Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
ICAP
Bank
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted,
in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, without
the prior permission in writing of Emile Woolf Publishing Limited, or as expressly permitted by law, or under
the terms agreed with the appropriate reprographics rights organisation.
You must not circulate this book in any other binding or cover and you must impose the same condition on
any acquirer.
Notice
Emile Woolf International has made every effort to ensure that at the time of writing the contents of this study
text are accurate, but neither Emile Woolf International nor its directors or employees shall be under any
liability whatsoever for any inaccurate or misleading information this work could contain.
C
Audit and Assurance
Contents
Page
Question and Answers Index v
Questions
Section A Multiple choice questions 1
Section B Objective test and long-form questions 13
Answers
Section C Multiple choice answers 73
Section D Objective test and long-form answers 77
I
Audit and Assurance
Question Answer
page page
Question Answer
page page
18 Threats and Safeguards 18 90
Planning and risk assessment
19 Durable Cement Limited (DCL) 18 91
20 Saad Co 18 91
21 Alpha 19 92
22 Engagement letter and documentation 19 92
23 Shahid Corporation 19 93
24 Assertions 20 93
25 Companies Act, 2017 20 94
26 ASPL 20 95
27 Information Limited 21 96
28 Distributor 21 96
29 Fraudulent Financial Statements 22 97
30 Kashif and Company 22 98
31 Delicious Biscuits Limited (DBL) 22 98
32 Daud and Company 22 98
33 ABC (Private) Limited 22 99
34 Materiality 23 99
35 Auditor‟s Expert 23 99
36 Mineral Limited 23 100
37 AMF 23 100
38 Acceptance and planning 24 101
39 SPL 24 101
40 Fruit and nuts 24 102
41 Discussions and judgment 24 102
42 Dynamic 25 103
43 Changing Terms 25 104
44 EL 25 104
45 Calm Co 25 105
46 Azam 26 105
47 Hurricane 26 107
48 Zakir Co 27 109
49 Educational University (EU) 28 111
50 Hajira 28 111
Question Answer
page page
51 Tahir Co 28 112
52 Elegant Limited 29 115
53 Roof Limited 29 115
54 Door Limited 29 116
55 Clocks (Private) Limited 30 116
56 HSB & Company 30 117
57 Green Limited 30 117
58 Sukkur Limited 30 118
Internal control
59 Training Manager 31 119
60 Vision Limited 31 120
61 Types of Controls 32 120
62 Deehan Super Stores 32 121
63 IT Department 32 122
64 Controls 32 123
65 Bhurbhan Limited 33 123
66 Audit trail 33 123
67 Supermarkets 33 124
68 Controls 33 124
69 Shahzad Limited 33 125
70 Waheed Engineering 34 126
71 Danish 35 127
72 Roses Anytime 35 129
73 Trade Receivables 36 131
74 Granger 36 133
75 TS Limited 37 135
76 Pacific Shipping Limited 37 135
77 Advanced Limited 37 136
78 Bell Limited 38 137
79 General IT Controls 38 138
Audit evidence
80 Verification of Evidences 38 139
81 Rehan Limited 39 139
82 Sehat Pharmaceutical Limited 39 140
Question Answer
page page
83 Nobel 40 140
84 Masoom Limited 40 141
85 Sky Blue 40 141
86 Direct confirmations 1 40 141
87 Chill 41 142
88 Sales sampling 41 142
89 PQR 41 143
90 Hard Stone Limited 42 144
91 Related parties 42 145
92 Kamil Limited 42 145
93 Direct confirmations 2 42 146
94 Working papers 42 146
95 Al-Shams 42 147
96 Auditor‟s expert 43 147
97 ADL 43 148
98 Guava & Co 43 149
99 RP Planning 44 149
100 Manufacturing inventories 44 150
101 Framework 44 152
102 MWL 44 152
103 BPR 44 153
104 Taskeen Co 44 154
105 Wings 45 156
106 Glasses2Go 45 157
107 ISA 620 46 159
108 Cuddly World 46 159
109 Auditors 47 161
110 Analytical procedures and materiality 47 163
111 Tahira Transporters 48 164
112 Willow 48 165
113 Sparkle Forever 49 168
114 Bubbles 50 169
115 ISA 500 50 171
116 Javeria Co 50 172
Question Answer
page page
117 Porridge 50 172
118 Trembridge Engineering 51 175
ISA 620: Using the Work of an Auditor‟s
119 52 176
Expert
120 Heidi Co 52 177
121 Babar Limited 53 179
122 Concordia Limited 53 180
123 Blue Bell Limited 53 180
124 BAC Limited 53 180
125 Stewardship and Accountability 53 181
126 Shahbaz Chemicals limited 53 181
127 Express Limited 54 181
128 Farhan Foods Limited 54 182
129 Fresh Dairies Limited 54 182
Scenarios
130 Zeedin Co 54 183
131 Sahito Co 55 186
132 Bashir Co 57 187
133 Multiple Situations 58 190
Completion
134 Final audit file 58 192
135 Energy Limited 59 192
136 XYZ & Company 59 193
137 XYZ Limited 59 193
138 Noncurrent assets 59 193
139 Customized Machinery Limited (CML) 59 194
140 Nadeem Limited 60 194
141 System logs 60 195
142 Overtime payments 60 195
143 Khanewal Limited (KL) 60 195
144 ABD Limited 60 196
145 Cell Phones (Private) Limited 61 196
146 Substantive procedures 61 197
147 Pioneer Textile Limited (PTL) 61 198
Question Answer
page page
148 Multiple Questions 61 198
149 Analytical Procedures 62 200
150 Auditor Responsibility 62 201
151 Al-Badr 62 202
152 The engagement partner 64 202
153 Different audit clients 65 202
Situations have arisen on different
154 65 203
clients
155 MM Electronics (Private) Limited 66 204
156 Ranjha Limited 66 205
157 Pervasive effects 67 206
158 Audit report at the end of the audit 67 206
159 Iqra Industries Limited 67 207
160 Written Representations 68 208
161 Kazmi-Wassan 68 208
162 RK Resourcing 69 210
163 Rake Enterprises 70 212
164 Tariq Limited 70 213
165 GMP & Company 71 214
166 BLC & Company 71 215
167 Audit Partner 71 216
168 Afzal Textile Mills Limited 72 216
Review engagements
169 ISRE 2400 72 217
A
Audit and Assurance
SECTION
Multiple choice questions
8 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
13 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
18 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
19 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
20 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
22 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
32 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
39 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
44 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
47 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
49 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
52 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
57 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.
61 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
62 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
63 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
66 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
B
Audit and Assurance
SECTION
Objective test and
long-form questions
Required:
(i) Briefly describe each of the fundamental principles of professional ethics.
(ii) Briefly describe different categories of the threats to compliance with the fundamental
principles.
(b) 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.
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.
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.
4 Core concepts
(a) Briefly highlight the management‟s responsibilities relating to the financial statements?
(b) 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.
5 Threats
(a) 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.
(b) Discuss the threats and the related safeguards in each of the following situations:
(i) Saleem is the audit senior at Mango Industries Limited (MIL). MIL‟s finance manager has
requested him to provide the residential addresses of the engagement manager and the
engagement partner. The finance manager wants to send them one of MIL‟s latest
product.
(ii) Akram is the audit senior engaged on the audit of Dragon Limited (DL). He has informed
the audit manager that he has been offered a job by DL and that he would be joining DL
from 1 April 2018. The audit is expected to be completed on 15 March 2018.
(c) Amjad is the audit senior at Orange Limited (OL), a software house. OL has adopted IFRS 15
„Revenue from Contracts with Customers‟ for preparation of its financial statements for the year
ending 31 March 2018. However, the manager finance of OL is indecisive as regards revenue
recognition on certain contracts.
He has asked Amjad to suggest accounting treatment of such contracts in accordance with IFRS
15. Amjad does not have in-depth knowledge of this IFRS and therefore, he has consulted his
friend who has recently attended a workshop on IFRS 15.
Required:
i. Discuss the threats in the above situation.
ii. What actions the firm should take to ensure that such situation is avoided in
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.
(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.
(c) Briefly discuss the key benefits which may arise due to splitting of work between interim and final
audit.
10 Fundamental principles
Explain each of the FIVE fundamental principles of ICAP‟s Code of Ethics
11 Confidential information
Explain the situations where an auditor may disclose confidential information about a client.
Required:
Explain why it is essential for external auditors to be independent of their clients
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.
14 ABC Limited
Comment on each of the following situations with reference to the appointment of external auditors in
accordance with the requirements of the Companies Act, 2017.
(a) ABC Limited and DEF Limited are associated companies on account of common directorship.
Salman and Company, Chartered Accountants (SCC) have received an offer for appointment as
the auditor in ABC. Salman, a partner in SCC is the spouse of Naveen, who is an employee in
DEF.
(b) All the partners of Kashif Associates are Cost and Management Accountants. The firm has
received an offer for appointment as the auditor of Nihal (Private) Limited (NPL). NPL has a paid-
up capital of Rs. 500,000 and 30% of its shares are held by Siyal Limited which is a public
company.
17 Professional Ethics
Discuss the threat(s) that may be involved and the related safeguards in each of the following
situations:
a) Anwar, an ex-trainee has recently rejoined your firm. He is interested in acting as the
engagement manager on Curtains Limited, where he had been employed during the past two
years.
b) House Limited (HL) owns the building in which the Karachi office of your firm is located. HL owns
multiple projects across the city and provides its premises to various concerns on rental basis.
HL has requested your firm to become its auditor for the year ending 30 June 2018.
c) Window Limited (WL), an audit client of your firm has approached the taxation department of
your firm to review the income tax return to be filed by WL.
Required:
Assess the inherent risks (high, low or moderate) along with appropriate justification, related to the
following assertions:
Valuation of factory plant
Valuation of trade receivables
Ownership right of finished goods inventory
Valuation of unlisted securities
Accuracy of long-term finance
Valuation of provision for gratuity
20 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.
(b) For each ethical threat, discuss how the effect of the threat can be mitigated.
21 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.
(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 Act, 2017, which should be
fulfilled in order to accept the audit engagement.
23 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.
(b) need to send a new engagement letter.
24 Assertions
(a) “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.
(ii) List down the risk assessment procedures as referred above.
(b) “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.
(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
26 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;
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.
(iii) 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.
(b) What action would you take to deal with the above matters?
27 Information Limited
(a) Discuss the external auditor‟s responsibility relating to fraud in an audit of financial statements.
(b) Sometime the management‟s attitude towards the audit/auditors is indicative of the possibility of
material misstatement in the financial statements due to fraud. Give four examples of such
attitude/circumstances.
(c) You are the auditor of Information Limited (IL), which is engaged in the development of
customized software. During the last three years IL has become the leading software developer
in the industry due to completion of large number of projects.
During the initial meeting the client has informed that:
i. IL has achieved a growth of 60% as compared to the growth target of 30% set for the
financial year ended 30 June 2016 and the board of directors are considering to distribute
25% of the profit to the management staff as performance bonus.
ii. one of the competitors has shown its willingness to acquire IL.
Required:
Identify the fraud risk factors in the above situations.
28 Distributor
While reviewing the audit files of four different clients you confronted the following situations:
i. Due to tough competition in the market, the company has been unable to increase the prices of
its products since last 5 years.
ii. Addition to intangible assets, amounting to Rs. 500 million include research cost of Rs. 10 million
which is duly supported by invoices from suppliers.
iii. During the last three years, the Chief Executive and higher management has been earning
handsome bonuses, based on the profitability of the company.
iv. Physical stock take on 31 December 2014 included goods sold but not despatched amounting to
Rs. 52 million. The delivering of goods was stopped on the request of a distributor. Upto 20
January 2015, the distributor has taken delivery of goods amounting to Rs. 2 million.
Required:
(a) In each of the above situations, identify with justification whether it represents risk of fraud.
(b) Describe what actions are to be taken by an auditor on identifying a fraud risk factor.
Required:
In accordance with the requirements of the Companies Act, 2017 state whether and under what
circumstances DC could accept the audit, under each of the following situations:
(a) JL holds 51% shareholding in RL.
(b) JL is an associated company of RL.
(c) One of the directors in JL also holds 10% shareholding in RL.
(b) Nasir is the audit manager on the audit of Diamond Limited (DL) for the year ended 30 June
2016. Nasir has informed that his father owns 10,000 shares in DL. (04)
34 Materiality
(i) Determination of materiality level requires professional judgment on the part of the auditor.
(a) Briefly describe the importance of materiality in the following stages of audit:
i. Planning stage
ii. Reporting stage
(b) What aspects of materiality should be documented by an auditor in the working papers?
(ii) Apart from profit before tax, list any four benchmarks which can be used to determine the
materiality at the financial statement level.
35 Auditor’s Expert
(i) You are the audit manager in a firm of Chartered Accountants. Your firm is often required to
engage an auditor‟s expert for reporting on matters relating to the audits.
(a) List four key terms of engagement which should be agreed with the expert.
(b) Specify the factors which should be considered in evaluating the adequacy of the work
performed by the expert.
(ii) Identify four examples of situations which may require the engagement of an auditor‟s expert.
36 Mineral Limited
Mineral Limited (ML) has incorporated a liability for gratuity payable to its employees on the basis of
actuarial valuation carried out by Professionals Limited (PL). As the audit partner of ML you are not
satisfied with the valuation report prepared by PL, and have decided to appoint Experts Limited (EL) to
carry out the valuation exercise again.
Required:
(a) State the matters that you would consider regarding:
i. The competence, capabilities and objectivity of EL.
ii. Evaluation of the adequacy of EL‟s work.
(b) Briefly discuss the course of action in case you are not satisfied with the work performed by EL.
37 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.
(b) Briefly discuss the effect of each of these risks on the audit of AMF.
39 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.
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
42 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:
43 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.
44 EL
(a) List the important matters that are required to be included in an audit engagement letter.
(b) List any four situations that may require revision in the terms of audit engagement letter.
45 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:
(i) Explain the purpose of risk assessment procedures.
(ii) Outline the sources of audit evidence the auditor can use as part of risk assessment procedures.
46 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.
(b) List and explain the audit tests to be performed on income and expenditure from fund raising
events.
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.
47 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.
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) 3,600 4,500
Current assets
Inventory 200 1,278
Receivables 6,000 4,052
Cash and bank 500 1,590
――― ―――
Total assets 10,300 11,420
――― ―――
Capital and reserves
Share capital 1,000 1,000
Accumulated profits 5,300 5,764
――― ―――
Total shareholders‟ funds 6,300 6,764
Non-current liabilities 1,000 2,058
Current liabilities 3,000 2,598
――― ―――
10,300 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) Using the information provided above, prepare the audit strategy for Hurricane for the year
ending 31 December 20X4.
48 Zakir Co
(a) With reference to ISA 520 Analytical Procedures explain
(i) what is meant by the term „analytical procedures‟;
(ii) the different types of analytical procedures available to the auditor; and
(iii) the situations in the audit when analytical procedures can be used.
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
Revenue 7,482 6,364
Cost of sales (3,520) (4,253)
–––––– ––––––
Gross profit 3,962 2,111
Operating expenses
Administration (1,235) (1,320)
Selling and distribution (981) (689)
Interest payable (101) (105)
Investment income 145 –
–––––– ––––––
Profit/(loss) before tax 1,790
‗‗‗‗‗‗ (3)
‗‗‗‗‗‗
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.
(c) Confirmation of the end of year bank balances is an important audit procedure. Explain the
procedures necessary to obtain a bank confirmation letter from Zakir Co.‟s bank.
50 Hajira
(a) Explain the term „audit risk‟ and the three elements of risk that contribute to total 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:
(b) Identify areas of inherent risk in the Hajira charity and explain the effect of each of these risks on
the audit approach.
(c) Explain why the control environment may be weak at the charity Hajira.
51 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.
Required:
(a) List the audit procedures and actions that you should now take in respect of the above matter.
(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;
(ii) Discuss to which groups the auditors of Tahir Co could report the „fictitious‟ 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.
52 Elegant Limited
Your firm has been re-appointed as the auditor of Elegant Limited (EL) for the year ended 30 June
2015. The firm has been the auditor of EL for the last five years.
Required:
(a) How would you assess whether it is necessary to send an audit engagement letter to EL for the
year ended 30 June 2015?
(b) State how you would proceed if EL requests your firm to change certain terms of the
engagement.
54 Door Limited
Your firm has recently been appointed as the external auditor of Door Limited. The engagement partner
has planned a meeting with the audit team to discuss the overall audit strategy and finalize the audit
plan.
Required:
List the planning activities which you would need to discuss with the engagement partner regarding the
issues related to first year of audit engagement.
57 Green Limited
Green Limited (GL) is a listed company engaged in the manufacturing of garments and apparels.
During the audit planning meeting for the year ending 31 March 2018, the Chief Financial Officer of GL
has provided the following information:
(i) GL was previously exporting all its production under the brand name of „Wearables‟. However,
it has been facing the issue of decline in export orders and therefore has decided to start
focusing on the local market. Accordingly, it has made an agreement with BL, according to
which GL‟s products would be sold to BL who would market them through BL‟s retail outlets
spread throughout Pakistan. A director of GL holds major shareholding in BL.
(ii) Two of the directors of GL holding 16% and 13% shares in GL have informed the Board that
they intend to sell their entire shareholding in GL in order to concentrate on some of their other
businesses.
(iii) While discussing some of the internal control deficiencies in the payroll processing department,
which were raised in the previous year‟s management letter, the CFO has informed that the
matter has been referred to the internal audit department but is pending because of the illness
of the Chief Internal Auditor.
Required:
(a) Identify fraud risk factors in the above scenario.
(b) Describe what actions an auditor should take on identifying a fraud risk factor.
58 Sukkur Limited
You have been assigned the audit of Sukkur Limited (SL), a listed company, for the year ended 31
December 2016. The company engaged in the business of manufacturing security equipment for the
local market. During the planning phase, while reviewing the previous year‟s audit file, you have noted
that in 2015, due to introduction of many new equipment in the market and changes in technology, SL
faced stiff competition and its market share reduced from 45% to 35%. However, the management has
now informed you that SL has made significant investment in technology which has helped the
company to increase the market share to 38% in 2016.
The following information has been extracted from the draft financial statements:
Extracts from the statement of comprehensive income
2016 2015 2014
(draft) (audited) (audited)
------------- Rs. in million-------------
Revenue 10,742 9,703 9,650
Cost of sales 8,050 7,177 6,740
Financial charges 750 600 350
Profit before tax 1,550 1,601 2,260
Required:
(a) Identify any four fraud risk factors in the above scenario.
(b) Identify four audit risks which the auditor should consider while planning the audit.
INTERNAL CONTROL
59 Training Manager
You are the training manager in a firm of chartered accountants. Prepare brief presentation for newly
inducted trainees, on the following:
(a) Control Environment and its elements.
(b) Walk through tests and why these are performed.
(c) Materiality and Performance Materiality.
60 Vision Limited
Following IT related controls are being employed at Vision Limited:
(i) The general ledger system is automatically updated with sub-ledger transactions (e.g. Accounts
Receivable) every night through batch processing.
(ii) The system automatically maintains second copies of all programs and data files.
(iii) Access to programs and data files is restricted using passwords.
(iv) Invoices that are entered into the system are physically counted.
(v) Firewalls (software and hardware) are installed to restrict unauthorized access.
(vi) Screen warnings are displayed as regards incomplete processing.
(vii) Vision Limited has service level agreements with reliable software companies, for technical
support.
(viii) Review of output against expected values.
Required:
(a) In respect of each control, determine whether it is a preventive, detective or corrective control.
(b) Also classify each of the above between general IT controls and application controls.
61 Types of Controls
Classify the following controls as preventive, detective, or corrective controls. Give brief reasons to
justify your answers.
(i) Training on applicable policies, department policy/ procedures
(ii) Batch totals
(iii) Segregation of duties
(iv) Contingency planning
(v) System logs
(vi) System backup
Required:
(a) Draw a flow chart showing the payment process including point accumulation and point redemption.
(b) Describe the limitations of flowcharts as a tool of system documentation.
63 IT Department
You are working in IT department of a firm of Chartered Accountants. The partners are concerned
about the confidentiality of client data which is electronically transmitted by firm‟s staff from the clients‟
offices.
Required:
Suggest controls over data transmission to ensure confidentiality of data.
(a) Discuss the auditor‟s course of action if management refuses to allow auditor to send
confirmation request. (Impact on audit report is not required)
(b) In the context of control activities explain what is included in „Performance reviews‟.
(c) Explain the term „Communication protocols‟.
(d) Specify any four main categories of general controls that an auditor would expect to find in a
computer based information system.
64 Controls
Controls over data transmission help to ensure that transmitted data is complete, secure and unaltered.
Required:
State any five controls over data transmission which help to ensure that the data is secure and
unaltered.
65 BHURBHAN LIMITED
You have been assigned to plan the test of controls in respect of receiving of goods and invoices from
suppliers of Bhurban Limited. In this regard, you are required to identify the following:
(a) The related risks
(b) Controls that you expect to see to address the above risks
(c) Audit procedures that you need to perform to test the controls
66 Audit trail
Briefly describe the following concepts:
(a) Audit trail in a computerized environment
(b) Embedded audit facilities and its significance
67 Supermarkets
You are the CFO of a newly incorporated company which has recently established five supermarkets in
the city. One of your responsibilities is to implement internal controls.
List six key controls:
(a) over cash sales and cash handling;
(b) to reduce possibility of misappropriation of inventory.
68 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 decide to test the controls again, in the very next
audit.
(b) Briefly describe the components of internal control.
(c) State any four controls that an auditor expects over data transmission.
69 Shahzad Limited
(a) Briefly explain the components of internal control as referred to in the International Standards on
Auditing.
(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.
70 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.
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.
(b) Describe how you would verify that employees are not paid before they commenced work for the
company.
(c) Describe the audit procedures you would carry out in connection with attending a pay out of
wages in cash to manufacturing employees.
(d) Describe the substantive procedures on transactions you would carry out on the unclaimed
wages system.
(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.
71 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.
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.
(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.
72 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) 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;
(ii) collection of cash.
73 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.
(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.
(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 accounting system.
(d) Explain why external auditors seek to rely on the proper operation of internal controls wherever
possible.
74 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.
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.
(ii) Identify other control procedures you would consider necessary to ensure the
completeness of the recorded cash receipts and accounts receivable.
(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) Explain the procedures to be followed in making a cash-count for audit purposes.
(ii) 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.
75 TS Limited
TS Limited is a small software house. Due to the nature of the business no significant human resources
are required except the programmers and system analysts. The Managing Director (MD) oversees all
the operations. Besides the programmers and system analysts there is only one manager, who reports
to the MD.
Required:
Describe the key characteristics of such organisations with respect to internal controls and the risk
which the auditor may face in such audits.
77 Advanced limited
You are audit senior at Advanced Limited (AL) which is engaged in the business of assembling and
marketing of consumer electronics. The process followed by AL for procurement is as follows:
(i) Store Department generates a numerically sequenced purchase requisition (PR), when the
quantity falls below re-order level. PR shows the name of goods and quantity required and is
signed by the store officer. The approved PR is forwarded to the Purchase Department for
procurement.
(ii) Purchase Department has a list of suppliers which was prepared in 2015 by including all the
suppliers who had supplied goods to AL during the previous five years. Later, some suppliers
were added to the list on the recommendation of the store manager.
(iii) When a PR is received, the five most experienced suppliers are contacted and purchase order
(PO) is issued to the most experienced supplier provided he agrees to supply the goods on the
same price which was paid by AL on the latest purchase. The PO is issued in the form of an
email by the purchase manager. A copy of the email is also sent to the store manager and the
finance manager. In case of large or unusual purchases, PR and PO are also authorised by the
store manager prior to sending the email.
(iv) On receiving the goods, the store officer agrees the goods dispatch note (GDN) of the supplier
with the PO to ensure that description of goods is the same as were ordered by AL. An
acknowledged copy of GDN is given to the supplier and another copy is sent to the accounts
department.
(v) Store Department prepares sequentially numbered Goods Received Note (GRN), which is
signed by the store officer after counting the goods received. Entry in the stores ledger is made
on the basis of GRN.
(vi) On receiving the invoice, purchase is recorded by the accounts department after comparing the
quantity received as per the GDN with PO and the invoice.
Required:
Identify the weaknesses in the internal control system of AL and their possible effects and give your
recommendations to AL.
78 Bell Limited
Your firm is the auditor of Bell Limited (BL) which is engaged in manufacturing and assembling of
vehicles. BL has been encountering frequent stock-outs. To address this issue, it has developed an
Inventory Management System (IMS) and connected it with the systems of all the suppliers. IMS
generates and sends purchase orders to the suppliers automatically when the inventory reaches the
reorder threshold.
Required:
(a) Discuss the risks to be considered due to the introduction of the above mentioned solution.
(b) What controls would you expect in IMS to mitigate the above risks?
79 General IT Control
(a) Differentiate between General IT controls and Application controls. Also give two examples of
each type of control.
(b) Discuss the effects on Application controls where General IT controls are ineffective.
AUDIT EVIDENCE
80 Verification of Evidences
(a) List any four ways in which the debtor balances may be stratified.
(b) You are the audit incharge on the audit of Opportunity Limited (OL). OL deals in fast moving
consumer goods. For sending of confirmations, an audit team member has stratified the debtors
as follows:
Category A Balances exceeding Rs. 50 million 12 customers
Category B Balances below Rs. 50 million 100 customers
Category C Balances below Rs. 10 million 280 customers
Category D Balances below Rs. 1 million 600 customers
During a meeting some of the team members have expressed divergent views, as follows:
(i) Verification of balances of category A and B will provide sufficient coverage and evidence;
therefore there is no need to cover other categories.
(ii) Selection should be done on haphazard basis, as under this method all items of population have
equal chance of selection.
(iii) Selection of sample should be done systematically, whereby items constituting 10% of the
amounts in each category should be selected in descending order.
Required:
Discuss the appropriateness of options discussed in the meeting and give your suggestion in this
regard.
81 Rehan Limited
You are the Audit Incharge of Rehan Limited for the year ended 31 December 2015. While reviewing
the working papers and discussion with audit team, you have noted the following:
(i) The audit team did not send balance confirmation requests for amounts below Rs. 100,000
because according to the client, lot of efforts were required to follow up the customers and the
balances were also not material.
(ii) One of the conclusions drawn as per the working papers is “there are no unrecorded liabilities, as
confirmations have been received from all selected parties and no differences were noted.
Hence, no further test is required.”
Required:
(a) Discuss with reasons whether you agree with the approach dopted/conclusion drawn by the audit
team.
(b) Provide brief guidance to the audit team in respect of each of the above situations.
No. of
Customer Balance Confirmations Amount Nature of Confirmations
custo
segment outstanding sent covered confirmations received
-mers
---------------------------------- Rs ----------------------------------------------
Replies received from the hospitals did not agree with the balance outstanding in SPL‟s records.
However, the differences were reconciled by the audit staff.
All the 12 confirmations received from the retailers showed disagreement with the records of
SPL. However, only 2 could be reconciled.
Required:
(a) Evaluate the decision regarding sending of negative confirmations.
(b) Determine the course of action the auditor should consider in case of balances agreed, balances
not agreed and replies not received.
(c) State the procedures that need to be performed in case of amount due from SDPL.
83 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 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?
84 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.
85 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.
86 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.
(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.
(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.
87 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.
88 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.
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:
(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:
Sohail
Other audit team members.
(b) Describe the circumstances in which an auditor may decide to examine entire population of items
that make up an account balance.
89 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.
(b) List the important differences between internal and external audit with respect to the following:
Independence
Objectives
Reporting
91 Related parties
(i) Describe the procedures that the auditor may perform, in order to ensure the completeness of the
information provided by the management, about related parties.
(ii) Briefly describe any three risks of material misstatement in case of significant related party
transactions.
92 Kamil Limited
You are the audit manager on the audit of a listed company, Kamil Limited (KL). Prior to completion of
audit, you came across a prospectus issued by Neelum Limited (NL) according to which a director of KL
is the chief executive of NL. However, the name of NL was not included in the list of related parties
provided by KL. On being confronted the management has advised that the name was omitted
inadvertently as the appointment took place just two months prior to the year end.
Required:
Discuss your course of action in the above situation.
93 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.
(b) What are the factors that an auditor considers while designing the requests for direct
confirmation?
(c) Describe the alternative audit procedures which may be conducted if the customer does not reply
to a request for confirmation.
94 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.
95 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.
(b) Give four examples of situations that may be indicative of dominant influence exerted by a
related party.
96 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.
97 ADL
(a) Differentiate between the following:
(i) Statistical and non-statistical sampling
(ii) Sampling and non-sampling risk
(b) 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.
98 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.
99 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.
101 Framework
(i) Fair presentation framework and compliance framework
(ii) Tolerable misstatement and performance materiality
102 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:
Required:
(a) Indicate what would be the basis for selecting debtors for circularising positive and negative
requests for confirmations.
(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.
103 BPR
List the substantive procedures that may be performed by an auditor to verify the following:
(a) Bank reconciliation statements
(b) Payroll
(c) Raw material purchases
104 Taskeen Co
(a) (i) In the context of ISA 530 Audit sampling, explain and provide examples of the terms
„sampling risk‟ and „non-sampling‟ risk.
(ii) Briefly explain how sampling and non-sampling risk can be controlled by the audit firm.
(b) 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.‟
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.
(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.
105 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.
(b) Explain how the quality of the internal audit function is likely to influence the extent of your
reliance on internal audit work.
(c) Describe the audit evidence you will seek relating to internal controls over the out-sourced
functions (in-flight catering and payroll).
106 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.
(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.
(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.
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) For each of the above procedures:
(i) explain its use in gathering audit evidence;
(ii) describe one example for the audit of Cuddly World.
(b) Discuss the suitability of each procedure for Cuddly World, explaining the limitations of each.
109 Auditors
(a) State five key substantive audit procedures for verification of Provisions.
(b) Briefly describe how an auditor evaluates the sufficiency of audit evidence.
(c) Briefly explain how an external auditor would evaluate the adequacy of the work performed by
the internal audit function.
(d) List six physical access controls over an IT system.
(e) Briefly discuss the concept of „Professional skepticism‟.
(f) What course of action should the auditor take, if he doubts the reliability of the management
representation due to its inconsistency with other audit evidence?
(g) State the factors which determine the extent to which an auditor may use Analytical procedures
as a form of substantive audit evidence.
112 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 Plant and machinery Total
Rs m Rs m Rs m
Cost or valuation
1 April 20X2 340 275 615
Additions – 123 123
Disposals – (72) (72)
Revaluations 120 – 120
–––– –––– ––––
31 March 20X3 460 326 786
–––– –––– ––––
Accumulated depreciation
1 April 20X2 24 213 237
Provision 5 30 35
Written back on disposal – (65) (65)
Adjustment on revaluation (24) – (24)
–––– –––– ––––
31 March 20X3 5 178 183
–––– –––– ––––
Required:
(a) State, with reasons, the initial audit procedures you would perform on the schedules provided by
the company‟s accountant.
(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.
(c) Describe the audit procedures applicable to verifying the revaluation of property.
(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.
Required:
(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.
(b) Explain the factors you should consider when placing reliance on the work of UJ.
(c) Describe the audit procedures you should perform to ensure that jewellery inventory is valued
correctly.
114 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.
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.
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.
116 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.
(b) List the further substantive procedures that should be carried out on the bank balances in Javeria
Co.‟s financial statements.
117 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
for production department purchases, with GINs
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.
(b) Discuss the reasons for undertaking or not undertaking a payables‟ circularisation.
(c) Outline substantive procedures you would apply in your audit of trade payables relating to
production department purchases.
(d) Explain additional procedures you would perform in verifying the completeness of non-production
department payables.
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) check suppliers' statements to the balances on the purchase ledger;
(b) verify that purchases cut-off has been correctly carried out at the year end;
(c) ensure that sundry payables and accruals are correctly stated.
120 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) (i) Explain the benefits of using audit software in the audit of Heidi Co;
(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.
(b) 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.
Required:
Explain the steps which the auditor should perform to ensure that carrying value of inventories is based
on lower of cost and net realisable value.
FDL is a low risk client and therefore you are assessing whether to send negative confirmation
requests.
Required:
In respect of each of the above categories of customers, discuss the appropriateness of sending
negative confirmation requests.
SCENARIOS
130 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.
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) List SIX audit procedures that an auditor would normally carry out on the purchases system at
Zeedin Co, explaining the reason for each procedure.
(b) List FOUR audit procedures that an auditor will normally perform prior to attending the client‟s
premises on the day of the inventory count.
(c) (i) State the aim of a test of control and the aim of a substantive procedure.
(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.
(d) On the day of the inventory count, you attended depot nine at Zeedin. You observed the following
activities:
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.
All count staff were drawn from the inventory warehouse and were counting in teams of
two.
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.
Information was recorded on the count sheets in pencil so amendments could be made
easily as required.
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.
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) List the weaknesses in the control system for counting inventory at depot nine.
(ii) For each weakness, explain why it is a weakness and state how that weakness can be
overcome.
131 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:
Customers visit Sahito‟s warehouse and load the goods they require into their vans after showing
their Sahito identification card to the despatch staff.
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.
One copy of the GDN is sent to the accounts department, the second copy is retained in the
despatch department.
Accounts staff enter goods despatch information onto the computerised sales system. The GDN is
signed.
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.
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.
Paper copies of the receivables ledger control account and list of aged receivables are also
available.
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.
The aged receivables report produced by the computer is shown below:
Required:
(a) Explain the steps necessary to check the accuracy of the previous year‟s internal control
questionnaires.
(b) 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.
(c) State and explain the meaning of FOUR assertions that relate to the direct confirmation of
receivables.
(d) (i) Describe the procedures up to despatch of letters to individual receivables in relation to a
direct confirmation of receivables.
(ii) Discuss which particular categories of receivables might be chosen for the sample.
132 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 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) List FOUR control objectives of a wages system.
(b) 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.
(c) 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.
(d) 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.
COMPLETION
134 Final audit file
(a) State the auditor‟s responsibility in respect of „Assembly of final audit file‟.
(b) The audit report of Salim Limited was signed on 30 April 2016. After issuance of the audit report,
the auditor was informed that a major debtor has become bankrupt.
Required:
Specify the matters that the auditor would be required to document in the above situation.
Required:
Evaluate the above situation, comment on the management‟s stance and suggest the appropriate
course of action available to the auditor.
Required:
Analyse the above situations and explain how you would proceed in the above matters.
Required:
Comment on the above situation in the light of International Standards on Auditing.
Required:
Discuss how you would deal with the above situation.
Required:
Discuss the possible impact on the audit report.
Required:
What matters would you consider in order to ensure that preconditions for the audit exist?
Required:
(a) In the light of the Companies Act, 2017 explain the procedures to be followed and formalities to
be complied with for appointment of your firm as the auditor of HGM. Also explain the rights of
the existing auditors in this situation.
(b) Explain the responsibilities of your firm and the existing auditors in the above situation under the
Code of Ethics for Chartered Accountants.
Required:
(a) Identify and briefly describe the fraud risk factors in the above scenario.
(b) State whether it would be advisable to use the internal audit working papers in the above
situation and give three distinct reasons to support your decision.
Required:
Discuss the appropriateness of management representation and how would you deal with the above
situation.
(i) State any two factors which the auditor should consider to ensure reliability of audit evidence.
(j) Discuss the circumstances in which an auditor may include other matter paragraph in the audit
report.
(k) The auditor should actively look for subsequent events up to the date of auditor‟s report. State
the procedures which an auditor should perform specifically for identification of subsequent
events.
(l) Discuss the course of action which may be adopted by the auditor if pre-conditions of audit are
not present.
Required:
(i) Describe the nature and purpose of analytical procedures used during an audit.
(ii) Describe the factors that the auditor needs to consider while designing and performing
analytical procedures as substantive procedures.
(iii) Describe the objectives which an auditor expects to achieve while applying analytical
procedures at the overall review stage of an audit.
(b) Representations by management are considered as audit evidence. Describe the basic
elements of a management representation letter.
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‟.
151 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 Act, 2017. The job in charge has drafted the following audit report:
Auditors’ Report to the Directors
Opinion
We have audited the annexed financial statements (or revised financial statements, if applicable) of
Al-Qasim Limited, which comprise the statement of financial position as at June 30, 20x3, and the
statement of profit or loss and other comprehensive income or the income and expenditure statement,
the statement of changes in equity, for the year then ended, and notes to the financial statements,
including a summary of significant accounting policies and other explanatory information, 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 the audit.
In our opinion and to the best of our information and according to the explanations given to us, the
statement of financial position, statement of profit or loss and other comprehensive income or the
income or expenditure statement, the statement of changes in equity and the statement of cash flows
together with the notes forming part thereof conform with the accounting and reporting standards as
applicable in Pakistan and give the information required by the Companies Act, 2017 (XIX of 2017), 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 or loss and other comprehensive income or loss, or the surplus or
deficit, the changes in equity and its cash flows for the year then ended.
Conclude on the appropriateness of management‟s use of the going concern basis of accounting
and, based on the audit evidence obtained, whether a material uncertainty exists related to events
or conditions that may cast significant doubt on the Company‟s ability to continue as a going
concern. If we conclude that a material uncertainty exists, we are required to draw attention in our
auditor‟s report to the related disclosures in the financial statements or, if such disclosures are
inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to
the date of our auditor‟s report. However, future events or conditions may cause the Company to
cease to continue as a going concern.
Evaluate the overall presentation, structure and content of the financial statements, including the
disclosures, and whether the financial statements represent the underlying transactions and events
in a manner that achieves fair presentation.
We communicate with the board of directors regarding, among other matters, the planned scope and
timing of the audit and significant audit findings, including any significant deficiencies in internal control
that we identify during our audit.
We also provide the board of directors with a statement that we have complied with relevant ethical
requirements regarding independence, and to communicate with them all relationships and other
matters that may reasonably be thought to bear on our independence, and where applicable, related
safeguards.
From the matters communicated with the board of directors, we determine those matters that were of
most significance in the audit of the financial statements of the current period and are therefore the key
audit matters. We describe these matters in our auditor‟s report unless law or regulation precludes
public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter
should not be communicated in our report because the adverse consequences of doing so would
reasonably be expected to outweigh the public interest benefits of such communication.
Report on Other Legal and Regulatory Requirements
Based on our audit, we further report that in our opinion:
a. proper books of account have been kept by the Company as required by the Companies Act, 2017
(XIX of 2017);
b. the statement of financial position, the statement of profit or loss and other comprehensive income
or the income and expenditure account, the statement of changes in equity and the statement of
cash flows together with the notes thereon have been drawn up in conformity with the Companies
Act, 2017 (XIX of 2017) and are in agreement with the books of account and returns;
c. investments made, expenditure incurred and guarantees extended during the year were for the
purpose of the Company‟s business; and
d. zakat deductible at source under the Zakat and Ushr Ordinance, 1980 (XVIII of 1980), was
deducted by the company and deposited in the Central Zakat Fund established under section 7 of
that Ordinance.
[Signature]
[Place/ location]
[Date]
Required:
Identify and explain (where necessary) the errors in the above audit report.
(Note: You are not required to redraft the report.)
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.
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.
(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.
Required:
Discuss the impact of each of the above matters on your audit report.
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.
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.
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?
161 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:
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.
162 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:
15 August Bankruptcy of major customer representing 11% of the trade receivables on the
statement of financial position.
1 November 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.
30 November 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.
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.
(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 non-adjusting
according to IAS 10 Events After the Reporting Period, giving reasons for your decision.
(ii) Explain the auditor‟s responsibility and the audit procedures that should be carried out.
Note: Marks are allocated evenly across the three dates.
Required:
(a) Compare the responsibilities of the directors and auditors regarding the published financial
statements of Rake Enterprises.
(b) 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 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:
You are the audit partner of the firm and your manager has highlighted the following matters:
(a) The profit before tax of Tariq Limited (TL) for the year ended 30 June 2017 is Rs. 790 million. TL
provides three year warranty to its customers and has made provision of Rs. 80 million in this
regard. The management carries out the computation internally. The process is complex and
based on various assumptions. Therefore, your firm has appointed an expert after following all
the necessary procedures for assessing the competence, capability and objectivity of the expert.
(b) Your firm has been appointed as the auditor of Yaqoob Limited for the audit of the year ended 30
June 2017. The audit team was not able to perform the inventory count at year end because the
appointment was made on 15 July 2017.
Required:
Describe the steps that will be performed in each of the above situation and discuss the possible
implications of the above on the audit report. (Drafting of audit opinion is not required)
Required:
Discuss how you would deal with the above situations
Required:
Discuss how you would deal with each of the above situations and the possible implications of the
above on the audit report. (Drafting of audit opinion is not required)
(b) There is a legal dispute between Marvi Limited and one of its customers. In this regard, the legal
advisor has confirmed the stance of the management in a meeting with you.
However, he has refused to provide a written confirmation thereon.
(c) The management of Laila Limited is not willing to make certain disclosures. The management is of
the view that these disclosures will not add any value to the financial statements. Further, the
information required to make these disclosures cannot be compiled before the deadline for
completion of the audit.
Required:
Discuss the possible impact on the audit report and specify the procedures (if any) which you would
undertake in the above situations.
Required:
Discuss whether it would be necessary to obtain management representation in respect of the above
matters.
REVIEW ENGAGEMENTS
Required:
Set out the main types of procedures which an accountant should perform when carrying out a
review engagement.
(c) Differentiate between review engagement of financial statements and the annual audit.
C
Audit and Assurance
SECTION
Multiple choice answers
D
Audit and Assurance
SECTION
Objective test and
long-form answers
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.
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.
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) 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.
4 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.
5 Threats
(a) 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.
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.
Safeguards:
As the Companies Act, 2017, 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.
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:
(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
8 Audit process
(a) 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.
(b) 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.
(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.
(c) Key benefits that may arise from splitting the work between interim and final audit are as follows:
More flexible resource planning within the firm (the timing of interim audit is typically more
flexible than the timing of final audit. This helps to reduce demand for audit staff during
„busy season‟)
Earlier identification of significant matters
Shareholders and other users receive audited accounts earlier / earlier completion of the
audit
Increased audit efficiency
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.
(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 (i.e. Companies Act, 2017) 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. For listed companies in Pakistan this period have been prescribed as 5
years by the Code of Corporate Governance 2012.
(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.
(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
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-to-date 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 behavior
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 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.
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.
(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.
14 ABC Limited
(a) Salman and Company is eligible to be appointed as the auditor of ABC Limited because, Naveen
is in the employment of DEF which is an associated company and such employment has no
relevance in the context of appointment of an auditor.
(b) Kashif Associates can be appointed as the auditor of NPL as for a private company having paid
up capital of less than Rs. 3 million the auditor can be a chartered accountant or cost and
management accountant.
Holding of 30% shares of NPL by a public company is of no relevance.
(b) The lending of staff by a firm to an audit client will create a self-review threat. However, the
threat may be reduced to an acceptable level if the firm's personnel:
are not involved in exercising discretionary authority; or
do not assume management responsibilities.
are not given audit responsibility for any function or activity that they performed or supervised.
The audit client should acknowledge its responsibility for directing and supervising the activities of
assigned personnel.
(c) Familiarity and self-interest threats are created by using the same senior personnel on an audit
engagement over a long period of time. This applies to the audit manager also.
The significance of the threats shall be evaluated and following safeguards should be applied if
necessary to eliminate the threats or reduce them to an acceptable level:
Rotating the audit manager as well;
Having a professional accountant who was not a member of the audit team review the work of
the audit manager;
Regular independent internal or external quality reviews of the engagement.
17 Professional Ethics
(a) The association of Anwar with Curtains Limited will create self-review and familiarity threat. If the
threats are significant, Anwar should not be part of the assurance engagement team.
In case Anwar is included in the Audit engagement the related safeguards may include:
Involving an additional chartered accountant to review the work done by Anwar or otherwise
advise as necessary.
Independent internal quality reviews.
(b) In the given situation, the acceptance of audit engagement will result in a business relationship
with an audit client which may pose a familiarity threat to objectivity.
However, the significance of the threat in such situation depends upon the following:
Whether it is in the ordinary course of business;
Whether the tenancy agreement is on an arm‟s length basis; and
The materiality of the contract for either of the party.
From the situation given, it can be determined that this business relationship is in the ordinary
course of business on an arm‟s length basis and not material to either of the parties, hence, the
engagement can be accepted.
(c) Income tax return contains information which is directly related to a significant figure in the
financial statements. Therefore, the acceptance of review of income tax return would create a
self review threat.
In case the engagement is accepted the related safeguards may include the following:
The review may be performed by professionals who are not members of the audit team;
If the service is performed by a member of the audit team, a partner or senior staff member
with appropriate expertise and is not a member of the audit team, review the tax calculations;
or
The firm does not get involved in management decision making and clarifies this fact in the
communication with the client.
20 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 position
of signing the audit report.
This means he may be too familiar with
the client to be able to make objective
decisions due to this long association.
There is no ethical rule which stops Mr To show complete independence, Zhura
Sher recommending Zhura for the audit, should not be part of the audit team.
or letting Zhura take part in the audit, However, if Mr Sher is no longer the
providing Zhura has the appropriate skills. engagement partner then this removes the
If she does not have the appropriate skills ethical threat and Zhura could be included
then there could be a breach of the need in the audit team so long as she possesses
for an audit team to demonstrate the appropriate skills.
professional competence and due care.
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.
21 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 ensuring that the
credit card balance remains within the limit of Rs 1 million.
(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 fact of holding shares is disclosed at the time of
appointment and the share are disposed within ninety days of appointment.
23 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
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.
(b) 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
24 Assertions
(a) (i) 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.
(ii) The risk assessment procedures related to the risk of material misstatement at the
financial statement/assertion level are as follows:
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.
Analytical procedures.
Observation and inspection.
(b) 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.
(c) Assertions about classes of transactions and events and related disclosures are as follows:
Occurrence: Transactions and events that have been recorded or disclosed have
occurred and relate to the entity.
Completeness: There are no unrecorded transactions, events and disclosures.
Accuracy: Amounts and other data relating to recorded transactions and events have
been recorded appropriately and related disclosures have been appropriately measured
and described.
Cut-off: Transactions and events have been recorded in the correct accounting period.
Classification: Transactions and events have been recorded in the proper accounts.
Presentation: Transactions and events are appropriately aggregated or disaggregated
and clearly described and related disclosures are relevant and understandable.
Assertions about account balances and related disclosures are as follows:
Existence: Assets, liabilities and equity interests exist.
Rights and obligations: The entity holds or controls the rights to assets, and liabilities
are those of the entity.
Completeness: There are no unrecorded assets, liabilities or equity interests and all
related disclosures have been included.
Accuracy, valuation and allocation: Assets, liabilities and equity interests are included
in the financial statements at appropriate amounts and any resulting valuation or
allocation adjustments areappropriately recorded and related disclosures have been
appropriately measured and described.
Classification: Assets, liabilities and equity interests are appropriately aggregated or
disaggregated and clearly described, and related disclosures are relevant and
understandable
(c) Syed & Co. shall not be appointed as auditor of the company because one of the partners‟
spouse holds shares in its subsidiary company. However, the firm can be appointed as auditor
of Fazal Limited if the fact of holding shares is disclosed at the time of appointment and 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.
(f) According to Companies Act, 2017, there is no bar on Bilal and Company to be appointed as
the auditor of DL as holding of TFC‟s in the audit client is not prohibited under the provisions of
the Companies Act, 2017
(g) Zain and Company is ineligible for appointment as the auditor of HL as Imran is a partner in
Pure Investment Associates, which holds share in HL which is prohibited under the Companies
Act, 2017. In order to be eligible for appointment, the fact of holding of shares is required to be
disclosed at the time of appointment. Further, the shares are to be disposed-off within 90 days
of such appointment.
26 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.
(b) (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.
We should consider whether there are matters related to fraud to be discussed with those
charged with governance of the entity. Matters may include:
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.
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.
(iii) 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.
27 Information Limited
(a) The objective of a statutory audit (an external audit) is to express an opinion on the truth and
fairness of the views presented by the financial statements. The auditor is not primarily
responsible for the prevention or detection of fraud.
The auditor will be concerned with fraud only to the extent that it might impact on the view shown
by the financial statements. He will therefore be concerned with the risk of material fraud.
The auditor should maintain an attitude that includes a questioning mind, being alert to conditions
which may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence.
Further, he must respond appropriately to fraud or suspected fraud identified during the audit.
(b) Management‟s attitude towards the auditor which may indicate the possibility of a material
misstatement includes:
Denial of access to records, facilities, certain employees, customers, vendors, or others from
whom audit evidence might be sought.
Undue time pressures imposed by management to resolve complex or contentious issues.
Unusual delays by the entity in providing requested information.
An unwillingness to add or revise disclosures in the financial statements to make them more
complete and understandable.
(c) Rapid growth or unusual profitability.
Significant portions of key management personnel‟s compensation i.e. bonus being contingent
upon achieving aggressive targets for operating results.
Pressure on management to show good profitability considering the proposed acquisition.
28 Distributor
(a) i. Inability to increase the prices of its products since last 5 years
The Company‟s profitability is under threat due to increased competition therefore the
management may be inclined to manipulate the accounting records.
ii. Research costs wrongly capitalized
It is an error and is not indicative of fraud, as research costs is only 2% of the total amount
capitalized and the underlying records were duly supported by invoices from the suppliers.
iii. Bonuses linked with profitability
It is a fraud risk factor as it is evident that management is receiving profit related bonuses,
therefore the management may be inclined to manipulate the accounting records.
iv. Goods sold but not dispatched
It is a fraud risk factor as it seems that management has tried to inflate the sales in order to
deceive financial statement users, an apparent intention behind this action can be to
overstate the profits of the company.
The directorship of Daud‟s wife in RL is not relevant for the appointment of DC as the auditor of
JL.
(c) One of the directors in JL also holds 10% shareholding in RL:
Daud and Company can be appointed as the auditor of JL as there is no disqualification with
respect to common shareholding in another company, which is neither a subsidiary nor an
associated company of the prospective audit client.
(b) As the father of Nasir is a close family member, having a direct financial interest in DL, a self-
interest threat is created.
Safeguards:
Disposing as soon as practicable, of all the shares by Nasir‟s father (a close family member)
34 Materiality
(i) (a) i. Planning stage – The concept of materiality is used in determining the nature,
timing and extent of further audit procedures;
ii. Reporting stage – The materiality concept is used in evaluating the effect of
uncorrected misstatements, if any, on the financial statements and in forming the
opinion in the auditor's report.
(b) The auditor shall document the following aspects of materiality:
i. Materiality for the financial statements as a whole;
35 Auditor’s Expert
(i) (a) ) (i) the nature, scope and objectives of the expert‟s work
(ii) the respective responsibilities of the expert and the auditor
(iii) the form of the expert‟s report
(iv) confidentiality requirements
(b) ) The factors that should be considered in evaluating the adequacy of the expert‟s work,
include:
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.
(ii) Following are the situations which may require the engagement of an auditor‟s expert:
legal opinions
specialist valuation areas, such as property or pension liabilities
analysis of complex or unusual taxation issues
specialized inventory counts
36 Mineral Limited
(a) (i) Matters that should be considered by the auditor in determining the competence, capabilities
and objectivity of EL
The competence, capabilities and objectivity of an expert may be assessed in one or more of
the following ways:
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 that 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.
(ii) While evaluating the adequacy of the EL‟s work, the following would be considered:
Reasonableness of the EL‟s conclusions.
Consistency of such conclusions with other audit evidence.
Reasonableness of significant assumptions and methods used.
Relevance, completeness and accuracy of source data.
(b) If the auditor decides that the work of the expert is not adequate he is required to:
agree additional work with the expert, or
perform other appropriate additional audit procedures.
hire another expert
37 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.
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.
39 SPL
(a) 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.
(b) 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.
(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.
(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:
(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.
42 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
(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.
43 Changing terms
(a) 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.
(b) 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.
(c) 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:
(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.
44 EL
(a) 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.
(b) Situations that may require revision in the terms of engagement letter are as follows:
Any indication that the entity misunderstands the objectives and scope of the audit;
Any revised or special terms of the audit;
A recent change in the senior management/ ownership;
A significant change in nature or size of the entity‟s business;
45 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:
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.
46 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.
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) 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.
(b) 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.
47 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:
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.
(b) 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.
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.
48 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:
– 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.
(iii) 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.
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.
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.
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.
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.
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.
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.
– 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.
50 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. It is difficult to estimate that income in the
There is a risk that donations will fall, future will be sufficient to meet the expenditure
especially where donors‟ own income is of the charity.
limited by the „credit crunch‟ etc. Audit of the going concern concept (as in
ensuring that the charity can still operate) will
therefore be quite difficult.
Completeness of income – where there are Audit tests are unlikely to be effective to meet
no controls to ensure income is complete for the assertion of completeness. The audit
example sales invoices are not raised to report may need to be modified and qualified
obtain donations and donations could be to explain the lack of evidence stating that
stolen by staff. completeness of income cannot be confirmed.
51 Tahir Co
(a) 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.
(b) (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.
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.
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.
52 Elegant Limited
(a) In determining the need to send an engagement letter, the firm should assess whether:
circumstances require a revision in the terms of engagement.
management need to be reminded of the existing terms of the engagement.
The following factors may indicate that the above is appropriate:
Any indication that the entity misunderstands the objective and scope of the audit.
Any revised or special terms of the audit engagement.
A recent change of senior management.
A significant change in ownership.
A significant change in nature or size of the entity‟s business.
A change in legal or regulatory requirements.
A change in other reporting requirements.
53 Roof Limited
To CEO, APL.
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 arise because of the
following:
(i) The use of testing/sampling techniques;
(ii) The limitations that exist in any accounting and internal controls system (for example, the
possibility of collusion);
(iii) The fact that most audit evidence is persuasive rather than conclusive; and
(iv) The work undertaken by the auditor to form an opinion is permeated by judgment.
Further, other limitations may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions (for example, transactions between related parties).
54 Door Limited
Since it will be the first time we will be auditing Door Limited, I will have to discuss the following
additional matters with the engagement partner:
Arrangements to be made with the predecessor auditor, for example, to review the predecessor
auditor‟s working papers;
Any major issues (including the application of accounting principles or of auditing and reporting
standards) 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 overall audit strategy and audit plan;
The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening
balances; and
Other procedures required by the firm‟s system of quality control for initial audit engagements.
57 Green Limited
(a) Fraud risk factors:
Significant decline in customer demand:
Due to significant decline in demand of foreign customers, the management may be inclined to
show improved results by manipulating the accounting records.
Significant related party transactions:
Significant related party transactions between GL and BL would provide an opportunity for
engaging in fraudulent financial reporting.
Sale of shares by director:
The directors' intention to sell their shareholding in GL provides them an incentive to manipulate
the annual profits so that they can achieve the maximum possible gain from the sale of shares.
Non-implementation of last year’s external auditor’s recommendations:
Management failure to place controls against weaknesses identified by the external auditor on
timely basis shows the management‟s attitude towards the improvement of internal controls and
consequently it increases the risk of fraud.
58 Sukkur Limited
(a) Fraud risk factors in the scenario are:
high degree of competition or market saturation, accompanied by declining margins and
profitability.
high vulnerability to rapid changes, such as changes in technology, product obsolescence, or
interest rates.
excessive pressure exists for management to meet the requirements or expectations of third
parties due to the need to obtain additional debt financing to stay competitive.
recurring negative cash flows from operations or an inability to generate cash flows from
operations while reporting profitable operation.
(b) Audit risks
(i) Risk of fraudulent financial reporting by Management override of controls:
In view of the declining earnings trend and declining margin and increase in financing the
management may be inclined to fraudulent financial reporting by overstating the revenues or
understating the expenses.
(ii) Risk of impairment in value of property, plant and equipment:
Due to introduction of new technology there is a possibility that value of existing plant and
machinery is impaired.
(iii) Risk of overstatement of existing inventory:
Due to change in technology, the demand for SL‟s products has been affected and there is a
possibility that net realizable value of inventory may have declined and a provision for
obsolescence may be required.
(iv) Risk of overstatement in value of debtors:
In view of the negative operating cash flows, it seems that SL has not been able to generate
operating cash flows despite increase in sale, which might indicate that debtors are either
doubtful or not recoverable.
INTERNAL CONTROL
59 Training Manager
(a) Control Environment and its elements
The „control environment‟ is often referred to as the general „attitude‟ to internal control of
management and employees in the organization.
The elements of control environment include the following:
Communication and enforcement of integrity and ethical values
Commitment to competence
Participation of those charged with governance.
Management‟s philosophy and operating style
Organizational structure
Assignment of authority and responsibility
Human resource policies and practices
(b) Walk through tests:
Auditor is required to gain an understanding of the various elements of the internal control
system operating within an entity. Once this understanding has been gained, the auditor should
confirm that his understanding is correct by performing „walk-through‟ tests on each major
transaction type (for example, revenue, purchases and payroll). Walk-through testing involves the
auditor selecting a small sample of transactions and following them through the various stages in
their processing in order to establish whether his understanding of the process is correct.
(c) Materiality:
Information is material if its omission or misstatement could influence the economic decisions of
users taken on the basis of financial statements. The auditor keeping in view the concept of
materiality gives his opinion i.e. whether the financial statements present fairly in all material
respects the financial position and performance of the entity.
Performance Materiality:
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.
If applicable, 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.
Performance materiality recognizes the fact that errors/omissions detected in a particular area
may not breach the overall materiality level but when all the errors/omissions in all the areas is
combined or added together, the overall materiality could be breached.
60 Vision Limited
Type of General IT controls /
Control
controls Application controls
(i) The general ledger system is automatically updated with Preventive Application controls
sub-ledger transactions (e.g., Accounts Receivable) every
night through batch processing.
(ii) The system automatically maintain second copies of all Corrective Application controls
programs and data files.
(iii) Access to programs and data files is restricted using Preventive General IT controls
passwords.
(iv) Invoices are physically counted that are entered into the Detective Application controls
system.
(v) Firewalls (software and hardware are installed to restrict Preventive General IT controls
unauthorized access).
(vi) Screen warnings about incomplete processing. Detective Application controls
(vii) Service level agreements. Corrective General IT controls
(viii) Review of output against expected values. Detective Application controls
61 Types of Controls
(i) Training on applicable policies, department policy/ procedures:
It is a preventive controls, as the individuals are trained to perform their duties as per the
applicable policies and procedures that are in place.
(ii) Batch totals:
It is a detective control as program will report any discrepancy between the manually counted
batch total and its own batch total, as an error report.
(iii) Segregation of duties:
It is a preventive control as it involves assigning different people the responsibilities of authorising
and recording transactions and maintaining the custody of assets.
This reduces the likelihood of an employee being able to both carry out and conceal errors or
fraud.
(iv) Contingency planning:
It is a corrective control as it involves the corrective measures to be adopted in case of any
mishap.
(v) System logs:
It is a detective control as this generates an audit trail that can be used to understand the activity of
the system and to diagnose problems.
(vi) System backup:
It is a corrective control as it will involve any retrieval measures in case of any damage to the
original data.
start
N No
No o
Updation of
points to the
loyalty card
Payment of bill
partly through Payment of bill through
redemption and redemption of points
Payment of bill
through cash partly through casg
or credit card
Updating the
loyalty points
Printing of bill
Yes
Session card End
No
Next customer
(b) The limitations of flowchart as a tool of system documentation includes the following:
These are only suitable for describing standard systems rather than recording systems with
numerous unusual transactions.
Flowcharts are also not appropriate for recording systems with further classifications of
subsystems or subroutines.
Constructing a flow chart is a time consuming process because an auditor must learn about
the operating personnel involved in the system and gather samples of relevant documents
There is a possibility of recording and checking areas that are of no audit significance.
Flowcharts are difficult to amend because a single amendment may require changes in the
entire chart.
63 IT Department
(a) Controls over data transmission may include the following:
Firewalls to prevent intrusion into the programs that send and receive data
Only using secured Wi-Fi with password protection
Data encryption
(b) If management refuse to allow the auditor to send a confirmation request the auditor
should:
inquire as to management‟s reasons for the refusal, and seek audit evidence as to the validity
and reasonableness of those reasons;
evaluate the implications of management‟s refusal on the auditor‟s assessment of the relevant
risks of material misstatement, including the risk of fraud, and on the nature, timing and extent
of other audit procedures; and
perform alternative audit procedures designed to obtain relevant and reliable audit evidence.
The auditor shall communicate with those charged with governance if:
the auditor concludes that management‟s refusal to allow the auditor to send a confirmation
request is unreasonable; or
the auditor is unable to obtain relevant and reliable audit evidence from alternative audit
procedures,
(c) Performance reviews – In the context of control activities, performance review includes:
analyses of actual performance against budget and forecasts;
analyses of actual performance against prior period performance
control reporting and variance analysis
(d) Communications protocol
A communications protocol is set of digital rules for message exchange within or between
computers.
When systems communicate they use pre-defined formats for exchanging the messages.
This ensures that each part of the message is recognized and interpreted by the recipient in the
intended fashion.
For each communication a protocol must define:
Syntax – the arguments used to create the message
Semantics – how each argument is to be interpreted
Synchronization – how the sender and receiver will actually exchange the message
Communication protocols are implemented through a combination of hardware and software.
(e) The main categories of general controls that an auditor would expect to find in a
computer-based information system are:
i. controls over the development of new computer information systems and applications
ii. controls over the documentation and testing of changes to programs
iii. the prevention or detection of unauthorised changes to programs (for example, by an
employee committing fraud or by a „hacker‟ accessing the system)
iv. controls to prevent the use of incorrect data files or programs
64 Controls
Controls over data transmission include:
firewalls to prevent intrusion into the programs that send and receive data.
restricting access to source data that is transmitted.
only using secured Wi-Fi with password protection.
using check sums and check digits to ensure that data received is intact.
data encryption.
65 Bhurbhan Limited
(a) Risks:
Risks related to receiving of goods and invoice from suppliers are as follows:
Goods may be accepted from a supplier without having been ordered.
The company may fail to claim discounts from suppliers despite being due.
Supplier may raise invoices for goods that have not actually been received / purchased.
Goods received from suppliers are of inferior quality.
(b) Related controls
Suitable controls may be as follows:
A copy of all delivery notes should be retained, with a signature of the member of staff who
took receipt and checked the goods.
Goods received notes should be produced for each delivery, from the delivery note or after a
physical count of the items received.
A member of the accounts staff or purchasing staff must be responsible for checking
discounts allowed by suppliers.
There should be a segregation of duties between the individuals who take delivery of goods,
those who place the orders and those who record the purchase invoices in the accounting
system.
All purchase invoices should be checked against a purchase order and a goods received
note.
(c) Tests of control
Ensure that goods received notes, purchase orders and purchase invoices are matched with
each other.
Confirm from documentary evidence that discounts are claimed from suppliers when
available.
Check that the segregation of duties does exist.
66 Audit trail
(a) Audit Trail in a computerized environment:
An audit trail refers to the ability of the auditor to trace a transaction through all its processing
stages. An audit trail can be provided by a record („log‟) of how the computer has processed any
transaction.
An audit trail may not exist in „paper form‟ in an online system, but the computer program should
be written so as to generate the audit trail on request for any transaction.
67 Supermarkets
(a) Key controls on cash sales and cash handling:
(i) Responsibility to receive cash should be clearly identified.
(ii) Proper locks should be provided to each person responsible for handling cash.
(iii) Cash should be kept in a locked and secure area until it is deposited.
(iv) Cash registers and credit card machines should be balanced at least once a day.
(v) Proper policies should be made to deal with cash shortages/excesses.
(vi) Timely deposit of cash should be ensured.
(vii) Cash register should be used to record cash sales.
(viii) Transfers of cash from one person to another should be kept at a minimum.
(b) (i) Adequate segregation of duties or independent checks.
(ii) Adequate system of authorization and approval of transactions (for example, in
purchasing, movement between locations etc.)
(iii) Use of door locks and surveillance cameras.
(iv) Surprise physical count and timely reconciliation of inventory items.
(v) Mandatory vacations for employees performing key control functions.
(vi) Periodic rotation of employees.
(vii) Restricted storage area.
(viii) Different entry and exit doors.
(ix) Access controls over automated records, including controls over and review of computer
systems event logs.
(x) Job applicant screening of employees with access to assets.
68 Controls
(i) (a) 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.
(b) 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.
(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.
(c) Data encryption during data transmission
Availability of firewalls to prevent intrusion into the programs that send and receive
data
Program controls that ensure data is transmitted in the correct format
Restricting access to source data that is transmitted
Only using secured Wi-Fi with password protection
Using check sums and check digits to ensure that data received is intact
69 Shahzad Limited
(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
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.
70 Waheed Engineering
(a) Control Purpose
(b) 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.
(c) 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.
(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.
(d) 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.
(e) 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.
71 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.
(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 time-consuming. 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.
(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.
72 Roses Anytime
(a) Key procedures
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.
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.
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.
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.
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.
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.
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.
(ii) 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.
73 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 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.
(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‟.
74 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
Possible misstatement Reassignment
reassigned
Sending out monthly If there are errors in the This function should be
statements and chasing accounts receivable ledger assigned to Clerk 2 since
overdue accounts. the monthly statements Clerk 1 could also falsify
could be altered or statements to conceal
suppressed. errors in recording sales in
the accounts receivable
If payments by customers
ledger. (See additional
have been misappropriated
procedure 2.)
and not credited to the
customer account,
customers‟ suspicions
would not be aroused by
chasing apparent overdue
balances.
Function to be
Possible misstatement Reassignment
reassigned
Writing off uncollectible If errors have been made Clerk 2 should advise the
balances. resulting in an manager of overdue
understatement of cash balances that may need to
received from credit be written off. (see
customers, their accounts additional procedure 4.)
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.
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.
Have the custodian sign the record of the count as being in agreement in the event
of any subsequent disagreement.
(ii) 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.
75 TS Limited
Many of the control activities that are typically found in a large company such as segregation of duties,
internal audit etc. may be inappropriate for a small entity because they are too costly or impractical for
such smaller organizations. Often, control systems in small entities are based on a high level of
involvement by the directors or owners. Following audit risks may arise when control systems rely
excessively on the involvement of senior management:
(i) There may be a lack of evidence as to how systems are operating.
(ii) There may be lack of evidence of controls.
(iii) Management may override controls that are in place.
(iv) Management may lack the expertise necessary to control the entity effectively.
It appears that changes are made All changes must be authorized at an appropriate level.
in the system without proper
authorization. Change requisition, assessment and approval should be
properly documented.
It appears that there was lack of No change shall be made in live environment. All changes
testing in the offline environment made in the program should first be tested in offline
prior to the implementation, which environment.
resulted in the malfunction of the
system. Impact of change on existing functioning must be assessed
before implementing the change.
It appears that due to Backup policy as per needs of the PSL must be in place.
unavailability of last updated
backups or improper backup Recorded backups must be restored periodically to assess
policy, the invoicing system was their effectiveness.
not operational for four days.
77 Advanced limited
(i) The list prepared by the There might be suppliers There should be a formal process
purchase department has on the list who are not of approving the list and also for
not been approved by competent enough to placing the suppliers on the
anyone other than the make the supply. approved list.
purchase department.
(ii) List has not been updated The list of the suppliers should be
since 2015. updated on a regular basis.
(iii) Lack of proper criteria for Purchases may be made The criteria for addition of new
selecting suppliers as from unreliable suppliers. supplier should be comprehensive
presently suppliers are which should cover both financial
added to the list without and technical capabilities of the
considering their financial suppliers.
soundness, experience,
etc.
(iv) Purchase requisitions are This could lead to All purchase requisitions should be
processed merely on the inappropriate purchases, authorized by the store manager
initials of the stores officer. i.e. in terms of type of as well as the user department.
/There is no formal goods or their quantity.
process of reviewing the
purchase requisition
received from store
department.
(v) Purchase orders are not Liabilities for goods PO should be pre-numbered or be
pre-numbered as they are received may not be issued in sequential order controlled
issued in the form of recorded or may be by a computer system.
email. recorded more than
once if there is no
sequential numbering.
(vi) Quotations are not Purchases may be made Prior to ordering of goods the
obtained from the supplier at a higher price or shortlisted suppliers should be
before placing the orders. discounts may not be asked to submit the quotations,
availed. which should be reviewed by the
purchase committee.
(vii) High value or other than This leads to lack of A purchase committee comprising
routine purchases are only segregation of duties of senior officials should be formed
authorized by the which may result in to oversee purchases above a
purchase manager and inefficiencies. certain amount.
store manager.
(ix) Although GRN has been There is a possibility of Before payment, supplier‟s invoice
prepared by the store incorrect payment to the should be reconciled with GRN
department, payment has supplier. and PO.
been made on the basis of
GDN instead of GRN.
(x) Inventory and payable are Cut off errors may arise Inventory/payables should be
recorded upon receipt of i.e. where goods are recorded on the basis of GRN.
invoice only. received but invoice is
received after year end.
78 Bell Limited
(a) The introduction of IMS may create the following risks:
There is an increased level of dependency on the computer system of the organisation and
also of the supplier. Any computer failure may therefore have an increased impact on the
organisation.
There is an increased risk of possible loss or corruption of data due to the process of
transmission.
There are also security risks in the transmission of data and unauthorised individuals may be
able to gain access to the data.
(b) Controls that could mitigate the above risks are as follows:
Controls over transmission of data (encryption, acknowledgement systems, authentication
codes, etc.);
Monitoring and checking of output;
Virus protection systems; and
Contingency plans and back up arrangements.
79 General IT Controls
(a)
General IT controls aim to establish a framework Application controls are the specific controls over
of overall control over the computer information the relevant applications maintained by the
system‟s activities to provide a reasonable level computer. The purpose of application controls is
of assurance that the overall objectives of internal to establish specific control procedures over a
controls are achieved. particular application. In order to provide
reasonable assurance that all transactions are
authorized and recorded, and are processed
completely, accurately and on a timely basis.
(b) Weaknesses in general IT controls may result in IT application controls becoming ineffective.
However it is possible that manual procedures exercised by users may provide effective controls
at the application level.
AUDIT EVIDENCE
80 Verification of Evidences
(a) Ways in which debtors population may be stratified are as under:
By product
Geographically
By values
i. The view that if verification of balances of category A and B is carried out than there is no
need to perform further procedures is not correct as the results of audit procedures applied to
items in category A and B will only provide evidence about the items that make up that
category (stratum).
The auditor should obtain sufficient appropriate audit evidence regarding items in categories
C & D as these can also be material.
ii. The view that sampling should be carried out on haphazard basis to ensure equal chance of
selection is not correct as such assurance is only ensured by using random sampling, i.e.
use of random numbers to select items.
iii. The view related to systematic sampling is not correct, as selection of 10% items is not
systematic sampling. Systematic sampling involves, selection of first item on random basis
and then items are selected with a standard gap between them (for example, every 10th
item).
Suggestion:
Both haphazard and systematic sampling may be used in the normal manner, either with or without
stratification. However, these methods cannot be used in the manner as suggested by the team
members because it may result in extensive testing on immaterial items, thereby increasing the cost
which may not be efficient. It may also be appropriate to use random sampling to ensure all items in a
population have an equal chance of selection.
81 Rehan Limited
(a) (i) The approach of not sending confirmation requests to balances below Rs. 100,000 is not
correct unless the total of such balances is clearly immaterial.
(ii) The conclusion documented by the team is not correct as the confirmation received from
creditors only confirms the recorded amount and is not relevant for the purpose of testing
of unrecorded liabilities.
(b) (i) The audit team is required to discuss the matter with client‟s management and ask them
to send confirmation as per the normal sampling procedure of the audit firm.
In case the management does not agree, the audit team should evaluate the implications of
management's refusal on the auditor's assessment of the relevant risks of material
misstatement, including the risk of fraud, and on the nature, timing and extent of other audit
procedures;
(ii) Following information should be tested by the audit team to draw conclusion related to
unrecorded liabilities:
subsequent disbursements
83 Nobel
The audit evidences which may be gathered in the cases referred to in the question are as follows:
(i) Legal Opinion.
The terms and conditions of the contract related to defective material and liability thereof.
Documentation of response of other customers, to whom similar items have been supplied.
Opinion of independent experts (regarding useful life, pattern of wear tear etc.)
The environment (production load, maintenance policies etc.) under which the company is
operating and its comparison with other firms in the industry.
The reasons for sale of equipment (normal case or otherwise)
84 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.
85 Sky blue
The investigation of unusual fluctuations and relationships ordinarily begins with inquiries of
management, followed by:
(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.
86 Direct confirmations 1
(a) 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.
87 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.
88 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.
(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:
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.
89 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:
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.
Sufficient appropriate audit evidence was obtained to serve as a reasonable basis for
conclusions reached.
Conclusions reached are appropriate in the circumstances and any reports prepared are
consistent with the results of work performed.
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.
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.
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:
Discussion with the credit manager.
91 Related parties
(i) 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:
(a) Review prior year working papers for names of known related parties;
(b) Review the entity‟s procedures for identification of related parties;
(c) Inquire as to the affiliation of those charged with governance and officers with other
entities;
(d) Review shareholder records to determine the names of principal shareholders or, if
appropriate, obtain a listing of principal share-holders from the share register;
(e) Review minutes of the meetings of shareholders and those charged with governance and
other relevant statutory records such as the register of directors‟ interests;
(f) Inquire of other auditors currently involved in the audit, or predecessor auditors, as to
their knowledge of additional related parties; and
(g) Review the entity‟s income tax returns and other information supplied to regulatory
agencies.
(ii) Accounting systems may not be effective at identifying and summarizing related party
transactions and balances.
Related party transactions may not be conducted on normal market terms.
Related parties may operate through complex structures and therefore may be used to
commit fraud.
92 Kamil Limited
In the scenario, a previously undisclosed related party has been identified. I shall:
communicate the relevant information to the audit team.
assess as to why the entity‟s system failed to identify or disclose the related party relationship.
request management to identify all transactions with NL and disclose them accordingly.
perform appropriate substantive procedures on the newly identified related parties or significant
related party transactions.
assess the reasonableness of the management‟s explanation and;
evaluate the implications on the audit, if the non-disclosure appears intentional.
93 Direct confirmations 2
(a) 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.
(b) 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.
(c) 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 cut-off assertion.
94 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.
95 Al-Shams
(a) (i) Evaluate the company‟s procedures for identifying and for properly accounting for related-
party transactions.
(ii) Inquire of management regarding:
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.
(iii) Inspect information supplied by the entity to regulatory authorities (e.g. SECP, FBR, SBP,
etc.)
(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.
(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.
(b) 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.
96 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.
97 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.
A sampling approach that does not have above characteristics is considered non-statistical
sampling.
(ii) 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.
That the auditor should consider the risk of material misstatement on the entire
population.
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.
98 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) 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.
(c) 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.
99 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:
The nature of these transactions
Whether related parties are involved in these transactions
(f) 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.
Finished Goods:
(i) Obtain a list of items (schedule) shown as finished goods, with full particulars, quantity and
value
(ii) Compare the list with physical count sheet balances and with stock ledger balances
(iii) On test basis check the items and quantities in the stock ledger with the bin card.
(iv) 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.
(v) 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.
(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 Act, 2017.
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.
101 Framework
(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
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.
102 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 above-mentioned 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:
(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.
103 BPR
(a) 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.
(b) Substantive Procedures for Payroll:
From the payroll record:
Select a sample of newly appointed staff and check their salaries with the appointment
letter.
Select a sample of other staff (appointed in previous years) and check their salaries
with the increment letter.
In both the above cases check that allowances and deductions are in accordance with
the company‟s policies or the relevant legal requirements.
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.
(c) Substantive Procedures for Raw material purchases:
Select a sample of transactions and carryout the following tests.
Check weather appropriate measures have been taken as per the company‟s policy to
ensure that purchases are made from most competitive sources.
Check the relevant invoices.
104 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.
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.
105 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.
(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.
(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.
(b) 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.
(c) 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.
(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.
106 Glasses2Go
(a) Purposes of audit working papers
The purposes of audit working papers include:
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.
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.
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.
109 Auditors
(a) Key substantive procedures for verification of provisions include the following:
(i) Ensure that all provisions have been recognized in accordance with the IAS 37.
(ii) Review the measurement of the closing balance for each provision and discuss these
with management if appropriate. Consider whether it might be appropriate to take expert
advice on the existence or measurement of a provision.
(iii) Review the board approval related to provisions booked in the financial statements.
(iv) Review the list of provisions for possible omissions, based on the auditor‟s knowledge of
the business and the industry in which it operates.
(v) Relate the testing of provisions to other areas of the audit work, such as correspondence
with lawyers/minutes of Board of director‟s meeting (which might reveal more information
about matters to which the provisions relate).
(vi) Compare provisions for the current financial year with provisions in previous years, and
investigate any major differences or omissions.
The decision relating to sufficiency of audit evidence depends upon the judgment of the auditor. Apart
from professional judgment, following factors are also relevant in determining the sufficiency of audit
evidence.
(i) the seriousness of the risk that the financial statements might not give a true and fair
view; when this risk is high, more audit evidence will be required
(iii) the strength of the internal controls in the client‟s accounting systems
(c) In order to evaluate the adequacy of internal audit function, the external auditor should assess
whether:
(i) The work was properly planned, performed, supervised, reviewed and documented;
(ii) Sufficient, appropriate evidence was obtained to enable internal auditors to draw
reasonable conclusions;
(iii) Appropriate conclusions were reached, consistent with any reports prepared;
(ii) Alarms
It refers to an attitude that includes a questioning mind, being alert to conditions which may
indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.
However, it does not mean that the auditors should disbelieve everything they are told, but they
should view what they are told with a skeptical attitude, and consider whether it appears
reasonable and whether it conflicts with any other evidence.
(f) Perform other audit procedures to attempt to resolve the matter or finalize your view point.
Consider the effect of the above on reliability of other representations and the audit
evidence.
Consider whether the risk assessment remains appropriate and if not, revise the risk
assessment and determine the nature, timing and extent of further audit procedure. The
auditor may also reconsider assessment of the competence, integrity, ethical values or
diligence of the management.
If the auditor has concerns about the integrity of management, he should document those
concerns and consider withdrawing from the audit and the impact on the report.
(g) The factors which determine the extent to which analytical procedures may be used as a form of
substantive procedures are as follows:
reliability of data from which the auditor's expectation of recorded amounts or ratios is
developed;
whether the expectation as regards the recorded amounts is sufficiently precise to identify a
misstatement that, individually or when aggregated with other misstatements, may cause
the financial statements to be materially misstated.
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.
Cast the list of invoices in the receivables To ensure that the total sales for that month are
ledger programme for one month. Trace accurate. Transfer of data to the nominal ledger
total sales to the general ledger ensures that the total sales amount is recorded
programme. correctly in the ledger.
Cast the monthly sales figures in the The final cast and checking ensures that the
general ledger and agree to the financial financial accounts figure is accurate.
statements. Investigage any discrepancies.
Casting tests can be carried out manually or using
computer audit software.
112 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:
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.
(b) 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.
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
Ensure that the items properly meet the definition of plant and equipment and are properly
recorded as such.
(c) 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.
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.
114 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:
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.
(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) 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.
(b) 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.
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.
116 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:
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.
(b) 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
the year-end bank balance on the computer system, and
the balance on the financial statements.
(2) 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.
117 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:
(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.
(b) 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.
(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.
(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 year-end.
(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.
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.
(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.
120 Heidi Co
(a) (i) Benefits of using audit software
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 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.
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
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
If management has made a statement in the notes to the financial statements that a related party
transaction was made on the same terms as an arm‟s length transaction, the auditor must obtain
evidence to support this statement.
Compare the list of trade payables with the listing of the previous year‟s audit. Look for explanations
as to why any major supplier is not appearing on the current year‟s listing.
Apply other analytical procedures and obtain explanations for any significant differences identified
while carrying out the above tests.
extend the review of subsequent events up to the date of the new audit report
if management does not agree to change the financial statements, the auditor should consider the
available alternative to him.
SCENARIOS
130 Zeedin Co
(a) Audit procedures procurement and purchases system
131 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
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.
(d) (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.
(ii) Specific receivables for selection:
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.
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.
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.
Receivables with balances more than two months old. Receivables with old balances
may indicate a provision is required for non-payment. 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.
Random sample of remaining balances to provide an overall view of the accuracy of
the receivables balance.
132 Bashir Co
(a) Control Objectives – wages system
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.
(d)
Audit procedure Benefit to auditor in testing accuracy of time recording
system
Confirmation
Confirmation is the process of Obtaining information from a third party will be difficult. The
obtaining a representation of manufacturer of the time recording system could be
information or of an existing approached to discuss known errors with the system;
condition directly from a third however, information provided may be limited by the need to
party. protect the manufacturer‟s integrity.
It is therefore unlikely that the auditor will benefit from this
procedure.
Observation
This procedure involves Testing will be limited to ensuring all shift-workers actually
watching a procedure being clock in and out when they arrive to and depart from work.
performed by others – in this The procedure has limited use as it only confirms it worked
case watching shift-workers when shift-workers were observed. It also cannot confirm
using the time recording system. that hours have been recorded accurately.
Inquiry
Inquiry involves obtaining Inquiry only confirms that shift-workers confirm they clock-in
information from client staff or or out. It does not directly confirm the action actually
external sources. happened or the accuracy of the recording of hours worked.
Recalculation
Recalculation means re- Recalculation can confirm the hours worked are correctly
checking the arithmetical calculated as the difference between the clocking in and out
accuracy of the client‟s records; times in the time recording system. When used with
in this case the hours worked by reperformance evidence this will confirm the overall
the time-recording system. accuracy of the time recording system.
Reperformance
This is the auditor‟s independent If the auditor notes the time of clocking in and out, then
execution of procedures or these times can be agreed to the time recording system
controls that were originally confirming the accuracy of recording (or confirm that client
performed as part of the entity‟s staff actually perform this control). Re-performance is
internal control. therefore a good source of audit evidence.
Analytical procedures
COMPLETION
134 Final Audit File
(a) The auditor is required to assemble the final audit file(s) on a timely basis after the date of the
auditor‟s report. This usually excludes drafts of working papers or financial statements, or notes
that reflect incomplete or preliminary thinking. After the assembly of the final audit file has been
completed, the auditor must not delete or discard audit documentation before the end of its
retention period.
(b) In such case the auditor is required to document:
the circumstances;
the new or additional procedures performed, audit evidence obtained, conclusions reached
and their effect on the auditor‟s report; and
when and by whom the resulting changes to audit documentation were made and who
reviewed them.
Review the allocation of total expenditure on non-current assets between capital and revenue
amounts.
Verify amounts in the financial statements with the valuer‟s report.
Obtain an understanding of the work of the expert through considering the reasonableness of
valuations/assumptions used in valuations.
Evaluating the competence, capabilities and objectivity of the expert.
Check that valuations are regularly updated.
Check that all the assets of the similar class are revalued.
Review relevant material related to the industry as a whole such as financial statements of
major companies in the industry to identify possible industrywide contingencies.
Review the client‟s correspondence with lawyers.
Review the invoices for legal services to identify undisclosed contingencies and additional
information about contingencies
Consider direct confirmation from the company‟s lawyers and legal advisors.
Consider whether expert advice may be required from outside sources other than lawyers.
Ensure that provisions has been made in case the relevant condition as specified in IFRS are
met.
As substantive procedures when their use can be more effective or efficient than
tests of details.
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.
That an audit involves evaluating the overall presentation, structure and content of the
financial statements, including the disclosures
That auditor communicate with those charged with governance regarding, among other
matters, the planned scope and timing of the audit and significant audit findings, including
any significant deficiencies in internal control that auditor identify during the audit.
That auditor also provide those charged with governance with a statement that auditor
have complied with relevant ethical requirements regarding independence, and to
communicate with them all relationships and other matters that may reasonably be
thought to bear on auditor‟s independence, and where applicable, related safeguards.
151 Al-Badr
(i) Audit report should be addressed to the members of the company instead of directors.
(ii) In the opinion paragraph, the word “cash flow statement” has been omitted.
(iii) After the statement “We conducted our audit in accordance with the auditing standards” in the
basis of opinion paragraph, the words “as applicable in Pakistan” have been omitted.
Key audit matters have not been reported, after the basis of opinion paragraph.
(iv) In the auditor’s responsibility paragraph, the sentence “evaluate the appropriateness of accounting
policies used and the reasonableness of accounting estimates and related disclosures made by
management” has been omitted.
(v) In the “Report on Other Legal and Regulatory Requirements” paragraph a) proper books of account
have been kept by the Company as required by the Companies Act, 2017 (XIX of 2017) has been
omitted.
(vi) Name of the engagement partner has not been mentioned.
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 Act,
2017 have not been kept by the Company”.
(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.
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 under the paragraph “Information Other than the Financial
Statements and Auditor‟s Report Thereon “ describing the material inconsistency in
accordance with ISA 706;
(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.
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.
(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.
(b) (i) The amount of Rs. 9.6 million which is due from MIL is material to the financial
statements.
(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.
(c) 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.
(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
(d) 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.
The value of plant is material to the financial statements in terms of total assets as
well as profit before tax of the company.
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.
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.
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.
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.
(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.
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.
(b) The situations in which a report is modified without affecting the auditor‟s opinion are as follows:
(i) 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.
(ii) In case, other information attached with the financial statements are inconsistent with the
information in the financial statements.
(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 Key Audit Matters.
(iv) The emphasis of matter paragraph should ordinarily refer to the fact that the auditor‟s
opinion is not qualified in this respect.
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.
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.
(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
(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.
161 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.
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.
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
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.
162 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
New borrowing commitments
Significant sales of assets
New shares or debentures issued
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.
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.
(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.
(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.
(vii) Fisrt paragraph of the auditor‟s responsibility is wrongly given under this heading; it should
have been classified under the basis of opinion section of the report as per ISA 700
(Revised)
(viii) Some other information decribed by the ISA 700 (Revised) undrer the section of Auditor‟s
Responsibility is not provided in the given scenerio.
(ix) Heading should be “Auditor‟s Responsibilities for the Audit of the Financial Statements”
instead of “Auditor‟s Responsibility”
However, before arriving at any conclusion, we must consider the effects of the information
destroyed in the fire on the financial statements and on our ability to obtain the necessary audit
evidence and the possible impact on our audit report.
(c) If adjustments are immaterial, representation letter may include the effect of any uncorrected
immaterial misstatements. However, the decision regarding materiality of the uncorrected
misstatements is to be made by the auditor and not by the client.
Further, materiality depends on the fact that omission or misstatement would influence the
economic decision of the user, and the financial statements are relevant not only for the owners
but also for other users which may include bankers, government institutions, etc., therefore, the
comment of the managing director regarding the effect on decision making is not correct.
If financial statements remain uncorrected and the required correction is material also, its impact
on audit report would need to be assessed.
Discuss this matter with the management and those charged with governance to assess their
plans for arranging the necessary finance. In case the auditor believes that there is a doubt
as regards the company‟s ability to complete the development work, the intangible asset
should be derecognized and the auditor should request the management to amend the
financial statements.
If the management fails to resolve the issue appropriately, the auditor may have to qualify the
report as the misstatement is material, but not pervasive.
(ii) Since the fire has destroyed a significant portion of RL‟s plant, the auditor should consider RL‟s
ability to continue as a going concern.
Evaluate financial condition of RL as the cost of new plant is expected to be much higher and
insurance claim of Rs. 400 million may not be sufficient to purchase a new plant.
Discuss with the management and those charged with governance that how they intend to
finance the new plant and the operational expenses during the closure of the plant.
Inspect the insurance policy and the correspondence with insurance company for the
verification of the insurance claim.
Read the minutes of those charged with governance for further details.
Analyze the latest available interim financial statements, to assess the impact of the accident
on RL‟s financial performance.
In case the going concern basis is inappropriate but the financial statements have not been
adjusted accordingly we will express an adverse opinion.
In case going concern basis is appropriate but material uncertainty exists and the
management has not made appropriate disclosures, we will express a qualified or adverse
opinion depending upon the materiality and pervasiveness of the situation.
If the management has made appropriate disclosures in the financial statements regarding
material uncertainty, we will express an unmodified opinion and will draw attention to the
disclosure through a separate section under the heading material uncertainty related to going
concern.
REVIEW ENGAGEMENTS
169 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‟.
(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:
the entity‟s accounting policies, practices and procedures, including the preparation of
financial statements;
material assertions in the financial statements that are subject to the review;
decisions taken at board meetings and other meetings of the entity that may affect the
financial statements;
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:
discussions with the company‟s auditors;
(c)
Review Engagement Annual Audit
A review does not provide a high level of An audit is designed to provide a high
assurance and in some cases do not level of assurance to the users of the
provide any assurance. financial statements.