team placing particular
emphasis on how and where the entity’s financial statements may be
susceptible to material misstatement due to fraud, including how fraud
might occur.
Identification of fraud
In situations where the external auditor does detect fraud, then the auditor
will need to consider the implications for the entire audit. In other words, the
external auditor has a responsibility to extend testing into other areas
because the risk of providing an incorrect audit opinion will have increased.
(ii)
Groups to report fraud to
Report to audit committee
Disclose the situation to the audit committee as they are charged with
maintaining a high standard of governance in the company.
The committee should be able to discuss the situation with the directors
and recommend that they take appropriate action e.g. amend the financial
statements.
Report to government
As Tahir Co is acting under a government contract, and the over-statement
of inventory will mean Tahir Co breaches that contract (the reported profit
becoming a loss), then the auditor may have to report the situation directly
to the government. The auditor of Tahir Co needs to review the contract to
confirm the reporting required under that contract.
Report to members
If the financial statements do not show a true and fair view then the auditor
needs to report this fact to the members of Tahir Co. The audit report will
be qualified with an except for or adverse opinion (depending on
materiality) and information concerning the reason for the disagreement
given. In this case the auditor is likely to state factually the problem of
inventory quantities being incorrect, rather than stating or implying that the
directors are involved in fraud.
Report to professional body
If the auditor is uncertain as to the correct course of action, advice may be
obtained from the auditor’s professional body. Depending on the advice
received, the auditor may simply report to the members in the audit report,
although resignation and the convening of a general meeting is another
reporting option.
(iii)
Intimidation threat – safeguards
In response to the implied threat of dismissal if the audit report is modified
regarding the potential fraud/error, the following safeguards are available to
the auditor.
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Discuss with audit committee
The situation can be discussed with the audit committee. As the audit
committee should comprise non-executive directors, they will be able to
discuss the situation with the finance director and point out clearly the
auditor’s opinion. They can also remind the directors as a whole that the
appointment of the auditor rests with the members on the recommendation
of the audit committee. If the recommendation of the audit committee is
rejected by the board, good corporate governance requires disclosure of
the reason for rejection.
Obtain second partner review
The engagement partner can ask a second partner to review the working
papers and other evidence relating to the issue of possible fraud. While this
action does not resolve the issue, it does provide additional assurance that
the findings and actions of the engagement partner are valid.
Resignation
If the matter is serious, then the auditor can consider resignation rather
than not being re-appointed. Resignation has the additional safeguard that
the auditor can normally require the directors to convene a general meeting
to consider the circumstances of the resignation.
35
Controls
(a)
(b)
On account of the following factors, the auditor may decide, not to rely on
audit evidence obtained in prior audits:
‰
A weak control environment.
‰
Weak monitoring of controls.
‰
A significant manual element to the relevant controls.
‰
Changes in the personnel that significantly affect the application of the
controls.
‰
Change in circumstances that indicate the need for changes in the
control.
The components of internal controls are as follows:
(i)
Control Environment:
The control environment includes the attitudes, awareness and actions
of management and those charged with governance concerning the
entity’s internal control and their importance in the entity.
(ii)
Entity’s Risk assessment process:
The entity’s risk assessment process includes how management
identifies risks relevant to the preparation of financial statements to
ensure that it gives a true and fair view in accordance with the entity’s
applicable financial reporting framework, estimates their significance,
assesses the likelihood of their occurrence, and decides upon action to
manage them.
(iii)
Information System, Including the related business processes,
relevant to financial reporting, and communication:
An information system consists of infrastructure (physical and hardware
components). Software, people, procedures, and data.
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(iv) Control activities:
These are the policies and procedures that help ensure that
management’s directives are carried out, for example, that necessary
actions are taken to address risks that threaten the achievement of the
entity’s objectives.
(v)
Monitoring of Controls:
Management’s monitoring of controls includes considering whether they
are operating as intended and that they are modified as and when
appropriate.
36
Shahzad
(a) The components of internal controls are as follows:
(i)
Control environment:
The control environment includes the attitudes, awareness and actions of
management and those charged with governance concerning the entity’s
internal control and their importance in the entity.
(ii)
Entity’s risk assessment process:
It is the entity’s process for identifying business risks relevant to financial
reporting objectives and deciding about actions to address those risks, and
the results thereof.
(iii) Information system, including the related business processes, relevant to
financial reporting, and communication.
(iv) Control activities:
These are the policies and procedures that help ensure that management’s
directives are carried out.
(v)
Monitoring of controls:
It is a process of assessing the design and operation of controls on a timely
basis and taking necessary corrective actions on account of change in
conditions.
(b) Following weaknesses in inventory count are identified from audit senior’s
observations:
(i)
Lack of segregation of duties
The Inventory Controller is responsible for the physical control of the
inventory and is also supervising the stock count.
(ii)
Non availability of detailed plan
Allocation of counting area by the teams themselves indicates non
availability of detailed plan which may lead to certain inventory items being
counted more than once while some items may not be counted at all.
(iii)
No system of marking on counted items
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This again may lead to double counting or omission completely.
(iv)
Perpetual inventory records available on count sheets
The person responsible for counting may try to match the numbers provided
instead of carrying out an independent count.
(v)
Additional count sheets are not pre-numbered
If the separate sheets are numbered as they are used, there is no means of
identifying that all sheets issued have been returned and the last count
sheet(s) may go unnoticed.
37
Waheed Engineering
(a)
(b)
(c)
Control
Purpose
Payroll data is approved by a senior
official.
To prevent any unauthorised
inaccurate deductions being made.
Payroll transactions should be
recalculated.
The correct amount is paid over to
employees or the relevant authorities.
Official notification of starters and
leavers i.e. tax documentation.
To prevent employees being paid after
they have left or before they have
started.
All hours worked are authorised.
To prevent the company paying for
work not done.
All employees to collect their wages in
person.
To prevent loss/theft.
Verifying that employees are not paid prior to commencing work
(i)
Two payrolls should be selected from different periods in the year.
(ii)
Employees not listed on the second payroll should have left during the year
and employees not listed on the first payroll should have started during the
period.
(iii)
This can then be verified by examining the permanent payroll information
where there should be a copy of each employee’s contract of employment.
(iv)
Also tax authority official forms should confirm departure and start dates.
The main reason for carrying out this exercise is to ensure that all
employees are bona fide i.e. payments are being made to authorised
employees.
Attendance at the wages pay-out
(i)
Before attendance I will review the payroll to ensure that a pay packet
exists for all employees.
(ii)
Each employee should sign for the pay package when they collect it. As
they sign, the auditor should verify the signature to the contract of
employment.
(iii)
It should be ensured that no one employee collects more than one pay
packet.
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(d)
(e)
38
(iv)
All unclaimed wages should be listed; the payroll date, name and amount
noted.
(v)
The unclaimed wages should then be stored in the safe until collected.
Procedures re unclaimed wages
(i)
All unclaimed wages should be recorded in an unclaimed wages book and
it should be checked that a wage packet physically exists for each entry in
the book.
(ii)
If someone has collected wages on behalf of somebody else then it should
be ensured that a letter of authorisation exists allowing the pay packet to be
collected.
(iii)
After a certain period, say a month, all unclaimed wages should be returned
to the bank so the details for each pay package should be agreed from the
unclaimed wages book to the banking slip.
(iv)
Any significant delay in banking unclaimed wages should be noted and
investigated.
Verification of direct bank payments
(i)
Carry out a physical verification of employees to ensure that they actually
exist.
(ii)
Check employee details to the personal records from payroll information.
(iii)
The finance directors could be asked to sign a copy of the payroll to verify
that all the employees are bona fide.
(iv)
Employees’ existence can be verified by confirmation of signatures on
expense claims.
(v)
Also, annual tax authority returns can be reviewed.
Danish
(a)
Problems expected at Danish resulting from poor internal control
(i)
I would expect the company to experience some level of over-ordering,
leading to reduced profitability as a result of inventory going past its ‘best
before’ date.
(ii)
Inventory that is not well-controlled in a supermarket may result in a breach
of health and safety regulations which may result in fines or even closure of
the supermarkets.
(iii)
I would expect there to be stock-outs leading to the potential loss of
business to other supermarkets.
(iv)
I would expect there to be inefficiencies as a result of a lack of central
ordering system resulting from quality discounts not being obtained.
(v)
All of the problems noted above are likely to be exacerbated where local
managers or staff are either inexperienced or possibly dishonest – the
question states that poorer quality staff have been recruited recently.
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(vi)
Supermarket inventory is very easily pilfered either by staff or customers
even where it is well-controlled. The lack of regular inventory counts in
particular means that pilferage is very easy to hide.
(vii) I would expect there to be a lack of understanding in the business as a
whole as to the availability of new products, products with high margins or
other areas in which profitability might be improved.
(b)
Four recommendations to improve internal controls
(i)
Recommendation 1: that an integrated system be introduced across all
supermarkets that links sales, purchases and inventory records.
Advantages
This would provide the company with an overall view of what inventory is
held at any particular time, enable it to order centrally and reduce the scope
for pilferage. It would result in reduced stock-outs and reduced inventory
obsolescence.
Disadvantages
This would require considerable capital investment in hardware, software
and training. It would also take control away from local managers which
would almost certainly cause resentment.
(ii)
Recommendation 2: the imposition of regular or continuous inventory
counting procedures together with the prompt update of inventory records
for discrepancies found and investigation of the reason for the
discrepancies.
Advantages
This would further reduce the possibility of stock-outs and provide evidence
of over-ordering, which would enable purchasing patterns to be refined.
Disadvantages
There are costs in terms of staff time and, again, a certain level of
resentment among staff who may feel that they are being ‘spied on’, or that
they are no longer trusted. Training would also be required and additional
administrative work would need to be undertaken by local managers.
(iii)
Recommendation 3: that management accounts are produced on at least
a quarterly basis that figures relating to each supermarket are provided to
head office on a monthly basis, and that an analysis is undertaken by head
office on the performance of individual supermarkets and inventory lines.
Advantages
This would enable the company to determine which supermarkets are
performing better than others. It would also enable the company to identify
those inventory lines that well and those that are profitable.
Disadvantages
The production of more regular and detailed information will be timeconsuming. Local managers may feel that they are unable to service the
particular needs of their customers if decisions are made on a global basis;
customers may feel the same way.
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(iv)
Recommendation 4: that sales price decisions are made by head office.
Advantages
This would enable the company to experiment with the use of ‘loss leaders’,
for example, and to impose a degree of consistency across supermarkets
to prevent inappropriate pricing decisions being taken by local managers.
Disadvantages
Again, loss of control at a local level is likely to result in resentment and the
possible loss of good staff. What sells well in one supermarket may not do
so in another. To the extent that head office have less experience of local
conditions than local staff, it is possible that inappropriate pricing decisions
may be made by head office.
39
Roses Anytime
(a)
Key procedures
(i)
Documentation of accounting and internal control systems
Auditors document accounting and internal control systems in order to
evaluate them for their adequacy as a basis for the preparation of the
financial statements and to make a preliminary risk assessment of internal
controls.
In very simple systems with few internal controls where auditors do not
intend to perform tests of internal controls, it is not necessary to document
the internal control system in detail. It is always necessary, however, to
have sufficient knowledge of the business to perform an effective audit.
For large entities, where the client has already documented the system, it is
not necessary for the auditors to repeat the process if they can satisfy
themselves that the client’s documentation is adequate.
(ii)
Walk-through tests
The purpose of walk-through tests is for the auditors to establish that their
recording of the accounting and internal control system is adequate.
Auditors trace a number of transactions from source to destination in the
system, and vice versa. For example, customer orders can be traced from
the initial documentation recording the order, through to the related entries
in the daybooks and ledgers.
It is common for walk-through tests to be performed at the same time as
tests of controls, where auditors are reasonably confident that systems are
recorded adequately.
(iii)
Audit sampling
Auditors perform tests of controls and tests of detail on a sample basis in
order to form conclusions on the populations from which the samples are
drawn.
It is not possible in anything but the very smallest of entities to take any
other approach, as testing 100% of a population may be impractical, not
cost effective and not accurate because populations are too large and
because of human error.
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Samples can be selected in a number of ways – either statistically or on the
basis of auditor judgement. In all cases, the sample selected must be
representative of the population as a whole.
(iv)
Testing internal controls
Auditors test internal controls in order to establish whether they are
operating effectively throughout the period under review. If controls are
operating effectively, auditors can reduce the level of substantive testing on
transactions and balances that would otherwise be required.
In testing internal controls, auditors are checking to ensure that the stated
control has been applied. For example, auditors may check that there is a
grid stamp on a sales invoice with various signatures inside it that show
that the invoice has been approved by the credit controller, that it has been
checked for arithmetical accuracy, that the price has been checked, and
that it has been posted to the sales ledger. The signatures provide audit
evidence that the control has been applied.
Auditors are not checking to ensure that the invoice is, in fact, correct. This
would be a substantive test. Nevertheless, it is possible to perform tests of
control and substantive tests on the same document at the same time.
(v)
Dealing with deviations from the application of control procedures
Where it appears that an internal control procedure has not been applied, it
is necessary to form an opinion as to whether the deviation from the
application of the procedure is an isolated incident, or whether the deviation
represents a systematic breakdown in the application of the control
procedure. This is usually achieved by selecting a further sample for
testing.
If it cannot be shown that the non-application of the procedure is isolated
(i.e. there are no further instances in which the control has failed), it is
necessary either to find a compensating control that can be tested, or to
abandon testing of controls and to take a wholly substantive approach.
Where there is a breakdown in internal controls it is also necessary to
reassess the auditor’s preliminary risk assessment. Abandoning tests of
control may place strains on the budget for the audit and auditors should
always consider the possibility of compensating controls before abandoning
tests of controls.
(b)
Internal controls
(i)
Receipt, processing and recording of orders
‰
All orders taken should be recorded on a pre-numbered multi-part
document generated by the computer. One part might be a copy for
the customer, one might form the invoice, one might be for the
despatch department and one might be retained for accounts
receivable ledger purposes. Manual or computer systems should
perform checks on the completeness of the sequence of prenumbered documents at various stages. Any documents
unaccounted for should be traced and investigated.
‰
The computer system should apply the credit limits set by the credit
controller and the system should reject any orders that exceed
customer credit limits at the point at which the order is taken, so that
the customer can be advised. Any override of credit limits should be
authorised by the credit controller.
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(ii)
40
‰
From time to time, there should be a check to ensure that the credit
limits within the system are being properly calculated and properly
applied to individual transactions. Similar considerations apply to
prices maintained within the system.
‰
The computer system should also reject any order for which there are
no Roses available so that orders cannot be taken for Roses that
cannot be delivered.
‰
All invoices should be posted to the sales daybook, the accounts
receivable ledger and the accounts receivable control account
automatically by the system and the accounts receivable ledger and
that accounts receivable control account should be reconciled each
month in order for sales and receivables records to be kept up to
date.
‰
There should be controls in place to deal with credit notes and other
discrepancies involving the price, type or quality of Roses delivered in
order to maintain the accuracy of records and customer goodwill.
Collection of cash
‰
At the end of each period, the system should produce a list of
overdue receivables. There should be procedures for chasing these
customers and for putting a ‘stop’ on accounts where amounts are
significant in order to control bad debts.
‰
When bank transfers are received from customers, they should be
input into the system and matched with individual transactions and
controls should ensure that the correct amounts are allocated to the
correct customers and transactions.
‰
An exception report should be produced for any unallocated bank
transfers. Exceptions should be promptly investigated. This will
ensure that receivables information is accurate and up to date and
that customers are not chased for amounts that have been paid.
‰
A bank reconciliation should be performed on a monthly basis in
order to ensure that the company’s cash records are complete,
accurate and up to date.
Trade Receivables
(a)
Types of error, omission and misappropriation receivables
(i)
Where internal controls are weak, the errors that occur may include the
issue of invoices and credit notes for the wrong amounts, the issue of
invoices and credit notes to the wrong customers, the incorrect recording of
invoices, credit notes, cash and contras in the ledgers and daybooks, and
the incorrect setting of credit limits.
(ii)
Where internal controls are weak, invoices, credit notes cash and contras
may simple go unrecorded.
(iii)
The effect of this will be that receivables may be under or over-stated in the
records and that the company will not receive that money that is due to it,
or that goodwill with customers is damaged.
(iv)
The assets that may be misappropriated include cash and inventory. If
records are poor, it will be easy to hide the misappropriation of cash that is
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received from customers. It will also be possible for inventory to be
misappropriated and hidden by the issue of false or incorrect invoices,
credit notes or contras.
(b)
(c)
Inherent weaknesses in any internal control system
(i)
No internal control system is perfect and all internal control systems are
subject to inherent weaknesses. This means that auditors can never rely
on the proper operation of the internal control systems alone. Even if their
tests show that the system appears to be working perfectly, it will be
necessary to perform some substantive testing.
(ii)
Inherent weaknesses include human error.
systems and people make mistakes.
(iii)
Other inherent weaknesses include the abuse of authority. For example,
false invoices may be issued towards the year-end to improve the sales
figure and false credit notes to cancel them out may be issued just after the
year-end. This is sometimes known as ‘window dressing’.
(iv)
Fraudulent collusion can happen both within the company and outside the
company. Those who have the right to authorise the issue of credit notes
may authorise false credit notes for customers who are their friends. Those
who have access to cash and the receivables records may collude to
misappropriate cash, and make entries in the accounting records to hide
the misappropriation. This is sometimes known as ‘teeming and lading’.
People operate the control
Main internal controls over receivables
(i)
Segregation of duties between those who control the accounting records,
those who receive the cash, those who authorise the issue of invoices and
credit notes and those who issue the goods to customers.
(ii)
Two people should be involved wherever cash or inventories are being
handled in order to prevent both the misappropriation of assets and to
prevent false accusations of misappropriation.
(iii)
The maintenance of a separate receivables ledger showing the individual
balances owing from customers. This ledger should be reconciled at least
monthly to the total figure in the nominal ledger.
(iv)
The issue of statements to customers at the end of each month (from the
ledger) showing how much is owed by the customer.
(v)
Arithmetical and accounting controls over the issue of invoices and credit
notes, some of which may be computerised, in order to ensure that they are
calculated correctly in accordance with authorised prices.
(vi)
The use of batch and hash totals, document counts and sequence checks
in the input of transactions into the computer system to ensure
completeness and accuracy.
(vii) The appointment of a credit controller who limits the credit available to
customers, together with restricted access to those sections of the system
that contain credit limits.
(viii) The use of exception reporting to highlight overdue accounts and accounts
where the credit limits have been exceeded, together with a system for
investigating and dealing with such accounts.
(ix)
The regular review by the financial controller of amounts receivable and the
independent authorisation of the write-off of bad debts.
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(d)
41
Reliance on proper operation of internal controls
(i)
Auditors seek to rely on the proper operation of internal controls wherever
possible because where internal controls are operating properly, reliance
on internal controls is the most efficient method of auditing.
(ii)
If the auditor’s tests showing that internal controls are operating properly,
the volume of substantive testing on transactions and balances can be
reduced.
(iii)
It is always possible (in theory) to perform an audit on the basis of
substantive testing alone, but given the volume of transactions in all but the
smallest of businesses, such an approach would be prohibitively expensive
for the audited entity.
Granger
(a)
(i)
Inadequate segregation of duties and proposed reassignment
A basic principle of segregation of duties is that an individual employee
should not be able to make errors and be in a position to conceal the fact.
Proper segregation means that, if an error or misstatement is made, it will
be detected by another employee in the ordinary course of his or her
duties. A general rule of segregation is that the funtions of processing
transactions, recording transactions and maintaining records over the
subsequent assets or liabilities, should be performed by different
individuals.
The receptionist’s duties should be restricted to processing cash receipts
transactions. All other functions should be assigned to other staff
members.
Function to be
reassigned
Possible
misstatement
Reassignment
Checking the
numerical continuity of
invoices, determining
the total cash sales
and entering the cash
receipts journal.
The receptionist could
deliberately understate
the total in order to
misappropriate the
cash or conceal a
shortage of cash.
This should be
assigned to Clerk 1.
(See additional
procoedure 1.)
Posting the accounts
receivable ledger.
An invoice could be
deliberately omitted
and the subsequent
cash receipt
misapprpriated if done
by the same person.
Clerk 1 should post the
accounts receivable
ledger from credit
sales invoices whose
numerical sequence is
checked.
Errors, such as
transaction errors,
made in entering the
sales journal are likely
to be repeated in
entering the accounts
receivable ledger.
Cash receipts could be
temporarily
misappropriated and
the shortgage
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Function to be
reassigned
Possible
misstatement
concealed by delaying
recording the receipt.
(See the answer to
part (b)).
Reassignment
Sending out monthly
statements and
chasing overdue
accounts.
If there are errors in
the accounts
receivable ledger the
monthly statements
could be altered or
suppressed.
This function should be
assigned to Clerk 2
since Clerk 1 could
also falsify statements
to conceal errors in
recording sales in the
accounts receivable
ledger. (See additional
procedure 2.)
If payments by
customers have been
misappropriated and
not credited to the
customer account,
customers’ suspicions
would not be aroused
by chasing apparent
overdue balances.
Reconciling accounts
receivable with the
control account in the
general ledger.
This procedure detects
errors, deliberate or
accidental, in the
maintenance of
accounts receivable
records. If the
receiptionist has made
errors in processing
sales and cash
receipts transactions to
accounts receivable
then he would have an
incentive to conceal
their discovery by
falsifying the
reconciliation.
Clerk 2 should perform
the reconciliation as
having no
responsibility for
recording either cash
or sales transactions
or maintaining the
accounts receivable
ledger. (See additional
procedure 3.)
Writing off uncollectible
balances.
If errors have been
made resulting in an
understatement of
cash received from
credit customers, their
accounts will appear to
be overdue. The error
can be concealed by
writing off the balance.
Such an error could
arise from the
deliberate
misappropriation of
cash received from
credit customers.
Clerk 2 should advise
the manager of
overdue balances that
may need to be written
off. (see additional
procedure 4.)
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(ii)
(b)
(i)
Other control procedures needed
1.
A bank reconciliation should be performed at least monthly by Clerk 1
to ensure that cash deposited is in agreement with amounts recorded
in the cash receipts book. the bank reconciliation should be
scrutinised and signed by the manager.
2.
The garage manager should review the list of customer account
balances (which should, if practicable, be aged), enquire into steps
being taken to collect overdue balances and consider whether further
credit may be allowed.
3.
The reconciliation of accounts receivable balances with the control
account in the general ledger should be scrutinised by the garage
manager to ensure that it appears to be properly drawn up.
4.
Final decisions on bad debt write offs must be approved in writing by
the garage manger.
5.
The opening of mail should be done in the presence of a second clerk
who should confirm the total amount of cash receipts enclosed
therein to minimise the likelihood of such receipts being
misappropriated.
Procedures to be followed in making cash count
‰
‰
‰
Control all cash funds until completion of the count to prevent cash
from a counted fund being transferred to an uncounted fund to
conceal a deficiency.
Count funds in the presence of the custodian to prevent any
suggestion, in the event of a shortage, that the funds were complete
when released to the auditors.
List each item in the fund, such as the denominations of notes, details
of cheques and, for petty cash funds, of vouchers so that the count
can subsequently be agreed with the deposit slip and other
accounting records.
‰
(ii)
Have the custodian sign the record of the count as being in
agreement in the event of any subsequent disagreement.
Discrepancy
If the details of the items counted differ from the cash receipts book I would
suspect a misappropriation of cash by failing to record a receipt from a
receivable. To conceal this from the receivable, cash received several
days later from another customer is credited to the first customer’s account.
The first customer will not notice anything wrong, the delay in the receipt
being attributed to postal delays or just delays in processing cash receipts.
Failure to credit payment by the second customer will be concealed by
using a payment received from a third customer and so on. Providing the
amounts involved are reasonable, the perpetrator can usually conceal the
fraud indefinitely. Such a fraud is only possible if the person responsible for
maintaining the accounts receivable ledger also has access to cash
received from customers before any control is established over that cash.
This fraud is sometimes called ‘teeming and lading’ or ‘lapping’.
It will be necessary to undertake a further investigation by comparing
deposit slips receipted by the bank with details recorded in the cash
receipts book and postings to the accounts receivable ledger for a series of
consecutive days. If a pattern of differences emerges consistent with the
pattern associated with this type of fraud, then the existence of the fraud
must be suspected.
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42
Nobel
The audit evidences which may be gathered in the cases referred to in the question
are as follows:
(i)
(ii)
43
x
Legal Opinion.
x
The terms and conditions of the contract related to defective material and
liability thereof.
x
Quality Control procedures prevalent in the company.
x
Documentation of response of other customers, to whom similar items
have been supplied.
x
Opinion of independent experts.
x
Documentation of the Evaluation of the basis of provision.
x
Industry standards.
x
Opinion of independent experts (regarding useful life, pattern of wear tear
etc.)
x
The environment (production load, maintenance policies etc.) under which
the company is operating and its comparison with other firms in the
industry.
x
The reasons for sale of equipment (normal case or otherwise)
Masoom Limited
Using the work of an expert
An auditor may need the opinion of an expert on matters which require professional
expertise, other than accounting and audit.
Example of such circumstances are:
‰
Valuation of assets such as plants, work of art etc.;
‰
Determination of quantities such as stockpile, underground mineral etc.;
‰
Determination of amount using specialized methods like actuarial valuation;
‰
Measurement of work completed;
‰
Legal opinions.
Auditor’s Responsibility while using the work of expert
‰
Evaluate the professional competence of the expert;
‰
Evaluate the objectivity of the expert;
‰
Obtain sufficient appropriate audit evidence that the scope of the expert’s work
is adequate;
‰
Evaluate the appropriateness of expert’s work regarding the assertion being
confirmed;
‰
Resolve the inconsistency, if any, between results of the expert and other audit
evidence.
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44
Sky blue
The investigation of unusual fluctuations and relationships ordinarily begins with
inquiries of management, followed by:
45
(a)
Corroboration of management’s responses, for example, by comparing them
with the auditor’s understanding of the entity and other audit evidence obtained
during the course of the audit; and
(b)
Consideration of the need to apply other audit procedures, if management is
unable to provide adequate explanation.
Direct confirmations 1
(a)
(b)
A positive external confirmation request asks the respondent to reply to the
auditor in all cases, whether he agrees with the information provided in the
confirmation request or not.
A negative external confirmation request asks the respondent to reply only in
the event of disagreement with the information provided in the request.
Associated risks and necessary steps to be taken by the auditor.
Positive External Confirmation
The risk associated with such type of confirmation is that the respondent may
reply to the confirmation request without verifying that the information is correct.
The auditor is not ordinarily able to detect whether this has occurred.
The auditor may reduce this risk, by using positive confirmation requests that
do not state the amount (or other information) on the confirmation request, but
asks the respondent to fill in the amount or furnish other information.
Negative External Confirmation
Risk associated is that when no response is received, there is no explicit audit
evidence that intended third parties have received the confirmation requests
and verified that the information contained therein is correct.
Accordingly, the use of negative confirmation requests ordinarily provides less
reliable audit evidence than the use of positive confirmation requests.
(c)
The auditor considers performing other substantive procedures to supplement
the use of negative confirmations.
Negative confirmation requests may be used under one or more of the
following circumstances:
(i)
The assessed risk of material misstatement is lower;
(ii)
A large number of small balances is involved;
(iii)
Substantial number of errors are not expected; and
(iv)
The auditor has no reason to believe that respondents will disregard
their requests.
A combination of positive and negative external confirmations may be
used, for example, where the accounts receivables comprise a small number of
large balances and a large number of small balances.
The auditor may then decide that it is appropriate to confirm all or a sample of
the large balances with positive confirmation requests and a sample of the
small balances using negative confirmation requests.
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46
Chill
When planning to use the report the auditor should evaluate the professional
competence of the expert.
This will involve considering the expert’s:
‰
Professional certification or licensing by, or membership in, an appropriate
professional body; and
‰
Experience and reputation in the field in which the auditor is seeking audit
evidence.
The auditor should also evaluate the objectivity of the expert. The risk that the
expert’s objectivity will be impaired increases when the expert is in some way
related to or dependent on the entity.
47
Sales sampling
(a)
(i)
Audit efficiency may be improved as the auditor has stratified a population
by dividing it into discrete sub-populations which have an identifying
characteristic. The stratification reduces the variability of items within each
stratum and therefore allows the sample size to be reduced without a
proportional increase in sampling risk
(ii)
Other ways by which sales population may be stratified are as under:
‰
By product
‰
By customers or category of customers
‰
Geographically
‰
Terms of sales such as credit, cash, advance etc.
Precaution: sub-categorization/sub-populations need to be carefully defined
such that any sampling unit can only belong to one stratum.
(iii) Views expressed by Sohail
His view that if verification of total transaction of category A is carried out
than there is no need to perform further procedures is not correct due to
the following reasons:
‰
The results of audit procedures applied to all the items within
category A can only provide evidence about the items that make up
that category (stratum).
‰
The auditor should obtain sufficient appropriate audit evidence
regarding items in Categories B & C as these are also material.
Views expressed by other audit team members
Their view that proper sampling should be carried out from the total
population of 640 million and categorization should be ignored altogether is
not correct because stratification helps in improving the efficiency of the
audit.
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(b)
Circumstances in which an auditor may decide to examine entire population of
items that make up an account balance.
The auditor may decide to examine the entire population in the following
circumstances:
48
‰
when the population constitutes a small number of large value items.
‰
when there is a significant risk and other means do not provide sufficient
appropriate audit evidence; or
‰
when the repetitive nature of a calculation or other process performed
automatically by an information system makes a 100% examination cost
effective.
PQR
(a)
For the purpose of determining the extent of reliance that may be placed on the
work of internal auditor in specified areas, it may be evaluated by:
(i)
Inspecting the adequacy of the scope of the work and related programs.
(ii)
Determining by means of inspection whether the preliminary assessment of
Internal audit function remains appropriate.
(iii) Obtain evidence that:
ƒ The work is performed by staff having adequate technical training and
proficiency as internal auditors and the work of assistants are properly
supervised, reviewed and documented.
ƒ Sufficient appropriate audit evidence was obtained to serve as a
reasonable basis for conclusions reached.
ƒ Conclusions reached are appropriate in the circumstances and any
reports prepared are consistent with the results of work performed.
ƒ Any exceptions/unusual matters disclosed by internal audit are properly
resolved.
(b)
Important differences between Internal Audit and the External Audit
Independence
Since internal audit is a part of the entity, no matter how autonomous and
objective it is., it cannot reach the level of independence enjoyed by the external
auditors.
Objectives
The objectives of internal audit function vary according to management’s
requirements. Whereas, the primary objective of external auditor is to ascertain
whether or not the financial statements are free of material misstatements.
Reporting
‰
Report of external auditor is addressed to the members (shareholders) /
owners / those charged with the governance of the entity.
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49
‰
Internal audit reports are addressed to the management and those
charged with the governance.
‰
The reporting requirement of the external auditor is determined by the
framework under which the audit is being carried out and by applicable
legal and regulatory requirements.
‰
Reporting requirement of internal audit is based on the objectives/scope of
work determined by the management and those charged with governance.
Hard Stone Limited
(a)
(b)
Substantive procedures for verification of trade debts (excluding receipt from
customers)
‰
Investigate any unexpected or unusual movement/differences between
current and prior period as regards the amounts of trade debts, debtor’s
turnover, ageing of receivable and ratio of debtors to credit sale etc.
‰
Review of period end reconciliation of subsidiary and general ledger and
investigate large and unusual items.
‰
Reviewing the period-end bank reconciliation statements with specific
reference to the list of cheques deposited but not credited in the bank.
‰
Review the following:
x
Large or unusual postings in the general ledger.
x
Large or unusual balances in subsidiary records including, credit
balances, past due balances and balances exceeding credit limits
etc.
‰
Circularization of confirmations and performance of appropriate follow-up
of selected customer balances at the period end and obtaining and testing
reconciliation of balances confirmed with the book balance.
‰
Review the ageing schedule and ensure reasonableness of provision
based on:
x
Discussion with the credit manager.
x
Examination of the subsequent collections made.
x
Past practice and consistency.
Substantive procedures for verification of stores and spares
(i)
Obtain the listing of stores and spares balances at period-end and
investigate large or unusual quantities or amounts.
(ii)
Review large or unusual entries in the ledger account.
(iii)
Review period end reconciliation of subsidiary and general ledger and
investigate large and unusual items.
(iv) Attend inventory counts at period end and ensure that physical differences
are appropriately recorded and resolved and damaged items if any are
identified.
(v)
Check valuation of selected items using one or more of the recommended
sampling techniques.
(vi) Identify slow moving items and discuss/determine the impact thereof.
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50
Related parties
Procedure to identify Related Parties
The auditor may perform the following audit procedures to ensure the completeness of
the information provided by management about related parties:
51
(i)
Review prior year working papers for names of known related parties;
(ii)
Review the entity’s procedures for identification of related parties;
(iii)
Inquire as to the affiliation of those charged with governance and officers with
other entities;
(iv)
Review shareholder records to determine the names of principal shareholders
or, if appropriate, obtain a listing of principal share-holders from the share
register;
(v)
Review minutes of the meetings of shareholders and those charged with
governance and other relevant statutory records such as the register of
directors’ interests;
(vi)
Inquire of other auditors currently involved in the audit, or predecessor auditors,
as to their knowledge of additional related parties; and
(vii)
Review the entity’s income tax returns and other information supplied to
regulatory agencies.
Direct confirmations 2
(a)
(b)
The auditor may consider not to circulate the direct confirmation to the
customers where:
(i)
accounts receivables are immaterial to the financial statements; or
(ii)
the response rate is not expected to be adequate; or
(iii)
the responses are not expected to be reliable; or
(iv)
inherent and control risk in aggregate are assessed at low level.
(v)
audit evidence expected to be gathered through other substantive
procedures (e.g. analytical procedures) is sufficient to reduce the audit
risk to an acceptable level.
vi)
management requests not to send the confirmation and auditor after
satisfying himself from the reason and explanation given by the
management.
While designing the confirmation request, the auditor considers the following
factors:
(i)
Assertions being addressed through the direct confirmation.
(ii)
Form of the external confirmation requests (i.e. positive or negative or
combination of both)
(iii)
Prior experience on the audit of similar engagements.
(iv)
The nature of the information being confirmed.
(v)
The intended respondent.
(vi)
Type of information respondents will be able to confirm readily.
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(c)
52
The auditor may perform one or more of the following steps:
(i)
Check receipt from customers after balance sheet date.
(ii)
When there is no receipt from customers after balance sheet date, the
auditor should consider the following audit procedures:
‰
Verify validity of purchase orders, if any.
‰
Verify goods dispatched note other documents duly acknowledged
by the customers.
(iii)
Obtain explanations for invoices remaining unpaid, if any, after
subsequent one have been paid.
(iv)
Examine sales near the period end to provide audit evidence about cutoff assertion.
Working papers
The auditor should consider the following factors while determining the form, content
and extent of audit working papers.
(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.
53
Al-Shams
(a)
(i)
Evaluate the company’s procedures for identifying and for properly
accounting for related-party transactions.
(ii)
Inquire of management regarding:
(iii)
‰
the identity of the entity’s related parties, including changes from
prior period;
‰
the nature of relationship between the entity and these related
parties; and
‰
whether entity entered into any transaction with these related
parties during the period and, if so, the type and purpose of the
transactions.
Inspect information supplied by the entity to regulatory authorities (e.g.
SECP, FBR, SBP, etc.)
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(iv)
Identify all employee benefit plans and the names of the officers and
trustees thereof.
(v)
Review shareholder registers to identity the entity’s principal
shareholders.
(vi)
Review material investment transactions during the audit period to
determine whether the nature and extent of investments during the
period create related parties.
(vii)
Review contracts and agreements with key management or those
charged with governance.
(viii) Review significant contracts re-negotiated by the entity during the period.
(b)
54
(ix)
Review significant contracts and agreements not in the entity’s ordinary
course of business.
(x)
Review of internal auditor’s report
(xi)
Review of third party confirmations obtained by the auditor
(xii)
Minutes of meetings of shareholders and of those charged with
governance.
Indicators of dominant influence exerted by a related party include the
following:
(i)
Significant transactions are referred to the related party for final approval.
(ii)
There is little or no debate among management and those charged with
governance regarding business proposals initiated by the related party.
(iii)
Transactions involving the related party (or a close family member of the
related party) are rarely independently reviewed and approved.
(iv)
The related party has vetoed significant business decisions taken by
management or those charged with governance.
Auditor’s expert
Information regarding the competence, capabilities and objectivity of an auditor’s
expert may come from a variety of sources, such as:
-
Personal experience with previous work of that expert.
-
Discussions with that expert.
-
Discussions with other auditors or others who are familiar with that
expert’s work.
-
Knowledge of the expert’s qualifications, membership of a professional
body or industry association, license to practice or other forms of
external recognition.
-
Published papers or books written by that expert.
-
The auditor’s firm’s quality control policies and procedures.
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55
ADL
(a)
(i)
Statistical and non-statistical sampling
An approach to sampling that has the following characteristics is called
statistical sampling:
‰ Random selection of the sample items; and
‰ The use of probability theory to evaluate sample results, including
measurement of sampling risk.
(ii)
A sampling approach that does not have above characteristics is
considered non-statistical sampling.
Sampling and non-sampling risk
Sampling risk is the risk that the auditor’s conclusion based on a sample
may be different from the conclusion if the entire population were subjected
to the same audit procedure.
Non sampling risk is the risk that the auditor may reach an erroneous
conclusion for any reason not related to sampling risk.
(b)
(i)
The following shortcomings have been observed in the approach adopted
by the Audit Team:
‰ By ignoring less than Rs. 5,000 debtors, the government debtors and
some of the related parties, for the purpose of sampling, the following
important principles have not been complied with.
x
That the auditor should consider the risk of material misstatement
on the entire population.
x
That the auditor should attempt to ensure that all items in the
population have a chance of selection.
‰ In stratification, the audit efforts are directed towards larger value items.
However, the audit planning documentation should explain why the only
10 debtors out of 50 largest debtors were selected.
(ii)
Alternative means of sampling material balances are as follows:
Stratification
This would involve dividing the sample into discrete sub-populations
(stratum) which have an identifying characteristic. In our case, the
population may be stratified by monetary value. For example, following
strata may be created:
‰ Above Rs. 1,000,000
‰ Between Rs. 500,000 and Rs. 1,000,000
‰ Below Rs. 500,000
The sample may be made from each strata allowing effort to be directed to
the larger value items.
Value weighted selection (Monetary unit sampling)
When performing test of details, it may be efficient to identify sampling as
the individual monetary units that make up the population. In this method,
each monetary unit in a population has an equal chance of being selected
for testing. Audit effort is directed to the larger value items because they
have a greater chance of selection, and can result in smaller sample sizes.
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56
Guava & Co
(a)
After the assembly of the final audit file has been completed, the auditor shall
not delete or discard audit documentation of any nature before the end of the
retention period.
The firm should establish its own policies and procedures for the retention of
engagement documentation. The retention period for audit engagement
ordinarily is no shorter than five years from the date of auditor’s report.
(b)
(c)
Changes in the audit documentation during the final file assembly process may
only be made if they are administrative in nature. Examples of such changes
include:
(i)
Deleting or discarding superseded documentation;
(ii)
Sorting, collating and cross referencing working papers;
(iii)
Signing off on completion checklist relating to file assembly process;
(iv)
Documenting audit evidence that the auditor has obtained, discussed
and agreed with the relevant members of the engagement team before
the date of the auditor’s report.
The auditor must respond appropriately to facts that become known to the
auditor after the date of the auditor’s report, that, had they been known to the
auditor at that date, may have caused the auditor to amend the auditor’s report.
Examples might include:
-
Evidence as to the valuation of assets e.g. the agreement of a sale price
significantly lower than previously recorded for the disposal of a large
property portfolio.
-
Evidence that brings into question the appropriateness of the going
concern assumption, for example the non-renewal of financing.
-
The resolution of a legal case for an amount that is materially different
from the expected liability recorded in the financial statements.
-
The bankruptcy of a major client.
In this relation the auditor should document:
(i)
The circumstances encountered.
(ii)
The new or additional audit procedures performed, audit evidence
obtained, and conclusion reached, and their effect on the auditor’s
report.
(iii)
When and by whom the resulting changes to audit documentation were
made and reviewed.
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RP planning
The steps that I as an auditor would consider as part of the audit planning to ensure
that all related party relationships and transactions are identified and disclosed in the
financial statements are as follows:
(a) Obtaining 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.
(b) Inquiring of the management regarding:
(i)
The identity of the entity’s related parties, including changes from the prior
period;
(ii) The nature of relationships between the entity and these related parties; and
(iii) Whether the entity entered into any transactions with these related parties
during the period and, if so, the type and purpose of the transactions.
(c) Inspecting the following documents for indications of the existence of related party
relationships or transactions that management has not previously identified or
disclosed:
(i)
Bank and legal confirmations
(ii) Minutes of meetings of shareholders and of those charged with governance;
and
(iii) Any other records or documents as the auditor considers necessary (e.g.
Form A, Form 29, Register of members etc.).
(d) Reviewing the extent and nature of business transacted with major customers,
suppliers, borrowers and lenders for indications of previously undisclosed
relationships.
(e) Reviewing 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:
(f)
58
‰
The nature of these transactions
‰
Whether related parties are involved in these transactions
Once related parties have been identified, the client should provide the details of
transactions with such parties. I as auditor would ensure that these transactions
are disclosed appropriately in the financial statements as per applicable financial
reporting framework.
Manufacturing inventories
Substantive Procedures
Physical verification:
(i)
Evaluate the client’s physical inventory taking instructions and procedures
to their staff.
(ii)
Attend physical inventory count to observe the inventory count procedures.
(iii)
Ascertain whether the staff members are carrying out the physical
inventory count as per approved instructions issued to them.
(iv)
Perform test counts to ensure the efficiency and effectiveness of the
physical count procedures.
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(v)
Observe the physical inventory count and identify the matters for
appropriate follow-up during the audit. These matters may include the
following:
‰ Excess/ Shortages found in test count performed by the auditors.
‰ Items of inventory identified as obsolete, slow moving, damaged or
defective.
‰ Details of instances where the approved inventory count procedures
are not followed by the staff members of the client.
‰ Instances where the stock records (bin cards, stock and stores ledger
etc.) do not contain adequate details relating to balance of inventory in
hand, minimum level, maximum level, ordering level, specification of
inventory and location of inventory etc.
‰ Cut-off procedures and adherence thereto.
(vi)
Check that the adjustments arising out of the physical count have been
made in the stock count sheets.
(vii)
Check final stock sheets for quantity, pricing, extensions, casting,
summarization, and signatures of the stock taking staff.
Finished Goods:
(i)
(ii)
(iii)
(iv)
(v)
Obtain a list of items (schedule) shown as finished goods, with full
particulars, quantity and value
Compare the list with physical count sheet balances and with stock ledger
balances
On test basis check the items and quantities in the stock ledger with the
bin card.
With regard to cut-off procedures performed during the attendance at the
physical inventory count, check the ‘goods outward book’ or ‘delivery
outwards’ book for the last few days of the year, and early few days of the
succeeding financial year.
If goods are sold on consignment, check the closing stock with the
consignment account.
Work in Process:
(i)
Obtain a list of items shown as work in progress, with full particulars,
quantity and value.
(ii)
Compare the list with physical count sheet balances and with stock ledger
balances
(iii)
Check the quantity and items included in the list with the production reports
and job cards etc.
(iv)
Check records showing the work in progress opening balances, raw
material and other material issued and labour and overheads charged to
production and closing balance of work in process.
(v)
Where it is not possible to quantify or value the work in process for
technical reasons, the auditor should consider to use an expert.
Raw material:
(i)
Obtain a list of items shown as Raw material, with full particulars, quantity
and value.
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(ii)
Compare the list with physical count sheet balances and with stock ledger
balances.
(iii)
Verify the cost of raw material appearing in the financial statements by
matching with them with the purchase invoices etc.
Valuation of Inventories:
(i)
Ensure that stock has been valued in accordance with the valuation policy.
(ii)
Ensure that inventories have been valued at the lower of cost and net
realizable value.
(iii)
Ensure that the cost of inventories comprise of purchase price, cost of
conversion and other costs incurred in bringing the inventories to their
present location and condition.
(iv)
Check that the following costs have not been included in the cost of
inventories:
‰
Abnormal wastes in labour, material or other production overheads.
‰
Storage costs unless considered necessary for the production process/
inventory.
‰
Administrative overheads
‰
Selling and distribution costs
‰
Financial charges
(v)
Examine and perform test checks to verify the proper allocation of
overheads is in accordance with the requirements of IAS 2.
(vi)
Where the inventories are valued at net realizable value, check that
valuation is correct and is based on the most reliable evidence.
(vii) Check that the cost of obsolete and damaged items is properly written
down.
(viii) Test arithmetical accuracy of the calculation of the stock sheets.
Disclosure:
Ensure that inventories have been disclosed in accordance with the requirements
of International Financial Reporting Standards and the Companies Ordinance,
1984.
General:
(i)
Trace opening balance from last years working papers.
(ii)
Agree closing balance appearing in the financial statements with books of
accounts.
(iii) Ensure that inventories have been appropriately classified.
(iv) Obtain direct confirmation for stocks held by third parties.
(v)
Check reconciliations of opening and closing balances with production/ sale
records, wherever possible.
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59
Wedge & Co
(a)
Factor
Effect on sample size of
Tests of controls
Effect on sample size
of tests of details
(i)
The expected rate of
deviation has
increased such that
this increase is
unacceptable to you
as an auditor.
If the expected rate of
deviation is unacceptably
high, it means that controls
are not operating
effectively and the auditor
cannot place reliance on
test of controls,
accordingly the auditor do
not perform the test of
controls
No effect, as the
factor is not related to
test of details.
(ii)
Number of debtors
has increased from
4,500 to 5,000.
Negligible effect, as for
large population, the actual
size of the population has
little, if any, effect on
sample size.
Negligible effect, as
for large population,
the actual size of the
population has little, if
any, effect on sample
size.
(iii)
You expect that the
amount of
misstatements has
decreased from Rs.
300,000, to Rs.
200,000, whereas the
monetary amount in
respect of which you
need an appropriate
level of assurance is
increased by Rs.
50,000.
No effect, as the factor is
not related to test of
controls.
(iii)
The results of audit procedures applied in prior periods and
(iv)
The results of other audit procedures
A decrease in the
amount of
misstatements and
increase in the
monetary amount in
respect of which the
auditor requires an
appropriate level of
assurance will
decrease the sample
size as both the factor
will reduce the audit
risk. Hence the
sample size of the test
of details will
decrease.
(b) Following factors are relevant to the auditor’s consideration of the expected rate of
deviation:
(i)
Auditor’s understanding of the business, in particular, risk assessment
procedures undertaken to obtain an understanding of internal control.
(ii) Changes in personnel or in internal controls
(c) (i)
Fair presentation framework and compliance framework:
The term fair presentation framework is used to refer to a financial reporting
framework that requires compliance with the requirements of the framework
and:
‰
Acknowledges explicitly or implicitly that, to achieve fair presentation
of the financial statements, it may be necessary for management to
provide disclosures beyond those specifically required by the
framework; or
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‰
Acknowledges explicitly that it may be necessary for management to
depart from a requirement of the framework to achieve fair
presentation of the financial statements. Such departures are
expected to be necessary only in rare circumstances.
The term ‘compliance framework’ is used to refer to a financial reporting
framework that requires compliance with the requirements of the framework,
but does not contain the acknowledgements of fair presentation framework.
(ii)
Tolerable misstatement and performance materiality
A Tolerable misstatement is a monetary amount set by the auditor in respect
of which the auditor seeks to obtain an appropriate level of assurance that
the monetary amount set by the auditor is not exceeded by the actual
misstatement in the population.
Performance materiality means the amount or amounts set by the auditor at
less than materiality for the financial statements as a whole to reduce to an
appropriately low level the probability that the aggregate of uncorrected and
undetected misstatements exceeds materiality for the financial statements
as a whole. Performance materiality also refers to the amount or amounts
set by the auditor at less than the materiality level or levels for particular
classes of transactions, account balances or disclosures.
60
MWL
(a)
Selection of Accounts Receivable for circulation at year-end
(i)
The debtors listing will be stratified in accordance with the different market
segments (Super markets, whole sellers, retailers and five star hotels)
(ii)
For positive circulation the selection may be as follows:
‰
All twelve super markets, as well as the seven five star hotels will be
purposely selected (59% of the total debtors balance will be covered in
this manner).
‰
Whole sellers and retailers will be stratified further according to value
and days outstanding. A sample will be made from the abovementioned sub-populations, with greater focus on the high value and
long-outstanding populations.
‰
Debtors with nil and credit balances, as well as overdue debtors should
also be selected.
(iii) A negative circulation of non-selected debtors may be considered on
sample basis.
(b)
Situation where a debtor confirms a balance which is different from the
amount appearing in the confirmation request:
A response that indicates a difference between information requested to be
confirmed and information provided by the confirming party is termed as
exception. The exception may be on account of:
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61
(i)
Timing difference
(ii)
Misstatement
‰
In case of timing differences, the auditor will need to reconcile the amount
confirmed by the confirming party and the amount sent for confirmation.
‰
If the amount cannot be reconciled, the auditor is required to evaluate
whether it is indicative of a fraud or deficiency or deficiencies in the entity’s
internal control over financial reporting.
‰
In either case, the auditor will consider whether he needs to revise his risk
assessment and audit procedures.
BPR
(a)
(b)
Substantive Procedures for verification of Bank reconciliation statements:
‰
Trace and agree balances per books of accounts (ledger or bank book) as
appearing in the bank reconciliation statement with the general ledger/
bank book.
‰
Trace and agree balances per bank statement as appearing in the bank
reconciliation statement with the bank statements.
‰
Trace reconciling items appearing in the previous month’s bank
reconciliation into current month’s ledger/ bank statement/ bank
reconciliation statement.
‰
Check subsequent clearance of current months reconciling items.
‰
Review and discuss long outstanding items appearing in the bank
reconciliation statement.
‰
Ensure that all outstanding items requiring adjustments are properly
accounted for in the books of accounts.
‰
Check arithmetical accuracy of reconciliation statements.
Substantive Procedures for Payroll:
‰
‰
From the payroll record:
x
Select a sample of newly appointed staff and check their salaries with
the appointment letter.
x
Select a sample of other staff (appointed in previous years) and check
their salaries with the increment letter.
x
In both the above cases check that allowances and deductions are in
accordance with the company’s policies or the relevant legal
requirements.
Select a sample of payroll summaries and:
x
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Check that payroll summary has been approved by an appropriate
authority.
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(c)
x
Trace totals of payroll summaries to appropriate general ledger
accounts.
x
Check allocation of payroll to cost of sales and operating expenses.
x
Compare net payroll after deductions with transfer letter issued to the
bank.
‰
Carryout analytical review by comparing the monthly and annual payroll
and inquire reasons for significant fluctuations.
‰
Ensure that payroll costs have been properly disclosed in the financial
statements.
Substantive Procedures for Raw material purchases:
‰
Select a sample of transactions and carryout the following tests.
x
Check weather appropriate measures have been taken as per the
company’s policy to ensure that purchases are made from most
competitive sources.
x
Check the relevant invoices.
x
Match invoices with goods receiving notes to ensure that goods have
been received for all billings made by supplier.
x
Match supplier’s invoices with purchase orders to ensure that:
Purchases were duly authorized.
Rates and quantities mentioned on the invoice are same as those
mentioned on the purchase order.
ƒ
62
x
Check posting of supplier’s invoices to creditor’s accounts/ general
ledger.
x
Perform cut-off procedures on purchases.
Perform analytical procedures on purchases made during the year by
comparing current year purchases with the last year and investigate
significant differences, if any.
Taskeen Co
(a)
Sampling risk
Sampling risk is the possibility that the auditor’s conclusion, based on a sample,
may be different from the conclusion reached if the entire population were
subjected to the audit procedure.
The auditor may conclude from the results of testing that either material
misstatements exist, when they do not, or that material misstatements do not
exist when in fact they do.
Sampling risk is controlled by the audit firm ensuring that it is using a valid
method of selecting items from a population and/or increasing the sample size.
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Non-sampling risk
Non-sampling risk arises from any factor that causes an auditor to reach an
incorrect conclusion that is not related to the size of the sample.
Examples of non-sampling risk include the use of inappropriate procedures,
misinterpretation of evidence or the auditor simply ‘missing’ an error.
Non-sampling risk is controlled by providing appropriate training for staff so they
know which audit techniques to use and will recognise an error when one occurs.
(b)
Sample selection methods
The audit manager suggests checking all invoices, effectively ignoring any
statistical sampling; in other words this is not statistical sampling. Audit tests will
be applied to all of the sales invoices. This approach may be appropriate for the
audit of Tam because:
‰
The population is relatively small and it is likely to be quicker to test all the
items than spend time constructing a sample.
‰
All the transactions are not large but could be considered material in their
own right, e.g. compared to project. As all the transactions are material,
then they all need to be tested.
The audit senior suggests using statistical sampling. This will mean selecting a
limited number of sales invoices from the population using probability theory
ensuring a random selection of the sample and then applying audit tests to those
invoices only. This approach may be appropriate because:
‰
The population consists of similar items (i.e. it is homogeneous) and there
are no indications of the control system failing or changing during the year.
There is the query about how long it will take to determine and produce a
sample, which may make statistical sampling inappropriate in this situation.
The audit junior suggests using ‘random’ sampling, which the junior auditor
appears to understand as manually choosing which invoices to look at. The
approach therefore involves an element of bias and is not statistical or true
‘random’ sampling.
While this approach appears to save time, it is not appropriate because:
(c)
‰
The sample selected will not be chosen ‘randomly’ but on the whim of the
auditor. Human nature will tend to avoid difficult items for testing.
‰
Also, as invoices will not have been chosen using statistical sampling, no
valid conclusion can be drawn from the results of the test. If an error is
found it will be difficult extrapolating that error on to the population.
Materiality
Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement.
It is important that the auditors of Tam ensure that the financial statements are
free from material error for the following reasons:
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63
‰
There is a legal requirement to audit financial statements and present an
opinion on those financial statements. If the auditors do not detect a
material error then their opinion on the financial statements could be
incorrect
‰
There are only two owner/directors who will be the initial users of the
financial statements. While the owners/directors maintain the accounting
records, the directors will want to know if there are material errors resulting
from any mistakes financial statements are materially correct
‰
There are also other users of the financial statements who will include the
taxation authorities and the bank who have made a loan to the company.
They will want to see ‘true and fair’ accounts. The auditors must therefore
ensure that the financial statements are free from material misstatement to
avoid any legal liability to third parties if they audit the financial statements
negligently.
Wings
(a)
Use of the work of the internal auditors by external auditors
Sales and ticketing
(i)
The sales function is likely to be integrated with the accounting and internal
control system used to produce the figure in the financial statements for
revenue, on which the external auditor reports.
(ii)
The internal auditors' work on the ticketing system is less likely to be useful
because it relates to an operational area which does not have a direct
impact on the financial statements. There are, however, regulatory matters
that may need to be considered by the external auditor. Ticketing may also
have an indirect effect, because it is likely to be integrated with the sales
system and there is likely to be some crossover between the controls over
ticketing and controls over sales generally. The work of the internal auditors
is therefore likely to be of some use to the external auditor.
Fleet acquisition and maintenance
(iii)
The internal auditors' work on the fleet acquisition system is likely to be
very relevant to the external auditors because owned aircraft and leased
aircraft will constitute a substantial element of statement of financial
position assets and liabilities, and depreciation and finance charges in the
income statement,
(iv)
Much of the internal auditors' work is likely to relate to ensuring that
company policy has been complied with. Policy will relate to the
authorisation for and acquisition of aircraft, and accounting for aircraft in
terms of the correct classification of leases (operating or financing) and
depreciation policy, for example. Company policy is likely to be extensive
and detailed for such material items and external auditors will be concerned
to ensure that it is both appropriate and has been complied with.
(v)
It is also possible that the internal auditors' work may involve some
verification of the income statement/statement of comprehensive income
and statement of financial position entries at the year-end. Given the likely
materiality of the amounts involved, this work will also be of interest to the
external auditors.
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(vi)
It is possible that the internal auditors' work may also relate to the quality of
aircraft, and other operational aspects of fleet management. These issues
may also be relevant to the external auditors, at least insofar as they relate
to compliance with laws and regulations.
(vii) In relation to maintenance, the internal auditors' work is likely to relate to
the authorisation and correct accounting for maintenance expenditure
(capitalisation or expensing), and on the operational side, to the quality
thereof, as for fleet acquisition (above). Maintenance expenditure in the
income statement/statement of comprehensive income may well be
material and the work of the internal auditors is therefore of interest to
external auditors.
Trade payables and long-term debt financing
(viii) The extent of the external auditor's interest in the internal auditors' work on
trade payables and long-term financing will depend on the materiality of the
amounts involved. Trade payables (for certain types of routine
maintenance, and payables due to the service organisations, for example)
may be material. Long-term debt financing is very likely to be material as
many airlines have substantial debt financing.
(b)
(c)
(ix)
Internal audit work on trade payables is likely to involve ensuring that
routine internal controls are properly designed and are operating. The
external auditors may well be interested in the internal auditors' work in this
area.
(x)
There are substantial financial statement disclosures required for debt
financing. The internal auditors' assistance with ensuring that disclosures
are properly made, as well as with ensuring that any covenants have been
complied with and that the accounting for the financing is appropriate, may
also be helpful to the external auditors.
Quality of internal audit function: extent of reliance
(i)
The quality of the internal audit function will have a significant effect on the
extent of the external auditor's reliance. If the quality of work is not
adequate, reliance will not be possible, regardless of the extent and
relevance of the work performed.
(ii)
The firm will seek to ensure that there is an appropriate structure within the
department itself, with appropriate reporting lines outside the department,
preferably reporting to the audit committee.
(iii)
The internal audit function has recently been expanded and there are likely
to be changes in the way that it is organised. The function should have
operational independence within the organisation and formal terms of
reference that encompass the recent changes made.
(iv)
The function should have a clearly defined set of operating procedures, as
well as a work program. Proper documentation of all work performed is
essential.
(v)
Staff should be appropriately trained, experienced and qualified. The head
of such an important department should preferably be professionally
qualified.
Audit evidence: outsourced functions
(i)
Internal controls exercised by the company over in-flight catering and
payroll must be properly designed and operated. The firm will seek to
review documentation of controls and internal audit reports. It will seek to
obtain evidence that controls have been applied.
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64
(ii)
A breach of regulations or deterioration in the quality of catering could both
have a significant effect on the financial statements, particularly if fines
were payable or adverse publicity was likely. Enquiries into both areas and
a review of relevant documentation provided by, for example, food licensing
authorities to the company or the service organisation, and company
lawyers (in relation to passenger complaints, perhaps) will be necessary.
(iii)
Evidence of controls sought by the firm will include:
‰
controls over the selection of the service organisations selected (by
competitive tendering, for example);
‰
evidence relating to the completeness, accuracy and timeliness of
information provided to, and received from, the payroll organisation
(batch summaries and exception reports, for example);
‰
evidence relating to the security measures taken by the payroll
organisation to ensure that confidential information is kept
confidential;
‰
evidence relating to the security measures taken by the catering
organisation to ensure that health and safety standards are
maintained and that no 'sabotage' of the food can take place.
Glasses2Go
(a)
Purposes of audit working papers
The purposes of audit working papers include:
(b)
‰
To assist with the planning and performance of the audit.
‰
To assist in the supervision and review of audit work, and
‰
To record the audit evidence resulting from the audit work performed to
support the auditor’s opinion.
Documentation
Information obtained
Memorandum and articles of
association
Details of the objectives of Specs4You, its
permitted capital structure and the internal
constitution of the company.
Most recent published financial
statements
Provide detail on the size of the company,
profitability, etc. as well as any unusual
factors such as loans due for repayment
Most recent management
accounts/budgets/ cash flow
information
Determine the current status of the
company including ongoing profitability,
ability to meet budget, etc. as well as
identifying any potential going concern
problems.
Organisation chart of Spec4You
To identify the key managers and
employees in the company and other
people to contact during the audit.
Industry data on spectacles
sales
To find out how Specs4You is performing
compared to the industry standards. This
will help to highlight any areas of concern
for example, higher than expected cost of
sales, for investigation on the audit.
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(b)
(c)
Documentation
Information obtained
Financial statements of similar
entities
To compare the accounting policies of
Specs4You and obtain additional
information on industry standards.
Prior year audit file
To establish what problems were
encountered in last year’s audit, how those
problems were resolved and identify any
areas of concern for this year’s audit.
Internet news sites
To find out whether the company has any
significant news stories, (good or bad)
which may affect the audit approach.
Working paper
The audit working paper does not meet the standards normally expected in a
working paper because:
‰
The page reference is unclear making it very difficult to either file the
working paper in the audit file or locate the working paper should there be
queries on it.
‰
It is not clear what the client year end date is – the year is missing. The
working paper could easily be filed in the wrong year’s audit file.
‰
There is no signature of the person who prepared the working paper. This
means it is unclear who to address queries to regarding the preparation or
contents of the working paper.
‰
There is evidence of a reviewer’s signature. However, given that the
reviewer did not query the lack of preparer’s signature or other omissions
noted below, the effectiveness of the review must be put in question.
‰
The test ‘objective’ is vague – it is not clear what ‘correct’ means for
example, it would be better to state the objective in terms of assertions
such as completeness or accuracy.
‰
The test objective is also stated as an audit assertion. This is not the case
as no audit assertions are actually listed here.
‰
It is not clear how the number for testing was determined. This means it will
be very difficult to determine whether sufficient audit evidence was obtained
for this test.
‰
Stating that details of testing can be found on another working paper is
insufficient – time will be wasted finding the working paper, if it has, in fact,
been included in the audit working paper file.
‰
Information on the results of the test is unclear – the working paper should
clearly state the results of the test without bias. The preparer appears to
have used personal judgement which is not appropriate as the opinion
should be based on the facts available, not speculation.
‰
The conclusion provided does not appear to be consistent with the results
of the test. Five errors were found therefore it is likely that there are some
systems weaknesses.
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ISA 620
Reliance on the work of an auditor’s expert
(i)
(ii)
Likely areas of reliance
‰
Legal opinions, for example, the expert’s view on the likely outcome of an
ongoing court case.
‰
Specialist valuation areas, such as property.
‰
Determination of stage of completion of complex work-in-progress in the
audit of inventories.
‰
Determination of likely realisable value of assets, such as plant which is
possibly obsolete, to see if a write-down is needed.
Assessing the work of an expert
The audit firm should carry out the following procedures.
‰
Assess the competence, capabilities and objectivity of the expert.
‰ Obtain an understanding of the expert’s field of expertise. This must be
sufficient to allow the auditor to determine the nature, scope and objectives
of the expert’s work and evaluate the adequacy of that work.
‰ Agree the terms of engagement with the expert, including:
-
the nature, scope and objectives of the expert’s work
-
the respective responsibilities of the expert and the auditor
-
the form of the expert’s report
-
confidentiality requirements
‰ Evaluate the adequacy of the expert’s work, including the:
66
-
reasonableness of the expert’s conclusions
-
consistency of those conclusions with other audit evidence
-
reasonableness of significant assumptions and methods used
-
relevance, completeness and accuracy of source data.
Cuddly World
(a)
Procedures
(i)
Use in gathering audit evidence
Analytical procedures consist of evaluations of financial information made
by a study of plausible relationships among both financial and non-financial
data.
Inquiry means to seek relevant information from sources, both financial
and non-financial, either inside or outside the company being audited.
Evidence may be obtained orally or in writing.
Inspection is the physical review or examination of records, documents
and tangible assets. It may include examination of records for evidence of
controls in the form of a compliance test.
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Observation involves looking at a process or procedure as it is being
performed to ensure that the process actually works as documented.
Recalculation means the checking of the mathematical accuracy of
documents or records.
(ii)
One example for each method
(1)
Analytical procedures
Review of sales income year on year to try to identify whether income
has been under-stated, possibly by cash being taken prior to banking.
There is no control over the opening of post so cash could be
withdrawn by one assistant, and the deficit made up by a fraud on
customers.
(2)
Inquiry
Obtain statements from suppliers to check the completeness of
liabilities at the end of the year. As there is no control over
purchases, invoices could have been misplaced resulting in a lower
purchases and suppliers figure.
(3)
Inspection
The assets of the company, namely cuddly toys in inventory at the
end of the year, can be inspected to ensure all inventory is recorded
and that the toys are saleable in their current condition.
(4)
Observation
Procedures such as the opening of cash and recording of customer
orders can be observed to ensure that the administrator is recording
all orders in the sales day book and cash books.
(5)
Recalculation
Checking additions in the cash book to confirm that the total amount
of cash recorded is accurate and can be included in the sales figure
(cash receipts normally equal sales because there are no
receivables).
(b)
Suitability for Cuddly World
(1)
Analytical procedures
This method of collecting evidence will be useful in Cuddly World because
it will help to identify unusual changes in income and expenditure. As
Cuddly World is a relatively small company, monitoring gross profit will
show relatively small changes in sales margin or purchasing costs.
Decisions by Mr Kabir to amend margins can therefore be traced into the
actual sales made.
However, the technique may be limited in its application because it will not
detect errors or omissions made consistently year on year. If either
assistant is defrauding the company (for example by removing cash) each
year, then analytical procedures will not detect this.
(2)
Inquiry
Inquiry evidence will be very useful in the audit of Cuddly World, especially
where this is derived from third parties. Third party evidence is generally
more reliable than client originated evidence as there is a decreased
likelihood of bias. Suppliers can therefore be verified using statement
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reconciliations. A review of any customer complaints file (if those letters
are kept) will also help to identify any orders that have not been
despatched.
External inquiry evidence will be less useful in the audit of sales and
receivables because goods are paid for prior to despatch – there are no
receivables. Internal evidence will be available from Mr Kabir and the
assistant; however the lack of segregation of duties means that this will not
be so reliable.
(3)
Inspection
Inspection of documents within Cuddly World will be useful, particularly
regarding checking whether expenses are bona fide. All purchase invoices,
for example, should be addressed to Cuddly World and relate to purchases
expected from that company e.g. cuddly toys for resale, office expense etc.
Inspection of documents can take a long time, however, given the poor
internal control system within Cuddly World, the auditor may have no
choice but to use this method of gathering evidence.
The fact that an invoice is addressed to the company does not confirm
completeness of recording so inspection of the cash book for unusual
payments verified by checking the purchase invoice will also be required.
Additional substantive testing would also be required due to poor controls.
(4)
Observation
Observation may be useful because it will show how the assistants check
documents. However, no information is provided on any internal controls
with Cuddly World so simply viewing how documents are checked without
any evidence of checking has limited benefit.
Observation tests will be of limited usefulness because the assistants may
act differently when an auditor is present. The same problem will apply to
any observation checking carried out by Mr Kabir.
(5)
Recalculation
Recalculation evidence is very useful for checking additions on invoices,
balancing of control accounts etc. This means that the arithmetical
accuracy of the books and records in Cuddly World can be confirmed.
The main weakness of recalculation checking is that calculations can only
be carried out on figures that have been recorded. If there are any
omissions then checks cannot be carried out.
67
Analytical procedures and materiality
(a)
Possible reasons for changes in ratios
All of the changes noted below may also be due to simple accounting errors or, in
some cases, misappropriation of inventory or cash.
(i)
Increase in current ratio
An increase in the current ratio may indicate increased inventory, cash or
receivables levels. The implications of this may be that the company is
expanding, or alternatively that it is experiencing trading difficulties and is
unable to sell its inventory or to collect its receivables. An increase may
also be due to a decrease in trade payables or other current liabilities.
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(ii)
Decrease in gross profit margin
A decrease in the gross profit margin may indicate that the cost of raw
materials or bought-in goods has increased, or that discounts or selling
prices have decreased. This may not be a bad thing if the reason for this is
an overall increase in revenue.
(iii)
Increase in inventory holding period
The inventory holding period indicates the number of days the company
could continue to trade if supplies were to cease. The longer the period,
the higher the level of inventory held.
Inventory holding involves
expenditure. Generally, the lower the figure the better provided that the
company does not run out of inventory. An increase can indicate that the
company is unable to sell its inventory. An increase can also indicate that
the company is expecting additional sales, or simply that the business is
expanding. Many businesses are cyclical and increases and decreases are
to be expected.
(b)
Materiality
Concept
Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of financial statements.
Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement. So what might be material in one
year might not be material the next, and what might be material to one company
might not be to another.
Effect on audit work
The quantitative aspects of materiality are often, in practice, calculated as
percentage of revenue, profit before tax or assets, or a particular class thereof.
Auditors calculate materiality for the financial statements as a whole and calculate
performace materialty for individual account areas. They look at the aggregate
(net) effects of misstatements and omissions for the financial statements as a
whole. Companies sometimes adjust the accounting records and financial
statements for immaterial items, sometimes they do not.
Materiality is related to risk and used in the calculation of sample sizes and
tolerable misstatement, and in the performance of analytical procedures. Less
work is performed in immaterial areas than in material areas, although some work
is always performed because an area that may appear to be immaterial may,
when tested, provide to be material.
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68
Tahira Transporters
(a)
Audit test
Discuss with booking clerk how orders
are recorded from the customer.
Discuss with the directors the
recruitment and training of booking
clerks.
With client’s permission, attempt to
enter orders into the VMS from an
input terminal.
For the sample of confirmed e-mail
orders held in the e-mail programme,
trace details onto the VMS ensuring
that details of vehicle hire regarding
time and dates are accurately
recorded.
Review hard copy customer complaint
files and e-mail files on computer for
evidence of unfilled orders.
For a sample of bookings in the VMS,
trace details to the list of sales invoices
raised maintained in the receivables
ledger programme.
For a sample of sales invoices in the
VMS, trace details to the list of sales
invoices raised maintained in the
receivables ledger programme.
Cast the list of invoices in the
receivables ledger programme for one
month. Trace total sales to the general
ledger programme.
Cast the monthly sales figures in the
general ledger and agree to the
financial statements. Investigage any
discrepancies.
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Reason for test
The main problem with the sales
system in TT is the lack of evidence for
the receipt of the telephone order.
checks are therefore required to ensure
that orders are completely and
accurately recorded in the VMS where
no input document is available.
To check on the personnel controls in
TT which will be designed to minimise
loss of customer orders.
To ensure that staff have appropriate
skill and training to operate the ordering
system without losing customer orders.
To confirm the completeness and
accuracy of recording of orders by the
computer system.
To check for accuracy of transfer of
information from the e-mail to the VMS.
The method of filling of the e-mails
means that completeness of e-mail
orders cannot easily be determined.
Audit software may be able to re-sort
the orders.
To check for evidence of orders being
sent by customers but not entered into
TT’s sales system.
To check for completeness of transfer
of information between the two
programmes. The test can be carried
out manually or using test data. Manual
testing may be difficult where there is
no obvious audit trail between the two
systems.
To check for accuracy of charging for
each individual vehicle hire. Evidence
of undercharge would indicate that
sales are understated.
To ensure that the total sales for that
month are accurate. Transfer of data to
the nominal ledger ensures that the
total sales amount is recorded correctly
in the ledger.
The final cast and checking ensures
that the financial accounts figure is
accurate.
Casting tests can be carried out
manually or using computer audit
software.
The Institute of Chartered Accountants of Pakistan
Answer bank: Objective test and long-form answers
(b)
Audit work
‰
Obtain non-current asset register from client. Cast the cost, depreciation
and net book value columns of the register and agree to the financial
statements of TT.
For a sample of new additions in the non-current asset register:
‰
Agree to board minute or similar documentation for evidence of authority to
purchase vehicle. (Occurrence assertion)
‰
Agree to the physical asset to confirm existence of the vehicle. Where the
vehicle is on hire during the audit visit, obtain alternative evidence of
existence such as payment from customer near year end for hire
(Existence assertion)
‰
Check the physical condition of the vehicle to ensure that repairs and
renewal expenditure is not being understated. (Existence of repair
expenditure)
‰
Agree details to purchase invoice or similar document for evidence of
ownership. (Ownership assertion)
‰
Test the calculation of depreciation in the non-current asset register,
ensuring that the rates used are those disclosed in the financial statements.
(Valuation assertion)
‰
Review profits and losses generated on sale of vehicles and ensure these
are not excessive. If they are check the accuracy of the depreciation rates
used as this may indicate over or under charge of depreciation. (Valuation
assertion).
‰
Compare sales income to sale of similar vehicles with similar mileage and
ensure comparable.
For a sample of disposals during the year (for occurrence assertion):
‰
Ensure asset has been removed from the non-current register
‰
Check calculation of profit or loss on sale
‰
Agree receipt on sale to the cash book
For a sample of vehicles purchased durin the year, agree details to purchase
invoice and purchase day book (PDB) ensuring details recorded in the correct
year. (Occurrence assertion)
For a sample of vehicle purchases in the PBD, agree details to the non-current
asset register. (Completeness assertion)
Agree totals in non-current asset register to the financial statements, ensuring
vehicles are disclosed separately in the non-current asset note (material item).
(Disclosure assertion)
Ensure that the accounting policy for depreciation is clearly stated in the financial
statements and is the same as last year. (Disclosure assertion)
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69
Willow
(a)
Initial audit procedures
Clerical accuracy
This schedule has been prepared by the company’s accountant. If I am to use
the schedule as the basis for planning and performing my audit. I must first
ensure that it is correct in accordance with the company’s books and records. I
would, therefore:
‰
verify the schedule to and from accounts recorded in the nominal ledger
and with the draft financial statements;
‰
check the correctness of additions and other calculations on the schedule.
The basis for this procedure is that of professional scepticism which requires
making no presumption as to the accuracy of information provided by
management.
Opening balances
I would check that the opening balances are in agreement with the balances in
the previous year’s audit file. This is for two reasons:
(b)
‰
To ensure that any amendments to the previous year’s closing balance
agreed at audit had been properly recorded in the company’s books and
records.
‰
With plant and equipment most audit procedures are applied to
transactions that change the balance. Reliance is placed on audit
procedures performed in previous years in verifying assets brought forward
at the beginning of the year.
Audit procedures additions
Existence
‰
Vouch additions to suppliers’ invoices.
‰
Examine goods inward notes or evidence confirming delivery of the items
prior to the year end.
‰
Examine purchase orders, requisitions and other evidence, such as Board
approval, that the purchase had been properly authorised.
‰
Physically examine some of the items confirming description and serial
numbers to the invoice.
Completeness
‰
Analyse repairs and maintenance to ensure that no items charged to this
account should not have been capitalised.
‰
Scrutinise the company’s capital budget and capital commitments recorded
in the previous year’s financial statements for details of proposed additions
and enquire as to why any such items are not recorded as additions.
Rights and obligations
‰
Ensure that the purchase documentation assigns ownership rights to the
company.
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Valuation
‰
Ensure that the amount recorded as additions is in accordance with the
cost on the purchase invoice including all matters properly included, such
as delivery, but excluding amounts that should not be capitalised, such as
the cost of removal of plant being replaced. Where other costs are
capitalised, such as own labour for assembly and testing, I would verify the
amounts as appropriate.
Presentation and disclosure
‰
(c)
Ensure that the items properly meet the definition of plant and equipment
and are properly recorded as such.
Revaluation
Competence and objectivity of the valuer
My prime concern would be that the valuer is an employee of the entity.
Nevertheless, I may be prepared to accept the valuation although I would need to
be satisfied that the valuation has been performed with sufficient objectivity that it
represents sufficient, appropriate audit evidence. This depends on factors such
as the materiality of the amounts involved and the available of corroboratory
evidence. The revaluation is certainly substantial representing a gain of Rs 144m
on property, plant and equipment having a written down value of Rs.603m.
It is a common practice for interim valuations to be undertaken by valuers
employed by the entity providing they are confirmed by less frequent independent
valuations, such as every five years. If this is the practice I would examine the
record of past valuations to see if the employee’s valuations tended to be
confirmed by the independent valuations.
I would also enquire into the professional qualifications and experience of the
valuer to ensure that he or she is both suitably qualified to perform valuations and
sufficiently experienced in valuations of the type undertaken.
Scope of work
I would obtain a copy of the valuer’s report and:
‰
check that the valuation given in the report is consistent with the valuation
recorded in the financial statements;
‰
check that the basis of valuation is consistent with an acceptable basis of
financial statement valuations, such as open market value and, in
particular, that it relates to the property as it is and does not anticipate
future uncertain events such as rezoning for planning, new roads etc. and
‰
form a view as to how thoroughly the valuer has undertaken his or her
work.
Although the valuer was an employee of the company I would need to ensure
that no undue restriction was placed on the valuer’s access to relevant
information having a bearing on the valuation.
Assessing the work of the valuer
When reviewing the work of the valuer I would expect to see the basis of the
valuation explained and justified in the report. Where practicable I could confirm
any data used such as recent transactions involving similar property. I could also
consider the reasonableness of any assumptions made concerning which I have
some knowledge, such as the effect of recent changes in legislation or in the
economic climate.
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Conclusion
If I find that:
‰
the valuer is professionally qualified, and sufficiently experienced,
‰
the scope of the work is adequate; and
‰
other evidence corroborates the reliability of the valuation
I would probably be prepared to accept the work of the valuer as an expert
providing sufficient appropriate evidence as to the valuation of the property. My
confidence in the valuation would be enhanced if it were an interim valuation
subject to periodic confirmation by independent valuers.
(d)
Accumulated depreciation
According to IAS 8 the correction of errors which are the natural result of
estimates inherent in the accounting process are normally dealt with in the
income statement in the period in which they are identified. This would appear to
be the accountant’s argument.
An alternative view is that this is a fundamental error and the cumulative
adjustments applicable to prior periods have no bearing on the results of the
current period. In this case, as a prior period adjustment, the benchmark
treatment required by IAS 8 is to adjust the opening balance of retained earnings
of retained earnings and to amend the comparative figures for the previous
accounting period. However, the accountant’s proposed treatment is consistent
with the allowed alternative treatment providing it is accompanied by additional
pro forma information as required by the benchmark treatment.
70
Sparkle Forever
(a)
Audit procedures and reasons in relation to inventory count
Audit procedure
Reason
Perform an overall review with client
staff to ensure that they are following
the client’s physical count instructions.
Specifically ensure that:
To check that client’s physical count
instructions are being followed as this
will help to ensure that the count is
complete and accurate.
‰
Inventory is divided into
appropriate sections for recording
– perhaps by type of jewellery
To ensure there is a clear layout of
inventory, ensuring items are not
missed.
‰
Staff are counting in pairs with
one person checking the inventory
and another recording.
Prevents collusion and provides a
check over security of inventory
(jewellery is high value) and that the
count sheets are not falsified.
‰
Appropriate checks are in place to
ensure that each item of jewellery
is only counted once.
To ensure that inventory is not doublecounted
‰
The shop is closed during the
count.
To ensure that there is no confusion
regarding which items are sold.
‰
Count sheets are pre-numbered.
To ensure that no count sheets are
lost.
Obtain a sample of inventory items
already recorded on the count sheets
and agree to the jewellery inventory.
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To ensure that the inventory recorded
on the count sheets actually exists.
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(b)
Audit procedure
Reason
For a sample of jewellery in the shop,
agree to the count sheets.
To ensure that all inventory is
recorded on the count sheets – check
for completeness of recording.
Obtain a sample of count sheets,
photocopy and place on the audit file.
To check that details on the count
sheets are not subsequently amended
and for agreement to the final
inventory sheets to ensure quantities
are recorded correctly.
Check all count sheets are returned
after the physical inventory count.
Ensures that all sheets are accounted
for and inventory is therefore not
understated.
Obtain last inventory receipt note and
sales invoice numbers.
To ensure that cut off is correct.
Subsequent checking should show
that goods received notes post
physical count are not included in
payables for the year, and sales
invoices after the physical inventory
are not included in sales for the year.
Review the condition of the jewellery
with the independent valuer. Ensure
that there are no reasons why the
inventory could be obsolete (e.g. due
to changes in fashion) or damaged.
To check that any inventory which is
damaged or unsellable is correctly
valued.
Form an opinion regarding the overall
accuracy of the physical count.
To confirm that inventory quantities
have been correctly recorded.
Factors to consider when placing reliance on the work of JJ:
Dandy & Co need to confirm that they actually need an expert. It is not clear
whether Dandy & Co have the necessary skills in-house. However, given that
Sparkle Forever is the only client in the diamond industry, then some assistance
would be expected as valuing diamonds is difficult.
Check that the specialist has relevant experience in valuing diamond jewellery.
Part of the appointment process will include checking the work portfolio of JJ to
show that they have valued diamonds in other situations.
Ensure that JJ is a member of an appropriate professional body. This will help
ensure that JJ follows the appropriate ethical standards as these will be enforced
by their professional body.
Check that JJ cannot be influenced by the client – for example because they are
employed by Sparkle Forever. Being employed by the client would imply less
independence and limit the value of the specialist’s report.
Check that the report produced by the specialist regarding the valuation of the
diamonds appears to be reasonable. Although Dandy & Co do not have any
other clients retailing diamonds, basic price comparisons for a given weight of
diamond could still be obtained from other shops or Internet site to prove the
accuracy of JJ’s figures.
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(c)
71
Audit procedures to ensure that jewellery inventory is correctly valued
‰
The jewellery inventory should be valued at the lower of cost and net
realisable value.
‰
For a sample of jewellery on the final inventory sheets, trace the cost of
those items to the original purchase invoice, ensuring that the description of
goods on the invoice matches the jewellery.
‰
For jewellery sold after the end of the year, check a sample of sales
invoices back to the final inventory sheets ensuring that the sales value
exceeds the cost. Where sales value is less than cost, ensure that the
jewellery is stated at the realisable value on the inventory sheet.
‰
Review the report of the professional valuer. Ensure that the inventory is
genuine. For the items checked by the valuer, agree the valuation to the
items of jewellery on the inventory statements. Where there is a difference,
for example due to age of the inventory or where it is unlikely to be sold due
to changes in fashion, discuss with the client and agree a realistic
valuation. In these situations, the value should be that provided by the
professional valuer.
‰
Where an item has been in inventory for a long period of time (perhaps
over one year), check the valuer’s report to find out whether any allowance
is required.
Bubbles
(a)
Audit tests on ‘Stockpop’ system during the year
(i)
There are two main aspects to the audit of the Stockpop system; those
relating to quantities and those relating to costs, in order to rely on the
system as a basis for the figure in the financial statements I would need to
ensure that management had a system for ensuring that:
‰
the system was accurate and up-to-date;
‰
errors were investigated and corrected on a regular basis; and
‰
each item of inventory was counted at least once a year (in practice
items are likely to be counted more often that this as such systems
are often relied on to produce figures for management accounts).
(ii) I would ask management about the procedures for inventory counting and
review the related documentation, including inventory counting instructions,
and form a view as to whether the system was adequate in principle. I
would also review the results of any internal audit work on the system
design (assuming that I considered the internal audit function to be
adequate).
(iii) I would need to obtain evidence relating to the three items noted in (i)
above. I would therefore visit the warehouses during the year, possibly on
a rotational basis, to ensure that the system was being operated in the
manner prescribed.
(iv) I would perform certain preliminary analytical procedures to establish which
warehouses to visit (such as those where the records indicated that large
volumes of inventories were held, warehouses that were experiencing
problems or had experienced problems in the past, or warehouses that
were considered high risk or other reasons). I might use different offices of
my own firm for these purposes, and/or I would enlist the help of internal
audit. I would review the results of the work already performed by internal
audit.
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(v)
I would ask local staff about the procedures performed, especially about
any variations from the procedures prescribed. I would observe procedures
being performed.
(vi)
I would test check records of goods received and goods despatched and
trace them through the Stockpop system to ensure that records were
accurate and input on a timely basis. I would ensure that the correct
corresponding entries for costs had been made in the purchases and sales
systems.
(vii) I would perform my own test checks of inventory and trace my counts
through the Stockpop, sales and purchases systems.
(viii) I would consider using CAATs (computer assisted audit techniques),
including test data and audit software to establish whether, for example, the
system is rejecting entries outside certain pre-determined parameters (cost
per unit for example), and that the system highlights any old inventory, or
any exceptions such as negative inventory quantities.
(ix)
(b)
I would review all exception reports produced by the system to see if there
were any recurring or old items and to ensure that all errors and exceptions
were being dealt with on a timely basis.
Audit tests on records at year end
(i)
I would analytically review the year-end records to establish the overall
quantities and costs of inventories and the quantities and costs of raw
materials and finished goods.
(ii)
I would ask management about any problems experienced with the system
at, or close to, the period-end and about how they had been dealt with to
ensure that they had been appropriately resolved.
(iii)
I would also ask management about the likely level of write-down of either
raw materials or finished goods (inventory being of inadequate quality or
spoiled, for example). I would compare this with prior years and form an
opinion as to its appropriateness. I would check the calculation of the
allowance for damaged inventory and review exception reports close to the
period-end.
(iv)
I would obtain schedules of the costs and quantities to be included in the
financial statements and trace these back to the output of the Stockpop
system noting and substantiating any significant adjustments.
(v)
I would enquire as to how accurate cut-off had been achieved. I would
perform cut-off tests on the records by tracing samples of goods received
and despatch notes just before and just after the year-end to the Stockpop,
sales and purchases systems in order to ensure that costs had been
correctly allocated to the correct accounting period. I would also perform
this test in reverse, from the Stockpop, sales and purchases systems
through to goods received and despatch notes.
(vi)
I would ensure that the valuation method used by Bubbles was in
accordance with IAS 2 Inventories and that, for example, the system was
adequate to ensure that finished goods included an appropriate element of
labour and overhead costs.
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72
ISA 500
(a)
Four examples of external confirmations
Four examples of external confirmations are:
(b)
‰
Accounts receivable letter
‰
Solicitor letter
‰
Bank report letter
‰
Inventory held by third parties.
Assertions achieved and not achieved by each example (only one example of
each required).
Accounts receivable letter
This letter provides evidence of the existence of the receivable when a reply is
returned from that receivable direct to the auditor.
The letter provides evidence on cut-off because sales or cash receipts recorded
in the incorrect accounting period will have to be reconciled to the balance
provided by the receivable.
The letter does not provide evidence of completeness of the receivables balance
because receivables may not query balances which are understated.
The letter does not provide evidence of the valuation of the receivables balance
because the receivable cannot be expected to list all outstanding balances and
external confirmation of the debt does not mean it will be paid.
Solicitor letter
A solicitor letter provides evidence as to the existence of claims at the period end
as the solicitor will confirm specific claims.
However, the letter does not necessarily confirm the valuation of claims due to
uncertainty about the future or the completeness of any legal claims as solicitors
do not normally provide a list of all claims – they prefer to comment only on
claims they are actually asked about.
Bank report letter
A bank confirmation letter provides good evidence on the existence of the
company’s bank accounts as the bank has confirmed this information in writing.
A bank letter cannot necessarily be relied on to provide complete or accurate
information. Most banks place a disclaimer on the letter of ‘errors and omissions
excepted’ indicating that the auditor must review this evidence against other cash
and bank evidence obtained.
Inventory held by third parties
A letter from the third party holding the inventory will provide evidence of the
existence of that inventory because the third party has confirmed this in writing.
However, the letter does not provide evidence regarding the valuation of the
inventory; confirming something exists does not necessarily mean it is in good
condition.
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73
Javeria Co
(a)
Procedure for obtaining a bank letter
The auditor should consider if a bank letter is required. For the audit of Javeria
Co the letter is required as the company has significant cash transactions and a
loan from the bank.
The auditor will produce an external confirmation letter in accordance with local
audit regulations and practices.
The letter will be sent to the client to sign and authorise disclosure and then it will
be forwarded on to Javeria’s bank.
Alternatively, the client may already have provided a standard authority for the
bank to respond to a bank letter each year. In this case separate authority would
not be required.
Ideally the letter should be sent before the end of the accounting period to enable
the bank to complete it on a timely basis e.g. at the year-end.
The bank will complete the letter and send it back directly to the auditor.
Audit procedures on the bank letter include:
(b)
‰
Agree the balances for each bank account to the relevant bank
reconciliation and the year-end balance in the financial statements.
‰
Agree total interest charges on the letter to the interest expense account in
the general ledger.
‰
For any details of loans, ensure repayment terms are correctly disclosed in
the financial statements between current and non-current liabilities.
Substantive procedures for the audit of bank balances
(1)
Obtain a copy of the year-end trial balance.
Agree the bank balance on the trial balance to
(2)
‰
the year-end bank balance on the computer system, and
‰
the balance on the financial statements.
Obtain a copy of Javeria Co.’s bank reconciliation.
‰
Cast the reconciliation
‰
Agree the bank balance to the trial balance.
‰
Agree the bank statement balance to the year-end bank statement.
‰
Agree any unpresented lodgements to the bank statement after the
end of the year
‰
Agree any unpresented cheques or similar expenses to the cash
book before the end of the year and the bank statements after the
end of the year.
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74
Porridge
(a)
Inherent risk – trade payables
In my audit of trade payables I would regard completeness as presenting the
greatest level of inherent risk for the following reasons:
(b)
(i)
Management has an incentive to understate purchases and thus payables
in order to improve profits. This applies not only to senior management but
to line managers who are close to budgetary limits on certain expenditures
and are under pressure to withhold recording of suppliers’ invoices until
after the year end.
(ii)
Senior management may be under pressure to understate payables in
order to improve the company’s apparent liquidity. This would be the case if
the company were seeking to raise additional finance or to renew existing
borrowing agreements. The more liquid the statement of financial position
shows the company to be the more favourable the terms are likely to be.
(iii)
Principal control procedures placed in operation by the company relate to
the occurrence assertion in order to prevent improper purchasing by
employees or overpayments to suppliers.
(iv)
The primary source of information initiating recognition of a liability is the
supplier’s invoice. During the year the company has no incentive to
accelerate the receipt of suppliers’ invoices. This means that, as at the end
of the reporting period, there could be outstanding claims not yet invoiced
by suppliers which the entity has no formalised procedures for identifying
promptly.
(v)
Valuation is rarely a problem except in complex contractual situations
where the amount due is contingent upon some future event such as a
volume discount dependent on total purchases at some future date
exceeding some agreed amount.
Accounts payable circularisation
In my audit of Porridge I would not normally undertake a payables’ circularisation
for the following reasons.
(i)
For payables, much of the documentary evidence available is in the form of
third party sourced suppliers’ invoices and statements, in contrast to
accounts receivable for which most of the available documentation is entity
prepared.
(ii)
Examination of documentary evidence is usually a cheaper form of
substantive evidence than external confirmation.
(iii)
Although examination of third party sourced documentary evidence is less
reliable than external confirmations received directly by the auditor, it
usually provides sufficient evidence.
I would, however, consider an accounts payable circularisation in the following
situations.
(iv)
A substantial proportion of the company’s suppliers does not issue monthly
statements.
(v)
Statements from suppliers with whom the company does substantial
business are unexpectedly unavailable for the last month of the year.
(vi)
Only fax or photocopies of statements are available whose authenticity is
doubtful.
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(vii) I have reasons to suspect that the company, or a member of the company’s
staff, may be deliberately understating liabilities and there is a possibility
that some of the suppliers’ statements may be forgeries given the ease of
replicating documents with modern scanning and desk top publishing
technology. Assessment of control risk as slightly less than high, the limited
segregation of duties, and the failure to routinely reconcile all statements
with the accounts payable ledger mean that this is not necessarily a remote
possibility.
(c)
Substantive procedures applicable to production payables
Initial procedures
(i)
Obtain a list of such accounts payable and test its accuracy by testing it to
and from the computer records and adding it and agreeing it to the control
account. (If production payables are not segregated from other payables
this procedure will apply to all payables.)
Analytical procedures
(ii)
Perform analytical procedures on accounts payable and compare the
results with expectations:
‰
compare current year’s balance with previous years;
‰
compare the average age of payables with previous years;
‰
compare gross profit with previous year and industry average.
Tests of details of transactions
(iii)
Ascertain cut-off data for goods received notes (GRNs) (probably obtained
during attendance at the physical inventory count).
(iv)
Check cut-off by obtaining GRNs for two weeks prior to the year end and:
‰
checking their numerical continuity;
‰
tracing GRNs to the purchases recorded before 31 October or the
accrual journal entry.
(v)
For a smaller sample I would verify the existence of recorded purchases
prior to the year end by vouching a sample of purchases and purchase
accruals to GRN’s in the sequence issued prior to the year end.
(vi)
For a sample of the closing accruals I would verify the amount of the
accrual by vouching the amount to a subsequently received supplier’s
invoice.
Tests of details of balances
(vii) Select a sample of accounts payable using criteria such as:
‰
all suppliers from whom the entity bought more than 1% of its
purchases during the year;
‰
a random sample of all other suppliers including nil and credit
balances;
(viii) For each supplier in the sample I would compare the balance with the
supplier’s statement and investigate differences.
(ix)
If any supplier’s statements were unavailable I would consider confirming
the balance directly with the supplier.
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(d)
Verifying the completeness of non-production payables
Detection risk over the completeness assertion must be set as low because of
the assessment of control risk as only just less than high and from problems
identified in obtaining the understanding of the accounting system in that:
(i)
there are no goods received notes to determine the date of receipt of the
goods;
(ii)
invoices are not recorded until after approval by the department manager
which could cause considerable delay and even a failure to record liability
for invoices mislaid or even lost before being recorded;
(iii)
suppliers’ statements are not reconciled which would otherwise detect most
delayed or missing invoices.
My audit procedures would be centred on cut-off and the search for unrecorded
liabilities.
(i)
Vouch purchases entered in the purchase journal as at 31 October
(including those entered while the journal was held open after the year-end)
to invoices to verify that they are properly recorded as accounts payable at
the end of the reporting period.
(ii)
Vouch larger purchases recorded in the first two weeks of the subsequent
year to invoices to ensure that they are properly recorded after the yearend.
(iii)
Obtain suppliers’ statements from major suppliers and reconcile them with
the balance in accounts payable for evidence of invoices missing or
mislaid.
(iv)
Review outstanding purchase orders for evidence of goods or services
received prior to the year-end not yet invoiced by the supplier.
(v)
Similarly vouch cash payments for the first two weeks after the end of the
reporting period for payments for goods and services received before the
year-end not processed as payables.
(vi)
Review both purchases and cash payments for items that may relate to
goods or services received prior to the end of the reporting period. This
review should be continued up to the date of signing the auditors’ report.
(vii) Compare prepayments and accruals with the previous year for items such
as rent or utility bills normally paid in advance or arrears of receipt of goods
and services and investigate differences.
(viii) Analyse expense accounts for significant differences either in absolute
amounts or relative to sales. Any unexpected difference could be due to
unrecorded purchases at the end of the reporting period.
75
Trembridge Engineering
(a)
Checking suppliers' statements to the balances on the purchase ledger
(i)
Assess the system of control in the purchases system and its reliability. If
discrepancies are found in the audit tests, increase the sample of items
checked.
If the company's staff regularly perform checks on the supplier's statements
then perform fewer checks and instead rely on their work as evidence.
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(ii)
Generally, check a larger proportion of suppliers where the balances are
large, or where there are a large number of transactions. If no statements
are available from a particular supplier then consider telephoning to confirm
the balance instead.
(iii)
If the balance on the supplier's statement agrees to the balance on the
purchase ledger then no further work needs to be carried out.
(iv)
If differences arise they will be due to a number of occurrences, such as:
‰
goods in transit;
‰
cash in transit; and
‰
other differences such as incorrect treatment of discounts.
(v)
Goods in transit are invoices on the supplier's statement which are not on
the customer's purchase ledger. If these differences have been included in
purchase accruals no further checks are necessary. However, for large
value items, check the goods received note (GRN) to ensure they were
received before the year-end.
(vi)
Cash in transit may be verified by checking against the following month's
supplier’s statement.
(vii) Other differences, such as discounts, need only be investigated if they are
material.
(b)
Verification of purchases cut-off
In order to complete an adequate cut-off test for purchases and goods inwards
the ideal starting point is the population of goods received notes.
A sample should be selected that includes items from both before and after the
year end.
For each item, it will be ensured that the date included in inventory, the purchase
invoice date and the date posted to the purchase ledger all correspond. For
example a goods received note dated before the year end means the following.
(i)
the items should be in inventory;
(ii)
the purchase invoice should be included in the income statement/statement
of comprehensive income and dated before the year end;
(iii)
the purchase ledger should include the purchase invoice before the year
end.
A cut-off error will exist if the items are not recognised in the correct accounting
period.
(c)
Audit work on sundry payables and accruals
(i)
Compare to the previous year's figures and identify any material
fluctuations.
(ii)
Net wages accruals and tax/social insurance payables can be verified by
referring to the monthly payroll. Normally it would be expected that one
month of each may be outstanding.
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76
(iii)
The sales tax payable is verified by agreeing the amount to the tax return
and then agreeing the tax return calculation by checking input tax to the
purchase day book, output tax to the sales day book and any sundry
amounts to either cash book or petty cash book
(iv)
Accrued interest on the bank loan and overdraft will be checked to the bank
letter.
(v)
Other accruals will be checked to invoices received after the year-end (or if
no invoices have been received after the year end, then invoices received
before the year end will be used).
(vi)
Consider whether there are any circumstances which have arisen in the
year which may result in new accruals, and check if these accruals have
been included.
ISA 620: Using the Work of an Auditor’s Expert
(a)
Competence and objectivity of experts
–
The expert’s professional qualification. The expert should ideally be a
member of a relevant professional body or have the necessary licence to
perform the work.
–
The experience and reputation of the expert in the area in which the auditor
is seeking audit evidence.
–
The independence of the expert from the client company. The expert
should not normally be employed by the client.
(b) Auditor rights
–
Right of access to the company’s books and records at any reasonable
time to collect the evidence necessary to support the audit opinion.
–
Right to require from the company’s officers the information and
explanations the auditor considers necessary to perform their duties as
auditors.
–
Right to receive notice of and attend meetings of the company in the same
way as any member of the company.
–
Right to speak at general meetings on any matter affecting the auditor or
previous auditor.
–
Where the company uses written resolutions, a right to receive a copy of
those resolutions.
(c) Tangible non-current assets – assertions
–
Completeness – ensure that all non-current assets are recorded in the noncurrent asset register by agreeing a sample of assets physically verified
back to the register.
–
Existence – ensure non-current assets exist by taking a sample of assets
from the register and physically seeing the asset.
–
Valuation and allocation – ensure assets are correctly valued by checking
the reasonableness of depreciation calculations.
–
Rights and obligations – ensure the company owns the asset by seeing
appropriate document of ownership for example, a purchase invoice.
–
Presentation and disclosure assertions – ensure all necessary financial
statements disclosures have been made by reviewing the financial
statements and ensure non-current assets are correctly categorised in
those financial statements.
Note: only four assertions were required.
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77
Heidi Co
(a)
(i)
Benefits of using audit software
Standard systems at client
The same computerised systems and programs as used in all 25 branches
of Heidi Co. This means that the same audit software can be used in each
location providing significant time savings compared to the situation where
client systems are different in each location.
Use actual computer files not copies or printouts
Use of audit software means that the Heidi Co.’s actual inventory files can
be tested rather than having to rely on printouts or screen images. The
latter could be incorrect, by accident or by deliberate mistake. The audit
firm will have more confidence that the ‘real’ files have been tested.
Test more items
Use of software will mean that more inventory records can be tested – it is
possible that all product lines could be tested for obsolescence rather than
a sample using manual techniques. The auditor will therefore gain more
evidence and have greater confidence that inventory is valued correctly.
Cost
(ii)
The relative cost of using audit software decreases the more years that
software is used. Any cost overruns this year could be offset against the
audit fees in future years when the actual expense will be less.
Problems on the audit of Heidi
Timescale – six week reporting deadline – audit planning
The audit report is due to be signed six weeks after the year end. This means
that there will be considerable pressure on the auditor to complete audit work
without compromising standards by rushing procedures.
This problem can be overcome by careful planning of the audit, use of
experienced staff and ensuring other staff such as second partner reviews are
booked well in advance.
Timescale – six week reporting deadline – software issues
The audit report is due to be signed about six weeks after the year end. This
means that there is little time to write and test audit software, let alone use the
software and evaluate the results of testing.
This problem can be alleviated by careful planning. Access to Heidi Co.’s
software and data files must be obtained as soon as possible and work
commenced on tailoring Cal & Co.’s software following this. Specialist computer
audit staff should be booked as soon as possible to perform this work.
First year audit costs
The relative costs of an audit in the first year at a client tend to be greater due to
the additional work of ascertaining client systems. This means that Cal & Co may
have a limited budget to document systems including computer systems.
This problem can be alleviated to some extent again by good audit planning. The
manager must also monitor the audit process carefully, ensuring that any
additional work caused by the client not providing access to systems information
including computer systems is identified and added to the total billing cost of the
audit.
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Staff holidays
Most of the audit work will be carried out in July, which is also the month when
many of Cal & Co staff take their annual holiday. This means that there will be a
shortage of audit staff, particularly as audit work for Heidi Co is being booked
with little notice.
The problem can be alleviated by booking staff as soon as possible and then
identifying any shortages. Where necessary, staff may be borrowed from other
offices or even different countries on a secondment basis where shortages are
acute.
Non-standard systems
Heidi Co.’s computer software is non-standard, having been written specifically
for the organisation. This means that more time will be necessary to understand
the system than if standard systems were used.
This problem can be alleviated either by obtaining documentation from the client
or by approaching the software house (with Heidi Co.’s permission) to see if they
can assist with provision of information on data structures for the inventory
systems. Provision of this information will decrease the time taken to tailor audit
software for use in Heidi Co.
Issues of live testing
Cal & Co has been informed that inventory systems must be tested on a live
basis. This increases the risk of accidental amendment or deletion of client data
systems compared to testing copy files.
To limit the possibility of damage to client systems, Cal & Co can consider
performing inventory testing on days when Heidi Co is not operating e.g.
weekends. At the worst, backups of data files taken from the previous day can be
re-installed when Cal & Co.’s testing is complete.
Computer systems
The client has 25 locations, with each location maintaining its own computer
system. It is possible that computer systems are not common across the client
due to amendments made at the branch level.
This problem can be overcome to some extent by asking staff at each branch
whether systems have been amended and focusing audit work on material
branches.
Usefulness of audit software
The use of audit software at Heidi Co does appear to have significant problems
this year. This means that even if the audit software is ready, there may still be
some risk of incorrect conclusions being derived due to lack of testing, etc.
This problem can be alleviated by seriously considering the possibility of using a
manual audit this year. The manager may need to investigate whether a manual
audit is feasible and if so whether it could be completed within the necessary
timescale with minimal audit risk.
(b)
Reliance on internal audit documentation
There are two issues to consider; the ability of internal audit to produce the
documentation and the actual accuracy of the documentation itself.
The ability of the internal audit department to produce the documentation can be
determined by:
–
Ensuring that the department has staff who have appropriate qualifications.
Provision of a relevant qualification e.g. membership of a computer related
institute would be appropriate.
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–
Ensuring that this and similar documentation is produced using a
recognised plan and that the documentation is tested prior to use. The use
of different staff in the internal audit department to produce and test
documentation will increase confidence in its accuracy.
–
Ensuring that the documentation is actually used during internal audit work
and that problems with documentation are noted and investigated as part of
that work. Being given access to internal audit reports on the inventory
software will provide appropriate evidence.
Regarding the actual documentation:
78
–
Reviewing the documentation to ensure that it appears logical and that
terms and symbols are used consistently throughout. This will provide
evidence that the flowcharts, etc. should be accurate.
–
Comparing the documentation against the ‘live’ inventory system to ensure
it correctly reflects the inventory system. This comparison will include
tracing individual transactions through the inventory systems.
–
Using part of the documentation to amend Cal & Co.’s audit software, and
then ensuring that the software processes inventory system data
accurately. However, this stage may be limited due to the need to use live
files at Heidi Co.
Zeedin Co
(a)
Audit procedures procurement and purchases system
Procedure
Reason for procedure
Obtain a sample of e-mails from the
store manager’s computer. Trace
details to the order database.
Ensure that all orders are recorded and
that the order details are correct.
Obtain a sample of orders in the
order database, record details of the
order and trace to the paper delivery
note filed in the goods inwards
department.
To confirm that all goods ordered were
received.
For the sample of orders above,
agree to the inventory database.
To confirm that goods received were
completely and accurately recorded in the
inventory database.
Obtain a sample of paper delivery
notes and agree to the order
database and inventory database.
To confirm that inventory received has
been recorded in Zeedin’s accounting
system and that liabilities are therefore not
understated.
For a sample of orders in the orders
database, agree details to the
payables ledger database,
confirming details against the
purchase invoice.
To confirm complete and accurate
recording of the inventory liability in the
payables database.
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Note: To ensure goods received have been
recorded as a payables liability the sample
selected from the order database should
be only those orders that have been
received. The invoice number in the order
database is then noted and traced to the
payables ledger in the purchase database.
The Institute of Chartered Accountants of Pakistan
Audit and Assurance
(b)
Procedure
Reason for procedure
For a sample of orders in the orders
database, agree details to the
payables ledger database,
confirming details against the
purchase invoice.
To confirm complete and accurate
recording of the inventory liability in the
payables database.
Within the purchase database, obtain
a sample of invoices recorded in the
purchase day book, agree details of
price and supplier to the purchase
invoice record in the database.
To confirm that purchase invoice details
have been correctly recorded in the
payables database.
For a sample of purchase invoices in
the purchase day book, agree details
to the delivery notes for items on that
invoice.
To confirm that the purchase liability has
been recorded only for goods actually
received.
For the sample of purchase invoices
above, agree details to the individual
payables account in the payables
database.
To confirm that the liability has been
recorded in the correct payables account.
For a sample of supplier invoices,
cast and cross cast invoice price and
quantities confirming price to the
original order.
To confirm the arithmetical accuracy of
invoices and ensure the company was
charged the correct price for goods
received.
Select increases in the purchase
daybook and vouch to the order
database.
To ensure that invoiced goods have been
ordered, confirming the occurrence
assertion.
Using computer-assisted audit
techniques, cast the purchase day
book and agree total of liability
incurred to the general ledger.
To confirm the completeness and accuracy
of the liability recorded in the general
ledger.
Note: To ensure goods received have been
recorded as a payables liability the sample
selected from the order database should
be only those orders that have been
received. The invoice number in the order
database is then noted and traced to the
payables ledger in the purchase database.
Audit procedures prior to inventory count attendance
‰
Review prior year working papers
‰
Contact client to obtain stocktaking instructions
‰
‰
Book audit staff to attend the inventory counts
Obtain copy of inventory count instructions from client
‰
Ascertain whether any inventory is held by third parties
‰
Obtain last year’s inventory count memo
‰
Prepare audit programme for the count.
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Answer bank: Objective test and long-form answers
(c)
(i)
Aims
The aim of a test of control is to check that an audit client’s internal control
systems are operating effectively.
(ii)
The aim of a substantive procedure is to ensure that there are no material
errors at the assertion level in the client’s financial statements.
Regarding the inventory count
Test of control
Observe the count teams ensuring that they are counting in accordance
with the client’s inventory count instructions.
Substantive procedure
Record the condition of items of inventory to ensure that the valuation of
those items is correct on the final inventory summaries.
(d)
Weaknesses in counting inventory
Weakness
Reason for weakness
How to overcome
weakness:
Inventory sheets
stated the quantity
of items expected
to be found in the
store
Count teams will focus on
finding that number of items
making undercounting of
inventory more likely – teams
stop counting when ‘correct’
number of items found.
Count sheets should not
state the quantity of
items so as not to prejudge how many units
will be found.
Count staff were all
drawn from the
stores
Count staff are also
responsible for the inventory.
There could be a temptation
to hide errors or missing
inventory that they have
removed from the store
illegally.
Count teams should
include staff who are not
responsible for inventory
to provide independence
in the count.
Count teams
allowed to decide
which areas to
count
There is a danger that teams
will either omit inventory from
the count or even count
inventory twice due to lack of
precise instructions on where
to count.
Each team should be
given a precise area of
the store to count.
Count sheets were
not signed by the
staff carrying out
the count
Lack of signature makes it
difficult to raise queries
regarding items counted
because the actual staff
carrying out the count are not
known.
All count sheets should
be signed to confirm
who actually carried out
the count of individual
items.
Inventory not
marked to indicate
it has been
counted
As above, there is a danger
that inventory will be either
omitted or included twice in
the count.
Inventory should be
marked in some way to
show that it has been
counted to avoid this
error.
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79
Weakness
Reason for weakness
How to overcome
weakness:
Recording
information on the
count sheets in
pencil
Recording in pencil means
that the count sheets could
be amended after the count
has taken place, not just
during the count. The
inventory balances will then
be incorrectly recorded.
Count sheets should be
completed in ink.
Count sheets for
inventory not on
the pre-numbered
count sheets were
only numbered
when used
It is possible that the
additional inventory sheets
could be lost as there is no
overall control of the sheets
actually being used. Sheets
may not be numbered by the
teams, again giving rise to the
possibility of loss.
All inventory sheets,
including those for
‘extra’ inventory, should
be pre-numbered.
Sahito Co
(a)
Prior year internal control questionnaires
‰ Obtain the audit file from last year’s audit. Ensure that the documentation on
the sales system is complete. Review the audit file for indications of
weaknesses in the sales system and note these for investigation this year.
‰ Obtain system documentation from the client. Review this to identify any
changes made in the last 12 months.
‰ Interview client staff to ascertain whether systems have changed this year
and to ensure that the internal control questionnaires produced last year are
correct.
‰ Perform walk-through checks. Trace a few transactions through the sales
system to ensure that the internal control questionnaires on the audit file are
accurate and can be relied upon to produce the audit programmes for this
year.
‰ During walk-through checks, ensure that the controls documented in the
system notes are actually working, for example, verifying that documents are
signed as indicated in the notes.
(b)
Tests of control
Test of control
Reason for test
Review a sample of goods despatch
notes (GDN) for signatures of the
goods despatch staff and customer.
Ensures that the goods despatched
are correctly recorded on the GDNs.
Ensures that the GDN details have
been entered onto the computer
system.
Review a sample of GDNs for
signature of the accounts staff.
Observe despatch system ensuring
Sahito staff have seen the customers’
identification card prior to goods being
loaded into customers’ vans.
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Ensures that goods are only
despatched to authorised customers.
The Institute of Chartered Accountants of Pakistan
Answer bank: Objective test and long-form answers
(c)
(d)
Test of control
Reason for test
Review the error report on numeric
sequence of GDNs produced in the
accounts department and enquire
action taken regarding omissions.
Ensures that the sequence of GDNs is
complete.
Observe despatch process to ensure
that the customers’ credit limit is
reviewed prior to goods being
despatched.
Ensures that goods are not
despatched to poor/bad credit risks.
Note: reviewing credit limits is not
specifically stated in the scenario;
however, most despatch/ sales
systems will have this control and
most candidates mentioned this in
their answers. Hence marks were
awarded for this point.
Review a selection of invoices
ensuring they have been signed by
accounts staff.
Ensures the accurate transfer of
goods despatched information from
the GDN to the invoice.
Assertions – receivables
Assertion
Application to direct confirmation of receivables
Existence
The receivable actually exists which is confirmed by
the receivable replying to the receivables
confirmation.
Rights and obligations
The receivable belongs to Sahito Co. The receivable
confirms that the amount is owed to Sahito again by
replying to the confirmation.
Valuation and allocation
Receivables are included in the financial statements
at the correct amount – the receivable will dispute
any amounts that do not relate to that account.
Cut-off
Transactions and events have been recorded in the
correct accounting period. The circularisation will
identify reconciling items such as sales invoices/cash
in transit.
(i)
Receivables circularisation – procedures
–
Obtain a list of receivables balances, cast this and agree it to the
receivables control account total at the end of the year. Ageing of
receivables may also be verified at this time.
–
Determine an appropriate sampling method (cumulative monetary
amount, value-weighted selection, random, etc.) using materiality for
the receivable balance to determine the sampling interval or number
of receivables to include in the sample.
–
Select the balances to be tested, with specific reference to the
categories of receivable noted below.
–
Extract details of each receivable selected from the ledger and
prepare circularisation letters.
–
Ask the chief accountant at Sahito Co (or other responsible official) to
sign the letters.
–
The auditor posts or faxes the letters to the individual receivables.
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Audit and Assurance
(ii)
80
Specific receivables for selection:
1.
Large or material items. These will be selected partly to ensure that
no material error has occurred and partly to increase the overall value
of items tested.
2.
Negative balances. There are 15 negative balances on Sahito’s list of
receivables. Some of these will be tested to ensure the credit balance
is correct and to ensure that payments have not been posted to the
wrong ledger account.
3.
Receivables in the range Rs 0 to Rs 20,000. This group is unusual
because it has a relatively higher proportion of older debts. Additional
testing may be necessary to ensure that the receivables exist and to
confirm that Sahito is not overstating sales income by including many
smaller receivables balances in the ledger.
4.
Receivables with balances more than two months old. Receivables
with old balances may indicate a provision is required for nonpayment. The lack of analysis in Sahito Co.’s receivable information
indicates a high risk of non-payment as the age of many debts is
unknown.
5.
Random sample of remaining balances to provide an overall view of
the accuracy of the receivables balance.
Bashir Co
(a)
Control Objectives – wages system
‰
‰
‰
‰
‰
‰
‰
(b)
Employees are only paid for work that they have done
Gross pay has been calculated correctly
Gross pay has been authorised
Net pay has been calculated correctly
Gross and net pay have been recorded accurately in the general ledger
Only genuine employees are paid
Correct amounts are paid to taxation authorities.
The Directors
Bashir Co
1701 Any Street
Big Town 12345
Pakistan
3 December 20X3
Dear Sirs
Management letter
We write to bring to your attention weaknesses in your company’s internal control
systems and provide recommendations to alleviate those weaknesses.
(i) Weakness:
(ii) Possible effect:
(iii) Recommendation:
The logging in
process for
employees is not
monitored.
Employees could bring
cards for absent
employees to the
assembly plant and scan
that card for the employee;
The shift manager should
reconcile the number of
workers physically present
on the production line with
the computerised record of
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(i) Weakness:
(ii) Possible effect:
absent employees would
effectively be paid for work
not done.
(iii) Recommendation:
the number of employees
logged in for work each
shift.
Overtime is not
authorised by a
responsible official.
Employees may get paid
for work not done e.g. they
may clock-off late in order
to receive ‘overtime’
payments.
All overtime should be
authorised, either by the
shift manager authorising
an estimated amount of
overtime prior to the shift
commencing or by the
manager confirming the
recorded hours in the
payroll department
computer system after the
shift has been completed.
The code word
authorising the
accuracy of time
worked to the wages
system is the name
of the cat of the
department head.
The code word is not
secure and could be easily
guessed by an employee
outside the department
(names of pets are
commonly used
passwords).
The code word should be
based on a random
sequence of letters and
numbers and changed on
a regular basis.
The total amount of
net wages
transferred to
employees is not
agreed to the total of
the list of wages
produced by the
payroll department.
‘Dummy’ employees –
payments that do not
relate to any real
employee – could be
added to the payroll
payments list in the
accounts department.
Prior to net wages being
sent to the bank for
payment, the financial
accountant should agree
the total of the payments
list to the total of wages
from the payroll
department.
Details of employees
leaving the company
are sent on an email from the
personnel
department to
payroll.
There is no check to
ensure that all e-mails
sent are actually received
in the payroll department.
There needs to be a
control to ensure all emails are received in
personnel – prenumbering of e-mails or
tagging the e-mail to
ensure a receipt is sent
back to the personnel
department will help meet
this objective.
In the accounts
department, the
accounts clerk
authorises payment
of net wages to
employees.
It is inappropriate that a
junior member of staff
should sign the payroll; the
clerk may not be able to
identify errors in the
payroll or could even have
included ‘dummy
employees’ and is now
authorising payments to
those ‘people’.
The payroll should be
authorised by a senior
manager or finance
director.
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Audit and Assurance
If you require any further information on the above, please do not hesitate to
contact us.
Yours faithfully
Global Audit Co.
(c)
Substantive analytical procedures
Substantive analytical procedure
Expectation
Compare total salaries cost this year Assuming that the number of shift
to total salaries cost last year.
managers has remained unchanged,
the total salary expenditure should
have increased by inflation only.
Ascertain how many shift managers Total salary should be approximately
are employed by Bashir and the total number of managers multiplied by
salary from the personnel department. average salary.
Calculate total salary and compare to
the salary disclosed in the financial
statements.
Obtain a listing of total
payments made each month.
salary The total payments should be roughly
the same apart from July onwards
when
salaries
increased
and
November when the annual bonus
was paid.
(d)
Audit procedure
Benefit to auditor in testing
accuracy of time recording system
Confirmation
Confirmation is the process of
obtaining a representation of
information or of an existing condition
directly from a third party.
Obtaining information from a third
party will be difficult. The
manufacturer of the time recording
system could be approached to
discuss known errors with the system;
however, information provided may be
limited by the need to protect the
manufacturer’s integrity.
It is therefore unlikely that the auditor
will benefit from this procedure.
Observation
This procedure involves watching a
procedure being performed by others
– in this case watching shift-workers
using the time recording system.
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Testing will be limited to ensuring all
shift-workers actually clock in and out
when they arrive to and depart from
work. The procedure has limited use
as it only confirms it worked when
shift-workers were observed. It also
cannot confirm that hours have been
recorded accurately.
The Institute of Chartered Accountants of Pakistan
Answer bank: Objective test and long-form answers
Inquiry
Inquiry involves obtaining information
from client staff or external sources.
Inquiry only confirms that shiftworkers confirm they clock-in or out. It
does not directly confirm the action
actually happened or the accuracy of
the recording of hours worked.
Recalculation
Recalculation means re-checking the
arithmetical accuracy of the client’s
records; in this case the hours worked
by the time-recording system.
Recalculation can confirm the hours
worked are correctly calculated as the
difference between the clocking in and
out times in the time recording
system. When used with
reperformance evidence this will
confirm the overall accuracy of the
time recording system.
Reperformance
This is the auditor’s independent
execution of procedures or controls
that were originally performed as part
of the entity’s internal control.
If the auditor notes the time of clocking
in and out, then these times can be
agreed to the time recording system
confirming the accuracy of recording
(or confirm that client staff actually
perform this control). Reperformance
is therefore a good source of audit
evidence.
Analytical procedures
Analytical procedures involve
comparing financial or non-financial
data for plausible relationships.
81
This procedure will be useful for the
auditor as the total time recorded for
each employee should be standard
hours plus any estimate of the
overtime worked.
Analytical procedures
(a)
(i)
‰ Analytical procedures include the consideration of comparisons of the
entity’s financial information with, for example:
Comparable information for prior periods.
Anticipated results of the entity.
Similar industry information, such as a comparison of the entity’s
ratio of sales to accounts receivable with industry averages or with
other entities of comparable size in the same industry.
‰ Analytical procedures also include consideration of relationships:
Among elements of financial information that would be expected to
conform to a predictable pattern based on the entity’s experience,
such as gross margin percentages.
Between
financial information and relevant non-financial
information, such as payroll costs to number of employees.
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Audit and Assurance
‰ Analytical procedures are used for the following purposes:
As risk assessment procedures to obtain an understanding of the
entity and its environment.
As substantive procedures when their use can be more effective or
efficient than tests of details.
As an overall review of the financial statements at the end of the
audit.
(ii)
When designing and performing analytical procedures as substantive
procedures, the auditor will need to consider a number of factors such as:
‰ The suitability of using substantive analytical procedures given the
assertions. These procedures are generally more applicable to large
volumes of transaction that tend to be predictable over time.
‰ The reliability of the data, whether internal or external, from which the
expectation of recorded amounts or ratios is developed.
‰ Whether the expectation is sufficiently precise to identify a material
misstatement at the desired level of assurance.
‰ The acceptable amount of difference between the recorded amounts
and the expected values.
(iii)
The auditor should apply analytical procedures at or near the end of the
audit in order to
‰ form an overall conclusion as to whether the financial statements as a
whole are consistent with the auditor’s understanding of the entity.
‰ Corroborate the conclusions drawn through other procedures.
‰ To identify unusual or unexpected balances (if any) in order to identify
a previously unrecognized risk of material misstatement. In such
circumstances, the auditor may need to re-evaluate the planned audit
procedures.
(b)
Basic Elements of a Written Representation Letter:
Address:
It should be addressed to the auditor.
Date:
Ordinarily the date should be the same as the date of
auditors’ report.
Signature:
It should ordinarily by signed by the members of
management who have primary responsibility for the entity
i.e. CEO and CFO.
Contents:
It should contain information as may be specified by the
auditor.
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Auditor responsibility
The statement of responsibility should state the following:
(i)
It is the responsibility of the auditor to express an opinion on the financial
statements.
(ii)
The audit was conducted in accordance with International Standards on
Auditing.
(iii)
Those standards require that :
‰
the auditor complies with ethical requirements.
‰
the auditor plans and performs the audit to obtain reasonable assurance
whether the financial statements are free from material misstatement.
(iv)
That an audit involves performing procedures to obtain audit evidence about the
amounts and disclosures in the financial statements.
(v)
That while selecting the procedures to be performed the auditor exercises
judgment, including the assessment of risks of material misstatements and
whether due to fraud or error.
(vi)
In making the risk assessment the auditor considers internal controls relevant to
fair presentation of financial statements in order to design audit procedures that
are appropriate in the circumstances but not for the purpose of expressing an
opinion on the effectiveness of the entity’s internal control.
(vii)
That an audit includes evaluation of the appropriateness of the accounting
policies used, the reasonableness of estimates and the overall presentation of
information in the financial statements.
(viii) The auditor believes that the audit evidence the auditor has obtained is sufficient
and appropriate to provide a basis for the auditor’s opinion.
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Al-Badr
(i)
Audit report should be addressed to the members of the company instead of
directors.
(ii)
In the introductory paragraph and opinion paragraph, the word “cash flow
statement” has been omitted.
(iii)
In the opinion paragraph, the words “its cash flows” have been omitted.
(iv)
The paragraph explaining the responsibilities of management and auditors has
been omitted. This paragraph should come after the introductory paragraph.
(v)
After the statement “We conducted our audit in accordance with the auditing
standards” in the audit responsibility paragraph, the words “as applicable in
Pakistan” have been omitted.
(vi)
In the auditor’s responsibility paragraph, the words “on test basis” have been
omitted.
(vii)
In the auditor’s responsibility paragraph, the word “all estimates....” should be
replaced with the words “significant estimates”.
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(viii) The opinion paragraph whether proper books of account have been kept by the
company as required under the Companies Ordinance, 1984, has been omitted.
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(ix)
In paragraph (b) of the opinion, the financial statements have incorrectly been
referred to have been drawn up in accordance with International Financial
Reporting Standards instead of the requirement i.e. approved accounting
standards as applicable in Pakistan.
(x)
Name of the engagement partner has not been mentioned.
Shahrukh and Company
(i)
In the introductory paragraph the word “Income and expenditure account” should
be replaced with “profit and loss account".
(ii)
In the introductory paragraph the phrase “to the best of our knowledge and
belief” is to be inserted before the phrase “were necessary for the purpose of an
audit”.
(iii)
In the responsibility paragraph the word “auditing standard” is to be replaced
with “accounting standard”.
(iv)
In the responsibility paragraph the phrase “of the fourth schedule” is to be
omitted.
(v)
At the end of responsibility paragraph the phrase; “Our responsibility is to audit
these statements” is to be replaced with the phrase “Our responsibility is to
express an opinion on these statements based on our audit”.
(vi)
In the scope paragraph the phrase “and limited” is incorrect and be omitted.
(vii)
In the scope paragraph the word “material” be added before the word
misstatement.
(viii) In the scope paragraph the phrase “on a test basis” should be added before the
phrase “evidence supporting the amounts and disclosures in the above said
statements”.
(ix)
In point (a) the phrase “as required by the Companies Ordinance 1984” be
added.
(x)
In para (b) point (ii) the phrase “was in accordance with the objects of the
Company” be replaced with “was for the purpose of the Company’s business”
(xi)
In para (b) point (iii) the phrase “was for the purpose of the Company’s
business” be replaced with “were in accordance with the objects of the
Company”
(xii)
In para (c) the phrase “of the profit or loss, its cash flows and changes in equity
for the year then ended”; be added at the end.
(xiii) The place of signing of accounts is to be mentioned after the signature of the
firm
(xiv) Name of the engagement partner has not been mentioned.
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The engagement partner
(a)
‰ The audit report will be modified on ground of limitation of scope.
‰ Either a qualified or disclaimer of opinion will be given depending upon the
materiality and pervasiveness of the matter.
‰ We may have to mention that “proper books of accounts as required by the
Companies Ordinance 1984 have not been kept by the Company”.
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(b)
There will be no impact on the audit report as the change of depreciation
method is a change in accounting estimate.
(c)
The auditor will include an other matter paragraph in the auditor’s report,
referring to the fact that the financial statements of Samarkand Limited for the
Previous year, were audited by another auditor, who expressed an un-modified
opinion on those financial statements.
Different audit clients
(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.
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‰ 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.
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Situations have arisen on different clients
(a)
(b)
(c)
(i)
If there are material inconsistencies in the additional disclosures the
auditor should discuss the reasons thereof with the management and ask
them to revise the other information or the financial statements, as may be
appropriate.
(ii)
If the revision of other information is necessary and the management
refuses to revise the same, the auditor shall communicate the matter to
those charged with governance and;
(iii)
Include in the auditor’s report an ‘other matter paragraph’ describing the
material inconsistencies, if they persist.
(iv)
If the revision of the draft financial statements is necessary and
management refuses to make the revision, the auditor shall consider
giving a qualified opinion or adverse opinion as may be appropriate.
(v)
The auditor should also consider that whether the supplementary
information that is not required by the applicable financial reporting
framework, is clearly differentiated from the audited financial statements.
(vi)
If it is not clearly differentiated, he shall ask the management to change
the way in which the unaudited supplementary information has been
presented.
(vii)
In case of disagreement in respect of the above, the auditor shall explain
in the auditor’s report that such supplementary information has not been
audited.
The amount of Rs. 9.6 million which is due from MIL is material to the
financial statements.
(i)
(ii)
With respect to job in progress ,if the auditor can satisfy himself that
management would be able to recover the cost of work in process from
another customer, he may conclude that a provision is not required in this
respect.
(iii)
In making the above decision the auditor should also consider the
expenses that are required to be incurred on the job, subsequent to year
end.
(iv)
The auditor should ask the management to provide for the loss of Rs. 9.6
million or any part thereof depending upon the estimated amount of
default, plus any further provision that may be necessary in respect of the
work in process. In case of management’s refusal, the auditor shall qualify
his report.
The auditor shall qualify the audit report by mentioning that investment of Rs.
150 million was not in accordance with the objects of the company with a
clarification that the object clause was amended a week before the issuance of
audit report, to include the said objective.
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Hafiz Limited
(i)
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.
(ii)
‰
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:
‰
x
That the amount paid was not for the purposes of the company’s
business.
‰
x
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.
‰
The indication of non-compliance with laws and regulations may require the
auditor to consider the potential financial consequences of the noncompliance, 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 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.
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An ‘emphasis of matter’ paragraph and an ‘other matter’ paragraph
(a)
Emphasis of Matter Paragraph and Other Matter Paragraph:
Emphasis of matter paragraph is a paragraph that is included in the auditor’s
report that refers to a matter appropriately presented or disclosed in the financial
statements that, in the auditor’s judgment, is of such importance that it is
fundamental to users’ understanding of the financial statements.
Other Matter paragraph is a paragraph that is included in the auditor’s report that
refers to a matter other than those presented or disclosed in the financial
statements that, in the auditor’s judgment, is relevant to the users’ understanding
of the audit, the auditor’s responsibilities or the auditor’s report.
(b)
(i)
Examples of circumstances which necessitate the inclusion of
emphasis of matter paragraph:
‰
An uncertainty relating to the future outcome of exceptional litigation or
regulatory action.
‰
Early application (where permitted) of a new accounting standard (for
example, a new International Financial Reporting Standard) that has a
pervasive effect on the financial statements in advance of its effective
date.
‰
A major catastrophe that has had, or continues to have, a significant
effect on the entity’s financial position.
‰
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 but has been appropriately disclosed.
(ii) Examples of circumstances which necessitate the inclusion of Other
matter paragraph:
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‰
Any matter which in the auditor’s opinion is relevant to user’s
understanding of the Audit
‰
Any matter which in the auditor’s opinion is relevant to User’s
Understanding of the Auditor’s responsibilities or the Auditor’s Report
‰
When the auditor is required to report on more than one set of
financial statements.
‰
When there is restriction on distribution or use of the auditor’s report.
MM Electronics (Private) Limited
(a)
Revaluation of Properties:
(i)
In accordance with IAS 16, Property, Plant and Equipment, if a policy of
revaluation is to be applied, it should be applied to all the non current assets
in a particular class of assets.
(ii) Since compliance with (i) above is not possible, the auditor should advise
the client to not to change the accounting policy and state the values of the
property at cost.
(iii) In case of disagreement the auditor may consider issuing a qualified report.
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(b)
(c)
(d)
Suit for damages:
(i)
The reliability of audit evidence provided by the legal advisor is high
because it has been obtained from an independent source outside the
entity. As management is also of the view that no liability exists at the
balance sheet date, therefore in the presence of legal advisor’s
confirmation a conclusion should not be drawn on the basis of manager’s
legal email.
(ii)
However, since there is inconsistency in audit evidence obtained and the
auditor is unaware of the context in which the manager (legal) sent the
email, he shall investigate the reasons thereof and may need modification
or addition to the audit procedures.
(iii)
The auditor should analyze the situation, in the light of IAS 37, Provisions,
Contingent Liabilities and Contingent Assets, and assess whether a
disclosure of the event as a contingent liability is required or not.
(iv)
If disclosure of contingent liability is required, and the client disagrees the
audit report may be qualified.
Warranty Provision:
(i)
The management’s claim that the amount cannot be measured reliably is
not correct because they were charging the customers at 25% above cost
prior to July 01, 2010 i.e. when there was no warranty on the sale of
television sets and hence they must be in a position to make a reliable
estimate based on their past experience and records available with them.
(ii)
If a provision is not made for the warranty then if the amount of provision
is material to the financial statements then the audit report should be
qualified
Non Disclosure of Earnings per share in the financial statements:
International Accounting Standards 33, Earnings per share does not apply to non
listed entities; therefore there is no requirement of disclosing earnings per share
in the financial statements.
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Ranjha Limited
(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.
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(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.
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Pervasive effects
(a)
Pervasive is a term used to describe the effects of misstatement on the financial
statements or the possible effects thereon if any misstatement remains
undetected due to the auditor’s inability to obtain sufficient appropriate audit
evidence.
Pervasive effects on the financial statements are those that, in the auditor’s
judgments:
(b)
(i)
are not confined to specific elements, account or items of the financial
statements,
(ii)
if so confined, represent or could represent a substantial proportion of the
financial statements or
(iii)
in relation to disclosures, are fundamental to user’s understanding of the
financial statements.
(i)
Issuance of bank guarantee after the year end does not require any
adjustment or disclosure. Therefore, there will be no effect on the audit
report on this issue.
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(ii)
The audit report shall state that “Zakat deductible at source under the
Zakat & Ushr Ordinance, 1980, was deducted and deposited in the
Central Zakat Fund established under section 7 of that Ordinance”.
(iii)
The auditor should consider the materiality of the amount. If the amount is
material, the auditor should express a qualified or adverse opinion.
(iv)
‰
‰
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The audit report shall mention the exception to the consistent
application of accounting policies and whether the auditor concurs
with it or not.
The financial statements shall be adjusted accordingly and the effect
of change in estimate shall be disclosed in the notes to the financial
statements unless the differences are material and auditor has
reasons to differ with the reviewed estimate. There would be no
impact on the audit report on this issue.
Audit report at the end of the audit
(a)
(b)
The statement of responsibility should state the following:
(i)
It is the responsibility of the auditor to express an opinion on the financial
statements.
(ii)
The audit was conducted in accordance with International Standards on
Auditing.
(iii)
Those standards require that :
‰
the auditor complies with ethical requirements.
‰
the auditor plans and performs the audit to obtain reasonable
assurance whether the financial statements are free from material
misstatement.
(iv)
That an audit involves performing procedures to obtain audit evidence
about the amounts and disclosures in the financial statements.
(v)
That while selecting the procedures to be performed the auditor exercises
judgment, including the assessment of risks of material misstatements and
whether due to fraud or error.
(vi)
In making the risk assessment the auditor considers internal controls
relevant to fair presentation of financial statements in order to design audit
procedures that are appropriate in the circumstances but not for the
purpose of expressing an opinion on the effectiveness of the entity’s
internal control.
(vii)
That an audit includes evaluation of the appropriateness of the accounting
policies used, the reasonableness of estimates and the overall
presentation of information in the financial statements.
(viii)
The auditor believes that the audit evidence the auditor has obtained is
sufficient and appropriate to provide a basis for the auditor’s opinion.
The situations in which a report is modified without affecting the auditor’s opinion
are as follows:
(i)
If the use of going concern assumption is appropriate but a material
uncertainty exists which was adequately disclosed in the financial
statements.
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(ii)
If there is a significant uncertainty (other than going concern or multiple
uncertainties), the resolution of which is dependent upon future events
and which may affect the financial statements.
(iii)
In case, other information attached with the financial statements are
inconsistent with the information in the financial statements.
How modification is presented:
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(i)
By adding an emphasis of matter paragraph to highlight an important
matter affecting the financial statements.
(ii)
The above paragraph is required to refer to the note to the financial
statements that more extensively discusses the matter.
(iii)
The paragraph should preferably be included after the paragraph
containing the auditor’s opinion but before the section on any other
reporting responsibilities.
(iv)
The emphasis of matter paragraph should ordinarily refer to the fact that
the auditor’s opinion is not qualified in this respect.
Iqra Industries Limited
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.
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Blue Sky Limited
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.
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Form 35A in the Companies
The report specified in form 35A in the in the Companies (General Provisions and
Forms) Rules, 1985 covers the following additional reporting responsibilities.
(i)
that proper books of accounts are being maintained by the company as
required by the Companies Ordinance, 1984.
(ii)
(iii)
that the balance sheet and the profit and loss account together with notes
thereonare in conformity with the Companies Ordinance, 1984 and in
agreement with the books of accounts and are further in accordance with the
accounting policies consistently applied.
Opinion as regards the following:
‰ whether expenditure incurred during the year was for the purposes of the
company’s business and
‰ whether the business conducted, investments made and expenditure
incurred during the year were in accordance with the objects of the
company.
(iv)
Opinion as regards the following:
‰ whether Zakat deductible at source under the Zakat and Usher Ordinance,
1980; was deducted and
‰ whether the zakat deducted (if any) was deposited in the Central Zakat
Fund.
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Written representations
Under the following situations, the auditor would have doubt as to the reliability of written
representation:
(a)
When the auditor has concerns about the competence, integrity, ethical values or
diligence of management, or about its commitment to or enforcement of these.
(b)
When written representations are inconsistent with other audit evidence obtained.
Course of action in situation (a)
(i)
The auditor shall determine the effect that such concerns may have on the
reliability of representations and audit evidence in general.
(ii)
If the auditor concludes that the risks related to management representations on
the financial statements is such that an audit cannot be conducted, the auditor may
consider withdrawing from the engagement
Course of action in situation (b)
(i)
The auditor may consider whether the risk assessment remains appropriate and, if
not, revise the risk assessment and determine the nature, timing and extent of
further audit procedures to respond to the assessed risks.
(ii)
If the matter remains unresolved, the auditor shall reconsider the assessment of
the competence, integrity, ethical values or diligence of management, or of its
commitment to or enforcement of these, and shall determine the effect that this
may have on the reliability of other representations and audit evidence in general.
(iii)
If the auditor concludes that the written representations are not reliable, the auditor
shall take appropriate actions, including determining the possible effect on the
opinion in the auditor’s report.
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Shahrukh and Co
(i)
In the introductory paragraph the word “Income and expenditure account”
should be replaced with “profit and loss account".
(ii)
In the introductory paragraph the phrase “to the best of our knowledge and
belief” is to be inserted before the phrase “were necessary for the purpose of
an audit”.
(iii)
In the responsibility paragraph the word “auditing standard” is to be replaced
with “accounting standard”.
(iv)
In the responsibility paragraph the phrase “of the fourth schedule” is to be
omitted.
(v)
At the end of responsibility paragraph the phrase; “Our responsibility is to audit
these statements” is to be replaced with the phrase “Our responsibility is to
express an opinion on these statements based on our audit”.
(vi)
In the scope paragraph the phrase “and limited” is incorrect and be omitted.
(vii) In the scope paragraph the word “material” be added before the word
misstatement.
(viii) In the scope paragraph the phrase “on a test basis” should be added before
the phrase “evidence supporting the amounts and disclosures in the above
said statements”.
(ix)
In point (a) the phrase “as required by the Companies Ordinance 1984” be
added.
(x)
In para (b) point (ii) the phrase “was in accordance with the objects of the
Company” be replaced with “was for the purpose of the Company’s business”
(xi)
In para (b) point (iii) the phrase “was for the purpose of the Company’s
business” be replaced with “were in accordance with the objects of the
Company”
(xii) In para (c) the phrase “of the profit or loss, its cash flows and changes in equity
for the year then ended”; be added at the end.
(xiii) The place of signing of accounts is to be mentioned after the signature of the
firm
(xiv) Name of the engagement partner has not been mentioned.
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Kazmi-Wassan
(a)
Purpose of a written representation letter
Written representations are a form of audit evidence. They are usually contained
in a letter, written by the company’s directors and sent to the auditor, just prior to
the completion of audit work and before the audit report is signed.
Representations are required for two reasons:
‰
firstly, so the directors can acknowledge their collective responsibility for
the preparation of the financial statements and to confirm that they have
approved those statements;
‰
secondly, to confirm any matters, which are material to the financial
statements where representations are crucial to obtaining sufficient and
appropriate audit evidence.
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In the latter situation, other forms of audit evidence are normally unavailable
because knowledge of the facts is confined to management and the matter is one
of judgement or opinion.
Obtaining representations does not mean that other evidence does not have to
be obtained. Audit evidence will still be collected and the representation will
support that evidence. Any contradiction between sources of evidence should,
as always, be investigated.
(b)
Matters
(i) Tiger’s Purr
The amount of the claim is material being 50% of profit before taxation.
There is also a lack of definite supporting evidence for the claim. The two
main pieces of evidence available are the claim from Tiger’s Purr itself and
the legal advice from Kazmi-Wassan’s solicitors. However, any claim
amount cannot be accurately determined because the dispute has not been
settled.
The directors have stated that they believe the claim not to be justified,
which is one possible outcome of the dispute. However, in order to obtain
sufficient evidence to show how the treatment of the potential claim was
decided for the financial statements, the auditor must obtain this opinion in
writing. Reference must therefore be made to the claim in the
representation letter.
Paragraph for inclusion in representation letter.
‘A legal claim against Kazmi-Wassan by Tiger’s Purr has been estimated at
Rs 4 million by Tiger’s Purr. However, the directors are of the opinion that
the claim is not justified on the grounds of breach of product specification.
No provision has been made in the financial statements, although
disclosure of the situation is adequate. No similar claims have been
received or are expected to be received.’
(ii)
Depreciation
This matter is unlikely to be included in the letter of representation because
the auditor appears to have obtained sufficient evidence to confirm the
accounting treatment. The lack of profit or loss on sale confirms that the
depreciation charge is appropriate – large profits would indicate overdepreciation and large losses, under-depreciation. The amount also meets
industry standards confirming the Kazmi-Wassan’s accounting policy is
acceptable. Including the point in the representation letter is inappropriate
because the matter is not crucial and does not appear to be based on
judgment or opinion. The only opinion here appears to be that of the auditor
– unless the ‘feelings’ can be turned into some appropriate audit evidence,
the matter should be closed.
(c)
Lack of representation letter
The auditor may take the following actions:
(i)
Discuss the situation with the directors to try and resolve the issue that the
directors have raised. The auditor will need to explain the need for the
representation letter again (and note that the signing of the letter was
mentioned in the engagement letter).
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(ii)
Ascertain exact reasons why the directors will not sign the letter. Consider
whether amendments can be made to the letter to incorporate the directors’
concerns that will still provide the auditor with appropriate and sufficient
audit evidence.
(iii)
The discussion must clearly explain the fact that if the auditor does not
receive sufficient and appropriate audit evidence, then the audit report will
have to be qualified.
The reason for the audit qualification will be uncertainty regarding the
amounts and disclosures in the financial statements.
(iv)
Even if the letter is subsequently signed, the auditor must still evaluate the
reliability of the evidence. If, in the auditor’s opinion, the letter no longer
provides sufficient or reliable evidence, then a qualification may still be
required.
100 RK Resourcing
(a)
Audit procedures to be used prior to the audit report being signed
‰
Reviewing procedures established by management to try and ensure that
subsequent events are identified.
‰
Reading minutes of the meetings of directors, the audit committee and
shareholders and enquiring into unusual items.
‰
Obtaining and reading the company’s latest interim accounts as well as any
budgets and cash flow forecasts.
‰
Obtaining additional evidence if possible from the company’s lawyers
concerning litigation and claims.
‰
Asking management as to whether any subsequent events have occurred
such as
x New borrowing commitments
x Significant sales of assets
x New shares or debentures issued
x Assets being destroyed by flood, fire etc. or impounded by the
government
x Unusual accounting adjustments made or being contemplated
‰
(b)
Checking whether any events have occurred that could call into question
the validity of the going concern assumption.
The three dates
15 August 20X3
(i)
Adjusting or non-adjusting?
The bankruptcy of a major customer provides additional evidence of
conditions existing at the end of the reporting period. The customer will not
be able to pay debts due, therefore receivables are overstated and the bad
debt expense in the profit and loss account is understated. An adjustment
for the amount of the receivable should be made in the financial
statements.
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(ii)
Auditor’s responsibility and audit procedures to be carried out
The bankruptcy of the major customer takes place after the end of the year
but before the financial statements and the auditor’s report are signed. As
the auditor’s report has not been signed, the auditor is responsible for
identifying material events that affect the financial statements. This means
that audit procedures should be carried out which are designed to identify
this event.
Specific procedures undertaken include the following:
‰
Confirming that the customer will not pay to a letter from the receiver
or similar authorised person.
‰
Confirming the amount due from the customer to invoices raised prior
to the year end, and if possible to a positive confirmation request.
‰
Auditing the adjustment to the financial statements decreasing the
receivable balance and increasing the bad debt write off in the profit
and loss account.
‰
Including the amount in the written representation letter to confirm no
other amounts are due from the customer.
1 November 20X3
(i)
Adjusting or non-adjusting?
The accidental release of toxic chemicals occurred after the reporting
period. Assuming that the inventory was not on the statement of financial
position at the year end, then the spill is indicative of conditions that arose
subsequent to the year end. No adjustment appears to be necessary.
However, the event may be significant in terms of the operations of the
company (a large legal claim could arise) and so disclosure of the event
would be expected.
(ii)
Auditor’s responsibility and audit procedures to be carried out
The accidental release of toxic chemicals takes place after the auditor’s
report has been signed but before the financial statements are sent to the
members. At this stage of the audit, the auditor does not have any
responsibility to perform procedures or make enquiries regarding the
financial statements. The management of RK Resourcing are responsible
for telling the auditor about any significant events, such as this one.
However, as the auditor is now aware of the event and this materially
affects the financial statements in terms of disclosure being required, the
auditor does have to discuss the event with management.
Specific procedures to be undertaken include the following:
‰
Obtain information concerning the chemical release from
management, reading local press and if possible the company’s
lawyers – the latter may be able to indicate whether there is any legal
liability.
‰
Discuss the appropriate accounting treatment with the directors,
confirming that disclosure is required in the circumstances.
‰
Read the disclosure note to confirm that the matter is adequately
explained in the financial statements.
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‰
Obtain an updated letter of representation from the directors
confirming that there are no other events requiring disclosure.
‰
Amend the auditor’s report to include an emphasis of matter
paragraph to draw attention to the full disclosure noted in the financial
statements.
‰
Date the new auditor’s report no earlier than the date of the amended
financial statements and update “active” subsequent events review to
that date.
30 November 20X3
(i)
Adjusting or non-adjusting?
The fire at an oil well means that RK Resourcing’s oil production and
presumably profits will fall in the next financial year.
The fire though does not provide additional evidence of conditions existing
at the end of the reporting period as at this time there was no indication that
this would occur. The event is therefore non-adjusting in the financial
statements. However, disclosure of the event should be made so that the
financial statements do not give a misleading position.
(ii)
Auditor’s responsibility and audit procedures to be carried out
The fire at an oil well takes place after the financial statements have been
issued. At this time, the auditor has no obligation to make any inquiry at all
regarding the financial statements. However, if the auditor becomes aware
of the event, then the potential effect on the auditor’s report must be
considered.
Specific procedures undertaken include the following:
‰
Checking the board minutes, insurance claims and similar documents
to ensure that the fire will be covered by insurance and there is no
contingent liability for replacing non-current assets or clearing up any
environmental damage.
‰
Enquiring of the directors how the members will be informed of the
situation.
‰
If the directors plan to re-issue the financial statements, ensure that
appropriate disclosure is made of the event, date the new auditor’s
report no earlier than the date of the amended financial statements
and update “active” subsequent events review to that date.
‰
If the directors do not intend to amend the financial statements, and
the auditor considers the matter to be material to understanding the
accounts, consider attempting to contact the members directly,
depending on the methods available in your country.
‰
If necessary, take legal advice to discuss what action can be taken
regarding the lack of disclosure.
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Answer bank: Objective test and long-form answers
101 Rake Enterprises
(a)
Comparison of directors’ and auditors’ responsibilities
(i)
Preparation of financial statements
The directors are normally required to prepare the financial statements of
the company using the appropriate law of their country and in accordance
with the International Accounting/Financial Reporting Standards
(IASs/IFRSs). The auditors are normally required to check or audit those
financial statements, again in accordance with the legislation of their
country and the International Statements on Auditing.
(ii)
Fraud and error
The directors are responsible for preventing and detecting fraud and error
in the financial statements, no matter how immaterial this may be. Auditors
are responsible for ensuring that the financial statements show a true and
fair view; in other words that the financial statements are materially correct.
Auditors are not required to detect immaterial fraud or error.
(iii)
Disclosure
The directors must ensure that there is adequate disclosure of all matters
required by statute or IASs/IFRSs in the financial statements. The auditor
will check that disclosure provisions have been complied with, and where
certain disclosures have not been made (e.g. ISA 550 regarding related
party transactions) provide this information in the audit report.
(iv)
Going concern
The directors are responsible for ensuring that the company will continue in
operational existence for the foreseeable future, and report to the members
in the published financial statements if this is unlikely to be the case. The
auditor will check the accuracy of the directors' workings and assumptions
and if these are considered incorrect or inappropriate, then the audit report
or opinion may be modified to bring the situation to the attention of the
members of the company.
(b)
Errors
The auditor’s responsibility paragraph does not meet the requirements of ISA 700
for the following reasons:
(i)
It does not follow the standard wording set out in ISA 700. For example, it
does not state at the outset that the auditor’s responsibitly is to express an
opinion on the financial statements based on his audit.
(ii)
The use of the term Auditing Standards is not clear, because the report
does not state which auditing standards have been used (e.g. ISAs). This
provides uncertainty regarding the actual standard of work performed.
(iii)
The assessment of estimates and judgements made by the directors
normally relates to material amounts only, rather than all of those estimates
and judgements. The correct wording from ISA 700 would state that the
procedures selected took into account ‘ the risks of material misstatement’
i.e. showing that the audit testing was probably focused on material
amounts only.
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(iv)
Stating that time was a factor in obtaining information and explanations for
the audit is not correct as this implies some factor which could have been
avoided and that the audit may therefore be incomplete. The auditor has to
plan the audit carefully and ensure that all the information and explanations
considered necessary are obtained to form an opinion, not simply stop work
when time runs out.
(v)
The auditor does not confirm that the financial statements are free from
material misstatement as this implies a degree of accuracy that the auditor
simply cannot provide. Making the statement could also leave the auditor
liable to claims from members or third parties should errors be found in the
financial statements later. Rather than make such a categorical statement,
the correct wording from ISA 700 states that the auditor provides
reasonable assurance that the financial statements are free from material
misstatement, which clearly implies that audit techniques are limited.
(vi)
The disclaimer regarding errors appears to be useful in that it limits the
auditor's liability. However, it does not belong in the auditor’s responsibility
paragraph as it appears to severely limit the auditor's responsibilities stating
that the directors are responsible for all errors. Management’s responsibility
is also clearly outlined in another section of the report, and this statement
also appears to extend those responsibilities making the audit report overall
less clear. This could also imply that the auditor has done little or no work.
102 ISRE 2400
(a)
Meaning and types of assurance
Meaning
‘Assurance’ means confidence. In an assurance engagement, an ‘assurance firm’
is engaged by one party to give an opinion on a piece of information that has
been prepared by another party. The opinion is an expression of assurance
about the information that has been reviewed. It gives assurance to the party that
hired the assurance firm that the information can be relied on.
Types
There are two main types of assurance:
‰
audit: this may be external audit, internal audit or a combination of the two;
and
‰
review.
An audit provides a high, but not absolute, level of assurance that the audited
information is free from any material misstatement. This is often referred to as
reasonable assurance. The opinion is usually expressed as positive assurance
that, in the opinion of the auditors, the financial statements do present fairly the
financial position and performance of the company.
A review is a ‘voluntary’ investigation. In contrast to the “reasonable” level of
assurance provided by an audit, a review into an aspect of the financial
statements would provide only a moderate level of assurance that the information
under review is free of material misstatement. The resulting opinion is usually
(although not always) expressed in the form of negative assurance. Negative
assurance is an opinion that nothing is obviously wrong: in other words, ‘nothing
has come to our attention to suggest that the information is misstated’.
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(b)
Review procedures
‰
The accountant should obtain an understanding of the entity’s business and
the industry in which it operates.
‰
The accountant should make enquiries into:
x
the entity’s accounting policies, practices and procedures, including the
preparation of financial statements;
x
material assertions in the financial statements that are subject to the
review;
x
decisions taken at board meetings and other meetings of the entity that
may affect the financial statements;
x
the completeness of the accounting records that were used to prepare
the financial statements.
‰
The accountant should use analytical procedures to identify unusual
relationships between items in the financial statements, and individual
items that appear unusual.
‰
Other procedures such as:
x
discussions with the company’s auditors;
x
obtaining representations from management;
x
considering the appropriateness of the accounting policies employed by
the entity;
x
making enquiries into subsequent events;
x
reviewing the statements as a whole.
103 Karim
In the above situation the auditor should carry out the following procedures:
(i)
He should inquire whether the management has changed its assessment of the
entity’s ability to continue as a going concern.
(ii)
If on account of the above inquiry or on account of his own assessment of the
situation the auditor concludes that the conditions cast significant doubts about
the entity’s ability to continue as a going concern, he should:
‰
Inquire the management about its future plans, the feasibility of these
plans and whether management believes that the outcome of such plans
will improve the situation.
‰
Consider the adequacy of the disclosure of such matters in the financial
information
(iii)
The auditor should consider whether the note given by the management
adequately discloses the uncertainty as regards the entity’s ability to continue
as a going concern.
(iv)
If he assesses that the note is adequate, the auditor should give an emphasis
of the matter paragraph.
(v)
If adequate disclosure is not made in the interim financial information, the
auditor should express a qualified or adverse opinion, as appropriate. The
report should include specific reference to the fact that there is such a material
uncertainty.
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104 IFI
Procedures which an auditor may perform to update the understanding of the entity
and its environment for an engagement to review interim financial information
includes the following:
(a)
Reading the documentation, to the extent necessary, of the preceding year’s
audit and reviews of prior interim period(s) of the current year and corresponding
interim period(s) of the prior year, to enable the auditor to identify matters that
may affect the current-period interim financial information.
(b)
Considering any significant risks, including the risk of management override of
controls that were identified in the audit of the prior year’s financial statements.
(c)
Reading the most recent annual and comparable prior period interim financial
information.
(d)
Considering materiality with reference to the applicable financial reporting
framework as it relates to interim financial information to assist in determining
the nature and extent of the procedures to be performed and evaluating the
effect of misstatements.
(e)
Considering the nature of any corrected material misstatements and any
identified uncorrected immaterial misstatements in the prior year’s financial
statements.
(f)
Considering significant financial accounting and reporting matters that may be of
continuing significance such as material weaknesses in internal control.
(g)
Considering the results of any audit procedures performed with respect to the
current year’s financial statements.
(h)
Considering the results of any internal audit performed and the subsequent
actions taken by management.
(i)
Inquiring of management about the results of management’s assessment of the
risk that the interim financial information may be materially misstated as a result
of fraud.
(j)
Inquiring of management about the effect of changes in the entity’s business
activities.
(k)
Inquiring of management about any significant changes in internal control and
the potential effect of any such changes on the preparation of interim financial
information.
(l)
Inquiring of management of the process by which the interim financial
information has been prepared and the reliability of the underlying accounting
records to which the interim financial information is agreed or reconciled.
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2015
AUDIT AND
ASSURANCE
QUESTION BANK