UNIVERSITY OF ZIMBABWE

2014 Nov/Dec Examinations

Faculty• Commerce
Department• Accountancy
Paper code and Title AC220 Auditing 2

Duration• 3 hours
Examiner• Mrs. L Nyikahadzoi

Authorized Materials: Nil

INSTRUCTIONS:

1. This paper contains ..5 .. Questions

2. Answer.. All. questions
3. Start each question on a new page
4. This question paper comprises...16 printed pages

NB: DO NOT TURN OVER THE QUESTION PAPER OR COMMENCE WRITING

UNTIL INSTRUCTED TO DO SO.
 QUESTION 1 [11 MARKS]

You have been assigned to audit the financial statements of Tagara Trading
Company for the year ending 31 December 2013. At the planning meeting,
attended by all members of the audit team, the audit manager confirmed that the
firm would adopt a risk-based approach to the audit, and for the benefit of the
junior members of the team he explained the use of the audit risk model
comprising inherent risk, control risk and detection risk. The manager also
explained the importance of preparing good audit working papers and confirmed
that he expected the header of every working paper to be properly completed. It
has been decided that for recurring audits, working papers will be split between
permanent and current audit files and the working papers on the current audit file
will be automated.

Required:

Draw and fully label a typical working paper (11marks)

QUESTION 2 [22 MARKS]

Audit procedures vary according to the risks associated with the client and the
methods used to record transactions. The third standard of fieldwork requires
that an auditor gathers sufficient and appropriate audit evidence.
Required

List and explain audit procedures used by auditors to gather evidence (22 marks)

QUESTION 3 [25 MARKS]

List numbers 1 through 25 in a vertical line and against each number write the
letter of the response that best answers the question.

1. Under which of the following situations would an auditor make use of audit
sampling to obtain audit evidence?

A
To carry out the test of control on procurement of raw material.

B
If the population in the sample size includes a low number of high value
items.

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 C To carry out substantive procedures on wages.

D To choose the sample items in inventory.

2. Financial statements are a summary of:

A Management's assertions

B Internal Auditor's assertions

C External Auditor's assertions

D Shareholder's assertions

3 In connection with a law suit, a third party attempts to gain access to the

auditor's working papers. The client's defence of privileged

communication will be successful only to the extent it is protected by the:

A. auditor's acquiescence in use of this defense.

B. common Law

C. Code of Professional Conduct.

D. specific statutes

4 During an audit engagement pertinent data are compiled and included in the

audit work papers. The work papers primarily are considered to be:

A. a client-owned record of conclusions reached by the auditors

who performed the engagement.

B. evidence supporting financial statements.

C. support for the auditor's representations as to compliance with

GAAS.

D. a record to be used as a basis for the following year's engagement.

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 5
As a consequence of his failure to adhere to GAAS in the course of his

examination of the Lamp Corporation, Harrison, CA, did not detect the

embezzlement of a material amount of funds by the company's controller. As a

matter of common law, to what extent would Harrison be liable to the lamp
Corporation for losses attributable to the theft?

A. He would have no liability, since the ordinary examination

cannot be relied upon to detect defalcations.

B. He would have no liability because privity of contract is lacking.

C. He would be liable for losses attributable to his negligence.

D. He would be liable only if it could be proven that he was

grossly negligent.

6.
Audit working papers are used to record the results of the auditor's
evidence-
gathering procedures. When preparing working papers the auditor
should remember that:

A. working papers should be kept on the client's premises so that

the client can have access them for reference purposes.

B. working papers should be the primary support for the financial

statements being examined.

C. working papers should be considered as a substitute for the

client's accounting records.

D. working papers should be designed to meet the circumstances

and the auditor's needs on each engagement.

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 7
Which of the following best describes a trend in litigation involving CAs?

A.
CA cannot render an opinion on a company unless the CA has
audited all affiliates of that company.

B.
A CA may not successfully assert as a defence that the CA had
no motive to be part of a fraud.

C.
A CA may be exposed to criminal as well as civil liability.

D.
A CA is primarily responsible for a client's footnotes in an
annual report filed with the ICAZ.

8. The auditor wishes to gather evidence to test the assertion that the client's

capitalization of leased equipment assets is properly valued. Which of the

following sources of evidence will the auditor find to be the most persuasive
(most reliable and relevant)?

A. Direct observation of the leased equipment.

B.
Examination of the lease contract and recomputation of capitalized amount
and current amortization.

C.
Confirmation of the current purchase price for similar equipment with vendors.

D.
Confirmation of the original cost of the equipment with the lessor.

9. The auditor wishes to gather evidence to test the assertion that the client's

capitalization of leased equipment assets is properly valued. Which of the

following sources of evidence will the auditor find to be the most persuasive
(most reliable and relevant)?

A. Direct observation of the leased equipment.

B.
Examination of the lease contract and recomputation of capitalized amount
and current amortization.

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 C.
Confirmation of the current purchase price for similar equipment with vendors.

D.
Confirmation of the original cost of the equipment with the lessor.

10. Which of the following is the least persuasive documentation in support of an

auditor's opinion?

A.
Schedules of details of physical inventory counts conducted by the client.

B. Notation of inferences drawn from ratios and trends.

C. Notation of appraisers' conclusions in the auditor's documentation.

D.
Lists of confirmations and the nature of responses received from the client's
customers.

11. Observation is considered a reliable audit procedure but one that is limited in

its usefulness. Which of the following does not represent a limitation of the use of
observation as an audit technique?

A.
Individuals may act differently when being observed than they do otherwise.

B. It is rarely sufficient to satisfy any assertion other than existence.

C.
It can provide an overview of the client's processing, but that processing may
be different than the client's procedures specify.

D.
It is difficult to generalize from one observation as to the correctness of
processing throughout the period under audit.

12. Confirmation is most likely to be a relevant form of evidence with regard to

assertions about accounts receivable when the auditor has concern about the
receivables'

A. Valuation

B. Classification
 C. Existence

D. Completeness

13. An auditor would most likely verify the interest earned on short-term bond
investments by:

A. Examining the receipt and deposit of interest checks.

B.
Confirming the bond interest rate with the issuer of the bonds.

C.
Recomputing the interest earned on the basis of face amount, interest

rate, and period held.

D.
Recomputing interest according to the face of the bond and adjusting by a
bond discount or premium amortization.

14. An auditor observes inventory held by the client and notes that some of the

inventory appears to be old, but in good condition. Which of the following

conclusions is justified by the audit procedure?

I. The older inventory is obsolete.

II. The inventory is owned by the company.

III. Inventory needs to be reduced to current market value.

A. I only

B. II only

C. I and III only

D. III only

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 15. Which of the following statements is not true concerning the auditor's
documentation?

A. The auditor should document the reasoning process and conclusions reached

for significant account balances even if audit tests show no exceptions.

B. Documentation review is facilitated if a standard documentation format is

utilised.

C. Audit documents should cross-reference other documents if the other

documents contain work that affects the auditor's overall assessment of an

account balance contained in the documentation.

D. The client should not prepare documentation schedules for the auditor even if

the auditor independently tests them.

16. For which of the following audit judgments would an auditor be least likely
to use an audit specialist?
A. Existence of cash.
B. Valuation of works of art.
C. Valuation of oil and gas reserves.
D. Interpretation of laws and regulations.

17. Which of the following statements is true regarding the auditor's use of the
work of a specialist?
A. The specialist, not the auditor, is responsible for evaluating whether the

specialist's findings support the assertions in the financial statements.

B. Because the individual is considered a specialist, the auditor does not

need to evaluate the professional qualifications of the specialist.

C. The auditor should obtain an understanding of the methods and
assumptions used by the specialist.
D. All of the above statements are true.

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 18. Which of the following statements is most accurate regarding the auditor's
primary focus on a client's related-party transactions?
A. The auditor wants reasonable assurance that all related-party transactions

are accounted for differently than transactions with unrelated parties.

B. The auditor will want to confirm the existence of the related parties.
C. The auditor wants reasonable assurance that all related-party

transactions have been appropriately disclosed.

D. The auditor will focus on verifying the valuation of the related party
transactions.

19. Which of the following transactions would be least likely to be a related party
transaction?
A. A purchase transaction between an entity and its owners.
B. A debt-related transaction between an entity and one of its workers.
C. An exchange of property between an entity and a joint venture in which
the entity has part ownership.
D. Writing-off obsolete inventory prior to year end.

20. Which of the following statements is true regarding audit documentation?

A. Auditors document only those significant issues that have not been
resolved by the audit report date.
B. Audit documentation provides the principal support for the audit opinion
expressed by the auditor.
C. Audit documentation would identify who reviewed the audit work, but not
who performed the audit work.
D. Documentation must be in paper format.

21. Which of the following items would typically not be included in the heading
of a work paper?
A. Client name.
B. Client balance sheet date.
B. Audit firm name.
D. A descriptive explanatory title.

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 22. Which of the following statements describes a purpose of an audit
program?
A. An audit program is used to specify the procedures to be performed in
obtaining audit evidence.
B. An audit program is used to record the completion of each audit step.
C. An audit program is useful for monitoring the progress of the audit.
D. All of the above statements describe the purpose of an audit program.

23. Which of the following items would typically not be included in an audit
program?
A. A list of audit procedures to be performed.
B. An indication of who performed the procedure.
C. A work paper heading.

D. All of the above would typically be included in an audit program

24. For which of the following auditing procedures would sampling be most
appropriate?
A. Examining documents.
B. Inquiring of management.
C. Observing controls being completed.
D. Conducting analytical procedures.

25 Which of the following activities would be most likely to be accomplished

using sampling?
A. Sorting a file to identify the largest items.
B. Scanning for unusual transactions.
C. Selecting items and tracing back to source documents.
D. Footing the file.

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QUESTION 4 [32 MARKS]

(a) The auditor needs to understand this environment and the security
features designed to ensure that only authorized users access the system
for approved purposes. Most computing systems are highly integrated,
utilizing enterprise resource planning systems (ERP systems) to ensure
consistency of processing. Companies become dependent on the security
and integrity of computerized systems. If the systems fail, it is quite
possible that the company itself may fail. If a company does nOt have a
comprehensive ERP system that incorporates computer risks, the
company has vulnerabilities that must be explicitly addressed in each
audit.
Required

Outline the risks that could exist in the following electronic data processing
areas.
Data Processing Area Risks
Computer Operations 3 marks
Computer Programs 3 marks
Data files 3 marks
Data Communications 3 marks

(12 marks)

(b) The auditor is not and can not be held responsible for fraud and errors, but
through his work he can play a positive role in preventing fraud and errors,
by deterring their occurrence. The fraud character of an operation can be
established only in court, so that, since the auditor has no responsibility to
prove fraud from a legal point of view, his concerns are directed rather
towards actions suspicious of fraud, than proven fraud.
KOSS CORPORATION AND GRANT THORNTON
Milwaukee-based Koss Corporation reported an embezzlement of funds
orchestrated by its CFO of approximately $31 million over a five-year period

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 of time when the company's reported earnings were only $26 million. The
CFO used the funds to buy personal goods, such as expensive coats,
jewellery, and other personal items that were mostly kept in storage facilities.
Interestingly, the CFO was neither an accountant nor a CPA; the CEO had a
college degree in anthropology; most of the board members had served on
the board for 20-30 years; and the company made highly technical products
that were in very competitive markets. During the fall of 2009, Koss
Corporation, a Wisconsin—based manufacturer of stereo headphone
equipment, revealed that its Vice President of Finance (Sujata "Sue"
Sachdeva) had defrauded the company of approximately $31 million over a
period of at least five years. Grant Thornton LLP was the company's auditor,
and the firm issued unqualified audit opinions for the entire period in which
they worked for Koss. According to reports, Sachdeva's theft accelerated
over a period of years as follows:
FY 2005: $2,195,477
FY 2006: $2,227,669
FY 2007: $3,160,310
FY 2008: $5,040,968
FY 2009: $8,485,937
FY 2010: $5,326,305
FY 2010: $4,917,005

To give you a sense of the magnitude of the fraud, annual revenues for Koss
Corporation are in the range of $40—$45 million annually. Previously
reported pre—tax income for fiscal years 2007 and through Q1 2010 was as
follows:
FY 2007: $8,344,715
FY 2008: $7,410,569
FY 2009: $2,887,730
FY 2010: $ 928,491

How could Sachdeva have stolen so much money and fooled so many people
over a long period? It is thought that Sachdeva hid the theft in the company's
cost of goods sold accounts, and that weak internal controls and poor
corporate governance and oversight enabled her to conceal the theft from

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 corporate officials. Certainly, there must have been questions raised about
the company's deteriorating financial condition. But any number of excuses
could have been used by Sachdeva to explain the missing money. For
example, she might have blamed higher cost of goods sold on a change in
suppliers or rising raw materials prices.

Another contributing factor in Sachdeva's ability to conceal her thefts was that
top-management of Koss had a high degree of trust in her, so they did not
monitor the accounts that she controlled at the company. Sachdeva's total
compensation for fiscal year 2009 was $173,734. But according to published
reports, Sachdeva was known for her unusually lavish lifestyle and shopping
sprees. It is reported that she spent $225,000 at a single Houston, Texas,
jewelry store. Another report describes a $1.4 million shopping spree at
Valentina Boutique in Mequon, Wisconsin. People familiar with her spending
habits assumed that she used family money and that her husband's job as a
prominent pediatrician funded her extravagant lifestyle. The fraud was
ultimately uncovered because American Express became concerned when it
realized that Sachdeva was paying for large balances on her personal
account with wire transfers from a Koss Corporation account. American
Express notified the FBI and relayed its concerns. Upon learning of the fraud,
Koss Corporation executives fired Sachdeva, along with the company's audit
firm, Grant Thornton LLP. Koss Corporation is attempting to recover its
monetary losses through the recovery and sale of merchandise that was
purchased by Sachdeva as part of the unauthorized transactions, and through
insurance proceeds and possible claims against third parties (including Grant
Thornton LLP). Law enforcement authorities notified Koss Corporation that at
least 22,000 items—including high-end women's clothing, shoes, handbags,
and jewellery have been recovered to date. Sachdeva stored the bulk of the
items she purchased in rented storage units in order to conceal the items
from her husband.
Required

The conditions and events that increase the risk of fraud or errors refer
primarily to the gaps in the functioning of accounting and internal control

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 systems or to inconsistencies of internal controls. After considering this
situation, answer the following questions:
i. What was Grant Thornton's obligation to uncover the fraud? (1 mark)
ii. Why should auditors have suspected Sachdeva? (1 mark)
iii. Why was the fraud ignored or explained away by her professional
colleagues? (1 mark)
iv. What were the internal control weaknesses (4 marks)

v. What was the audit committee's responsibility to notice that something

looked amiss in the financial statements? (1 mark)

vi.Some reports have described Sachdeva as having a very dominating

personality, and revelations were made about the fact that she would often be
verbally abusive of her subordinates in front of top-level managers at Koss.
What actions could the subordinates have taken to respond to this behaviour?
(1 mark)

vii). Why this behaviour a problem? (1 mark)

viii) Why might did Koss management fail to discover this fraud? (1 mark)

(10 marks)

(c)When carrying out audit sampling auditors need to consider whether to use
statistical sampling.
Required:

Compare and contrast statistical sampling and non-statistical sampling.

(10 marks)

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QUESTION 5 (10 MARKS)

You are the auditor of a company which sales goods to customers on credit and
an order is received from a customer.

REQUIRED

Outline the typical sales procedures you would expect to observe in a properly
functioning internal controls sales system (10 MARKS)

***************END OF EXAMINATION. BE BLESSED ********************

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