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MIA QE/SEPT 2010
QUESTION 1
a)
Independence in auditing means taking an unbiased viewpoint in the audit process
Users of financial statements would be unlikely to rely on the statements if they
believed that auditors were biased in issuing their audit opinions.
(2 marks)
b)
Reasons why the situations could create threats to auditor independence are:
i. Direct financial interests in an audit client by the partner in charge may create selfinterest threat.
Safeguards:
Dispose of the direct financial interest prior to the individual becoming a
member of the assurance team;
Remove the member of the assurance team from the assurance engagement (if
possible).
ii. A close business relationship between the audit firm and the assurance client or its
management which involves a commercial or common financial interest may create
self-interest and intimidation threats.
Safeguards
Terminate the business relationship;
Reduce the magnitude of the relationship so that the financial interest is
immaterial and the relationship is clearly insignificant; or
Refuse to perform the assurance engagement.
iii. Family and personal relationships between a member of the assurance team and a
director, an officer or certain employees, depending on their role in management
decisions, of the assurance client, may create self-interest, familiarity or intimidation
threats.
Safeguards
Removing the individual from the assurance team;
Where possible, structuring the responsibilities of the assurance team so that
the professional does not deal with matters that are within the responsibility of
the immediate family member; or
Policies and procedures to empower staff to communicate to senior levels within
the firm any issue of independence and objectivity that concerns them.
iv. The provision of services by the audit firm to a financial statement audit client that
involve the design and implementation of financial information technology systems
that are used to generate information forming part of a client’s financial statements
may create a self-review threat.
Safeguards
The audit client acknowledges its responsibility for establishing and monitoring a
system of internal controls;
The audit client designates a competent employee, preferably within senior
management, with the responsibility to make all management decisions with
respect to the design and implementation of the hardware or software system;
The audit client makes all management decisions with respect to the design and
implementation process;
The audit client evaluates the adequacy and results of the design and
implementation of the system; and
The audit client is responsible for the operation of the system (hardware or
software) and the data used or generated by the system.
(1 mark for explanation + 1 mark for safeguard x 4 = 8 marks)
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(Total: 10 marks)
QUESTION 2
A (i)
In an audit engagement, the auditor provides a high, but not absolute, level of
assurance that the information subject to audit is free of material misstatement. This
is expressed positively in the audit report as reasonable assurance.
A (ii)
In a review engagement, the auditor provides a moderate level of assurance that the
information subject to review is free of misstatement. This is expressed in the form of
negative assurance.
A (iii) For agreed - upon procedures, as the auditor simply provides a report of the factual
findings, no assurance is expressed. Instead, users of the report assess for
themselves the procedures and findings reported by the auditors and draw their own
conclusions from the auditor’s work.
(3 x 3 marks = 9 marks)
B. The types of assurance engagements that have significant market potential for public
accounting firms include:
Risk assessment. Assurance that an entity’s profile of business risks is comprehensive
and evaluation of whether the entity has appropriate systems in place to effectively
manage those risks.
Information system reliability. Assurance that an entity’s internal information systems
provide reliable information for operating and financial decisions.
Business performance measurement.
Assurance that an entity’s performance
measurement system contains relevant and reliable measures for assessing the degree
to which the entity’s goals and objectives are achieved or how its performance compares
to competitors.
Electronic commerce. Assurance that systems and tools used in electronic commerce
provide appropriate data integrity, security, privacy, and reliability.
Internal control. Assurance that ICS are adequate and effective to help reducing the risk
of material misstatement in the Financial Statements.
Prospective Financial Information. Assurance as the Result Forecast based on any
financial statements assumptions.
(any 3 x 2 marks = 6 marks)
(Total: 15 marks)
QUESTION 3
A (i) Three (3) assertions for tangible fixed assets - Plant, Property and Equipment
Completeness – ensure that all fixed assets are recorded in the fixed asset register by
agreeing a sample of assets physically verified back to the register.
Existence – ensure fixed 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
documentation of ownership for example, purchase invoice.
Presentation and disclosure assertions – ensure all necessary disclosures have been
made by reviewing the financial statements and ensure fixed assets are correctly
categorized in those financial statements.
( Any 3 x 1 mark = 3 marks)
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A(ii) Substantive procedures for plant, property and equipment
1. Check opening balances to last year’s working paper.
2. Inspect a sample of plant, property and equipment selected from the fixed asset register
3.
4.
5.
6.
7.
8.
9.
10.
11.
to verify its existence.
For a sample of additions in the year, trace to purchase invoices to verify cost.
Inspect repair & maintenance account to identify any assets, which should have been
capitalized in the year.
Apply rate of depreciation to the average balance on the account for the year. Compare
actual depreciation charge for the year. Investigate any significant differences.
Agree balance in fixed asset register to the general ledger.
For any disposal or acquisition during the year, ensure that appropriate authorization and
authority limits have been complied with.
Trace cash proceeds received to bank statements to verify selling price for any disposal
during the year and recalculate profit or loss on disposal.
Perform impairment test and review
Check approvals for write off during the year.
Check the provisions of impairment closing balance to the GL’s amounts.
(any 10 x 1 mark = 10 marks)
B (i) The substantive audit procedures on goodwill
1. Critically review the contract for purchase for the values placed on assets.
2. Trace the total in the account analysis for each significant acquisition to the general
ledger.
3. Trace the opening balance to the previous year’s working papers.
4. Examine supporting documents for evidence of continued ownership of acquisitions
that resulted in excess costs as compared to the fair value of net assets
5. Review the reasonableness and consistency of application of the method of
amortization.
6. Recompute amortization
7. Determine the carrying amount does not exceeds amount properly allocated to future
periods
8. Trace amounts amortized during the period to the related general ledger expense
accounts
9. Examine evidence supporting additions and reductions during the year
10. Ascertain whether goodwill and amortization are properly described and classified in
the financial statements and disclosed in the notes to the accounts
11. Review regularly the value of the goodwill and if there is a permanent diminution
ensure that the unamortized balance is written down immediately
12. Ensure that no amount has been attributed to internally generated goodwill.
(Any 8 x 1 mark = 8 marks)
B (ii) Patents and trademarks
1. Trace opening balances to previous year’s working papers.
2. Inspect the purchase agreements, assignments and any other supporting evidence
for patents and trademarks acquired during the year.
3. Verify the amount capitalised with supporting costing records on patents developed
by the company.
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4. Verify payment of annual fees to patents agents.
5. Review regularly the value of the patent and trademarks. When necessary, to
recommenced for write offs.
(any 4 x 1 mark = 4 marks)
(Total: 25 marks)
QUESTION 4
i.
Statistical sampling is any approach to sampling that involves random selection of
sample, and the use of probability theory to evaluate sample results, including
measurement of sampling risk.
Non-statistical sampling is an approach to sampling where the auditor does not use
statistical methods and draws a judgmental opinion about the population.
(4 Marks)
ii.
Sampling risk faced by auditors in tests of controls:
• Risk of under-reliance. (1/2 mark)
The risk that, although the sample result does not support the auditor’s
assessment of control risk, the actual compliance rate would support such an
assessment. (1 mark)
•
Risk of over-reliance (1/2 mark)
The risk that, although the sample result supports the auditor’s assessment of
control risk, the actual compliance rate would not support such an assessment. (1
mark)
Sampling risk faced by auditors in substantive procedures:
• Risk of incorrect rejection (1/2 mark)
The risk that, although the sample result supports the conclusion that a recorded
account balance or class of transactions is materially misstated, in fact it is not
materially misstated. (1 mark)
•
Risk of incorrect acceptance (1/2 mark)
The risk that, although the sample result supports the conclusion that a recorded
account balance or class of transactions is not materially misstated, in fact it is
materially misstated.
(6 marks)
(Total: 10 marks)
QUESTION 5A
i.
Audit risk is the risk the auditor is willing to accept that the financial statements may
be materially misstated after the audit is completed and an unqualified opinion has
been given.
Inherent Risk
This is the susceptibility of an assertion to a misstatement that could be material,
either individually or when aggregated with other misstatements, assuming that there
were no related controls.
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Control Risk
This is the risk that a misstatement that could occur in an assertion and that could be
material, either individually or when aggregated with other misstatements, will not be
prevented, or detected and corrected, on a timely basis by the entity’s internal control.
Detection risk
This is the risk that the auditor’s procedures fail to detect material misstatements
exceeding the tolerable amount, should such errors exist.
Inherent risk and control risk are the entity’s risks and they exist independently of the
audit of the financial statements. The auditor is required to assess both of these
components of audit risk. At planning stage, the model can be used to determine
detection risk and therefore the appropriate level of substantive procedures to be
carried out.
(4 marks)
ii.
Reasons why audit risk cannot be eliminated:
•
The use of testing/sampling
In most cases, auditor performs his audit on a test basis. Due to the use of test
checking, there is a risk that the auditor may draw a wrong conclusion about
the financial statement
•
The inherent limitation of internal control system
Auditor relies on the internal control system and accordingly decides the
nature, timing and extent of audit procedures. However, the internal control
has inherent limitations which affect the effectiveness of the internal control
system.
•
Nature of audit evidence
Audit evidence is persuasive rather than conclusive. As a result there is a risk
that the conclusion drawn is inappropriate.
•
Auditing is not objective.
The fact that auditing is not objective requires use of judgments and as a
result wrong judgments could be made by the auditor.
(Any 3 points x 2 marks = 6 marks)
B.i.
The purpose of risk assessment procedures are:
• To assist auditor in obtaining an understanding of the entity and its
environment, including internal control system
• To provide basis relating to the auditor’s risk assessment of a material
misstatement in the client’s financial statements
• To determine whether any of the risks identified are, in the auditor’s judgment,
significant risks
• To determine nature, timing and extent of audit procedures to be performed
• To obtain initial evidence regarding the classes of transactions and account
balances and the operating effectiveness of the client’s internal controls
• To assist auditor to identify risks in other areas such as being associated with
a particular client or not being able to follow ethical guidelines
(Any 4 points X 1 mark each = 4 marks)
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ii.
Identification of
inherent risk matters
(1/2 mark each)
New managing director
(MD) and financial
director (FD)
Five hotels in various
locations
Computer-based
accounting system with
remote terminals
Remuneration package
bonuses are based on
profits
New hotel was
constructed during the
year
Extension made to
existing hotels
MIA QE/SEPT 2010
Explanation of risk matters (Max 1 mark each)
Combination of experienced but aggressive and assertive MD with
unqualified and inexperienced FD could lead to misstatements in the
financial statements
Profits could be materially overstated/understated and the financial
statements could contain material errors
Information forwarded to head office accounts department could be
incomplete or erroneous due to the spread of operations; company assets
could be misappropriated
Material errors or omissions may exist in revenue and expenditure figures;
non-current assets could be overstated
Inaccurate or incomplete information could be forwarded to head office due
to remoteness of IT operations
Material errors or omissions may exist in revenue or expenditure figures
Bonuses to which employees are not entitled could be paid
Both profits and entitlement to bonus payment could be overstated
Significant amounts of expenditure during the
misappropriated, incorrectly classified, or overstated
year
could
Non-current asset values could be overstated, taxation liabilities could be
incorrectly stated, current liabilities could be understated
Significant amounts of expenditure during the year could be incorrectly
classified or overstated; large sums of unauthorized expenditure could be
incurred.
Expenditure may have been incorrectly classified between capital
expenditure, repairs, and maintenance expenditure.
(Total: 20 marks)
QUESTION 6
a.
be
Auditor’s responsibilities for identifying subsequent events.
31 December 2009 to 21 March 2010
The auditor is responsible in identifying material subsequent event affecting financial
statement by performing audit procedures during this period.
This is because the event happened after the balance sheet date and before the
financial statement and the audit report is being signed.
22 March 2010 to 23 May 2010
Auditor is not responsible to perform audit procedures to ensure all material
subsequent events have been identified.
This is because the date falls after the financial statement and the audit report have
been signed before the financial statement issued.
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b.
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MIA QE/SEPT 2010
Event on 15 February 2010, Bankruptcy of major customer
•
Event is an adjusting event because it provides further evidence on condition
existing at balance sheet date.
•
The information on bankruptcy of existing customers reflects the actual
receivables valuation collectible at the financial year end of 31 December
2009.
•
Adjustment is to be made on receivables in balance sheet on 31 December
2009 by recognizing the bad debts and decreasing the amount of receivables.
If adjustments are not made will result in receivable and profit being
overstated
(Any 2 points for 2 marks)
Event on 1 May 2010, Accidental release of toxic fertilizers chemicals
•
Event is a non-adjusting event as it provides evidence on the condition which
occur after the balance sheet date
•
As the impact of the accident is significant and material which might be
subject to legal action by the authorities and by the residents, disclosure on
the event and its potential impact need to be made in the notes during the
financial year end
c.
Audit procedures that should be carried out.
Event on 15 February 2010, Bankruptcy of major customer
•
Review letter from lawyer and the receiver to confirm the receivership.
•
Compare the amount due from the customer as informed against the invoices
issued to confirm the amount is accurate
•
Obtain management representation letter on the amount outstanding to
confirm there is no more amount outstanding from the customer.
•
Check the adjustment made by management in financial statement by
confirming bad debts have been increased and receivables decreased.
(4 marks)
Event on 1 May 2010, Accidental release of toxic fertilizers chemicals
Audit procedures to be carried out upon notification of the event by management are
as follows:
•
Inquire management and review local news release around the date to
confirm such event occurred
•
Inquire company’s lawyer about the incidence to confirm whether there’s any
potential legal action that might be or already faced by the company from the
authorities and residents. Assess the potential outcome whether remote,
probable or possible
•
Read the disclosure note made by the company on the matter to ensure it is
being disclosed and complete.
•
Obtain the management representation letter to confirm that there is no more
outstanding subsequent event that has yet to be disclosed
•
The seriousness of the impact of the pollution needs to be investigated. The
auditor should seek confirmation from the company’s lawyer on whether there
is any breach of environmental act which can result in the company’s
operation be suspended or closed.
(Any 4 procedures for 4 marks)
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d.
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MIA QE/SEPT 2010
Should the management refused to take into consideration the event on 15 February
2010 and on 1 May 2010 in accordance with FRS 110 requirement, the auditor is to
issue the following audit report:
15 February 2010:
The auditor is to issue a qualified opinion “except for” on the ground of
disagreement with management for not recognizing the write off of the 20% of the
trade receivable as bad debt in the statement of financial position for the year ending
31 December 2009.
The amount is considered material and can lead to overstatement of receivable and
profit by 20% unless the effect is pervasive in which adverse opinion is appropriate.
1 May 2010:
The auditor is to issue a qualified opinion “except for” on the ground of
disagreement with management for not disclosing the event and its potential impact in
the notes during the financial year end when the potential impact of the nondisclosure is considered material to the financial statement.
Furthermore confirmation on whether there is any legal action taken by the residents,
its potential outcome need to be discussed with the lawyer. Should the matter be
considered as material as it can affect the going concern status of Fitri, the auditor is
to issue a qualified opinion “except for” on ground of disagreement with management
for not disclosing the fact and potential impact of the chemical released unless the
effect is pervasive in which adverse opinion is appropriate.
(4 marks)
(Total: 20 marks)
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