Fundamentals Skills Module - Mock 1

Audit and Assurance

(International)
F8AA-MK1-X08-A

Answers & Marking Scheme

Accountancy Tuition Centre Ltd

ATC
INTERNATIONAL
1 TOPNOTCH4U
(a) Sales system report
(1 mark for each weakness, effect and recommendation total of 3 marks per matter. The solution provides a guideline of the detail expected. If
less, only award a maximum of mark per element.)
Weakness
The detail of the orders placed by customers
through the website is taken directly from the
web page to the orders file rather than being
verified through the product file first.
Despatch notes are not pre-numbered and only
the customers copy is authorised by the
despatch manager.
This effectively prevents completeness and
authorisation checks to be made to ensure all
orders despatched are valid, accounted for and
entered correctly into the system.
No completeness or accuracy checks are made
when the order data is transferred from the
orders file to the legacy system. Errors made
when transferring the data may not therefore
be identified.
Accountancy Tuition Centre (International Holdings) Ltd 2008
Potential effect of weakness
It is possible that data on the webpage may be
altered. In particular the sales price may be
lowered by an experienced hacker and this
price will then be used as the basis of charging
the customer, resulting in lost income.
The despatch note used by the despatch
manager may be lost and the goods not sent.
With the second copy of the note being sent to
the accounts department, it is possible that a
customer will be charged for goods not
received.
Additionally, if the second copy sent to the
accounts department is lost, then goods may
be sent to customers but no charge made.
In copying the converted data via the Zip drive
there is a possibility that some data may
corrupt. The sales report used to update the
inventory records may therefore be inaccurate.
2
Recommendation
The web program should be amended so that
when the customer accepts the shopping
basket order, key data will be transferred from
the product data base to the order file. This
will ensure that the sales price is the real price
and not the price as manipulated by the
customer.
Despatch notes should be pre-numbered by the
system.
As goods are despatched, the second copy
should be authorised by the despatch manager
as goods sent.
A completeness check can then be carried out
by the accounts department as well as a check
that each note is authorised.
Batch total controls should be used to check
for the completeness and validity of the data
transferred between the two systems.
In addition, the original sales order data should
be backed up (before conversion) and archived
at the end of each day. This will provide the
ability to restore any data that becomes
corrupted during the conversion and transfer
process.
 Weakness
The inventory programme is manually updated
from the product sales report. There is a risk
that the data will not be accurately entered.
The customers credit card is charged after
despatch of goods to the customer, meaning
that goods are already sent to the customer
before payment is authorised.
There is no check to verify the inventory level
at the point of customer order nor any formal
system to inform customers of a delay in
shipping their order.
The system does not produce a separate sales
invoice for despatch to the customer. A
despatch note is produced and the customers
credit card charged, but no VAT invoice is
produced and sent to the customer.
Accountancy Tuition Centre (International Holdings) Ltd 2008
Potential effect of weakness
The inventory records may not accurately
reflect the physical inventory held due to
inaccurate sales reports and/or inaccurate data
entry from the reports.
Incorrect inventory records may result in
orders not being placed to replace low levels
of inventory.
The company will not be paid for goods
despatched where the credit company rejects
the payment request, thus incurring a bad debt.
It is possible that a customer may be charged
for their toys, when no toys have been
sent/received as the second copy of the
despatch note may still be sent to the accounts
department.
Customer goodwill will also be lost if the
delivery of toys is delayed.
Under most jurisdictions, it is essential that a
VAT audit trail is maintained to clearly
identify the VAT payable to the authorities.
In addition, customers will require an input
VAT invoice for their own VAT process.
The current system is likely to raise negative
comments on a VAT inspection.
3
Recommendation
Data entered into the inventory system should
be validated to ensure its completeness and
validity.
A perpetual inventory counting approach
should be introduced to ensure that the
inventory records accurately reflect the level
of inventories held.
The customers credit card authorisation
should be obtained before the toys are
despatched. Ideally this should be done
directly after the customer submits their
shopping basket and confirmed to the
customer.
The product database should incorporate an
inventory program that informs the customer
of the current inventory status (eg In stock,
Out of stock, delivery will be made within one
week, Only 2 items in stock) and allows the
customer to accept, change their order or
cancel.
The system will require updating to keep track
of out of stock orders.
The system should be updated to provide a
VAT audit trail and a VAT invoice sent to
customers.
The invoice could be sent by e-mail to
customers on confirmation of order despatch
or as a hard copy with the order.
 Weakness
Inventory is only counted once a year, at the
end of the financial period. No regular
reconciliation takes place between items
purchased, sold and in inventory. It is possible
that items may be dispatched without being
recorded or stolen.
Accountancy Tuition Centre (International Holdings) Ltd 2008
Potential effect of weakness
Toys that are despatched in excess of the
orders or are directly stolen are considered to
be an understatement of sales, a direct impact
on the financial statements and profit.
4
Recommendation
A perpetual inventory counting approach
should be introduced to ensure that the
inventory records accurately reflect the level
of inventories held. Any discrepancies should
be thoroughly reviewed and explained.
Regular reconciliations of items purchased,
sold and held in inventory should take place.
(b) Internet sales system

(1 mark for each relevant and FULL point made. If no explanation is given for the test, only award
mark. Note that the requirement only refers to recording in the sales module of the legacy system
no marks should be awarded for tests relating to the use of day books, financial statements etc..)

In order to establish that the toys despatched are those ordered by the customer, it
will be necessary to test that the data initially entered through the website is
correctly captured by the system.

An order should therefore be placed by the auditor using the website and then
checked to the orders file agreeing the completeness and accuracy of the data.

In obtaining their initial understanding of the control design and implementation,

the auditors will have already established the functionality of the website and the
transfer of data to the orders file.

Access the order file and select a sample of orders. Agree the unit prices to an
authorised price list/file. Check the additions of the order and VAT calculations.

Trace each order through to the sales module within the legacy system, agreeing all
details to ensure completeness and accuracy of the data transfer. Agree that the
correct accounts have been updated, ie sales, receivables and VAT.

Agree the order detail to the despatch note filed in the accounts department. This
will provide evidence of goods having been despatched and that the despatch notes
were accurately printed by the system.

From the sales module, trace the order details through to a daily product sales
report., ensuring that the date of the report is the day after the order was placed.
This tests the completeness, accuracy and validity of the sales report.

From the daily sales report, agree that the inventory records have been updated for
the order placed. Completeness and accuracy of updating inventory records for
despatch of private customer orders.

Agree that the order entry in the sales module of the legacy system has been flagged
to show goods despatched and credit card authorisation obtained.

Agree to a credit card statement that the payment (less any agreed charges) has been
received. Trace the total of the credit card statement through to the cash book and
bank statement.

Use of CAATS

Whilst not specifically mentioned, award appropriate marks where answers refer to the use of
CAATs, eg:

Extract complete data files from the orders file and the sales files of the legacy
system. Compare both sets of data using a CAAT to ensure completeness and
accuracy of data transfer from the order system to the legacy system.

Applying the same procedure, compare the inventory data from the orders file with
the data extracted from the inventory files to ensure complete and accurate update
of the inventory system for internet sales.

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 For each month, using the data from the sales module of the legacy system, compute
the total sales value and reconcile to the credit card companies monthly statement to
test for completeness of credit card authorisation.

(c) Commercial customers receivables (1 mark for each FULL and valid point. mark only
if lack of explanation /depth. Max of 8 marks.

NOTE 1: As there are only ten commercial balances, procedures should reflect this. If
answers are clearly wrote learnt without consideration of the scenario, eg select sample
from balances, award no marks.

NOTE 2: As the customers are overseas, award no marks for any comments made on
sending second letters etc. There will be insufficient time to do so and the students answer
will be wrote learnt without application to the scenario. Only award marks if within the
specific context of the circularisation being done at the year end to allow time for second
letters to be sent

NOTE 3: Some students may take the view that as there are only ten commercial
customers, an alternative approach to circularisation should be taken.

An acceptable procedure would be to apply alternative procedures to all balances, eg

establish existence, makeup of balance, after date cash received PROVIDED a strong
systems approach (manual or CAATs) had been applied and made clear in the answer.

NOTE: Award no marks for any suggestion of using CAATs to select balances etc. As
there are only ten balances, this would clearly be inappropriate. CAATs would be
appropriate to establish closing balances from initiating records which could then be tested
for after date cash. )

Consider the timing of the circularisation re reporting deadlines and the audit
timing. As overseas, a longer period of time will be needed to receive replies. The
circularisation may therefore need to be carried out at or before the year end.

Obtain a list of the commercial customer receivables from the client. Check the
addition of the list and that the total receivables agrees to the general ledger. Check
the extraction of the list from the sales ledger to ensure completeness and accuracy
of the extraction.

Review the list for credit balances. Where the total of credit balances are material,
add back to the receivables balance and to the payables balance to ensure the
balances show a true and fair view. Establish the reasons why there are material
credit balances or a significant number and consider impact on audit approach (eg
may increase audit risk).

As there are only ten commercial customers, include all within the circularisation,
unless clearly immaterial. Agree with client that all will be circularised. If client
requests any not to be circularised, establish reason as to why (and is reasonable)
and include balance for other procedures.

Prepare positive , closed circularisation letters (ie those stating the balance due and
requiring a reply regardless of agreement or disagreement) on TopNotch4Us
letterhead and signed by the company.

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 The letters should be posted independent of the client (to ensure the client is not
able to suppress or directly reply to any ) with the return from customers to be made
directly to the auditors to reduce any risk of the client being able to interfere with
the letters or replies.

Replies will either agree balances or disagree balances. Where disagreement, the
amount disagreed must be analysed and audited. Disagreement will usually be
based on cash and/or goods in transit.

Where cash in transit, agree subsequent receipt of cash to cash book and through to
the bank statement. Where goods in transit, agree to sales invoice, goods despatch
note and entry in inventory records to ensure correct cut-off.

Where no replies, apply alternative procedures, eg establish existence of customer

(website, contracts, correspondence); make up of balance (invoices, despatch notes,
inventory entries); after date payment received (cash book, bank statement).

(d) Cut-off (1 mark for each valid point. Max of 3 marks. If no example given max of 2
marks)

Cut off is a financial statement assertion that basically means that a transaction that
occurred in one period is recorded within that period. A cut-off test gathers
substantive evidence that transactions are recorded in the period to which they
relate.

A cut off test, depending on its direction, provides evidence as to two types of
misstatement, namely:

a misstatement relating to completeness, where an economic event that

occurs in the financial period being audited (i.e. up to and including the
cut-off date) is recorded in the related account balance in the subsequent
accounting period. (1 mark)

a misstatement relating to validity, where an economic event that occurs

in the period following the period being audited (i.e. after the cut-off date)
is recorded in the related account balance in the period being audited. (1
mark)

Auditors perform cut-off tests for all major classes of transactions, either at the end
of the financial period or, where substantive evidence is gathered prior to the year
end, at an earlier cut-off date.

A basic example would be sales and receivables. Despatches made before the year
end should be recorded as sales and receivables before the year end and excluded
from inventory before the year end. Despatches made after the year end should be
evidenced as invoiced after the year end and recorded as sales/receivables after the
year end.

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2 ISAs

(a) Threats to the Fundamental Principles ( mark identifying plus mark explaining, to
include at least two examples, otherwise only mark. Max of 5 marks)

Self-interest may occur as a result of the financial or other interests of members

(including immediate or close family of the member) eg, loans or guarantees, close
personal or business relationships, financial interest in a client, gifts and hospitality.
Self-review may arise when a previous judgment needs to be re-evaluated by
individuals responsible for that judgment. Examples include:
providing a service to a client that will then be subject to review as part of
the assurance engagement;

reporting on the operation of systems after being involved in their design

or implementation;

the discovery of a significant error during a re-evaluation of the work

being undertaken by the member.

Advocacy occurs when members promote a position or opinion to the point that
subsequent objectivity may be compromised, eg

commenting publicly on future events in particular circumstances, having

made assertions without detailing the assumptions;

where information is incomplete or advocating an argument which is

unlawful;

promoting shares in a listed audit client or a client seeking to list;

acting as an advocate on behalf of an assurance client in litigation or

disputes with third parties.

Familiarity can arise where members, because of a close relationship, become too
sympathetic to the interests of others. There is a significant risk that professional
scepticism will not be applied. Examples include:

a member in a position to influence business decisions, financial (or non-

financial) reporting (e.g. the audit report) having an immediate or close
family who is in a position to benefit from that influence (e.g. a director or
shareholder);

over-familiarity with the management of the organisation such that

professional judgement could be compromised;

long association with business contacts influencing business decisions;

acceptance of gifts or preferential treatment, unless the value is clearly

insignificant.

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 Intimidation will occur where members may be deterred from acting objectively
by threats, actual or perceived, direct or indirect. Examples of circumstances that
may create intimidation threats include:

threat of dismissal or replacement of the member;

a dominant personality attempting to influence the decision-making

process;

being threatened with litigation;

coming under pressure to reduce necessary work to ensure a reduction in

fees.

(b) Controls ( mark each point, max of 1 mark each element, 5 marks in total)

The control environment - sets the tone of an organization, influencing the control
consciousness of its management and employees. It is the foundation for effective
internal control, providing discipline and structure.

Strongly relates to how management (and governance) has created a culture of

honesty and ethical behaviour, supported by appropriate controls to prevent and
detect fraud and error.

Risk assessment procedures how the entitys management identify business risks
relevant to the financial reporting objectives and how they decide to address those
risks and review the results of doing so.

Risks relevant to financial reporting include external and internal events and
circumstances that may occur and adversely affect an entitys ability to initiate,
record, process, and report financial data.

Information system consists of the physical and hardware (if IT based)

infrastructure, software (if IT based), people, procedures and data.

It includes the accounting system and consists of the procedures and records
established to initiate, record, process, report and maintain accountability which
must also be able to deal with errors and incorrect processing.

Control activities the policies and procedures that help ensure that management
directives are carried out, e.g. that actions are taken to address risks that threaten the
achievement of the entitys objectives.

They have various objectives and are applied at various organisational and
functional levels. Examples include authorisation, performance reviews,
information processing, physical controls and segregation of duties.

Monitoring controls the process to assess the effectiveness of internal control

performance over time. It involves assessing the design and operation of controls on
a timely basis and taking necessary corrective actions for changes in conditions.

Without monitoring control systems and receiving feedback on the performance of

those controls, the entitys management will have no idea if a control, whilst still
operating, is actually effective. Ongoing monitoring activities are often built into
the normal recurring activities of an entity and include regular management and
supervisory activities.

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3 ISA REGULATORY FRAMEWORK

(a) Financial statement risks (1 mark per valid point. Max of 12 marks)

Client business

Okalas operates in the high-tech field of military tank engine production. Inventory
obsolescence through technological change is a high risk area. Values may be
overstated.

Turnover consists of a small number of very high value contracts (eg currently
tendering for $200m NATO contract). Such economic dependence may lead to
going concern problems should one (or more) of the contracts fail.

Considerable expenditure is made in R & D, to develop up-to-date engines to

maintain the companys market position. Such expenditure classified as
development may not be recoverable, thus there is a risk of impairment and
overstatement of the balance.

The client faces the risk of high expenditure and investment in technical
development when: (2 points necessary to gain 1 mark)

fierce domestic and overseas competition may force unprofitable

tendering (going concern risk);

failure to deliver engines to the terms of contracts could lead to significant

penalties (understatement of provision for penalties);

the majority of sales are overseas (NATO, Middle-East, Australasia)

subjecting the company to:

foreign currency exposure;

potential bad debt problems (understatement of allowance);
political volatility (going concern considerations);

Products

Thunderflash Very recently developed with high development costs, this the
subject of the NATO tender. (1 mark each point, max of 2 marks)

Overall reliability is unclear until the engine has been in operation for a
longer period. There may be future developments or warranty expenses to
be incurred (potential understatement of provision).

Development costs may be fairly amortised under IAS 38 Intangible

Assets if it is:

likely to make future profits;

commercially and technically viable.

Otherwise, the capitalisation of such costs will be overstated.

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 Fox Okalas recently received a $25m warranty claim from a Middle East
government for faulty parts in 30 engines. (1 mark each point, max of 2 marks)

If this matter is not resolved by year-end (likely!) a provision may be

necessary in the year-end financial statements (potential understatement).
Also:

other recently completed contracts may lead to similar claims;

engines in WIP may need rectification work thus NRV needs to
be ascertained.

The client should consider the possibility of counter-claim against Young.

If so, it cannot be offset against the provision and would not be recognised
on the balance sheet until it was virtually certain the claim would succeed.

Snooper Development of Thunderflash may render the 20 year old Snooper design
obsolete. Engines and parts may have nil/scrap value (potential overstatement of
inventory values).

Inventory

Volatility of contract prices makes measuring NRV against cost difficult. Valuation
is therefore a high-risk area.

The continuous inventory-checking is seriously behind schedule for this year and
error incidence is high. Material error could exist between book and actual physical
quantities.

Internal audit involvement in other audit areas may be reduced, thereby increasing
the risk of errors arising.

(b) Audit work (1 mark per valid point, max of 4 marks per section, 8 in total)

(i) Warranty Claim

To assess what amount, if any, of the claim represents a liability, a wholly

substantive approach is required including:

discussion with senior management to obtain:

full information of the claim; and

their opinion on the most likely liability.

a review of the contract terms to assess whether:

warranty cover extends to sand clogging; and

any valid disclaimers exist.

Assuming some liability exists, the claim must be reviewed and the amounts
confirmed. This will involve: (2 points to obtain 1 mark max)

establishing what a potential figure for the claim would be;

comparing the Middle East claim to the liability calculated by Okalas;

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 obtaining legal opinion from the clients solicitors as to the reasonableness
(or otherwise) of the clients calculation;

reviewing all relevant board minutes and correspondence with the Middle
East government to establish the extent of the claim.

To confirm any amounts recoverable by Okalas: (2 points to obtain max of 1 mark)

review any product liability insurance taken out by Okalas which may
wholly or partially cover the liability (even though the insurance company
may dispute the claim or Okalas management may place too much
emphasis on the cover);

establish whether any counter-claim against Young is feasible by

reviewing all correspondence and relevant minutes on the matter;

obtain legal opinion from the clients solicitors as to the likelihood and
amounts of recovery.

There may be repercussions for other Fox contracts recently completed and for any
Fox engines currently in WIP. Therefore review: (2 points for max of 1 mark)

the clients procedures for identifying any further claims;

calculations for provisions and NRV of inventory made and assess their
materiality;

all correspondence and minutes with customers and solicitors concerning

further claims.

The situation must be monitored up to the date of the auditors report, that is a pro-
active approach to post balance sheet events.

Management representations should be obtained (eg regarding the completeness of

disclosure of post balance sheet events and the NRV of current WIP and inventory).

Disclosure in the financial statements may be required:

as exceptional gains/losses if the claims concerned crystallise;

as contingent gains/liabilities if the amounts or outcome are still highly

uncertain as at the date of signing the auditors report. (It is likely that a
reasonable estimate of amount can be made.)

(ii) Inventory

Audit approach

Because of the high volume of relatively low value items, we will aim to perform
tests of controls on the accounting and internal control system and use extensive
analytical review.

CAATs will be used wherever appropriate for these tests. In addition we must
carefully review the results of physical checks.

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 Interim work

Walk-through checks on the inventory accounting system will be required before

performing tests of controls. The test data programs should be run as soon as
possible thereafter.

Inventory checking

A meeting should be arranged as soon as possible with the internal audit manager to
ascertain the extent of potential errors in the inventory records, review the
effectiveness of correcting such errors and enquire whether all inventory lines will
have been counted at least once by the year-end.

We should attend a sample of physical checks to ensure they are being performed to
managements instructions and to check a sample of inventory items. Audit
software may assist with sample selection.

If results are not satisfactory a full year-end physical count may be required.

Warranty claim

In conjunction with the audit work on warranty claims, items selected for physical
counts should include those where future warranty provisions could arise.

Substantive work

Subject to satisfactory results from tests of controls we will aim to perform

extensive analytical procedures. Audit software may be used to produce data for:
(2 points for max of 1 mark)

inventory ageing, including turnover by product line and product

category;

reconciling opening and closing inventory quantities by accounting for

sales and purchases in the year;

comparing quantities and amounts of inventory in each product category

between this and previous years.

Other functions to be performed by audit software: (3 points for max of 1 mark)

casting the inventory ledger to agree to clients schedules;

identifying inventory items:

for physical checking;

for valuation and cut-off tests;
where standard cost is less than the contract price;
identifying items not counted this year;

identifying items where the quantity held in inventory exceeds the number
of items used in one year (for provisions work).

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 Other tests

For a sample of inventory items, compare standard cost to the latest purchase
invoice price to ensure that inventory is valued at cost (NRV tests will also be
carried out).

Perform full cut-off tests taking note of any inventory movement documents at the
year-end physical counts (whether full count or otherwise).

Review the make-up of inventory values paying special attention to any variances
from standard cost. Inventory must be valued at the lower of cost and NRV and not
at standard cost unless this approximates to cost.

4 CHARITIES

(a) Risks and implications for audit risk (1 mark for each valid point made, max 10)

Inherent and control risks

Charities can be viewed as inherently risky because they are often managed by non-
professionals and are highly susceptible to fraud (because of the high levels of
cash), although many charities and the volunteers that run them are people of the
highest integrity who take a great deal of care over their work.

In the case of EduChar, the scenario highlights the lack of a fulltime professional
accountant, it only has a part time bookkeeper and relies on volunteers for fund
raising. All of these increase inherent risk.

Charities are also at risk of being in violation of their 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 involvement of a recently retired Chartered Certified Accountant in the

preparation of accounts in the past may lower the auditors assessed inherent risk to
an extent.

However, the audit and accounting regulations are new. This implies a higher
inherent risk as the trustees, bookkeeper, part time ACCA member and auditors
have to fully understand the implications of the new regulations on the accounts
preparation and audit.

Most small charities have a high level of control risk because formal internal
controls are expensive and are not often in place. This means that donations are
susceptible to misappropriation by the volunteer collectors (tamper proof collecting
tins should be used).

It may not be possible to rely on basic business controls as the bookkeeper is only
part time and no indication is given within the scenario of the role of the trustees
(they should remain independent of the day to day running of the charity).

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 Detection risk

As the charity is small, it is possible that all transactions will be tested and therefore
sampling risk (the risk that samples are unrepresentative of the populations from
which they are drawn) is not present.

Detection risk will also be high as this is a new client and thus the auditors will be
unfamiliar with the client.

The audit team must contain senior individuals (eg the partner, manager and
supervisor) who are familiar with cash based audits and the legislation surrounding
charities.

Substantive analytical review may play a critical roll in establishing the

completeness of cash received and expenditure.

Audit risk

Audit risk is the product of inherent risk, control risk and detection risk and is the
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.

Where inherent risk is high and controls are weak (as is likely here) a greater level
of substantive testing will need to be carried out on areas identified as risky in order
to reduce audit risk to an acceptable level.

It will be critical to carry out a detailed risk analysis; obtain an in-depth

understanding of the way the charity operates and of the regulations (including the
new ones) it operates under.

(b) Audit tests fund raising events (1 mark per valid point. Note that the requirement
specifically deals with fund raising events only.)

Attend a selection of fund raising events (eg those expected to raise material
amounts of money) and observe the procedures employed in collecting, counting,
banking and recording the cash.

This is effectively confirming and testing the accounting system (initiation through
to recording and reporting) and will help provide audit evidence that funds have not
been misappropriated and that all income from such events has been recorded
(accuracy and completeness).

Where sealed collection boxes or tins are used at charity events, agree the control
over the issue and collection of the boxes/tins, eg number allocated to the event,
number used, not used and returned (completeness).

Ideally, the boxes/tins should be pre-numbered for use over many events. When
used they should be kept for audit inspection and not destroyed.

Observe that when opened, the boxes/tines are done so in the presence of two
volunteers, one counting the other checking. Perform random 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.

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 Agree audit count details to the clients schedules and forward through summary
sheets to final paying in bank slips. Check the additions of all summary schedules.
This will provide evidence as to the completeness and accuracy of recording the
cash.

Trace the bank paying in slips through to the cash book and bank statements,
checking that there is no unusual delay in banking the cash.

Re-perform the year end bank reconciliation and agree the rolling forward of the
opening bank balance through the reconciliations carried out each month. (If
reconciliations are not done each month, it will be necessary to audit the year end
reconciliation as a whole). This also provides evidence as to the completeness of
income.

Examine the records of bank expenditure for fund raising events (hire of equipment,
entertainers, purchase of refreshments. etc.), trace through to supporting evidence
(eg invoices and receipts) and ensure that these have been properly authorised. This
provides evidence as to the measurement and accuracy of expenditure.

Discuss with event organisers if any expenditure was met directly by paying cash
from the monies collected, without being recorded. Review expenditure of similar
past events to identify potential expenditure that has not been recorded. This will
provide evidence of completeness of income (eg that income has not been expensed
without being recorded).

Review the income and expenditure of fund raising events against any budgets that
have been prepared and against similar past events. Investigate any significant
discrepancies. This will provide evidence of completeness and accuracy.

Ensure that all necessary licences (such as public entertainment and lottery 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.

Obtain representations from the trustees to the effect that there are no unrecorded
liabilities for such events and for the completeness of income again for
completeness of income, expenditure and liabilities.

5 AUDIT REPORTS

(a) Responsibilities (1 mark each point, max of 6 marks)

Preparation of financial statements (2 marks )

The directors are normally required to prepare the financial statements of the
company using the appropriate law of their country and in accordance with an
appropriate accounting framework (GAAP), eg International Financial Reporting
Standards (IFRS).

The auditors are normally required to report to shareholders on the assertion that the
directors have prepared the financial statements in accordance with the appropriate
legislation and GAAP.

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 Fraud and error (2 marks)

The directors have the primary responsibility for the prevention and detection of
fraud and error in the financial statements, no matter how immaterial this may be.

Auditors have no responsibility for the prevention of fraud within an organisation.

However, they do have a responsibility to consider the risk of material misstatement
arising from fraud and error when planning and performing audit procedures and
then on the evaluation and reporting of their work.

Going concern (3 marks)

The directors are responsible for ensuring that the company will continue in
operational existence for the foreseeable future and prepare the financial statements
in accordance with this assumption (or otherwise with appropriate disclosure).

The auditor must consider the appropriateness of managements use of the going
concern assumption and whether material uncertainties require disclosure. They
must consider events and conditions that may cast doubt on the enterprises going
concern as part of their planning.

They must also be alert to such conditions and events as they carry out their audit
and will evaluate managements assessment for the same period as required by the
accounting framework.

(b)(i) Audit report elements ( mark each point, max of 5 as shown)

Statement of auditors responsibility: (max 2 marks)

to express an opinion on the financial statements based on their audit;

that the audit was conducted in accordance with ISAs or relevant national
standards or practices;
explains that ISA requires the auditor to comply with ethical
requirements; and
that the audit was planned and performed to obtain reasonable assurance
about whether the financial statements are free of material misstatement.

A scope paragraph that describes the audit in that: (max 3 marks)

the audit involves the performance of procedures to obtain audit evidence

about the amounts and disclosures in the financial statements;

the procedures selected depend on the auditors judgment, including the

assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error;

in making risk assessments the auditor considers internal control relevant

to the entitys preparation and fair presentation of the 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 entitys internal control); (1 mark)

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 the auditor: (1 mark for min of two points)

evaluates the appropriateness of the accounting policies used;

assesses the reasonableness of accounting estimates made by
management; and
assesses the overall presentation of the financial statements.

the audit evidence obtained is sufficient and appropriate to provide a

reasonable basis for the audit opinion.

(b)(ii) Errors and omissions ( mark for identifying plus mark for explaining. Max 9 marks.
Only give mark if no explanations given, with a max of 4)

The draft report contains (at least) the following errors and omissions:

No specific mention of the auditors responsibility, ie to express an opinion .

based on our audit. This is an essential requirement of ISA 700 and is not referred
to in any wording of the draft report.

Whilst referring to Auditing Standards, the report does not specify which auditing
standards, eg International Auditing Standards (ISA) or an appropriate national set
of standards. By referring to ISAs the user of the financial standards would have a
specific set of standards on which to assess the work carried out.

The report refers to the principles of auditing standards. Under the requirements
of ISA, all auditing standards must be applied, unless inappropriate (eg IAS 2 in the
case of a service company without inventory). Using the word principles implies
that the standards may have been interpreted to suit the client.

No reference is made to the fact that ISAs require the auditor to comply with ethical
requirements. Following the ethical principles of the IFAC (eg having integrity,
objectivity etc) is an underpinning concept of auditing and it is necessary to convey
this to the user of the report (hence the reference to the independent auditors
report within the report title).

The reference within the report to an assessment of ALL the estimates and
judgements made by the directors implies that immaterial matters were also
considered when the auditor only provides reasonable assurance that the financial
statements are free from material misstatement. This could mislead the user.

No reference is made to the use of the auditors judgment, assessment of risk and
consideration of internal control. For example, users may believe that the audit
opinion also covers the working of internal control.

The reference to the time available for the audit implies that time was a limiting
factor and that audit work may have been cut in order to complete the work within
the time limit. This would be directly against the requirements of the ISAs.

Under ISAs, the auditor must have planned and performed (the audit) to obtain
reasonable assurance whether the financial statements are free from material
misstatement. This includes ensuring adequate time is made available. This
specific statement is not included within the report as required by ISA 700.

The draft report confirms that the financial statements are free from material
misstatement. This can never be claimed due to the inherent limitations of an audit
and that only reasonable assurance can be obtained (see above point).

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 The disclaimer given by the auditor (no liability can be accepted by the auditor) is
highly unusual and is outside of the scope of ISA 700. To give such a disclaimer
would require the written consent of the shareholders and agreement with the
directors. As many other third parties usually have an interest in the financial
statements, most jurisdictions specifically legislate against disclaimers being made
by auditors.

The statement that the directors are wholly responsible for the accuracy of the
financial statements would be more appropriate if given as part of the section on
managements responsibility, rather than within the scope paragraph. In addition
the word accuracy implies being 100% correct, where as the assertions given by
the directors are for the fair presentation of financial statements that are free from
material misstatement.

The auditors responsibility relates to the financial statements and not the annual
report (which would include other items and reports, eg chairmans statement,
sustainability reports). ISAs only require the auditor to review other statements
issued with the financial statements for inconsistency and report if there is a
material inconsistency.

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