AUDITING
Suggested Answers
Intermediate Examinations – Autumn 2013
A.1
(a)
Steps that an auditor should take in order to establish whether preconditions of
an audit are present:
In order to establish whether the preconditions for an audit are present, the auditor
shall:
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(b)
Determine whether the financial reporting framework to be applied in the
preparation of the financial statements is acceptable; and
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, including where relevant their
fair presentation;
 For such internal controls as management and, where appropriate, those
charged with governance determine is necessary to enable the preparation
of financial statements that are free from material misstatement, whether
due to fraud or error; and
 To provide the auditor with:
— Access to all information of which management is aware that is
relevant to the preparation of the financial statements such as records,
documentation and other matters;
— Additional information that the auditor may request from
management for the purpose of the audit; and
— Unrestricted access to persons within the entity from whom the auditor
determines it necessary to obtain audit evidence.
Methods of Collecting Audit Evidence:
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Physical Examination:
Physical examination means physical verification of an asset, such as stocks,
investment certificates and fixed assets, as an evidence of its existence and its
condition.
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Third party confirmation:
Confirmation of an amount or other information shown in the client’s records
by an independent third party provides a reliable evidence of the existence of
the amount and correctness of the information, as the case may be. For
example, receivables, payables, contingent liabilities, stock with third parties
etc.
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Examination of original records:
Original records like ownership documents, bills, notices etc. provide a reliable
and conclusive evidence of the legal claims, transactions, balances etc.
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Recomputation:
Recomputation technique is applied to prove arithmetical accuracy of a
transaction and to verify that the computation is in accordance with the rules,
procedures and acceptable practices. The areas where recomputation
techniques are generally applied include depreciation computations, bonus
calculations, provisions etc.
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Enquiry:
Enquiry consists of seeking information from knowledgeable persons, both
financial and non-financial, within the entity or outside the entity. The enquiry
may not provide conclusive audit evidence but it may give some form of clue
which may lead to further verification.
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AUDITING
Suggested Answers
Intermediate Examinations – Autumn 2013
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A.2
Analytical Procedures
Analytical procedures consist of evaluations of financial information through
analysis of plausible relationships among financial as well as non-financial
data. Analytical procedures also encompass investigation of identified
fluctuations or relationships that are inconsistent with other relevant
information or that differ from expected values by a significant amount.
(a)
The Auditor is generally not in a position to obtain evidence from an external
source in relation to warranty provisions.
Hence the written representation, whilst being an entity generated source of
evidence, would still be useful as there are few other alternatives.
Steps to take if written representation on warranty provision is not provided
 If management does not provide the requested written representation on
the warranty provision the auditor should discuss the matter with
management to understand why they are refusing.
 In addition, the auditor should re-evaluate the integrity of management and
consider the effect that this may have on the reliability of other
representations (oral or written) and audit evidence in general.
 The auditor should then take appropriate actions, including determining
the possible effect on the audit opinion.
Impact on audit report
Unless the auditor is able to obtain sufficient appropriate evidence* to conclude
that the warranty provision is free from material misstatement, a modified
audit opinion will be required, as discussed below:
 If the warranty provision is material but not pervasive then a qualified
opinion would be appropriate, a disclaimer of opinion would be
appropriate if the effect of misstatement is both material and pervasive.
(b)
When the auditor of a parent entity is also the auditor of a subsidiary, the factors
that may influence the decision whether to send a separate engagement letter to the
subsidiary include the following:
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A.3
(a)
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who appoints the subsidiary’s auditor;
whether a separate auditor’s report is to be issued on the subsidiary’s financial
statements;
legal requirements in relation to audit appointments;
degree of ownership by parent; and
degree of independence of the subsidiary’s management from the parent
company.
There is a lack of segregation of duties in PNTL which increases the risk of
material misstatement at the assertion level.
The request of management of not sending confirmation request to GL must be
supported by strong verifiable reasons.
Recovery of Rs. 40 million from GL may not provide sufficient appropriate
evidence in view of the serious lack of segregation of duties.
Saleem should insist for direct positive confirmation unless the client has
significant and verifiable reasons to not to send the confirmation request.
If Saleem concludes that management’s refusal to allow him to send a
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AUDITING
Suggested Answers
Intermediate Examinations – Autumn 2013
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(b)
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A.4
(a)
confirmation request is unreasonable and subsequent recovery does not provide
sufficient appropriate audit evidence, he should communicate with those
charged with governance.
If those charged with governance donot take corrective measures then saleem
would need to determine the implications on the audit and audit opinion.
The amount of transaction is indicative of the fact that the management’s
contention regarding negligence is correct and the omission was not intentional.
However, the failure to detect this omission is indicative of a lack of appropriate
internal control.
Therefore, in such a situation, the auditor would need to reconsider his
assessment of risk of material misstatement and modify planned audit
procedures accordingly.
The auditor shall perform the audit procedures designed to obtain sufficient
appropriate audit evidence that all events occurring between the date of the financial
statements and the date of the auditor’s report that require adjustment or disclosure
in the financial statements have been identified*.
However, the auditor is not expected to perform additional audit procedures on
matters to which previously applied audit procedures have provided satisfactory
conclusions.
(b)
The following procedures will help the auditor in identifying ‘subsequent events’
that require either adjustment or disclosure in the financial statements. :
(i)
(ii)
(iii)
(iv)
(v)
A.5
(a)
The credit card balance of Rs. 100,000 is within the limit allowed by the Companies
Ordinance, 1984 i.e. Rs. 500,000 outstanding towards a credit card issuer. However,
because Mr. Khan has obtained personal finance from GBL, and no maximum limit
has been specified in this regard by the Companies Ordinance, 1984 he will be
deemed indebted to GBL. and hence Khan and Company cannot be appointed as
auditors of GBL.
(b) 
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A.6
Review existing procedures (if any) laid down by the management to identify
these events.
Study minutes of the meetings of the Members, Board of the directors and
other important executive committees (if any) held after the balance sheet date
and enquire about the matters which may be relevant in this regard.
Discuss with key officials on matters such as company’s policy on marketing
of new products, price structure, major sales orders booked or cancellation of
sales orders and loss of major customers, if any, new borrowings, capital
commitments, fresh guarantees, outcome of pending law suits and any change
in accounting policies etc.
Ascertain the status of litigations, claims etc. against the company from its
legal advisors.
Read the entity’s latest available budgets, cashflow forecasts and other related
management reports for periods after the date of the financial statements.
Saima has rightfully disposed off the shares held by her on appointment of
Abid’s firm as auditors of SL.
Holding of shares by Father of Abid and association of Saima as General
Manager Marketing in SL is not in contravention of any of the requirements of
the Companies Ordinance, 1984 and hence appointment of Abid’s firm as an
auditor is valid.
The matters which are required to be included in the audit report issued under the
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AUDITING
Suggested Answers
Intermediate Examinations – Autumn 2013
Companies Ordinance, 1984 but are not specified by ISA 700 are as follows:
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It is mentioned that the Auditor has obtained all the information and explanations
which to the best of his knowledge and belief, were necessary for the purpose of his
audit.
It is mentioned that the management is responsible to present the financial
statements in conformity with the requirements of the Companies ordinance, 1984.
Whether the financial statements give the information required by the Companies
Ordinance, 1984, and in the manner so required.
Opinion relating to maintenance of proper books of account as required by the
Companies Ordinance, 1984.
Opinion whether the balance sheet and profit and loss account are drawn-up in
conformity with the Companies Ordinance, 1984;
Opinion whether the balance sheet, profit and loss account and notes are:
— in agreement the books of account and
— are further in accordance with accounting policies consistently applied;
Opinion whether the expenditure incurred during the year was for the purpose of the
Company’s business; and
Opinion whether the business conducted, investments made and the expenditure
incurred during the year were in accordance with the objects of the Company
Opinion as regards deduction and deposit of Zakat.
Matters which are required to be mentioned in the Audit Report prescribed under the
ISA 700 but not mentioned in Audit Report under the Companies Ordinance, 1984:
A.7
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Statement that the auditor has complied with ethical requirements.
Auditor considers internal control relevant to the entity’s preparation and fair
presentation of the financial statements in order to design audit procedures, but not
for the purpose of expressing an opinion on the effectiveness of the entity’s internal
control.
(a)
(i)
Selecting all items
Selecting all items of a population for examination may be appropriate in the
following situations:
 The population constitutes a small number of large value items;
 There is a significant risk and other means do not provide sufficient
appropriate audit evidence; or
 The repetitive nature of a calculation or other process performed
automatically by an information system makes a 100% examination cost
effective.
(ii) Selecting specific items
The auditor may decide to select specific items for examination in the following
circumstances:
 High value or key items:
If the selected items are of high value, or exhibit some other characteristic,
for example, items that are suspicious, unusual, particularly risk-prone or
that have a history of error .
 All items over a certain amount:
The auditor may decide to examine items whose recorded values exceed a
certain amount so as to verify a large proportion of the total amount of a
class of transactions or account balance.
 Items to obtain information:
Where the auditor intends to obtain information about matters such as the
nature of the entity or the nature of transactions.
(b)
In deciding whether to select specific items from a population, the factors that may
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AUDITING
Suggested Answers
Intermediate Examinations – Autumn 2013
be relevant include:
 the auditor’s understanding of the entity,
 the assessed risks of material misstatement, and
 the characteristics of the population being tested.
A.8
(i)
Internal Controls
 Segregation of duties
There is a proper segregation of duties in respect of following functions:
— Authorization of purchase requisitions
— Initiation of purchase
— Stock keeping
— Stock recording
Test of controls
 Ensure that the person carrying out the procedures does not have incompatible
functions.
 Enquire about what happens when any of the persons carrying out a particular
function is on leave.
(ii) Internal Controls
 Authoristaion
Stock purchase requisitions, purchase orders and GRN’s are duly authorized.
Test of controls
Select suitable number of documents using appropriate sampling techniques and
check whether each document is duly authorized as mentioned in the purchase
procedures.
(iii) Internal Controls
 Completeness
Purchase orders and Goods Receiving Notes are pre-numbered.
Test of controls
Check files of copies of purchase orders and GRN’s and unused purchase orders/
GRNs to ensure that they pre-numbered and are arranged in serial.
(iv) Internal Controls
 Accuracy
The quality and condition of stock received are investigated on receipt thereof.
Test of controls
 Investigate a sample of goods-received notes and substantiate that the quantity
and condition of stock are noted thereon.
 Observe the storekeeper performing these duties.
(v) Internal Controls
 Documentation
Matching of purchase orders with purchase requisitions.
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Comparison of GRN with Purchase Orders.
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Tests of controls
Select suitable number of documents using appropriate sampling techniques and
check whether each document is duly matched/ compared as mentioned in the
purchase procedures.
Page 5 of 6
AUDITING
Suggested Answers
Intermediate Examinations – Autumn 2013
A.9
(a)
The purchase of goods and services from an assurance client by the firm would not
generally create a threat to independence unless the transaction is not in the normal
course of business and not on an arm’s length basis.
The creation of self interest threat or otherwise shall depend upon the nature of the
transaction and its magnitude.
If the threat created is other than clearly insignificant, safeguards should be
considered and applied as necessary to reduce the threat to an acceptable level.
Such safeguards might include:
 Discontinue the practice of staying in hotels managed by AHL or reducing its
frequency so as to reduce the magnitude of the billing.
 Ensure that the charge out rates are in accordance with those applicable to
normal customers.
 Ensure that the dealing is at arm’s length and no undue advantage is secured by
the firm.
 Discussing (informing) the issue with those charged with governance.
(b)
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As a result of inheritance of shares, a self-interest threat has been created. The
following safeguards should be applied to eliminate the threat or reduce it to an
acceptance level:
— The financial interest may be disposed of at the earliest practical date; or
— The concerned staff may be removed from the assurance engagement.
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During the period prior to disposal of the financial interest or the removal of the
individual from the assurance team, consideration should be given to whether
additional safeguards are necessary to reduce the threat to an acceptable level.
Such safeguards might include:
— Discussing the matter with those charged with governance, such as the
audit committee; or
— Involving an additional chartered accountant to review the work done, or
otherwise advise as necessary.
(THE END)
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