The Institute of Chartered Accountants of Bangladesh

AUDIT AND ASSURANCE

Professional Stage Application Level

Question Bank

www.icab.org.bd
 Audit and Assurance
The Institute of Chartered Accountants of Bangladesh Professional Stage

These learning materials have been prepared by the Institute of Chartered Accountants in England and Wales

ISBN: 978-1-84152-835-9
First edition 2009

All rights reserved. No part of this publication may be reproduced or

transmitted in any form or by any means or stored in any retrieval system, or
transmitted in, any form or by any means, electronic, mechanical, photocopying,
recording or otherwise without prior permission of the publisher.

ii © The Institute of Chartered Accountants in England and Wales, March 2009

Contents

Time Page
allocation
Title Marks Mins Question Answer

Legal, ethical and current issues

1 Short form questions – – 3 51
2 Mac Ltd 15 23 6 56
3 Criticisms of auditors 15 23 7 58
4 Alpha Ltd 20 30 7 61
5 Mart Ltd 16 24 7 63
6 Gardenvale Ltd 17 25 8 65
7 Beeches Technologies Ltd 32 48 8 67

Accepting and managing

engagements
8 Short form questions – – 11 71
9 Sleeper Ltd 21 32 12 74
10 Gemini Ltd 18 27 13 76
11 Hairsay Ltd 16 24 13 78
12 Wrapper Ltd 18 27 14 79
13 Waverley Ltd 18 27 14 81
14 Wavenden Ltd 21 32 15 83
15 Benson Ltd 33 50 15 85
16 Healey Ltd 40 60 16 88

Planning assurance engagements

17 Short form questions – – 17 93
18 Santander Ltd 23 35 22 99
19 Apparel Ltd 20 29 23 101
20 Holly Ltd 17 25 24 102
21 Garments Ltd 17 25 24 104
22 Curson Ltd 22 33 25 106
23 Builda Ltd 19 29 25 109
24 Lusco Ltd 20 30 26 111
25 Wrapak Ltd 18 27 27 113
26 Electra Ltd 19 29 28 114
27 WHAT 20 23 29 116
28 Pubgames Ltd 17 25 29 118
29 Nosh Ltd 40 60 30 121
30 Medical Diagnostics Ltd 42 63 31 126

© The Institute of Chartered Accountants in England and Wales, March 2009 iii
 Time Page
allocation
Title Marks Mins Question Answer
31 Sporticus Ltd 35 53 33 129
32 Atlantis Ltd 35 53 34 134
33 Pallas Ltd 40 60 35 137

Concluding and reporting on

assurance engagements
34 Short form questions – – 37 141
35 Anagram Ltd 18 27 41 146
36 Garb Ltd 18 27 41 148
37 Plumb Ltd 20 30 42 150
38 Delux Hotels Ltd 26 39 42 152
39 Salmonoid Ltd 22 33 43 154
40 Betta Networks Ltd 17 25 44 157
41 Audit report phrases 17 25 45 159
42 CCEP Ltd 20 60 45 161
43 Vista Ltd 37 56 46 164
44 Ironco Ltd 38 57 47 168

iv © The Institute of Chartered Accountants in England and Wales, March 2009

Question Bank
Your exam will consist of
Part one – 6 short form questions 20 marks
(worth between 2 and 4 marks each)
Part two – 3 questions 80 marks
(2 worth around 20 marks
and 1 worth around 40 marks)

Time available 2.5 hours

© The Institute of Chartered Accountants in England and Wales, March 2009

1
2 © The Institute of Chartered Accountants in England and Wales, March 2009
 QUESTION BANK

Section 1: Legal, ethical and

current issues

1 Short form questions

1 The IFAC has issued professional ethical guidance. The fundamental principles form part of this
guidance. What do the principles cover and at whom are they aimed? (2 marks)

2 If the regular fees from a client company or group of companies constitute a substantial proportion of
the fee income of an audit firm, a self-interest threat is likely to arise so as to impair objectivity.
Set out the safeguards a firm should use to recognise this threat and the procedures available to offset
it. (2 marks)

3 You are the auditor of Harmony Ltd of which the share capital is owned 40% each by David Dennis
and his wife, Diana, and 20% by Edward Endersby, its three directors.
David and Edward have fallen out with each other after an argument during a round of golf. You have
now been requested by Edward to provide him with details of reimbursement of expenses to David
and Diana for the last financial year. You are working on the audit and all the company’s books and
records are in your office.
State, with reasons, how you would respond to Edward’s request. (2 marks)

4 You are planning the audit of Sportsresults-a-minute.com.

You have ascertained that the company has overdue fees of CU15,000, being the previous year’s audit
fee.
Explain the threat to your firm’s independence and state the action your firm should take in respect of
this matter. (3 marks)

5 A partner in a firm of chartered accountants has been approached to accept appointments as auditor
of two separate companies.
(1) Jenkins Ltd, in which he is a 10% shareholder
(2) Davidson Ltd, to whom the auditor owes Tk40,000
State whether it would be acceptable for the partner to accept each of these appointments, and why.
(2 marks)

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Section 1: Legal, ethical and current issues

6 Your client has asked why the audit report your firm has issued on its financial statements talks about
‘true and fair’ rather than ‘correct’ given that you had spent two weeks on site reviewing all its
accounting records.
Explain why this type of opinion has been given on the financial statements. (2 marks)

7 Describe and explain the concept of assurance. (2 marks)

8 A fraud has recently been discovered, involving the chief buyer in the purchasing department of
Rodney Ltd and a purchase ledger clerk in the accounts department over a period of two years. The
managing director of Rodney Ltd has written to the company’s auditors claiming that they had a
responsibility to detect frauds during the course of their audits, and requesting an explanation as to
how they could have missed it.
What points should the auditors make in response to the managing director? (2 marks)

9 Dimension Ltd is a software company providing e-commerce solutions to business. It was

incorporated on 1 April 20W8 and revenue has doubled each year. Rapid expansion is expected to
continue for the next few years.
This growth requires heavy investment in working capital, particularly work in progress and
receivables, and the company will be seeking a substantial increase in the borrowing facility from its
bankers when the present facility is due for annual review in September 20X1.
List the benefits that the company may obtain from the statutory audit. (2 marks)

10 There is an ongoing debate surrounding the regulation of auditors and whether the profession should
regulate itself or be subject to independent regulation.
What are the main arguments in favour of independent regulation of auditors? (3 marks)

11 The ‘expectation gap’ is the possible difference between an auditor’s actual responsibilities and those
assumed by readers of an audit report.
What are the main misunderstandings in respect of the audit made by lay users of accounts?
(3 marks)

12 You have been invited to tender for the audit of Data Ltd, a company that owns and operates 35
hotels in Bangladesh. You have not previously acted for Data Ltd, but you are the current auditors of
Lodge Ltd, a company that owns and operates hotels in 30 out of the 35 towns in which Data Ltd
operates. The hotels operated by each company offer similar facilities to each other at a similar price.
Identify and explain the principal ethical issue that you may need to consider when deciding whether
or not to tender for the audit of Data Ltd, and state the procedures you may need to implement in
the event that your tender was successful. (3 marks)

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 QUESTION BANK

13 You are the auditor of Royale Limited, a manufacturer of fireworks. Following a disappointing last
three months of trading, the company has requested an extension to its overdraft facility from its
bankers. The bank has in turn asked your firm to provide a report on the company’s working capital,
focusing on the recoverability of trade receivables and inventory.
Explain the benefits and limitations to both the bank and Royale Limited of obtaining the working
capital report. (4 marks)

14 Briefly describe what you understand by the terms ‘reasonable assurance’ and ‘limited assurance’.
(2 marks)

15 State the types of pronouncement issued by the International Auditing and Assurance Standards Board
and describe in what kind of engagement each of these is relevant. (3 marks)

16 One of your clients, Selhurst Ltd, is a small company which is not legally required to have a statutory
audit.
Explain the benefits of a statutory audit for a small company such as Selhurst Ltd. (3 marks)

17 State three types of threat to an auditor’s objectivity and independence identified by the IFAC’s Ethical
Standards. For each give an example of how the threat might arise for an auditor. (3 marks)

18 In the past few years the cash flow position of your firm has altered considerably.
After a relatively stable period your firm found itself in a bad financial position. One of your fellow
partners discussed this problem with a major client during a golfing weekend. As a result the client
offered your firm a low interest loan. Fortunately, the position changed and your firm never took up
the client’s offer. Now your firm is financially sound and would be in a position to make a reciprocal
offer to the client, should he need it.
Why are practice loans to/from clients prohibited under the IFAC’s Ethical Standards? (1 mark)

19 Mrs Wallace is the audit partner in her firm for Racdale Ltd. She has just been appointed a trustee of
the Racdale Family Trust, which owns 20% of the shares in Racdale Ltd. She replaces the family
solicitor who has just retired.
In addition, Mr Netwater, the audit manager for Racdale Ltd, has given one month’s notice that he will
be leaving the firm to become finance director of the company.
State the threats to independence that these situations pose, and the safeguards that the firm should
employ to maintain objectivity. (3 marks)

20 State what you should do if you identify money-laundering activities during the course of an audit.
(1 mark)

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Section 1: Legal, ethical and current issues

21 The following is an extract from an independent accountant's unmodified report on a profit forecast:
‘Based on our examination of the evidence supporting the assumptions, nothing has come to our
attention which causes us to believe that these assumptions do not provide a reasonable basis for the
forecast.’
Describe the level of assurance provided by this statement and explain how and why it differs from the
level of assurance provided by an audit report on annual historical financial statements. (4 marks)

22 Your firm acts as auditor to Columbus Ltd, a retail car dealer. During the course of your audit for the
year ended 30 June 20X5, you discover that the company’s sales manager, assisted by the accounts
clerk, has deliberately falsified details of the value of vehicles sold in order to increase his monthly
bonus payments.
Set out your responsibilities in respect of the above matter and contrast these with the responsibilities
of the management of Columbus. (3 marks)

23 BSA 250 Consideration of Laws and Regulations in an Audit of Financial Statements sets out procedures
that the auditor must follow in order to help him identify those instances of non-compliance which
should be considered when auditing financial statements.
What additional procedures should be performed in respect of when instances of non-compliance
must be communicated to management without delay? (2 marks)

24 The auditors of Trigger Ltd have become aware during the course of their audit that the company has
been guilty of a serious breach of the law. This non-compliance has no direct effect on the financial
statements.
List the steps the auditors might have to take in these circumstances. (2 marks)

2 Mac
Your firm acts as external auditor for Mac, a partnership whose principal business activity is the
manufacture and export of high quality raincoats. Mac is not required by law to have an audit of its financial
statements for the year ended 28 February 20X5.
The partners of Mac have asked you to explain why your firm is trying to persuade them to continue to
have an audit even though it is not required by law. They believe that it would be more useful if your firm
provided a report on the profit and cash flow forecasts prepared by the partners.
Requirements
(a) List the advantages to the partners of Mac of continuing to have a full audit under the Companies Act
when exempt from the statutory audit. (6 marks)
(b) In respect of a report on profit and cash flow forecasts, set out the nature and the level of the
assurance which may be given in such a report and explain how and why it differs from the level of
assurance provided by an audit report. (9 marks)
(15 marks)

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 QUESTION BANK

3 Criticisms of auditors
Following high profile corporate failures, auditors have been criticised by various interested parties in
connection with
(1) Their responsibility for the detection of fraud
(2) The provision of non-audit services to their audit clients
(3) The period of time for which they can act as auditors for a client.
Requirement
Outline the current regulatory and professional requirements in respect of the matters identified in (1) to
(3) above and state how they might be further changed by the regulatory bodies. Set out the case for and
against changes to the current regulatory and professional requirements. (15 marks)

4 Alpha Ltd
Alpha Ltd, a listed company, operates a policy of putting its audit and related services out to tender every
five years. Following submissions from a number of firms of accountants, the audit committee of Alpha Ltd
recommended that your firm be appointed to provide the following services.
 The statutory audit of the annual financial statements.
 An independent review of the interim financial information which will be circulated to shareholders
together with your firm’s independent review report. The independent review will be restricted to
making enquiries of management, applying analytical procedures to the financial information and
assessing whether the accounting policies and presentation have been consistently applied unless
otherwise disclosed.
 Consultancy services in respect of the implementation of a new financial information technology
system.
Your firm has not previously acted for Alpha Ltd but does act as auditor for one of its major competitors.
Requirements
(a) Identify and explain the professional and ethical issues that should have been identified by your firm in
relation to the provision of the services, outlined above, to Alpha Ltd and outline the safeguards that
should be in place in order to address these issues. (14 marks)
(b) Comment on the level of assurance provided by the report on the interim financial information, and
explain how and why it differs from the level of assurance provided by the statutory audit report on
the annual financial statements. (6 marks)
(20 marks)

5 Mart Ltd
You work for a firm of auditors which has seven offices throughout Bangladesh. The firm’s largest client in
terms of fee income is Mart Ltd, a company which has grown steadily through a mixture of organic growth
and acquisition of companies in the same industry sector.
Your firm has acted for this client since its incorporation 20 years ago and, in addition to the statutory
audit, provides a range of non-audit services, including tax planning (for the company and its individual
directors) and consultancy work in respect of Mart Ltd’s acquisition policy.
Earlier this year the finance director of Mart Ltd retired and was succeeded by a former member of your
firm’s staff who had managed the audit of Mart Ltd for the preceding four years.

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Section 1: Legal, ethical and current issues

Requirements
(a) Discuss the ethical and professional issues raised by the situation described above and identify the
measures which should be implemented by your firm in order to mitigate any threats to objectivity
which might arise. (10 marks)
(b) Set out the implications for audit firms and their clients if the provision of all non-audit services to
audit clients is banned and mandatory periodic rotation of audit firms is introduced. (6 marks)
(16 marks)

6 Gardenvale Ltd
Gardenvale Ltd is a company which operates a chain of garden centres specialising in the retailing of high
quality garden products and the provision of landscaping services. Following information from one of the
employees, it was discovered that the financial controller had used company cheques and bank transfers to
pay for goods and services for his own use. Although the amounts involved were immaterial in the context
of the financial statements, it transpired that this had been going on for several years.
The managing director is considering whether the company’s auditors were negligent. He has requested
that your firm undertakes a detailed independent review of Gardenvale Ltd’s purchase and payments system
in order to establish any shortcomings in its policies and procedures, so that they can be rectified.
Requirements
(a) Distinguish between the responsibilities of the management and the statutory auditor of a limited
company for the prevention and the detection of fraud and outline how these responsibilities are
discharged. (6 marks)
(b) Prepare a list of questions in respect of internal control procedures, answers to which would establish
whether there are any shortcomings in Gardenvale Ltd’s purchase and payments system. (11 marks)
(17 marks)

7 Beeches Technologies Ltd

You are currently planning the audit of Beeches Technologies Ltd and its subsidiaries for the year ending 30
September 20X7. Beeches Technologies Ltd heads an international group which sells computer software
and related services. Software is developed in Bangladesh and sold throughout the world by the group’s
numerous overseas subsidiaries. These subsidiaries act as agents for the parent company, selling software
and providing support on its behalf. They receive a commission equal to their costs plus a 5% margin.
The costs incurred by the subsidiaries typically comprise:
 Payroll costs and associated expenses for sales, technical and administrative staff
 Sales commissions
 Establishment costs for the local office
 Depreciation
 Miscellaneous expenses
At 30 September 20X6, Beeches Technologies Ltd had 24 overseas subsidiaries, at which audit work was
performed as follows:
Number
Full audit by your firm 8
Limited review by your firm 5
No work 11
24
No new subsidiaries are expected to be established before 30 September 20X7.
With the exception of the two largest subsidiaries (at which your firm performs a full audit), all of the
subsidiaries are of similar size. The costs of each smaller subsidiary represent approximately 0.5% of the

8 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

group’s total cost base. Where a full local audit is not required, the subsidiaries are visited on a rotational
basis, each subsidiary being visited at least once every three years.
You called the group financial controller of Beeches Technologies Ltd in order to arrange a planning
meeting. She informed you that she has just returned from investigating a fraud at the group subsidiary in
Madrid, a location where your firm performed limited review procedures two years ago and no work in the
prior year.
The financial controller in Madrid misappropriated the equivalent of CU150,000 over a three-year period by
using company cheques and bank transfers to pay his own personal expenses. These were reported as
company expenses in the profit and loss account submitted to Beeches Technologies Ltd. Whilst the
amount involved is not material to the group as a whole, it is very significant to the local subsidiary.
The group financial controller told you that the group finance director has expressed concern that the audit
work performed did not uncover the fraud and has asked for a meeting with the audit partner to discuss
this. You have arranged a meeting for this Friday.
Requirements
(a) Prepare the following schedules to assist the audit partner in his preparations for Friday’s meeting:
(i) A list of questions you believe the audit partner should ask in order to ensure that he has
significant information about the fraud to assess its impact on the audit for the year ending
30 September 20X7. (8 marks)
(ii) A summary of the most important controls you would expect the group to have in place to
prevent and detect the misappropriation of funds by subsidiary employees. (10 marks)
(b) Using the Beeches Technologies fraud as an example, compare and contrast the responsibility of the
auditor in respect of fraud with the expectation of company directors and the general public in this
area. Your answer should refer to any duty the auditor has to report fraud. (14 marks)
(32 marks)

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 Section 1: Legal, ethical and current issues

10 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Section 2: Accepting and

managing engagements

8 Short form questions

1 What information should be included on every working paper originated by audit team members?
(2 marks)

2 An accountancy firm has previously used the services of an independent provider to conduct cold
reviews of its completed audit engagements. However, the partners have decided to undertake in-
house all aspects of monitoring the quality of audits carried out.
Set out the objectives of conducting cold reviews which the in-house system must achieve. (2 marks)

3 An audit partner has consulted a colleague on a question of judgement concerning the audit of his
client.
Explain the important features in respect of this matter that the working paper recording the
consultation should contain. (3 marks)

4 What are the three main considerations for an auditor when considering the acceptance and
continuance of client relationships and specific audit engagements? (2 marks)

5 List the principal items to be agreed in an engagement letter between an assurance firm and a person
commissioning an assurance engagement. (2 marks)

6 A prospective auditor is required to write to the client’s existing auditor to seek information which
could influence his decision as to whether he may accept the auditor appointment.
Give examples of relevant matters which could be within this letter and which would influence the
prospective auditor’s decision to accept the audit appointment. (2 marks)

7 Certain rights are conferred on an auditor by the Companies Acts when a company proposes to
remove him from office.
State the rights the auditor has in these circumstances. (2 marks)

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 Section 2: Accepting and managing engagements

8 The current auditors of Meldrew Ltd will not be proposed for re-appointment at the annual general
meeting to be held on 12 October 20X9. The directors were extremely unhappy at the additional
disclosures in the financial statements for the year ended 31 December 20X8 concerning the status of
the company as a going concern. The auditors had insisted upon these before they would express an
unqualified opinion.
As a result your firm has been asked to accept appointment as auditors of Meldrew Ltd. All the
shareholders of the company are directors.
Set out the matters your firm ought to consider and the procedures to follow before it should accept
appointment as auditors. (4 marks)

9 An audit partner has consulted a colleague regarding a question of judgement concerning the audit of
his client. The audit partner has prepared a working paper in respect of this matter, recording details
of facts known at the time, the reasoning for his conclusion and conclusion reached.
State why the partner should record this information in the working paper in respect of this matter.
(2 marks)

10 A mature student has recently joined your firm on a training contract. She has told you that in her
previous job, she was allowed to work on her own with little supervision and no review of her work.
She does not understand the importance of the review process in your firm.
State the reasons why assurance and audit work is reviewed by more senior staff and partners.
(3 marks)

11 List six functions of an audit committee. (3 marks)

9 Sleeper Ltd
Your audit firm has recently been invited to accept appointment as external auditor to Sleeper Ltd, a
company that owns and operates a number of mobile phone stores in the four major cities of Bangladesh.
You have not previously acted for Sleeper Ltd, but your firm is auditor to Zelig Ltd, a company which also
operates mobile phone stores in many of the same locations as Sleeper Ltd. Your audit firm has a total of
seven partners located in three offices which are situated in major cities within Bangladesh.
The current auditors of Sleeper Ltd have received notice from the company’s directors that they are not to
be re-appointed as auditors at the company’s forthcoming Annual General Meeting. The management has
given no reason for this course of action, although the auditors suspect that it is because they insisted on
modifying the audit report for the previous accounting year, despite substantial pressure from management
to issue an unmodified audit report.
The modification to the previous year’s audit report was in respect of inventory. It was discovered during
the audit that the year end inventory quantities at two of the company’s stores had been falsely inflated by
the managers of both stores in order to cover up a substantial theft of mobile phones immediately prior to
the year end. There were no satisfactory audit procedures that could be carried out to substantiate the
existence of the physical quantities of inventory at the year end.

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 QUESTION BANK

Requirements
(a) Identify and explain the professional ethical issues which you might need to consider in deciding
whether or not to accept appointment as external auditor to Sleeper Ltd. Recommend the possible
safeguards that could be put in place to resolve these issues. (6 marks)
(b) Set out the responsibilities and rights, including those under the Companies Acts, of the current
auditors of Sleeper Ltd in relation to the proposed change in professional appointment.
(3 marks)
(c) Set out the respective duties of both the management and external auditors of Sleeper Ltd in relation
to the prevention and detection of fraud, and outline how these duties are discharged.
(6 marks)
(d) List the financial statement assertions, other than existence, which are relevant to the audit of
inventory and, for each one listed, outline one relevant audit procedure to test that assertion in
respect of Sleeper Ltd. (6 marks)
(21 marks)

10 Gemini Ltd
Described below are situations that have arisen in companies which are external audit clients of your firm.
(1) During the year ended 31 May 20X2 your firm commenced a five-year contract to provide internal
audit services for Gemini Ltd. Over the course of the year the internal audit team carried out a risk
assessment exercise and an evaluation of the internal control systems supported by tests of control.
(2) Leo Starr, the managing director and majority (80%) shareholder of Taurus Ltd, received an offer from
Sagittarius Ltd, also an audit client, for the entire share capital of Taurus Ltd. Leo Starr has agreed in
principle to sell his shares to Sagittarius Ltd. The purchase consideration is likely to consist of an initial
cash payment based on the net assets of Taurus Ltd as at 31 August 20X2, and a deferred cash
payment contingent on the operating profit growing by an average of 5% over the next two years. Leo
Starr and the management of Sagittarius Ltd have requested, independently, that your firm acts as
advisors in respect of the negotiations and provides an assurance report on the calculation of the
amount of the net assets at 31 August 20X2.
Requirements
(a) Describe the purpose of quality control measures in respect of the provision of assurance and
advisory services. (6 marks)
(b) Discuss the ethical and professional issues raised by the situations described above, and identify the
quality control measures your firm should implement in order to mitigate any threats to objectivity
which might arise from the provision of the services described above. (12 marks)
(18 marks)

11 Hairsay Ltd
Hairsay Ltd is a company which operates six hairdressing salons. The company does not grant credit
facilities and customers pay by cash, cheque or debit or credit card. All branches have tills in which takings
are lodged, and receipts are issued when requested by customers.
Following a tip-off by one of the employees, the managing director discovered that another employee was
misappropriating cash takings by pocketing cash received from customers and deliberately failing to record
the related transactions. Although the amounts involved were immaterial in the context of the cash sales
and profit figures, it transpired that this had been going on for several years.
The managing director has expressed concern that the company’s auditors did not discover this fraud and
has requested that your firm undertakes an independent review of the company’s cash handling procedures.

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 Section 2: Accepting and managing engagements

He is worried that other cash handling irregularities may be occurring and is anxious to have a system in
place which will prevent any misappropriation of cash takings.
Requirements
(a) Outline the matters to be included in the letter of engagement which your firm should send to the
management of Hairsay Ltd prior to commencing the independent review of the company’s cash
handling procedures. (5 marks)
(b) Using Hairsay Ltd’s fraud as an example, compare and contrast the responsibilities of the auditors in
respect of fraud with the expectations of the managing director. (5 marks)
(c) Prepare a checklist of questions which you would ask in order to establish whether there are any
shortcomings in Hairsay Ltd’s policies and procedures which increase the risk of misappropriation of
cash. (6 marks)
(16 marks)

12 Wrapper Ltd
Your firm, which has six partners, has been invited by Mr Packer, the managing director and majority
shareholder of Wrapper Ltd, to accept appointment as auditor of the company and also provide assistance
with the preparation of the financial statements and the corporation tax computation.
The principal activity of Wrapper Ltd is the production of paper carrier bags, serviettes, coffee cups and lids
which are sold to customers operating in the fast food sector. Wrapper Ltd was incorporated on
1 October 20X4 and the financial statements will cover the 15 month period to 31 December 20X5.
Although the company's revenue and assets are below the thresholds for statutory audit purposes, the
company's bankers require the annual accounts to be subjected to a full audit.
Mr Packer started the business using a combination of money inherited from his grandfather and a bank
loan. The loan agreement includes a covenant specifying that the company's debt equity ratio should not
exceed parity (i.e. 1:1).
The accounting records are computerised and the company uses software which was developed by IT
Systems Ltd, a company owned by Mr Packer's brother. The software has been customised to integrate
inventory control with receivables and payables. IT Systems Ltd also provides support for the company’s
computer systems. The accounting records are maintained by Mrs Carlton, assisted by Mrs Biggs who
works one day a week and is responsible for payroll processing.
Requirements
(a) State, with reasons, the matters to be considered and procedures to be performed prior to your firm
accepting and commencing the audit of Wrapper Ltd for the period ending 31 December 20X5.
(8 marks)
(b) Identify, from the information provided above, the factors which should be taken into account when
assessing the risk of misstatement in the financial statements of Wrapper Ltd and explain why such
factors should be taken into account when conducting the audit. (10 marks)
(18 marks)

13 Waverley Ltd
The auditors of Waverley Ltd have resigned following a disagreement with the directors. The audit report
on the financial statements for the year ended 31 March 20X3 was qualified on the grounds that they did
not comply with accounting standards in some material respects.
Subsequently the directors have engaged your firm to review the accounting policies adopted by the
company and to investigate the application of the accounting policies in the financial statements for the year
ended 31 March 20X3. Your firm is required to report on the appropriateness of the policies adopted and
the extent to which they were properly applied in the financial statements.

14 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Requirements
(a) Contrast this assurance engagement with the statutory audit of the annual financial statements with
respect to the scope of the work you would undertake and the report you would issue. (11 marks)
(b) If, after presenting the report, your firm were requested to accept appointment as auditors of
Waverley Ltd, identify the matters it should consider and the procedures it should follow before it
accepts the appointment. (7 marks)
(18 marks)

14 Wavenden Ltd
Your firm has been asked by the directors of two companies to accept appointment as auditors.
The directors of Wavenden Ltd have become dissatisfied with the service of the existing auditor,
mainly due to the lack of urgency that he appears to display in his dealings with the company. He has
been notified of their wish to replace him and has been asked for his resignation.
This has not been received and the directors now wish to remove him from office.
The financial statements for the year ended 30 September 20X0 showed inventories of CU25,000.
Inventories at cost were CU50,000. A review of obsolescence was not performed but, on the
recommendation of the company’s accountants, the cost was written down by 50% on the grounds of
prudence. The directors admit that obsolete inventories rarely exceed 10%, but there are no
satisfactory audit procedures that could be adopted to confirm the true figure at that date.
Requirements
(a) Set out the steps that both Wavenden Ltd and your firm should follow in order to complete the
process of the appointment of your firm as its auditors. (13 marks)
(b) In respect of the issue over inventory, reach a conclusion on whether you would modify your audit
report on Wavenden Ltd for the year ending 30 September 20X1, on the basis that no other matters
arise which affect the opinion. You should give reasons for your conclusion and describe any additional
statements which would need to be made in the audit report. (8 marks)
(21 marks)

15 Benson Ltd
Benson Ltd is a medium sized entity, managed by its owners who bought it out from a large limited
company six years ago. The share capital is owned by four directors. One of the original directors, Andrew
Fisher, has recently passed away and his shares and his place on the board have been taken up by his son,
John Fisher.
A large loan from the bank which helped to finance the management buy out was paid off in the previous
period. This year, the directors have negotiated another loan from the bank to help finance an expansion
into Europe.
You work for a firm of chartered accountants called Andrews, Baker and Co (ABC). ABC became involved
with Benson at the time of the buy out when they provided advice to two of the (current) directors. They
have been involved with the business ever since, acting in the capacity of tax advisers, management
consultants, and personal tax advisers for all the directors. They have also been involved in some special
projects for Benson, taking part in an investigation due to a suspected fraud two years after the MBO, and
putting together projections and budgets for the potential expansion into Europe.
ABC were invited to tender initially for the audit, but their tender had the highest fee, and Mr Fisher senior,
who was the managing director at the time, strongly believed that an audit was a statutory necessity which
the company should obtain as cheaply as possible. The audit was given to a smaller firm of auditors, XYZ,
but ABC were engaged to provide what Mr Fisher always termed, 'the useful stuff – worth paying for'.

© The Institute of Chartered Accountants in England and Wales, March 2009 15

 Section 2: Accepting and managing engagements

The fee income from Benson has been considerable over the years. Two years ago, when the work was
done on the expansion, it represented 20% of the income of the firm for that year.
The increase in size of the business since the expansion has led to the current auditors, XYZ, resigning.
Rather than going through another tender, the directors have decided to offer the audit to their business
advisers, ABC, as they believe that it provides synergy to combine the two roles, and that synergy may
result in a lower overall cost to the company of accountancy and related services.
ABC have accepted the audit work. The first audit is due to start in three weeks’ time. At a recent board
meeting, attended by the partner who has been in charge of the work provided to Benson, and his
colleague, who has been appointed as the audit engagement partner, the directors discussed plans to float
the company on the Stock Exchange in the foreseeable future.
Requirements
(a) Explain the current ethical and legal considerations in connection with accepting appointment as an
auditor. (8 marks)
(b) Discuss whether the conduct of ABC has been ethical in its dealings with Benson Ltd during the
course of their relationship, and how Benson’s prospective listing might change the ethical situation.
(15 marks)
(c) ABC have appointed an audit engagement partner, who has not previously been involved with the
client, to the audit of Benson. What other quality control procedures and policies should ABC have in
place in relation to the audit of Benson to safeguard audit quality? (8 marks)
(31 marks)

16 Healey Ltd
Your firm has been invited by Mr Allard, the managing director of Healey Ltd, to accept appointment as
auditor of the company. Mr Allard owns 51% of the shares of the company and the remaining 49% is owned
by Mr Morgan, the sales director. The present firm of auditors will not be re-appointed when its term of
office expires as Mr Allard is dissatisfied with the cost of its services.
In addition, Mr Allard has requested that your firm takes on the following work.
(1) Advising both parties on the purchase consideration in respect of the sale of Mr Morgan’s shares in
Healey Ltd; Mr Morgan plans to retire and has agreed in principle to sell his shares to Mr Allard.
(2) Advising on an on-going basis in respect of Mr Allard’s plans to expand Healey Ltd’s operations by the
acquisition of other businesses; this will involve investigations and reports on businesses identified by
Mr Allard.
Requirements
(a) (i) State the matters, other than independence, that you would consider and the procedures you
would perform in deciding on the suitability of Healey Ltd as an audit client for your firm.
(8 marks)
(ii) Explain the six general threats to independence identified by ethical standards. (6 marks)
(iii) State, with reasons, the specific threats to the auditor’s objectivity which may arise out of
providing the additional services outlined above, and describe the safeguards which may offset
such threats. (7 marks)
(b) Outline the potential liability of the firm in respect of the three services requested by Mr Allard,
including suggestions related to how the firm might restrict its liability in respect of the services
provided. (15 marks)
(c) Identify four quality control policies or procedures the firm could implement to ensure that the
independence and quality of the audit was not impaired. (4 marks)
(40 marks)

16 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Section 3: Planning assurance

engagements

17 Short form questions

1 In the context of BSA 600 Using the Work of Another Auditor, state what is meant by the terms
“principal auditor” and “other auditor”. (2 marks)

2 Your firm is the principal auditor of Narberth Group Ltd. The financial statements of one of the
components which will be included in the financial statements of Narberth Group Ltd has been
audited by another firm of auditors who have modified their audit report on the component’s financial
statements.
State the matters that should be considered, in respect of the above issue, by the principal auditor
when reporting on the financial statements of Narberth Group Ltd. (2 marks)

3 The risk that the financial statements are materially misstated can be broken down into detection risk,
inherent risk, control risk and audit risk.
Explain what information an auditor uses to evaluate each of these components of risk during the
planning of an audit. (2 marks)

4 The external auditor of Thorpe Ltd has assessed the internal audit department of the company, and
concluded that its organisational status and the scope of its function are satisfactory. As a result he has
decided to make use of the department’s work which is relevant to him to reduce the extent of his
audit procedures.
On what other matters must he assure himself, and how should he obtain this assurance, in order to
reduce his own work? (3 marks)

© The Institute of Chartered Accountants in England and Wales, March 2009 17

 Section 3: Planning assurance engagements

5 Drusus Ltd has a financial year end 31 March 20X7 and it formed an internal audit department in
September 20X6. This new department was headed by the company’s senior management accountant,
and his deputy was then promoted to senior management accountant.
You have performed an assessment of the department and are satisfied with all aspects of its
organisational status, scope of operations, technical competence and professional care.
Since its formation the internal audit department has completed the following work.
(1) Documentation of the new purchases system which was introduced on 1 April 20X6.
(2) Tests of control on the purchases system from 1 October 20X6.
(3) Preparation of a report in February 20X7 on significant weaknesses revealed by the tests of
control. Its recommendations were implemented in full in March 20X7.
(4) Preparation of detailed reports for the board of directors on the monthly management accounts
since July 20X6.
To what extent might you be able to make use of this work during your audit, and what effect would it
have on the selection and scope of tests in the areas concerned? (4 marks)

6 An auditor is planning the audit of Cardigan Ltd for the year ending 31 December 20X1.
List the factors that will determine the balance between tests of control, analytical procedures and
other substantive procedures to be included in the audit plan. (4 marks)

7 After obtaining a general understanding of the legal and regulatory framework applicable to the entity
and the industry and how the entity is complying with that framework in accordance with BSA 250,
what further audit procedures should the auditor perform to help him identify those instances of non-
compliance which should be considered when preparing financial statements? (3 marks)

8 Why do auditors carry out preliminary analytical procedures at the planning stage of an audit?
(1 mark)

9 One of your existing audit clients has recently acquired a subsidiary company, Jade Ltd, and has
appointed you as its auditor. Jade Ltd is a developer of computer games software, an industry with
which neither you nor your firm is familiar.
From what sources would you obtain knowledge about Jade Ltd and the industry in which it operates?
(3 marks)

10 In the draft accounts of Gough Ltd, the gross profit percentage (i.e. gross profit as a % of sales) has
fallen from 44% in the previous year to 39% in the current year.
The following information has been obtained.
(1) Closing inventories have been understated due to the omission of some items from the physical
inventory count.
(2) Revenue has declined because the company has not reduced its prices to combat cut-price
competition.

18 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

(3) Purchases have increased due to a large receipt of raw materials on the last day of the year.
Describe what effect each of these matters would have on the gross profit percentage, and whether it
helps to explain the fall. (3 marks)

11 Your firm has recently acquired a new audit client, which has an internal audit department. The
department has conducted a rolling programme of tests of financial controls over all areas affecting the
financial statements, and you seek to rely on its work to reduce the extent of the audit procedures
you will carry out.
On what aspects of the internal audit department and its work will you need to satisfy yourself in
order to be able to place the necessary reliance? (2 marks)

12 You have conducted analytical procedures on the draft accounts of Blunt Ltd for the year ended 31
October 20X1. Two of your findings are as follows.
(1) The gross profit margin has decreased from 29% for the previous year to 23% for this year.
(2) The current ratio has decreased from 1.6 at the previous year end to 1.2 at this year end.
The directors had expected a decrease in both these measures but not by as much as shown above.
Indicate what errors might be incorporated within the draft accounts to produce these unexpected
variations, and in which areas you would carry out extra audit work in order to reach a conclusion.
(3 marks)

13 Auditors should have a sufficient knowledge of the business of the entity to be audited.
What sources of information would assist the auditor in identifying related parties? (2 marks)

14 During the course of the audit of your client Sloth Ltd you notice a balance within receivables entitled
‘advances against directors’ expenses’. The company’s managing director, who is familiar with the
concept of materiality, has questioned your need to audit this balance, which at the year end stands at
CU12,500. The company’s retained profit for the year is CU1.3m.
Prepare brief notes to the managing director explaining your audit approach in respect of this item.
(2 marks)

15 Your client, Neral Ltd, is a family owned and run haulage business. The managing director’s brother
runs a manufacturing business, Jaron Ltd, which uses Neral Ltd for its distribution requirements.
You are planning the audit of Neral Ltd. Identify the audit risks in respect of this relationship between
the two companies and state how you would plan to address these risks. (3 marks)

16 During the planning meeting for the audit of Omag Ltd, the client informed the audit team that Mr
Vada, the managing director, is being investigated by the local council for fraudulently trying to obtain a
residents’ parking permit for business premises. Explain what impact this would have on the audit
approach. (3 marks)

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 Section 3: Planning assurance engagements

17 You are planning the audit of Berlini Ltd, a manufacturer of air conditioning units, for the year ending
30 September 20X0. The company requires the financial statements to be signed by 31 October 20X0.
The finance director has supplied you with copies of the company’s monthly management accounts for
the first eleven months of the financial year.
Explain how you would seek to make use of these management accounts in your audit planning, and
what factors might limit their usefulness. (4 marks)

18 Woodruff Ltd is currently involved in a large scale construction project to develop part of the
waterfront in a medium-sized Gloucestershire town. A review of the current risk factors has
highlighted three key issues.
(1) A number of the subcontractors it plans to use may not complete the work within the specified
timescale.
(2) Although not within a flood plain area, the development will be at risk from flooding.
(3) Although the benefits from the project will be significant, Woodruff Ltd is concerned about the
funding required and is unhappy about the overall level of risk it will have to face.
What risk control strategies could Woodruff Ltd use to deal with the above issues? (3 marks)

19 At your planning meeting with the finance director of Dent Ltd, you are informed that the chief
accountant has been formally reprimanded for authorising payment of the servicing bill for his wife’s
car. The matter was discovered by accident. The amount was only CU80 and no further action was
taken.
Explain the effect this might have on your audit planning. (2 marks)

20 Grim Ltd has had an internal audit department of six persons for several years. Previously you have
been able to reduce your audit work by placing reliance on its work.
During the last three months of the year ended 30 November 20X9 four of the personnel, including
the department head and deputy head, left the company and replacements were recruited.
Before the departures the department had conducted tests of the control systems in all areas for the
first nine months of the financial year.
Since the appointment of the new members of the department, it has conducted an overall review of
the strength of the system of control as recorded in the procedures manual, and reported to the
board on recommendations for improvements.
Describe the effect these matters might have on the reliance you place on the work of the internal
audit department for the year ended 30 November 20X9. (3 marks)

21 Set out the principal audit objectives to be satisfied by tests of control of a company’s system.
(2 marks)

22 Your firm has acquired a new audit client. From the information that you gained in order to present
your audit proposal, you are hopeful that internal controls are strong and you will be able to place
reliance on them to reduce your substantive procedures.
List the steps you should follow before you are in a position to determine the combination of tests of
control and substantive procedures for the audit plan. (3 marks)

20 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

23 When planning to use the work of experts and in assessing the results of the work of experts, to what
matters should the auditor pay attention? (3 marks)

24 Struction Ltd designs and constructs conservatory extensions for domestic homes, operating
throughout the United Kingdom. It has administrative and works premises in Devon, and employs a
network of local subcontract building companies for all work on site.
Identify the risks from its customers to which Struction Ltd is exposed from this method of operation.
(3 marks)

25 Your firm has recently acquired a new audit client, Dilbert Ltd, and you have been assigned to draft
the audit plan.
The audit manager has briefed you on the firm’s knowledge of the business that he has compiled from
visits to the company, discussions with management and the previous auditors, and from industry and
other sources.
Set out which components of the audit strategy or plan would be influenced by this information.
(3 marks)

26 Springtime Ltd is a human resources consultancy company providing specialist advice to large
businesses on employment issues.
What would you consider to be the material information streams (accounting cycles) that would need
to be documented by the auditors in their recording of the company’s accounting and internal control
systems? (2 marks)

27 You have planned the audit of Craig Ltd for the year ended 31 March 20X2 based on the year end
management accounts. The week before the audit work is due to start the chief accountant informs
you that the directors are concerned by the likely amount of corporation tax on the profits shown,
and provides you with a schedule of 60 journal entries and the resulting draft financial statements.
The effect of the journal entries is to reduce gross profit by 20%, net profit by 65%, and net assets by
15%.
Explain how this information will affect the nature, timing and extent of the audit procedures in your
audit plan. (4 marks)

28 During the planning of the audit of Milten Textiles Ltd, the financial controller asked to have a quiet
word with you. She tells you that she suspects the payroll clerk is defrauding the company, as she is
regularly going on exotic holidays, buying new cars and spending substantial sums of money on home
improvements. There is only one payroll clerk who manages the single monthly payroll run.
What would be the impact on your audit approach in respect of the information provided by the
financial controller? (3 marks)

29 You have completed the tests of control in your audit. The only deviations found were that there was
no evidence that one particular control had been operated in three cases out of 25 tested.
Explain what considerations will determine whether you are able to reduce the substantive
procedures in the area of this control. (2 marks)

© The Institute of Chartered Accountants in England and Wales, March 2009 21

 Section 3: Planning assurance engagements

30 At the audit planning meeting for the year ended 28 February 20X4 with the finance director of
Malbec Ltd, you ascertained that payroll processing, which had been outsourced for a number of
years, was brought back in-house in December 20X3.
Management was not satisfied with the performance of the service provider and repudiated the
contract. The service provider had been responsible for making payments to the employees and the
monthly remittances to NBR. Two of Malbec Ltd’s accounts clerks have been trained in payroll
processing (4 marks)

18 Santander Ltd
Your firm has recently been appointed as auditor to Santander Ltd, a company whose principal business
activity is the manufacture and installation of children’s playground equipment.
You are planning the company’s audit for the year ending 31 October 20X5. Your audit manager has
arranged a planning meeting next week with the company’s finance director.
Your audit manager has given you the following extracts from the company’s management accounts for the
ten months to 31 August 20X5 and the comparative period to 31 August 20X4. He has asked you to
provide him with notes based on this information to assist him in his meeting:
(1) Operating results
10 months to 10 months to
31 August 20X5 31 August 20X4

CU’000 CU’000
Revenue 17,228 14,328
Cost of sales 10,854 8,024
Gross profit 6,374 6,304
Operating costs 3,207 2,915
Operating profit 3,167 3,389
(2) Balance sheet extracts
As at As at
31 August 20X5 31 August 20X4

CU’000 CU’000
Inventories 3,110 1,765
Trade receivables 4,996 3,400
(3) Additional information
The company’s principal customers historically have been local government authorities and schools
based in Bangladesh. The company has, however, within the past twelve months expanded its
customer base to include hotel and house developers based in South Asia. Previously the company felt
these customers were in economies which were too politically unstable to trade with. Business in
these countries is conducted both in £ sterling and in the local currency.
Due to increases in the number of personal injury claims, legislation was introduced in Bangladesh on 1
January 20X5 which requires the use by Santander Ltd of softer materials in the construction of its
playground bases. These new materials are approximately 30% more expensive to Santander Ltd than
the traditional ones that they replace. The introduction of the new legislation had a twelve month
lead-in period, but the company’s managing director announced in February 20X5 that in order to
keep ahead of the competition, all new playground installations were to use the new material with
immediate effect.

22 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Requirements
(a) State the reasons why it is important for auditors to carry out audit planning. (3 marks)
(b) Identify the main sources of information that are available to an auditor when planning an audit.
(4 marks)
(c) Prepare notes for your manager outlining the areas that he needs to discuss with the finance director
at the forthcoming planning meeting and, for each area identified, briefly state the potential audit risk.
(16 marks)
(23 marks)

19 Apparel Ltd
You are planning the audit of Apparel Ltd for the year ended 30 November 20X5. The principal activity of
the company is the retailing and wholesaling of outdoor clothing, footwear and equipment. All goods are
sold under one of the company's two brands:
 The Comfy brand which targets the everyday consumer offering family orientated products at mid
market prices; and
 The Elite brand which targets the specialist market for the serious outdoor consumer offering more
technical clothing, footwear and equipment at a higher price.
Apparel Ltd sources its products from suppliers based in Europe and, more recently, China. The company
sells its products through its own retail outlets and also wholesales to independent retailers.
In February 20X5, the company completed the implementation of a new dynamic warehouse management
system. The implementation commenced in 20X4 and was introduced in stages to avoid any disruption to
the business.
You are preparing for your planning meeting with the finance director and have obtained, in advance of the
meeting, a copy of the draft financial statements for the year ended 30 November 20X5. Following your
preliminary review, you have identified the following extracts from the financial statements as matters of
significance to discuss with management.
Income statement
Years ended 30 November
20X5 20X4
Draft Actual
CU000 CU000
Revenue
Own retail outlets 53,447 45,968
Wholesale 45,539 39,159
98,986 85,127

Cost of sales (46,518) (41,212)

Gross profit 52,468 43,915
Operating expenses (46,233) (40,192)
Profit from operations 6,235 3,723

Balance sheet As at 30 November

20X5 20X4
Draft Actual
CU000 CU000
Current assets
Inventories 16,087 14,742
Trade receivables 5,281 3,992
(wholesale business)
Current liabilities
Trade payables 7,021 5,792

© The Institute of Chartered Accountants in England and Wales, March 2009 23

 Section 3: Planning assurance engagements

Requirements
(a) In respect of the information provided above, prepare planning notes on matters which you wish to
discuss with management. Your notes should refer to the results of your analytical procedures.
(16 marks)
(b) As part of the completion stage of an audit, the auditor will carry out a review of the financial
statements. State the conclusions that the auditor should be in a position to reach as a result of this
review. (4 marks)
(20 marks)

20 Holly Ltd
You have recently been appointed auditor to Holly Ltd (‘Holly’) and are in the process of planning the audit
for the year ending 30 April 20X6. Holly owns and operates a chain of 50 high street coffee shops located
throughout Dhaka, and a further 20 located in the rest of Bangladesh.
Holly’s main expenses are the cost of coffee sold, premises costs, the cost of leasing the coffee making
machines, and staffing the shops. Holly meets these costs centrally, with all permanent staff salaries paid
monthly by direct bank transfer. Each shop is run on a day-to-day basis by a shop manager, who is
responsible for sourcing any food sold and other consumable goods locally and taking on any casual staff
needed to cover peak periods. Both these expenses are generally met using cash from the till. The company
made the decision to source goods locally both to encourage local management autonomy and to support
the local economies where each shop is based. Shop managers have bonus incentives linked to the annual
profit of their shop.
Holly has recently set up its own internal audit department, having previously outsourced this function to
their previous auditors. Several of the senior posts within the department were created by transferring
established long-serving staff members from Holly’s main finance department.
Requirements
(a) Outline the factors that need to be taken into account by an external auditor when evaluating an
internal audit function and its work. (5 marks)
(b) Identify, with reasons, from the situation outlined above, circumstances that should be taken into
account when planning the external audit of Holly. (12 marks)
(17 marks)

21 Garments Ltd
You are planning the audit of Garments Ltd for the year ending 30 June 20X1. Historically, the principal
activity has been the manufacture and wholesaling of fashion clothing, on a credit basis, to retailers.
However, early in 20X0, the company diversified into retailing and opened two retail outlets selling fashion
clothing to the general public. No credit facilities are granted to customers of the retail outlets.
During your planning meeting with the finance director, the following matters were highlighted as the major
changes since the last audit.
Expansion of retailing operations
As a result of the success of the retailing business, the company expanded its operations and opened ten
additional retail outlets during the year ending 30 June 20X1. The management accounts indicate that the
retail operations will amount to at least 20% of the company’s revenue for the year ending 30 June 20X1.
Increase in overdraft facility
The overdraft facility was increased to help to fund the expansion. The company is currently trading at its
overdraft limit as a result of the increased volume of business. The directors are seeking to increase the
facility and are negotiating with the company’s bankers.

24 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

New computer system

During the year the company replaced its computer system in order to accommodate the retailing
activities. It installed a central computer at head office linked to terminals at its warehouses and retail
outlets. The software is an integrated standard package, which includes an inventory control system,
modified by the supplier to the company’s requirements.
Requirement
Identify, from the circumstances described above, the audit risks, and for each risk
(i) List the factors which have led you to identify that risk
(ii) Outline the audit work you would perform in that risk area. (17 marks)

22 Curson Ltd
The management of Curson Ltd, a retailer of domestic appliances, has requested that your firm assists with
a risk assessment exercise, as it is seeking assurance that there are adequate controls in place to minimise
exposure to the risks to which its retailing operation is exposed.
The company operates a number of stores throughout Bangladesh and sells a wide variety of products,
ranging from inexpensive appliances to high value items, such as television and video equipment. The
company has a policy of providing a higher level of personal service and advice to its customers than
available from its competitors, and aims to reflect this in the remuneration of its employees. In addition, the
company operates a policy of flexible opening hours, whereby store managers have discretion to determine
opening hours to suit local demand.
The till systems in each store are networked devices which also perform inventory control and ordering
functions, and have additional linked devices for validating cheque guarantee cards and credit/debit cards in
respect of non-cash transactions. The product lines are competitively priced and it is company policy to
keep a full range of inventories so that it can provide any of its products within twenty four hours. Once
inventory has reached its re-order level, a purchase order is automatically generated and transmitted to the
approved supplier. Suppliers deliver the goods to the company’s central warehouse for distribution to the
stores by the company’s own fleet of vehicles.
The company uses a mixture of leasing and outright purchase to fund its property, plant and equipment. Its
premises are all leased, but all other property, plant and equipment is purchased. It replaces 20% of its
vehicles every year.
Requirement
Identify the risks to which the retailing operations of Curson Ltd are exposed and, for each risk, outline the
control procedures which should be in operation in order to minimise exposure to those risks.
(22 marks)

23 Builda Ltd
You are in charge of the audit of Builda Ltd for the year ending 30 June 20X3 and are responsible for
preparing the programme of work to be undertaken by the audit staff.
Builda Ltd is a small building company which specialises in the building of new houses. It has 24 employees
and normally builds between 25 and 30 houses a year. All employees are salaried, and the payroll is
processed by the business services section of your firm. Employees’ salaries are paid directly by electronic
transfer into their bank accounts each month. Your firm also prepares the annual statutory accounts from
the books and records maintained by the company.
All the shares in the company are owned by Eddy Brick, the managing director, who is actively involved in
running the company. He draws a salary from the business and awards himself a bonus once profits have
been determined. The company has a history of increasing retained earnings as Eddy Brick is very prudent,
and his remuneration is modest compared to company profits. The company has no borrowings and surplus
cash is invested on the money market.

© The Institute of Chartered Accountants in England and Wales, March 2009 25

 Section 3: Planning assurance engagements

The company owns a small amount of non-current assets comprising plant and equipment and motor
vehicles. Inventories are the largest asset in the balance sheet comprising undeveloped land and work in
progress, which represents houses at various stages of completion at the balance sheet date. The land was
purchased several years ago and is included in the balance sheet at cost. Costing records are not maintained
and the work in progress is based on Eddy Brick’s and his site manager’s estimate of direct costs and
overheads based on the stage of completion of each house as at the balance sheet date.
The company accounts for the sale of a property only when notified by its lawyers that contracts have been
exchanged. Receivables represent amounts owed by
 Customers for completions of sales
 The local authority for deposits paid, by Builda Ltd, which are released once access roads to the sites
are completed
 NBR for VAT.
The company is normally in a VAT repayment situation as the sale of new houses is zero rated for VAT
purposes, but the company is allowed to reclaim VAT on its purchases and expenses, and consequently
submits monthly VAT returns.
Payables represent amounts owed to trade suppliers and NBR in respect of payroll withholding taxes, and
deposits from customers which have been paid to Builda Ltd via its lawyers. Eddy Brick is keen to maintain
good relationships with the company’s suppliers and to pay them on time. There is no purchase ledger, but
Eddy maintains a file of unpaid invoices which he reviews on a daily basis. He pays an invoice as soon as he
receives the supplier’s delivery note from the site manager indicating that the materials have been delivered
to, and accepted on, the building site.
There are no cash transactions as all payments are made by cheque, and Eddy Brick is the only cheque
signatory. Receipts and payments are recorded in an analysed cash book which is prepared, on a monthly
basis, by a freelance accountant, who also undertakes monthly bank reconciliations. Receipts and payments
are recorded from details on the completion statements from the company’s lawyers, remittances from
NBR, and cheque stubs.
The accountant also prepares a day book, in respect of the purchases and expenses invoices, in order to
analyse the VAT to support the VAT returns which he completes on a monthly basis. The company is
subject to periodic inspections by the VAT Commissioner in respect of VAT and recent inspections have
not identified any problems.
Requirements
(a) Identify, from the circumstances outlined above, the factors which indicate low inherent risk in respect
of the audit of Builda Ltd and, for each factor identified, explain why it contributes to low inherent
risk. (8 marks)
(b) Outline the audit work which you would direct the audit staff to undertake in respect of the key
balance sheet and income statement items during the audit of Builda Ltd. (11 marks)
(19 marks)

24 Lusco Ltd
Your firm has recently been appointed auditor of Lusco Ltd (Lusco). The company operates a chain of 30
Dhaka based retail stores, selling luxury clothing and accessories. The company operates a central Dhaka
based warehouse from which it supplies all 30 stores with inventory.
The company sources its inventory from a small number of major fashion wholesalers based in China. The
majority of inventory items are previous year’s designs, which the wholesalers supply to Lusco at
discounted prices. Lusco places all its orders centrally three times a year, coinciding with the Spring,
Summer, and Winter seasons. All transactions are conducted in euros and payment is due in full on arrival
of the goods in Bangladesh.
Most of the company’s sales are conducted by cash, cheque, or credit card. In order to remain competitive
with other major high street retailers, the company offers a returns policy to its customers which allows

26 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

goods to be returned to the store for any reason with a full refund offered. Goods returned under this
policy are then sold on in bulk through the trade, sometimes at less than their original cost to Lusco.
The company’s employees include monthly paid head office staff and store managers and a weekly paid core
number of other store staff. In addition the company employs a number of casual staff in peak periods.
Permanent staff are paid by weekly/monthly direct bank transfer, and casual staff in cash.
Lusco’s managing director, aged 60, is also the company’s main shareholder. He adopts a very hands-on
approach to the business; he is involved in all major decisions and rarely delegates. He is known for his
lavish lifestyle and in order to finance this he seeks each year to grow the business and improve upon the
previous year’s profitability.
The company has recently acquired new offices adjacent to its central warehouse. The purchase was
financed by large bank borrowings under term loans, which call for annual capital repayments.
Requirements
(a) Describe the different elements of audit risk and explain why the auditor needs to consider risk when
conducting an audit. (4 marks)
(b) Identify, from the circumstances outlined above, the factors which indicate high audit risk in respect of
the audit of Lusco Ltd and, for each factor identified, explain why it contributes to high audit risk.
(10 marks)
(c) Outline the internal controls which Lusco Ltd should put in place to ensure the complete recording of
sales and safe custody of cash. (6 marks)
(20 marks)

25 Wrapak Ltd
You are responsible for the audit of Wrapak Ltd for the year ended 31 July 20X4. The principal activity of
Wrapak Ltd is the provision of a specialist packaging service for companies in the cosmetic industry. The
majority of Wrapak Ltd’s customers are blue chip companies but recently the customer base has broadened
to include small and medium sized companies.
Customers ship their products to Wrapak Ltd, and on arrival warehouse personnel enter details of each
consignment of goods received into Wrapak Ltd’s computer system. The system is updated to record the
completion of the packaging process and the subsequent despatch of each consignment to the customer.
On confirmation of despatch, the system generates the invoice which is printed out in the accounts office.
All invoices are reviewed and authorised by Anna, the accountant, prior to mailing to customers. At the end of
each week the system generates a list of consignments which have been completed but not yet despatched.
Anna is also responsible for ledger processing and sending monthly statements to customers. At the end of
each month she tries to find the time to chase slow payers as identified on the aged receivables analysis. No
other credit control procedures are undertaken.
As a result of the increased level of activity, the company moved its operations to larger freehold premises
in May 20X4. The acquisition was funded by a bank loan repayable in monthly instalments over 10 years.
The loan is secured on the premises.
A comparison of the draft accounts for the year ended 31 July 20X4 with the previous year indicates a
significant deterioration in the cash position despite an increase in profitability. The preliminary analytical
review also identified that work completed but not yet invoiced and trade receivables increased at
significantly higher rates than the rate of increase in revenue.
Requirements
(a) Identify, from the information provided above, factors which may have contributed to Wrapak Ltd’s
cash flow problems, and recommend policies and procedures to be implemented in order to improve
cash flow. (12 marks)
(b) Outline the audit procedures you would undertake in order to ensure that the loan has been properly
accounted for in the financial statements for the year ended 31 July 20X4. (6 marks)
(18 marks)

© The Institute of Chartered Accountants in England and Wales, March 2009 27

 Section 3: Planning assurance engagements

26 Electra Ltd
You are preparing for your audit planning meeting with the finance director of Electra Ltd, whose principal
activity is electrical contracting under fixed-price short-term contracts. You have been provided with the
following information in respect of the years ended 31 March 20X2 and 20X3.
Extracts from the income statement
Draft 20X3 Actual 20X2
CU’000 CU’000 CU’000 CU’000
Revenue 17,407 15,873
Cost of sales
Opening work in progress 533 499
Materials used 1,788 1,624
Wages and salaries 12,286 9,472
Closing work in progress (832) (533)
–––––– (13,775) –––––– (11,062)
–––––– ––––––
Gross profit 3,632 4,811
Administrative expenses (3,582) (3,175)
–––––– ––––––
Profit from operations 50 1,636
Finance cost (101) (51)
–––––– ––––––
(Loss)/profit before tax (51) 1,585
–––––– ––––––
Extracts from the balance sheet
Draft 20X3 Actual 20X2
ASSETS CU’000 CU’000 CU’000 CU’000
Non-current assets 1,006 939
Current assets
Work in progress 832 533
Receivables 3,214 1,684
Cash and cash equivalents 264
4,046 2,481
5,052 3,420

EQUITY AND LIABILITIES

Capital and reserves 538 589
Non-current liabilities
Bank loan 1,000 1,500
Current liabilities
Bank loan 500
Overdraft 990
Trade payables 438 330
Other payables 1,586 1,001
3,514 1,331
5,052 3,420
Requirements
(a) Identify, from the information provided above, the matters which give cause for concern, and explain
why they give cause for concern. (7 marks)
(b) In respect of the issues raised in (a), identify the matters after the balance sheet date to which you
would direct your attention. (6 marks)
(c) Identify the forms of audit report modification which may arise from the concerns raised above, and
state the circumstances in which they are appropriate. (6 marks)
(19 marks)

28 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

27 WHAT
Welfare and Help for the Aged Trust (WHAT) is an NGO. It has recently commenced operating from a
community centre in your locality by providing facilities for the well-being of senior citizens.
WHAT receives income from the following sources.
(1) Donations under deeds of covenant (contractual agreements to donate a specified amount for a
specified number of years) entered into by individuals
(2) Postal donations of cheques and cash
(3) Door-to-door collections by volunteers with boxes, and workplace collections
(4) Other donations (several mini-buses have been given, either new or second hand, by large businesses)
(5) Grants from local authorities
(6) Sales of refreshments at the community centre
(7) A variety of fund-raising events organised by voluntary helpers.
The directors have appointed your firm as auditors.
Prior to your work on the audit the directors have asked your advice, by way of an additional engagement,
on the internal controls which should be in place over the company’s income.
Requirements
(a) Briefly explain how this engagement differs from your engagement as statutory auditor, and set out the
approach that should be followed for any assurance engagement. (5 marks)
(b) Describe the controls over the above income which you would expect WHAT to operate. For (4)
above you should describe the controls over the donated assets. (15 marks)
(20 marks)

28 Pubgames Ltd
You are a member of the audit team for Pubgames Ltd, a company which manufactures electronic quiz
machines for use in pubs and clubs. The audit manager has informed you that on the current audit your
responsibility will be trade payables. The following schedule has been prepared by the client.
CU
Trade payables
Overseas suppliers 175,000
Ferganto Ltd 380,000
Others 110,000
GRNI (goods received but not invoiced) 72,000
Having reviewed last year’s audit files and discussed matters with the client, you have noted the following.
(1) During the current year the clerk who was responsible for overseas suppliers retired due to ill health.
She was not replaced as the company needs to cut costs, and her work has been shared out around
the rest of the accounts department.
(2) Ferganto Ltd is the sole supplier of high quality sheet steel which is used by Pubgames Ltd to build the
casings for the quiz machines. In the past Ferganto has always refused to confirm or give a year end
balance. In addition, during the current year Ferganto has introduced a reservation of title clause on all
invoices to Pubgames.
(3) ‘Others’ relates to around 100-150 small suppliers which produce specialist electrical components.
(4) ‘GRNI’ relates to goods received prior to the year end but where no invoices have yet been entered
in the purchase ledger. The figure is considerably higher than last year because of problems in the
computer system, which meant that no purchase invoices could be processed in the week immediately
following the year end.

© The Institute of Chartered Accountants in England and Wales, March 2009 29

 Section 3: Planning assurance engagements

At the briefing meeting for the audit the manager explained that the client had set a very tight deadline for
audit clearance. This is because it is currently negotiating a merger with one of its competitors, and the
financial statements are needed before final completion.
Requirements
(a) Identify the main audit risks for payables specific to Pubgames Ltd. (4 marks)
(b) Produce an outline audit approach to payables for submission to the manager. (10 marks)
(c) Some audit firms use directional testing as part of their audit approach, with payables being tested for
understatement. Identify and explain the specific audit techniques which could be used to try to
identify understatement errors in the payables cycle. (3 marks)
(17 marks)

29 Nosh Ltd
Your firm has recently been appointed auditor of Nosh Ltd, whose principal activity is the preparation of
chilled foods for the catering trade and supermarkets. Products are sold under the company’s own brand
name and that of a national supermarket chain with which it has a one-year renewable contract. The foods
are packaged in plastic trays purchased from Plasco Ltd, a company in which Charles Tuck, the managing
director and majority shareholder of Nosh Ltd, has a controlling interest.
The previous auditors, from whom you have obtained professional clearance, were not re-appointed as
Charles Tuck felt that your firm had the appropriate resources to assist with plans to develop the business.
He was impressed with the professional advice the company had received from your firm in respect of the
new computer system which was introduced during the year. The terms of engagement also include tax and
advisory services. These services are to include advice on expanding the business by the acquisition of
similar businesses and funding the expansion.
On reviewing the management accounts you ascertain that revenue and margins have improved significantly.
The finance director informs you that this has resulted from a significant increase in the sales of own brand
goods which have higher margins, and the successful launch of a new gourmet range which has already
exceeded sales targets. In addition, the company’s export market has grown.
Requirements
(a) (i) List, with reasons, the information you would require in order to carry out analytical procedures
on the draft financial statements of Nosh for the first audit.
(ii) Set out the limitations of using analytical procedures at the planning stages of this audit.
(10 marks)
(b) Prepare a file note which, from the circumstances identified above, identifies any professional issues
and audit risks and the factors which have led you to identify those issues and risks and outlines the
procedures to be undertaken in order to address the professional issues and audit risks identified.
(17 marks)
(c) Compare the purposes and characteristics (including the different levels of assurance provided) of the
different forms of assurance provided by
(i) Audit reports under the Companies Act
(ii) Other reports under legislation or regulation
(iii) Other reports where the scope of the work and of the report to be provided are agreed
between the two parties involved. (9 marks)
(d) Set out the benefits to Nosh Ltd of having an audit. (4 marks)
(40 marks)

30 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

30 Medical Diagnostics Ltd

You are an audit senior in the firm of West & Company. You have just heard that, following the resignation
of another senior, you have been assigned to the audit of Medical Diagnostics Ltd (MDL) for the year ended
31 October 20X3. You have received an initial briefing from the partner, Geoff West, who has provided
you with the following information:
Medical Diagnostics Ltd (MDL) supplies computerised diagnostic systems to hospitals and general
practitioners. It has three main streams of revenue:
1 The initial equipment sale
2 Engineering project work, billed on a 'time and materials' basis
3 Ongoing support for which the customer pays an annual fee.
The company was established 5 years ago by its present managing director, Andrew Young. He owns 75%
of the ordinary share capital, the remaining 25% being owned by the company's financial director, Bill Tyson.
The company has grown rapidly and now has 35 employees – 4 engaged in research and development, 7 in
sales, 5 in assembly, 15 in technical support and 4 in administrative functions. With the exception of final
assembly and testing, all of the company's manufacturing is performed by subcontractors.
Recent results
Forecast for
Year ended 11 months to year ending
31 October 30 September 31 October
20X2 20X3 20X3
CU'000 CU'000 CU'000
Revenue 8,540 10,064 11,200
Gross margin 3,450 3,704 4,140
(40%) (37%) (37%)
Operating expenses 1,985 2,130 2,350
Operating profit 1,465 1,574 1,790
Historically, the company has experienced little seasonality in either sales or profitability. However,
October 20X3 is expected to be a particularly good month with a large number of orders on hand for
delivery pre year end.
The following revenue recognition policies have been agreed with the company in previous years:
(i) Revenue on equipment sales is recognised on delivery, providing the supply contract is for standard
equipment. Where the supply contract is for equipment which requires significant customisation or
integration with existing customer systems, no revenue is recognised until the customer has signed an
acceptance certificate.
(ii) For each equipment supply contract, there is normally a separate installation contract covering work
done by the company's engineers to install the equipment, perform site testing and train the
customers' staff in its use. Revenue from these services is recognised as the work is performed.
(iii) Most customers also enter into a support and maintenance contract with MDL. An annual fee entitles
them to 24 hour telephone support, quarterly testing/calibration, repair work as and when necessary
and the loan of equipment if their own equipment needs to be removed for repairs. Fees for this
service are invoiced annually in advance and the revenue is spread evenly over the period to which it
relates. MDL uses a spreadsheet to record support invoices and to calculate the revenue deferral at
each month end.
(iv) The company holds inventories of standard machines, spare parts and sub-assemblies. It also has
significant work in progress, being machines in the process of manufacture, customised machines
which have been manufactured but not accepted by the customer and the time spent to date on
installing, integrating and testing such machines.

© The Institute of Chartered Accountants in England and Wales, March 2009 31

 Section 3: Planning assurance engagements

The managing director has successfully negotiated the sale of the entire share capital of Medical Diagnostics
Ltd to a public company in a similar field of business. The key terms of the sale and purchase agreement,
that has been signed, are as follows:
 MDL will receive initial cash consideration of CU7 million, with further cash consideration of CU4
million on 31 January 20X7, providing that the operating profit of Medical Diagnostics Ltd grows by an
average of 5% per annum over the next two years ending 31 October 20X5.
 The initial consideration of CU7 million is based on net assets at 31 October 20X3 of CU1.2 million. If
the net assets in the final audited accounts for the year ended 31 October 20X3 are less than CU1.2
million then the initial payment will be reduced by an amount equal to the difference between the final
reported net assets and CU1.2 million. There is no corresponding upward adjustment.
 The audited accounts must be available by 31 December 20X3.
Medical Diagnostics Ltd
Management Accounts
31 October 20X3
Month Year to date Year to date
Actual Actual Budget
CU'000 CU'000 CU'000
Revenue
Equipment sales 420 7,240 7,400
Installation, training and other services 20 395 400
Support 316 3,185 3,200
756 10,820 11,000
Cost of sales
Material purchases 182 3,145 3,200
Inventory provisions 100 130 40
Subcontract manufacture 303 2,364 2,100
Assembly staff 17 202 200
Engineering staff 57 682 700
Other 60 556 360
719 7,079 6,600

Gross margin 37 3,741 4,400

5% 35% 40%
Operating expenses
Sales staff 96 654 600
Sales expenses 21 252 250
Administrative staff 32 154 150
Establishment costs 87 522 450
Office equipment, stationery etc 21 248 250
Research and development 33 405 400
Other 17 202 200
307 2,437 2,300

Profit (loss) before taxation (270) 1,304 2,100

Taxation 80 (400) (650)
Profit (loss) after taxation (190) 904 1,450

32 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Balance Sheet
Movement 31 October 31 October
in month 20X3 20X3
Actual Actual Budget
CU'000 CU'000 CU'000
Non-current assets (65) 672 720

Inventory (2) 1,015 1,000

Trade receivables (176) 1,418 1,600
Prepayments 5 49 50
Cash 407 2,681 2,850
234 5,163 5,500

Trade payables 23 (1,183) (1,150)

Deferred revenue (300) (1,900) (1,600)
Accruals (105) (221) (130)
Corporation tax payable 80 (400) (650)
Other taxes (57) (927) (940)
(359) (4,631) (4,470)

Net assets (190) 1,204 1,750

Requirements
(a) Review MDL's 31 October 20X3 management accounts and identify, with explanation, any areas which
you believe warrant further investigation. (13 marks)
(b) Set out any key audit risks which you have identified from the information provided by the partner.
For each risk identified, you should briefly cover the nature of the risk and explain why you consider it
key to the MDL audit. Do NOT set out the audit work you would perform. (20 marks)
(c) Set out the audit work you would perform in the area of revenue recognition. (9 marks)
(42 marks)

31 Sporticus Ltd
Your client, Sporticus Ltd, has 40 sports shops and operates 10 leisure centres around the Midlands. You
are the senior in charge of the audit for the year ending 30 September 20X9.
In previous years substantive procedures have been reduced as a result of your assessment of control risk
as low. This assessment has been supported by evidence obtained by tests of control.
At the start of the year, in October 20X8, the company established an internal audit department. The new
department is independent of the accounting function and is responsible directly to David Campbell, the
finance director.
The head of the department, Peter Adams, a chartered accountant, was promoted from his previous
position of assistant chief accountant. An unqualified accountant with information technology experience
was recruited externally, and the staffing was completed by the internal transfer of a payroll clerk.
Since its formation the department has evaluated and re-documented the internal control systems in all
areas. It has also performed testing of the control procedures in the sales and cash handling system
throughout the financial year.
All of the working papers in respect of the work of the department will be provided to you for the audit.
Additionally, before the time the audit is scheduled to begin in November 20X9, the department is planning
to perform detailed testing of the control procedures in the purchases system during the whole year.
David Campbell has asked you to explain the extent to which you will be able to make use of the
department’s work during your audit for the year ending 30 September 20X9.

© The Institute of Chartered Accountants in England and Wales, March 2009 33

 Section 3: Planning assurance engagements

Requirements
(a) Write a formal letter to David Campbell setting out
(i) The factors that could limit your ability to use the work of the internal audit department in your
final assessment of control risk (10 marks)
(ii) The effect on your audit and the extent to which you may make use of the work that the
department has carried out, and is planning to perform before the audit. (8 marks)
(b) Set out the advantages to a company of establishing an effective internal audit function. (4 marks)
(c) Compare the responsibilities of management, internal auditors and external auditors in relation to
(i) The design and operation of systems and controls
(ii) The reliability of management information
(iii) The prevention and detection of fraud
(iv) Company compliance with laws and regulations
(v) Money laundering (13 marks)
(35 marks)

32 Atlantis Ltd
Atlantis Ltd is a long standing client of the firm. It is a supplier of kitchenware and bathroomware from a
number of outlets which comprise showrooms and stores. All sales are made on credit.
Features of the sales system of the business include the following.
(1) All processing of accounting information is performed centrally at head office from returns submitted
from the branches. The only system maintained at each branch is inventory control on a personal
computer. A full physical count is carried out at each branch at the year end.
(2) Sales orders are supplied from the branch concerned when inventory is available at that branch. When
this is not the case, inventory may be transferred from another branch or delivered to the customer
direct from the other branch. Inventory movement dockets are sent by the second branch to the
originating branch when inventory is transferred between branches. Sales are accounted for by the
branch taking the order.
(3) Due to the competitive nature of the business, branch managers have considerable discretion to offer
discounts from list price, within specified parameters. Part of the remuneration package of branch
managers is dependent on the revenue of their branch.
(4) After delivery of the goods, proforma sales invoices are submitted to head office from the branches on
a weekly basis, and are processed and sent to customers during the following week.
Requirements
(a) Explain the importance for audit purposes of obtaining an understanding of the business, setting out
appropriate sources of information about Atlantis and identifying the procedures the audit team would
use to obtain the information. (10 marks)
(b) Identify the potential risks to Atlantis Ltd arising from the above matters and, for each risk, describe
the possible consequences of the risk to the company. (11 marks)
(c) Propose and justify an audit approach for revenue at Atlantis Ltd, setting out the substantive audit
work you would perform in the areas of inventory quantities, revenue and trade receivables to
address the risks. (14 marks)
(35 marks)

34 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

33 Pallas Ltd
You have recently been appointed as auditor to Pallas Ltd (‘Pallas’). You are currently in the process of
planning its audit for the year ending 31 October 20X6 prior to your meeting next week with the
company’s finance director. The company’s principal activity is the hiring out of specialist camera
equipment.
Further information
Pallas owns approximately 5,000 items of camera equipment which it hires out to independent film and
television production companies for periods ranging from one day to six months. The individual pieces of
equipment vary in their original cost to Pallas from CU200 to CU25,000, the average value being CU2,000.
At any given point in time, 75% of these items of equipment are out on hire with customers. Customers are
responsible for insuring the equipment whilst on hire, and they are charged by Pallas for any lost or
damaged items. Customers place their orders either by telephone, by email, or through one of the
company’s sale agents. Equipment on hire is then either sent out by courier or collected by the customer
from Pallas’s warehouse. At the end of the period of hire, customers are invoiced in full for the relevant
hire charge.
Pallas sources much of its equipment directly from the manufacturers in Germany and Japan, for which
Pallas is invoiced in the appropriate local currency. Pallas calculates depreciation on a five-year straight line
basis for all its camera equipment.
Pallas employs a number of sales agents who are responsible for visiting existing and potential customers
with a view to generating business. Each sales agent has the authority to offer discounts of up to 35% off the
Pallas catalogue hire rate. These sales agents are also responsible for chasing overdue trade receivables
from customers.
During the year Pallas introduced new custom-written specialist software which deals with the booking in
and out of items on hire, and the invoicing of customers. Due to an incompatibility between the two types
of software, the information held on the old system had to be manually transferred to the new. This was
done over the first weekend of August 20X6, prior to the live launch of the new system.
Pallas operates an incentive scheme under which the executive directors are entitled to a bonus based on
the pre-tax profit of the company. The bonus is payable one month after the audited accounts are available.
Requirements
(a) From the information provided above, identify and explain the potential audit risks in respect of Pallas,
and indicate the matters you would discuss at the forthcoming meeting with the company’s finance
director. (14 marks)
(b) Describe the internal controls that Pallas should implement to prevent the following:
(i) Loss of non-current assets
(ii) Non-recoverability of trade receivables. (8 marks)
(c) Comment on the differences between an audit of a non-specialised profit oriented entity such as Pallas
Ltd and the audit of:
(i) Caring Hands Bangladesh Ltd, an NGO (8 marks)
(ii) Public sector entities, such as an Upazila Parishad and a central government department.
(10 marks)
(40 marks)

© The Institute of Chartered Accountants in England and Wales, March 2009 35

 Section 3: Planning assurance engagements

36 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Section 4: Concluding and

reporting on assurance
engagements

34 Short form questions

1 Your firm is the auditor of Swanky Cars Garages Ltd, a medium-sized chain of garages. The following
points have arisen from your audit.
(1) Mechanics in two of the garages are known to work at weekends – there is a possibility that they
may be using the company’s premises to service friends’ cars.
(2) The garages have been revalued this year resulting in an unrealised surplus of CU45,000.
(3) Some cars taken in part exchange are scrapped immediately. There is no evidence of any cash
being received.
State, for each of the above, whether they should be referred to in the letter to management or the
letter of representation or both. Where you believe they should be referred to, give reasons.
(3 marks)

2 The new auditor of a company has concluded that a material amount in the preceding year’s financial
statements was included within an incorrect current asset heading. The audit opinion was unqualified.
Explain the auditor’s responsibilities in relation to the current year’s audit report. (2 marks)

3 You have just completed the audit of Bitterne Ltd. One major expense has been disclosed in the
income statement under distribution expenses, but you feel that it should be included in cost of sales.
As a result you are of the opinion that the gross profit figure has been materially overstated. You are
satisfied with all other aspects of the financial statements.
What form should your auditors’ report take, and why? (2 marks)

4 The directors of Howkins Ltd have prepared the financial statements on the going concern basis,
although there is a significant doubt about the company’s ability to continue as a going concern.
What effects will this situation have on your audit report if the uncertainty over going concern is
(i) Fully disclosed in the financial statements
(ii) Not disclosed in the financial statements?
(3 marks)

© The Institute of Chartered Accountants in England and Wales, March 2009 37

 Section 4: Concluding and reporting on assurance engagements

5 An audit report contains the following sentence.

‘These financial statements are the responsibility of the company's management. Our responsibility is
to express an opinion on these financial statements based on our audit.’
Explain the meaning and purpose of this statement. (2 marks)

6 You are the auditor of Fenditton Ltd, a listed company with two UK subsidiaries. During your review
of the working papers and draft annual report for the year ended 31 July 20X4 you note the following
matter.
The chairman’s statement in the annual report indicates that the group’s profit has trebled in the year
to 31 July 20X4, without explaining that the principal reason for this is the exceptional profit on the
sale of a trade name ‘Butler’s Beauties’ for CU5 million. The name had not previously been recognised
in the financial statements.
State the action that you would take in respect of the above and how your audit report would be
affected if the matter remains unchanged. (4 marks)

7 As part of the completion stages of an audit, the auditor should carry out a review of the financial
statements.
What conclusions should the auditor be in a position to form as a result of this review? (2 marks)

8 During the year ended 31 August 20X2 Worboys Ltd, an outdoor leisure retailing chain, switched
purchases of tents and waterproof clothing from Leakproof Products Ltd to another supplier. Two
months later, Leakproof Products Ltd went into liquidation.
The liquidators of the company have issued a claim against Worboys Ltd for breach of implied
contract and consequential losses. No amount has yet been put on the claim, but lawyers advise that it
could be substantial and, although they are confident of a successful defence, also advise that the case
could go against Worboys Ltd. This would have a serious effect on the company.
Describe the effects this situation will have on the audit report of Worboys Ltd if the matter is
(i) Fully disclosed in the financial statements
(ii) Not disclosed in the financial statements. (3 marks)

9 During the audit of Morgan Ltd audit tests indicated that company policy requiring purchase orders to
be placed only by the company’s buying department was not adhered to in 10% of the transactions
examined.
In respect of the above breach in company policy, draft extracts suitable for inclusion in the auditor’s
management letter, which set out the possible consequences and the recommendations that you
would make. (4 marks)

10 Your firm has recently been appointed as auditor to Donner Ltd for the year ending 31 October
20X5. This is the first year of audit for Donner Ltd.
State the matters to be considered in respect of the opening balances of Donner Ltd. (3 marks)

38 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

11 During your post balance sheet events review of a second division football club, you found out that
the club has just been relegated to the third division. This means that revenues for the following
season are likely to be considerably lower than the current season.
Explain what additional procedures you would carry out in respect of this matter. (3 marks)

12 You have carried out a receivables circularisation as part of your audit of Charnley Ltd for the year
ended 31 October 20X0.
The following disagreements have been revealed.
(1) A customer disagreed the balance because it had sent a cheque on 27 October 20X0.
(2) A customer had been promised a credit note against an invoice dated 5 October 20X0 because
the wrong price had been charged, but this had not yet been issued.
What further information will you require in order to conclude on the results of this test, and why will
you require this information? (3 marks)

13 The directors of two companies, Fletcher Ltd and Dervish Ltd, have each prevented their auditors
from carrying out procedures considered necessary to verify the amount of inventories held by third
parties of CU250,000.
In the audit of Fletcher Ltd materiality has been set at CU200,000, and in the audit of Dervish Ltd
materiality has been set at CU15,000.
State the effect this matter will have on the audit report of each company. (3 marks)

14 The directors of Denzil Ltd are preparing the financial statements for the year ended 31 May 20X1,
and have approached the auditors for advice because they are unsure whether the company can be
considered a going concern.
State the importance of the going concern concept in the preparation of financial statements, and
describe the effect on the financial statements if the company
(i) Is considered a going concern, although there are significant doubts about this
(ii) Is not considered a going concern. (4 marks)

15 Your firm has been engaged to conduct a non-statutory audit of the year end accounts of the
Bangladesh branch of Finch Inc, an American company, and to provide an assurance report as near to a
statutory audit report as you are able.
Set out the main differences between the assurance report you will provide and a statutory audit
report. (2 marks)

16 With regard to auditors’ communication with those charged with governance, what matters should
auditors communicate according to BSA 260? (3 marks)

© The Institute of Chartered Accountants in England and Wales, March 2009 39

 Section 4: Concluding and reporting on assurance engagements

17 During the course of the audit of Beacon Ltd for the year ended 30 November 20X2 you discovered
that on 25 January 20X3 a receiver was appointed at Gamlec Ltd, a major customer of Beacon Ltd.
The balance due from Gamlec Ltd at 30 November 20X2 was CU150,000.
Identify the matters to which you would direct your attention after the balance sheet date. (3 marks)

18 The directors of Pinot Ltd have included the following note in the accounts for the year ended
31 December 20X3.
‘The company reached agreement with its lenders, in October 20X3, to extend the maturities of its
debt facilities until September 20X4, waive all existing covenant breaches and reduce interest costs.
All preconditions contained in the facilities agreement have now been satisfied. The company is
working on initiatives to significantly reduce its current debt levels and is to explore opportunities to
raise further funds by September 20X4. Based on progress to date, the directors remain confident that
the company will be successful in achieving its strategy. While there can be no certainty, the directors
believe that the adoption of the going concern basis is appropriate in the preparation of the financial
statements.
If adoption of the going concern basis was not appropriate, adjustments would be required to write
down assets to their recoverable value, to reclassify non-current assets as current assets and to
provide for any further liabilities that might arise.’
Describe, with reasons, the possible effects of this note on the audit report for the year ended
31 December 20X3. (4 marks)

19 Assurance firms may be engaged to prepare a report on the financial statements and other information
presented by organisations which are required to report under special legislation or regulations.
Give four examples of such organisations, and indicate why they might be subject to such special
reports. (2 marks)

20 You have carried out a receivables circularisation as part of your audit of Trump Ltd for the year
ended 31 December 20X2. It was revealed that a customer disagreed with the balance because it had
sent a cheque on 23 December 20X2.
What further information would you require in order to conclude on the result of this test, and why
will you require this information? (1 mark)

21 Siskin Ltd conducts all its sales on a cash basis. The managing director and majority shareholder of
Siskin Ltd has provided a written representation in respect of the completeness of cash sales.
What additional matters would you consider in determining whether or not you would rely on this
representation? (3 marks)

22 During the audit of Poplar Ltd for the year ended 31 January 20X3 you have been assigned the
responsibility of checking the cash at bank figure in the balance sheet. While checking the bank
reconciliation you discovered that receipts from customers, listed as outstanding lodgements at the
year end, were cleared through the bank on 14 February 20X3.
Explain why this matter should be investigated further. (2 marks)

40 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

35 Anagram Ltd
You are the senior in charge of the audit of Anagram Ltd (‘Anagram’) for the year ended 30 June 20X5.
Anagram is a manufacturer of silicon chips and wafers.
The bulk of the audit fieldwork in respect of this client was completed last week, and the audit manager has
asked you to pull the file together so that she can attend the final clearance meeting with the client’s
management.
During the course of the audit, particular attention was paid to a major sales contract that Anagram
entered into during the year. The contract is for the supply of a substantial number of custom-made silicon
chips to a Japanese component manufacturer. In order to service this contract, which has an initial duration
of five years, Anagram has invested heavily in new specialist plant and equipment. This investment has in
part been financed by substantial new bank loans and an extension to the company’s overdraft facility. The
contract also gives the customer a 60 day credit term on all purchases from Anagram, and this has in turn
increased Anagram’s working capital requirements.
The sales contract stipulates that the customer is to purchase the product from Anagram in fixed monthly
amounts, referred to in the contract as ‘call-downs’. The call-down for March 20X5 went ahead as planned,
but the amount of product called-down for April, May, and June 20X5 represented approximately only one-
third of the amount originally stipulated in the sales contract. The lead-time for raw materials purchased by
Anagram is two months and therefore the above shortfall in sales has resulted in a significant increase in the
holding of raw materials and finished goods inventories for Anagram at the year end.
Requirements
(a) List the principal components that you would expect to see in an audit completion memorandum for a
statutory audit conducted under the Companies Acts. (4 marks)
(b) Set out the matters to which you would direct attention during your subsequent events review in
order to reach a satisfactory conclusion on the accounting treatment and disclosure in respect of the
issues raised above. (7 marks)
(c) State with reasons how each of the issues raised above might cause you to modify your audit report in
respect of Anagram. (7 marks)
(18 marks)

36 Garb Ltd
You are the external auditor of Garb Ltd for the year ended 30 September 20X1. Its principal activity is the
design, manufacture and sale of clothing.
The company made a loss in the year ended 30 September 20X1, but the profit forecast indicates a return
to profitability in the year ending 30 September 20X2. The loss was due to redundancy and restructuring
costs following the loss of its major customer, a national retailer, to whom it supplied clothing under the
retailer’s brand name. The company is now focusing on its own branded goods which have been sold,
historically, at a higher margin. There are plans to develop its overseas market and to expand the customer
base for its recently launched corporatewear products, and contracts have recently been agreed with
several new overseas customers. The company has also negotiated a new contract with a major supplier,
which has resulted in reduced prices in return for committed monthly purchases.
During the year ended 30 September 20X1 the company suffered severe negative cash flow but managed to
stay within the overdraft facility by delaying payments to trade payables and NBR. The company has a bank
loan which is due for repayment in March 20X2 and is negotiating with its bankers for a replacement loan
required to repay the present loan.
Requirements
(a) Explain what is meant by the going concern concept and why the auditor should consider whether a
company is a going concern. (5 marks)

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 Section 4: Concluding and reporting on assurance engagements

(b) Identify the matters to be considered when reviewing the profit and cash flow forecasts prepared by
the company, in order to assess whether the company is a going concern. (9 marks)
(c) Discuss the implications for the audit report of Garb Ltd in respect of the financial statements for the
year ended 30 September 20X1, if the negotiations for the replacement loan are not completed by the
time the audit report is signed. (4 marks)
(18 marks)

37 Plumb Ltd
You are in charge of the audit of Plumb Ltd for the year ended 30 September 20X5. The principal activity is
the provision of plumbing and central heating services under fixed-price short-term contracts. The majority
of the company's business is conducted on a sub-contract basis for construction companies many of which
use Plumb Ltd on a regular basis. It is common practice in this industry sector for construction companies
to pay 95% of the contract value on completion with the 5% balance being retained by the customer for six
months as security against problems with the work undertaken.
Plumb Ltd also has retail outlets through which it sells consumables used in the plumbing trade. However,
management is currently negotiating the sale of the retail operation and plans to use the proceeds to repay
a loan falling due in February 20X6. Following the disposal of the retail operation, Plumb Ltd will continue
to buy consumables used in its contract work from the existing suppliers but in smaller quantities.
Plumb Ltd made an operating loss for the year ended 30 September 20X5. This is mainly due to a
substantial provision for rectification work relating to a contract for Builda Ltd, one of Plumb Ltd's major
customers. The contract was completed in early September 20X5 but failed to meet the customer's
specification. Furthermore, in October 20X5, Plumb Ltd received notification that Builda Ltd had lodged a
claim against the company for substantial compensation for alleged damage to the customer's business. No
provision has been made for this compensation as the directors of Plumb Ltd have instructed the company's
legal advisors to fight the claim.
The company is currently trading at its overdraft limit and the directors have been negotiating with the
company's bankers in order to increase its borrowings. The directors have prepared profit and cash flow
forecasts for the three years ending 30 September 20X8 in support of the request for funding. The
company's bankers require this information to be reviewed by independent accountants and the board of
directors has requested that your firm undertakes this review.
Requirements
(a) In relation to the audit of the financial statements, identify from the information provided above, the
matters which give cause for concern and explain why they give cause for concern. (6 marks)
(b) Identify the different types of audit report modification which may arise from a going concern problem
and state the circumstances in which they are appropriate. (6 marks)
(c) Identify from the information provided above, the specific matters you would consider when reviewing
the assumptions underlying the income and expenditure included in the profit forecast and the
receipts and payments included in the cash flow forecast. (8 marks)
(20 marks)

38 Delux Hotels Ltd

Your firm is the auditor of Delux Hotels Ltd, which owns and manages a chain of hotels. The hotel systems
are run on networked computers and the accounting function is centralised at head office which is
responsible, amongst other matters, for capital expenditure. The following significant points have been
identified during the audit.
(1) Room lettings – corporate customers
Staff have granted discounts in excess of authorised levels in 40% of the transactions examined.

42 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Formal credit limits are set for about 50% of corporate customers with credit accounts, and audit
tests indicated that about 20% of customers with formal credit limits have exceeded those limits for
more than six months.
(2) Property, plant and equipment
Company policy, which was to obtain three quotes for capital expenditure in excess of CU5,000, was
not adhered to on two occasions.
(3) Computer system
File servers holding business-critical data and systems are not sited in secure locations.
The changing of passwords is at the discretion of staff members.
Requirements
(a) Set out, in a manner suitable for inclusion in a report to management, the possible consequences
arising from the weaknesses identified above and the recommendations to remedy those weaknesses.
Your recommendations should clearly describe how the control procedures should operate.
Note: A covering letter is not required. (18 marks)
(b) When communicating audit matters to those charged with governance, describe the attributes
required for such communication to be effective. (5 marks)
(c) Set out what additional matters are reported to those charged with governance. (3 marks)
(26 marks)

39 Salmonoid Ltd
Salmonoid Ltd specialises in the production and sale of rainbow trout. It has three divisions all operating
from one site located in Hampshire.
Division 1 Fish culture and supply
Up to 300,000 fish of differing sizes are kept in cages supplied with fresh water from bore holes. When
inventories are at their maximum levels problems have been encountered with parasites and a fungus,
causing fish to lose weight and condition. Chemicals have been used as control agents with limited
success.
Division 2 Fish foods
To ensure rapid growth the fish are fed six times a day with high protein fish pellets. A minimum
inventory of eight tonnes is held at any time in airtight silos. After three months the pellets start to
deteriorate in quality in spite of the storage conditions, and if kept for too long actually become
poisonous.
Division 3 Supermarket liaison
In recent years the demand for freshly prepared trout has grown, and the company now sells to the
major supermarket chains. The prepared fish are blast frozen, and despatched monthly in refrigerated
lorries. The insurance policy covering these inventories is about to be renewed.
Salmonoid Ltd’s revenue has stabilised at CU9 million per annum generating 14% net profit. To grow
further it needs to secure an additional site, and an excellent location has been identified.
The directors of Salmonoid Ltd have approached their bank, the Sterndale Bank, to ask for a CU5 million
loan to fund the purchase. The bank is not averse to the proposition, but is nervous that 48% of the
company’s assets are represented by inventories (fish and feed pellets). If the net realisable value were to
fall dramatically Salmonoid Ltd’s credit rating would deteriorate, and the bank’s head office would question
the appropriateness of the loan. Consequently the bank has commissioned Bingt & Co to report on the
accuracy of the current inventory values of Salmonoid Ltd, and their sensitivity to future eventualities.

© The Institute of Chartered Accountants in England and Wales, March 2009 43

 Section 4: Concluding and reporting on assurance engagements

Requirements
(a) As the consultant of Bingt & Co undertaking the assignment
(i) Identify the factors, and consequential risks, you would consider when reviewing inventory values
for Salmonoid Ltd (assume that as a firm you have all the technical expertise required)
(ii) State the main features of your final assurance report on inventory values and briefly explain the
significance of each. (14 marks)
(b) Compare the purposes and characteristics (including the levels of assurance provided) of the different
forms of assurance provided by
(i) Audit reports under the Companies Act
(ii) Other reports under legislation or regulation
(iii) Other reports where the scope of the work and of the report to be provided are agreed
between the two parties involved. (8 marks)
(22 marks)

40 Betta Networks Ltd

Described below are situations which have arisen in three audit clients of your firm. The year end in each
case is 31 January 20X3.
Betta Networks Ltd
Betta Networks Ltd is a company in the telecoms sector which builds and operates national fibre optic
networks. During the year the company incurred costs of CU8.5 million in respect of repairs and
maintenance to its networks. These costs have been capitalised and included in non-current assets. The
directors refuse to make any adjustments in respect of this matter.
The pre-tax profit of Betta Networks Ltd for the year ended 31 January 20X3 is CU7.2 million.
Rayton Ltd
Inventories at the year end include CU240,000 in respect of the cost of items which had been returned by a
customer because they were not in accordance with the customer’s specification. The directors insist on
including the items at cost, as the company has an agreement to sell them to another customer for
CU320,000, following the modification of the items at an additional cost of CU140,000.
The pre-tax profit of Rayton Ltd for the year ended 31 January 20X3 is CU2.4 million.
Viva Ltd
In September 20X2 Mary Benton was paid CU60,000 for services in respect of interior design work at Viva
Ltd’s head office. Mary Benton is the wife of the managing director and majority shareholder of Viva Ltd.
The managing director refuses to disclose details of the transaction in the notes to the accounts because of
its sensitive nature.
The pre-tax profit of Viva Ltd for the year ended 31 January 20X3 is CU10.4 million.
Requirements
(a) Describe the role of the concept of materiality in the conduct of an audit and explain why it can be a
difficult area for auditors. (8 marks)
(b) In respect of the situations outlined above, reach a conclusion on whether or not you would modify
each audit report. Give reasons for your conclusions and describe the potential effect, if any, on each
audit report. (9 marks)
(17 marks)

44 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

41 Audit report phrases

The following audit report has appeared in published accounts.
Independent auditors’ report to the shareholders of Cain Ltd
We have audited the accompanying balance sheet of Cain Limited as of December 31, 20XX and the
related profit and loss account and statement of cash flows for the year then ended. These financial
statements are the responsibility of the company's management. Our responsibility is to express an opinion
on these financial statements based on our audit.
Scope :
We conducted our audit in accordance with Bangladesh Standards on Auditing (BSA).Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our opinion.
Opinion :
In our opinion, the financial statements prepared in accordance with Bangladesh Accounting Standards (BAS),
give a true and fair view of the state of the company's affairs as of December 31, 20XX and of the results of
its operations and it's cash flows for the year then ended and comply with the applicable sections of the
Companies Act 1994, the Securities and Exchange Rules 1987 and other applicable laws and regulations.

We also report that:

(a) we have obtained all the information and explanations which to the best of our knowledge and belief
were necessary for the purposes of our audit and made due verification thereof.
(b) in our opinion, proper books of account as required by law have been kept by the company so far as
it appeared from our examination of those books and (where applicable) proper returns adequate for
the purposes of our audit have been received from branches not visited by us.
(c) the company's balance sheet and profit and loss account dealt with by the report are in agreement
with the books of account and returns.
(d) the expenditure incurred was for the purposes of the company's business.
Able & Co
Chartered Accountants
Requirements
(a) Explain the meaning of and the purpose of including each of the phrases underlined above.
(13 marks)
(b) Describe the objectives of requiring unqualified audit reports to be published in a standard form.
(4 marks)
(17 marks)

42 CCEP Ltd
Described below are situations that have arisen in three audit clients of your firm.
Chittagong Corporate Engine Parts Ltd (CCEP)
CCEP manufactures engine parts. Revenue for the year ended 31 December 20X3 was CU200 million, and
net profit was CU17 million. NBR has launched an enquiry that is still underway. It is not possible to
ascertain at this stage if a tax liability will arise in this company. The directors have disclosed the enquiry in
a note to the accounts. They have also indicated a willingness to make any further disclosures that you
recommend. A tax specialist has advised you that the possible range of outcomes in respect of additional
tax liabilities is between a zero liability and a CU20 million liability but, because of the complexity of the
issues, she is unable to forecast the outcome.

© The Institute of Chartered Accountants in England and Wales, March 2009 45

 Section 4: Concluding and reporting on assurance engagements

Prime Volunteers Ltd – a charity

Prime Volunteers Ltd has accrued CU170,000 for the purchase of a freehold property and recorded this
liability within accruals in payables falling due within one year, and a corresponding expense in building costs
in the income and expenditure account. The charity has not yet identified a property to purchase and has
not entered into a contract to purchase a property. The draft financial statements for the year to
31 March 20X4 currently show an excess of income over expenditure of CU700. The trustees of the
charity refuse to adjust the financial statements because they believe disclosure of a large surplus would
inhibit their ability to raise funds in the future.
Worldwide Ltd
Worldwide Ltd exports a significant amount of its products and has a major distribution centre in an
overseas country, which is at war with a neighbouring country. Due to the imposition of travel restrictions
it was not possible for your firm to attend the year end inventory count. The inventory at the overseas
distribution centre at 31 March 20X4 represented 60% of Worldwide Ltd’s inventory.
Requirements
(a) Explain the reasons and benefits of auditors
(i) Completing a disclosure checklist
(ii) Carrying out a final analytical review
when they are conducting final checks on the financial statements. (4 marks)
(b) In respect of CCEP, set out the matters you would consider as part of a going concern review.
(6 marks)
(c) For each of the situations above, reach a conclusion on whether or not you would qualify the audit
report. Give reasons for each conclusion and describe the effect on each audit report. (10 marks)
(20 marks)

43 Vista Ltd
Described below are situations which have arisen in five audit clients of your firm. The year end in each
case is 30 September 20X2.
Vista Ltd
Vista Ltd, a supplier of retail display equipment, has included in its income statement immediately below
profit after tax, an exceptional loss of CU3.7 million on the sale of a trade investment. This accounting
treatment is not in accordance with accounting standards, which require the loss to be taken into account
in arriving at the profit or loss before taxation.
The pre-tax profit of Vista Ltd for the year ended 30 September 20X2 is CU694,000.
Expo Ltd
Expo Ltd exports a significant amount of its products, and has a major distribution centre in an overseas
country in which there has been a military coup. As a result of travel restrictions imposed by the military
junta, it was not possible for your firm to attend the year end physical inventory count. The inventories at
the overseas distribution centre at 30 September 20X2 represented 75% of Expo Ltd’s inventories.
Pharm Ltd
Pharm Ltd, a company engaged in the manufacture of pharmaceutical products, has extensive interests in an
overseas country which requires pharmaceutical products to be registered. The regulatory situation in that
country is undergoing considerable change and Pharm Ltd does not expect to obtain drug registration as
quickly as originally anticipated. However, after carrying out the appropriate review, the directors have
decided that Pharm Ltd has enough resources to continue for the next 12 months. Additional funding will
be required from that point, and the directors believe that this can be achieved by a further issue of shares
within the next 12 months.

46 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

The directors have included a note to the accounts explaining the situation.
Mog Ltd
Mog Ltd manufactures light fittings. Certain of its finished inventory lines are out of fashion and have a net
realisable value which is CU35,000 lower than their original cost. However, the directors have argued that,
overall, the net realisable value of the entire inventories exceeds original cost and that fashions may well
change over the next few years such that the company can ultimately sell these lines above their current
net realisable value.
The pre-tax profits of Mog Ltd for the year ended 30 September 20X6 were CU900,000. Net assets and
inventories on 30 September 20X6 totalled CU10 million and CU4 million respectively.
Hubbard Ltd
Hubbard Ltd is a family company which makes and sells medical syringes. The company’s factory is ultra-
modern and conforms to the appropriate hygiene standards. All of Hubbard Ltd’s syringes are supplied
sterilised and individually wrapped. Shortly before its year end the company’s solicitors notified the
company of an action being brought by a patient who had contracted gangrene in his right arm following a
routine influenza injection. The patient is claiming that the syringe used by his doctor was contaminated.
This patient will probably have to have his arm amputated. The company’s solicitors believe that the case
will not come to court for several months, if not years. In addition, they mention that the patient is also
suing the doctor who administered the injection. The patient concerned is pressing for at least CU500,000
in damages, an amount which is material to the financial statements. The directors of Hubbard Ltd do not
intend to provide for the claim in this year’s financial statements. However, a reference to the action will be
made in the notes to the accounts.
Requirements
(a) ‘The logical extension of audit deregulation would be to allow shareholders in all companies of
whatever size, listed or otherwise, to choose whether to have an audit.
If the audit were no longer a statutory requirement, shareholders could decide for themselves what
kind of audit suits their company and the commercial terms on which it is undertaken.
This would solve the problems of value for money, expectation gap and independence at a stroke’.
Discuss the issues raised by this quotation and consider, reaching a conclusion, the advantages and
disadvantages of there being a legal requirement for an audit. (12 marks)
(b) List the conditions of the Companies Acts which have to be satisfied before an unmodified audit report
on annual financial statements can be issued. (5 marks)
(c) In respect of the situations outlined above, reach a conclusion on whether or not you would modify
each audit report. Give reasons for your conclusions and describe the potential effects on each audit
report. (20 marks)
(37 marks)

44 Ironco Ltd
You are preparing for your audit planning meeting with the finance director of Ironco Ltd, a company
whose principal activity is the production of iron castings made to customers’ specifications. Although the
company’s revenue and assets are below the thresholds for statutory audit purposes, the company’s
bankers require the annual accounts to be subjected to a full audit.
The company’s revenue fell by 10% during the year ended 31 October 20X4 due to the loss of a major
customer, and as a result the company made an operating loss. However, the directors are forecasting a
return to profitability for the year ending 31 October 20X5 as they are currently negotiating contracts with
new customers.
The draft balance sheet as at 31 October 20X4 indicates net assets of CU148,850, but current liabilities
exceeded current assets by CU180,733. Details of current assets and liabilities as at 31 October 20X4 and
20X3 are set out below.

© The Institute of Chartered Accountants in England and Wales, March 2009 47

 Section 4: Concluding and reporting on assurance engagements

Draft 20X4 Actual 20X3

CU CU
Current assets
Inventories 238,095 194,414
Trade receivables 405,845 366,012
Other receivables 82,769 83,774
726,709 644,200
Current liabilities
Borrowings 260,956 215,440
Trade payables 500,538 480,130
Other payables 97,045 97,162
Taxation 48,903 35,294
907,442 828,026

Net current liabilities (180,733) (183,826)

The company is up to date with VAT payments to NBR but has fallen behind with its payments in respect of
payroll taxes.
Requirements
(a) Set out the benefits, other than the maintenance of its borrowing facility, to the company and its
management of having a full audit. (4 marks)
(b) (i) List ten indicators of going concern problems given in BSA 570.
(ii) Explain the auditors’ responsibilities in respect of going concern (including reporting
responsibilities). (15 marks)
(c) (i) Identify, from the information provided above, the matters which give cause for concern and
explain why they give cause for concern.
(ii) In respect of the issues raised in (i), identify the matters to which you would direct your
attention during the post balance sheet review.
(iii) Identify the different types of audit report which may arise from the concerns raised above and
state the circumstances in which they are appropriate. (19 marks)
(38 marks)

48 © The Institute of Chartered Accountants in England and Wales, March 2009

 Answer Bank

© The Institute of Chartered Accountants in England and Wales, March 2009

49
50 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

Section1: Legal, ethical and

current issues

1 Short form questions

1 Fundamental principles of IFAC
 Framed in broad and general terms, the principles constitute basic advice on professional
behaviour
 Aimed at all members of the profession whether in practice or not
2 Safeguards re fees
To recognise threat
 Before accepting/retaining audit, consider whether total fees represent a large portion of total
annual fee income of the firm (such as, in UK, more than 10% annual fee income or more than
5% for listed company/public interest company)
 Regularly review situation as client profile changes
To offset threat
 Consider whether firm could be open to criticism and either
– Refuse appointment, or
– Introduce safeguards, including independent review and disclosure to ethics engagement
partner and those charged with governance
 Must refuse assignment if total fees regularly become a large portion of the firm’s total annual
fees.
3 Reimbursement expenses
 Professionally dangerous to become involved in internal wrangle
 Encourage Edward to resolve dispute
Otherwise
 Ask other directors for permission to give information to Edward
 Refuse request if permission not given
 Duty of confidentiality prevents disclosure
4 Overdue fees
 Overdue fees constitute a self-interest threat to independence
 Issue of unqualified report this year may increase chance of collecting overdue fees
 Ideally arrange for settlement of the overdue fees
 If not settled and fees are
– Significant
– In dispute
consider resigning from the engagement
 If do not resign apply appropriate safeguards (e.g. second partner review)

© The Institute of Chartered Accountants in England and Wales, March 2009 51

 Section1: Legal, ethical and current issues

5 Safeguards

Accept appointment? Reason

(1) No  Holding shares of more than 5% disqualifies him

as an auditor. CA94 section 212 prohibits it.
(2) No  Owing more than Tk1,000 to a company
disqualifies him to be an auditor as per CA94,
section 212.

6 ‘True and fair’ rather than ‘correct’

 All transactions could not have been reviewed
 Audit is designed to ensure that accounts are free from material misstatement
 Sampling is used to identify a representative number from each population, but still a risk that
incorrect items would not be chosen
 To specify correct an audit member of staff would need to be present when each transaction was
generated
 Audit is not merely considering entries in accounting records, but also consideration of systems
and controls over transactions to ensure these have been recorded fully and accurately
 Judgement involved in the use of accounting policies and estimates
7 Concept of assurance
 In an assurance engagement an assurance firm is engaged to express a conclusion designed to
enhance the degree of confidence of the intended users other than the responsible party about
the outcome of the evaluation or measurement of a subject matter (e.g. financial or operational
information, systems or behaviour) against criteria.
 The conclusion is an expression of assurance, or comfort, about the subject matter which has
been examined
 Degree of comfort given depends on amount of work performed by the assurance firm
 It may be reasonable assurance or limited assurance
 The greater the examination of the supporting evidence, the greater the degree of assurance
provided
8 Points re fraud
 Duty is to report on financial statements
 No responsibility as such to detect fraud
 An audit conducted in accordance with BSAs obtains reasonable assurance that the financial
statements are free from material misstatement whether caused by fraud or error
 Auditors may not find material frauds
 Frauds involving collusion harder to detect
 Responsibility set out in engagement letter
 Management is responsible for implementing and monitoring the system of control
9 Benefits of statutory audit
 Independent confirmation of profits earned/net assets
 Assurance of compliance with Companies Acts
 Recommendations on systems via management letter
 Added credibility of accounts will assist negotiations with bank
 Reliable financial information for business decisions

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10 Arguments for independent regulation

 Public perception – self-regulation seen as cosy
 Institutes cannot be both trade association and regulator
 Independence must be seen to be central to process for acceptability
 Independent regulation means public accountability and transparency
 Input of public interest from outside profession

11 Expectation gap misunderstandings

 Responsibility for preparing accounts lies with auditor
 Auditor’s duty is to detect fraud
 Auditors check all transactions
 Auditor certifies accounts in report as being correct
 Unqualified report guarantees going concern

12 Principal ethical issue

Confidentiality
 Data and Lodge may perceive threat of disclosure/use of information
 Conflict of interest for audit firm
 Difficult to act in best interest of both clients
Procedures
 Ensure staff are aware of confidentiality issues
 Staff to certify they are aware of procedures
 Obtain informed consent of both clients/inform both clients
 Use different partners and teams
 Independent review of arrangements for ensuring confidentiality maintained
 Information barriers in place (Chinese walls)

13 Benefits
To the bank
 Reduces uncertainty as to reliability of the information/increases credibility
 Reduces the risk of management bias/independent
 Enables bank to determine risk in advancing more money to Royale
To Royale
 Enables them to obtain the overdraft which may not be possible without the report
Limitations
To the bank
 Not all receivable and inventory balances will be looked at by your firm
 Possibility of collusion or misrepresentation
 Evidence likely to be persuasive rather than conclusive/assurance not absolute – reasonable or
limited level of assurance depending on scope of work
 Report may not highlight full extent of problem/lack of sufficient information
 Inherent limitations of accounting system/integrity of data

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14 Reasonable assurance
 Objective is a reduction in assurance engagement risk to an acceptably low level in the
circumstances
 Conclusion expressed positively
 High level of assurance
 'In our opinion……….'/True and fair
 Not absolute level of assurance
Limited assurance
 Objective is a reduction in assurance engagement risk to a level that is acceptable in the
circumstances but where the risk is greater than for a reasonable assurance engagement
 Conclusion expressed negatively
 'Nothing has come to our attention…….'
15 IAASB pronouncements
 International Standards on Auditing (ISAs) – applicable to audit engagements
 International Standards on Review Engagements (ISREs) – applicable to review engagements
 International Standards on Assurance Engagements (ISAEs) – applicable to assurance engagements
which are not audits or reviews
 International Standards on Related Services (ISRSs) – applicable to other non-assurance
engagements
 International Standards on Quality Control (ISQCs) – applicable to all engagements carried out
under any of the IAASB’s standards
16 Benefits of statutory audit
 Can assist management in financial reporting process – e.g. advice re how to maintain accounting
records and prepare financial statements
 Helps instil better discipline of maintaining accounting data on an ongoing basis
 Audit opinion may give financial statements extra credibility with outside parties (e.g. bankers)
 External auditor (EA) can pass on experience/knowledge to help directors discharge
statutory/fiduciary duties (e.g. advice on safeguarding assets)
 EA advice on internal controls can assist in reducing risk profile of company (e.g. advice on
forecasting techniques)
 EA may help improve company efficiency/performance (e.g. advice on better inventory control
systems)
 More reliable financial information will result in more informed business decisions
17

Type of threat Example

 Self-interest  Fear of losing the client/fee dependency

 Self-review  Provision of non audit services such as tax and
accountancy work
 Intimidation  Pressure not to qualify report by dominating
personality at the client

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18 Practice loans  why threat

 Loan from  would make practice financially dependent on client  could jeopardise
independence as firm would feel obligated to the client
 Loan to  auditor could avoid qualifying because of concerns about recoverability
19 Threats to independence and safeguards
Mrs Wallace
 Self-interest threat
 Trustee interest held by a person in a position to influence the audit will be allowed where
– Mrs Wallace not a beneficiary of the trust
– The financial interest held by the trust in Racdale Ltd is not material to the trust
– Trust is not able to exercise significant influence over Racdale Ltd
– Mrs Wallace does not have significant influence over investment decisions made by the trust
 Therefore transfer audit responsibility to another partner
Mr Netwater
 Familiarity/self-interest/intimidation threat
 Should be removed immediately from audit role
 Review of the audit work performed by Mr Netwater in the current and, where appropriate,
most recent audit
 Firm should reassess composition of audit team
20 Money laundering
 Report to Bangladesh Bank under section 24 of Banking Companies Act 1993, for violation of
Money Laundering Act of 2002
21 Accountant's report on profit forecast
Comment
 Negative assurance which is limited assurance
How it differs
 Audit provides high level of assurance which is reasonable/not absolute assurance
 Opinion expressed in positive terms
– Give a true and fair view/properly prepared opinion in accordance with Companies Act
Why it differs
 Financial statements are based on fact as well as judgement
 Persuasive evidence available
 Often the delay between balance sheet date and audit report means that even items such as
provisions/estimates can be substantiated
 Scope of work on forecasts is limited as forecasts are based on assumptions about the future and
as such are subject to uncertainty
22 Responsibilities
Auditor responsibilities
 No responsibility to prevent fraud
 Responsibility to detect material misstatements in the financial statements whether due to fraud
or error
 Must design audit procedures to obtain reasonable assurance that financial statements are free
from material misstatement whether caused by fraud or error

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 Section1: Legal, ethical and current issues

Management responsibilities
 Responsible for preventing fraud
 Responsible for detecting fraud
 Must implement system of internal control suitable for the business and monitor such systems
 Responsible for safeguarding the assets of the company
23 BSA 250 –procedures for non-compliance
 Obtain a general understanding of procedures followed to ensure compliance with relevant legal
framework
 Enquire of management whether they are on notice of any possible instances of non-compliance
 Written representations to include actual or contingent consequences of the non-compliance
Differences re when should communicate without delay
 BSA 250 says when intentional and material
24 Steps re non-compliance
 Fully document findings
 Discuss with directors
 Formally report findings to directors
 If directors involved, report to audit committee or take legal advice
 Report to appropriate 3rd party authority where there is a statutory duty
 Resign, as last resort and make statement of circumstances on resignation

2 Mac

Marking guide
Marks
(a) Benefits (each) ½
Maximum 6
(b) Nature of assurance 2
Level of assurance provided by forecast 3
How it differs 4
Why it differs 3
Available 12
Maximum 9
Total marks available 15

(a) Benefits of audit

 The credibility of financial information would be enhanced.

 Enhances the value of accounts for business valuation purposes in the event of a sale.
 Authorities such as NBR can have more faith in the figures.
 Avoids the future cost of extra work by the auditor when audit exemption limits are exceeded.
 Avoids a potential future qualification over the opening inventory figure.
 Makes it easier to raise finance.
 May act as a deterrent to fraud/management abusing assets/reduce risk of management bias.

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 More reliable information results in more informed decisions.

 Provides management/shareholders with assurance that the financial statements are true and
fair/prepared in accordance with accounting standards.
 By-products of the audit such as identification of weaknesses and recommendations should
reduce risk and improve performance (management letter).
 Imposes discipline on management and accounts staff if they know that the figures will be subject
to third party scrutiny, and therefore encourages best practice.
 Gives management comfort that they are complying with their professional responsibilities/the
accounts comply with the Companies Act.
(b) Report on forecasts
Nature of the assurance
 Forecasts have been prepared in line with stated assumptions and are prepared in accordance
with the relevant financial reporting framework
 The accounting policies used are consistent with the annual financial statements
Level of assurance
The level of assurance would be limited and the conclusion would be expressed negatively i.e. “Based
on our examination of the evidence supporting the assumptions, nothing has come to our attention
which causes us to believe that these assumptions do not provide a reasonable basis for the forecast”.
How it differs
An audit provides reasonable assurance which is a high level of assurance and is expressed positively
i.e. 'in our opinion the financial statements give a true and fair view'.
In a reasonable assurance engagement, the level of risk is reduced to an acceptably low level in the
circumstances.
In a limited assurance engagement the risk is reduced to a level that is acceptable in the circumstances,
but is greater than for a reasonable assurance engagement.
Why it differs
Financial statements are a combination of historical fact and judgement which often involves estimates.
However even where there are estimates some comfort can be derived from events after the balance
sheet date.
Forecasts are estimates which are subject to uncertainty.

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3 Criticisms of auditors

Marking guide
Marks

(1) Responsibility for detecting fraud

Current situation 2
How it might be changed 1
Case for change 2
Case against change 3
8
Maximum available 5
(2) Provision of non-audit services
Current situation 2
How it might be changed ½
Case for change 4
Case against change 4
10½
Maximum available 5
(3) Period of time for which auditors can act for a client
Current situation 1
How it might be changed 2
Case for change 2
Case against change 2
7
Maximum available 4
General
Confidence and credibility 1
1
15

(1) Responsibility for the detection of fraud

Current regulatory and professional requirements
Auditors are not responsible for the detection of all fraud – it is management’s responsibility to detect
fraud.
The auditors’ responsibility is discharged by planning, performing and evaluating their work so that
they obtain reasonable assurance that the financial statements are free from material misstatements
due to fraud.
Possible changes
The auditors’ responsibility for the detection of fraud could be extended by requiring them to perform
specific (limited scope) procedures.
Case for change
This would narrow the expectation gap in respect of the auditors’ duty in relation to fraud detection
and this higher priority would be a greater deterrent to fraud.
Case against change
It would result in increased costs owing to additional work and also increased cost of professional
indemnity insurance due to extended exposure to litigation.
It may also not be feasible/practicable due to the inherent limitations of an audit.

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(2) Provision of non-audit services to audit clients

Current regulatory and professional requirements
Some non-audit services are permitted as long as objectivity would not be perceived to be impaired
and safeguards are in place. However
 Fee levels must be appropriate
 Accounts not to be prepared for listed companies
 Auditors must advise only and not make management decisions. Auditors of listed companies are
required not to perform the following non-audit services on a ‘comply or explain basis’ as per
SEC notification dated 20th February, 2006.
 Appraisal or valuation services or fairness opinions
 Financial information systems design and implementation
 Book-keeping or other services related to the accounting records or financial statements
 Broker-dealer services
 Actuarial services
 Internal audit services
 Any other service that the Audit Committee determines.

Possible further changes

The provision of all non-audit services could be banned with no exception and no explanation.
Case for change
This would negate the threats to objectivity, in particular
 Fear of losing fee
 Reluctance to report adversely on own firm’s work
 Insufficient rigorous checking of colleagues’ work.
It would discourage undercutting – the practice of quoting a low audit fee in order to attract more
lucrative consultancy work.
The use of a different firm may provide a different perspective/skill sets.
Case against change
Such action could result in
 A lower quality of services (the auditor would not be in possession of the whole picture)
 Increased costs due to a lack of pooling of background information
 A loss of convenience/one stop shop for clients
 A lack of comfort for clients from having services provided by a trusted source.
It may also impair the ability of firms
 To recruit high calibre personnel who value the broad-based training provided by firms
undertaking a variety of services
 To audit tax and computer systems
 To draw upon the wider intellectual capital which currently exists in firms.

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(3) Period of time for which auditors can act for a client
Current regulatory and professional requirements
Auditors are appointed from the conclusion of the AGM to the conclusion of the next AGM with no
limit on the number of reappointments.
There are professional requirements in the IFAC Code of Ethics which do not allow the engagement
partner or other key employees to act for a continuous period of more than seven years (for listed
clients).
Possible further changes
Fixed-term appointments/mandatory rotation (of audit firms, as opposed to audit partners) could be
introduced.
Case for change
There is currently a risk of familiarity/complacency – auditors who get too close to their clients may
lose their independence, objectivity, scepticism and become complacent.
Rotation stimulates the auditors’ courage and independence because there is no expectation of a long-
term relationship and hence they do not fear dismissal.
Case against change
Recurring first-time audits are likely to
 Be disruptive to clients (process of selection/answering questions, etc)
 Result in increased costs (introducing new auditors is costly to the client as the team builds
detailed knowledge of the client, its business and the key issues in its financial statements).
However, the understanding and experience of long-term complex issues where the auditors’
expertise is needed most is lost on rotation.
Rotation can discourage auditors from specialising to the required depth, thus limiting the choice of
available alternatives.
However, there would be increased risk due to first time audits, as auditors may miss things due to
their lack of experience with a particular client.
General
If users perceive auditors to be free from influence they will have more confidence in the audit
process and financial information will have greater credibility.

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4 Alpha Ltd

Marking guide
Marks

(a) Listed company implications 1½

Integrity of management/money laundering 1½
Identification and explanation of self interest threat 1½
Identification and explanation of self review threat 3½
Conflict of interest and confidentiality 2
Safeguards – general 2½
Safeguards – consultancy services 2½
Safeguards – competitor 2½
Marks available 17½
Maximum 14

(b) Level of assurance 3

How it differs 3
Why it differs 4
Marks available 10
Maximum 6
Total marks available 20

(a) Professional and ethical issues and safeguards

Issues
A listed company poses a greater threat as there is increased risk due to greater public interest.
Any question marks over the integrity of management can mean potential for money laundering and
fraud.
If both audit and non-audit services are provided, the following issues arise.
 A self-interest/fee dependency threat arises. Because of the fear of losing a large client, the
auditor may be tempted to turn a blind eye and issue an unqualified report when a qualified one
should be issued.
 A self-review threat arises when assessing the adequacy of internal controls over the new
financial information system, as the auditor may be reluctant to report
– Problems related to the new system
– Errors subsequently identified in interim accounts.
 A management threat arises in respect of the work on the system.
 The IFAC Code of Ethics does not allow the audit firm to undertake work on designing,
providing or implementing IT systems for an audit client where
– The systems are a significant part of the accounting system/significant to the production of
the financial statements, or
– For the purposes of the IT services the audit firm would undertake part of the role of
management.
Because the firm also acts for a major competitor, the following issues arise.
 Acting for a competitor may result in a conflict of interest such that the auditor may not be able
to act in the best interests of both parties.

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 The auditor will have access to confidential information which is not in the public domain – this
information must be protected.
Safeguards
General
 Obtain professional clearance from the retiring auditors.
 Separate engagement letters must clearly set out management and auditor responsibilities for
each assignment, the scope of work, the content of the reports and the level of assurance
provided.
 Ensure that fees do not become a large portion of the firm’s total annual fees.
 Confirm in writing to those charged with governance that appropriate safeguards are in place.
 Independent partner review of the audit.
Consultancy services (if it is acceptable to act at all)
 ‘Informed management’ is designated by Alpha Ltd.
 Management must acknowledge in writing that they take responsibility for the overall system of
internal control.
 Rigorous review of the system by the audit team.
 The audit firm must not make or appear to make management decisions.
 Separate teams and partners.
Competitor
 The circumstances should have been disclosed to the client.
 Informed consent of both clients must be obtained.
 Chinese walls/information barriers established.
 Staff to certify they are aware of these procedures.
 Separate teams and partners.
(b) The report on the interim financial information
Level of assurance provided
The report on the interim financial information will provide limited assurance.
A conclusion will be expressed in negative terms, i.e. ‘nothing has come to our attention that causes us
to believe that the accompanying interim financial information does not give a true and fair view of the
financial position …’.
How it differs from the level of assurance provided by the statutory audit report
An audit provides a high level (but not absolute) assurance.
The opinion is expressed in positive terms, i.e. ‘give a true and fair view and … have been properly
prepared in accordance with the Companies Act 1994’.
Why it differs
The work involved in an audit is more rigorous.
A review excludes
 Tests of controls
 Tests of detail
 Going concern review.

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5 Mart Ltd

Marking guide
Marks

(a) Fees - threats and safeguards 2½

Long association - threats and safeguards 4
Additional services – threats and safeguards 6
Conflict of interest 2
Former employee – threats and safeguards 4
18½
Maximum available 10
(b) Implications for firms
 Non audit services 2
 Mandatory rotation 2
Implications for clients
 Non audit services 2½
 Mandatory rotation 2½
9
Maximum available 6
Total available 16

(a) Ethical and professional issues and measures to be implemented to mitigate any threats
to objectivity

Issues Safeguards

 The fact that this client generates the  Regular review should be performed to
largest fee income and additional services ensure that regular fees do not become a
are provided gives rise to a fee large portion of total annual fees income.
dependency/self-interest threat.
 Fear of losing such a large fee may influence  External quality control review to be done.
the auditors’ judgement.
 Acting for a client for 20 years gives rise to  Periodic rotation of senior staff.
familiarity/trust/complacency threats.
 The auditors may be over-influenced by the  Per IFAC Code of Ethics, if Mart Ltd is a
personality and qualities of the directors listed company, engagement partners are
and management, and consequently too required to be rotated after seven years.
sympathetic towards them.
 The auditors may become too trusting of
management representations so as to be
insufficiently rigorous in testing them
because they are too familiar with the issue.

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 The provision of additional services also  The use of different teams with separate
gives rise to reporting lines.
– A self-review threat – the auditors may  Independent partner review of the audit.
be reluctant to challenge adversely the  ‘Informed management’ to be designated by
outcome of a previous engagement or Mart Ltd.
report on colleagues’ work
 No management decisions/role to be
– A management threat (re tax planning) taken/perceived to be taken.
– Possible undercutting – a low audit fee
may be set in order to retain lucrative
consultancy work.
 There is a conflict of interest by acting for  Use of different personnel to act for the
individual directors and the company – the individual directors.
firm may be tempted to favour one party at
the expense of the other.
 A former employee having joined the client  Assess the composition of the audit team in
in the last two years gives rise to the light of this (may need to remove team
members who have/had a close association
– A familiarity threat (too much reliance
with this ex-employee).
on representations of former employee)
 Quality control procedures should be in
– A former self-interest threat (as
place to ensure a healthy professional
manager this person may have been too
scepticism at all times.
sympathetic)
– Intimidation threat.

(b) Implications for audit firms and their clients if the provision of all non-audit services to
audit clients is banned and mandatory periodic rotation of audit firms is introduced
Audit firms
Non-audit services
Although a ban on the provision of non-audit services removes the threats to objectivity, it may impair
firms’ ability to
 Recruit high calibre personnel who value the broad-based training provided by firms undertaking
a variety of services
 Audit tax and computer systems
 Draw upon the wider intellectual capital which currently exists in firms.
This may result in a loss of income.
Mandatory rotation
Rotation stimulates the auditors’ courage and independence because there is no expectation of a long-
term relationship (i.e. they do not fear dismissal).
However, there will be increased risk due to the number of first time audits as the auditors may miss
things due to their lack of experience with a particular client.
Their clients
Non-audit services
The use of a different firm may provide different perspectives/skill sets.
However, it may result in
 A lower quality of services as the firm will not be in possession of whole picture

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 ANSWER BANK

 Increased costs due to a lack of pooling of background information

 A loss of convenience/one-stop shop
 A lack of comfort from having all services provided by one trusted source.
Mandatory rotation
Recurring first-time audits are likely to
 Be disruptive to the client (process of selection/answering questions)
 Result in increased costs (introducing new auditors is costly to the client as the team builds
detailed knowledge of the client, its business and the key issues in its financial statements).
Moreover, the accumulated cumulative knowledge and experience of long term complex issues where
the auditors’ expertise is needed most, is lost on rotation.
Rotation can discourage auditors from specialising to the required depth, thus limiting the choice of
available alternatives to the client.

6 Gardenvale Ltd

Marking guide
Marks

(a) Directors' responsibilities 1

Auditor’s responsibilities 2
Discharged - directors 2
Discharged - auditors 2
Marks available 7
Maximum 6

(b) Each question ½

Maximum 10
Use of question format 1
Maximum 11
Total marks available 17

(a) Distinction between the responsibilities of management and the statutory auditor for the
prevention and detection of fraud and how these responsibilities are discharged
Responsibilities
The directors are responsible for the prevention and detection of fraud.
The auditor has no responsibility for the prevention of fraud.
However, the auditor is responsible for detecting material misstatements in the financial statements
resulting from fraud.
How discharged
The directors should implement a system of internal control suitable for the size of the entity and
monitor that system of internal control.
The auditors should plan, perform and evaluate their work so that they obtain reasonable assurance
that the financial statements are free from material misstatements due to fraud.
(b) Questions re internal control procedures over purchase and payments system
 Is there segregation of duties between

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 Section1: Legal, ethical and current issues

– Authorisation of orders
– Processing of orders
– Suppliers’ master file amendments
– Authorisation of invoices
– Processing of invoices
– Cheque requisition
– Signing of cheques/transmission of details to bank
– Reconciliation of creditor accounts?
 Are duties rotated (do all staff take holidays)?
 Is access to supplier details/records restricted, in particular
– Password protected, and
– Passwords changed periodically
– High level password required for amendments to standing data?
 Are amendments to standing data
– Recorded on standard forms
– Authorised by responsible official
– Printed out and checked to authorising document
– Periodic one-for-one checking of suppliers on master file with independent list?
 Is a list of all approved suppliers maintained and reviewed on a periodic basis?
 Are purchase orders checked to agreed supplier prices and approved?
 Are large purchases over a predetermined limit approved by senior management and limits
placed on amounts?
 Are goods received checked to purchase orders?
 Are GRNs sequentially numbered with regular review of sequence?
 Are invoices matched to GRNs prior to being authorised?
 Are prices, additions and calculations on invoices checked?
 Are invoices authorised prior to posting to the ledger/payment?
 Are batch totals used when entering invoices?
 Are there periodic reconciliations of payables accounts to suppliers’ statements?
 Is access restricted to cash/cheque books, bank transfer facilities?
 Are two signatures required on cheques over a specified limit?
 Are bank reconciliations performed on a periodic basis?
 Is there budgetary control on a departmental basis?
 Is there a purchase and payments procedures manual?

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7 Beeches Technologies Ltd

Marking guide
Marks

(a) (i) Each question ½

Maximum 7
Use of question format 1
Maximum 8
(ii) Controls over expenditure 6
Controls over payroll 2
Budgetary control 4
Personnel controls 2
Internal audit 1
Marks available 15
Maximum 10

(b) Auditor's responsibility 4

Directors’ expectations 6
Public perception 6
Beeches Technologies as an example 6
Marks available 22
Maximum 14
Total marks available 32

(a) (i) Questions to ask re fraud

 How was fraud discovered?
 What group has done to ensure full extent of fraud discovered?
 What breakdowns in control made fraud possible?
– Who authorised payments?
– Why not identified by review of subsidiary results?
– Any previous concerns about individual’s behaviour?
– References for individual obtained and reviewed?
 How was fraud perpetrated?
 How were fraudulent transactions hidden?
 What action is to be taken to recover monies from individual?
 Is the company insured against fraud?
 What action has group taken to prevent/identify other similar frauds?
 What controls put in place?
 Any specific review procedures to look for other similar occurrences?
 Any other subsidiaries where have specific concerns?
 Consideration of collusion
 Do they have specific concerns about prior year audit team/procedures?
 What are management’s expectations of audit visits to overseas subsidiaries?

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(ii) Expected controls

 Appropriate authorisation of expenditure
– Group authorisation for significant or unusual expenditure
– Dual cheque signatories
– Review of supporting documentation by cheque signatories
– Appropriate authorisation of electronic funds transfers
– Control of passwords for electronic transfers
– Control of access to bank account details on supplier masterfile
– Review of changes to supplier masterfile details
– Segregation of duties between posting and payment (with explanation)
– Proper bank reconciliations
– Lines of communication for whistleblowing
 Controls over access to payroll data on computer
 Review and authorisation of employee expense claims
 Review of payroll masterfiles changes
 Review of costs incurred against budget on a sufficiently detailed basis to identify
inappropriate expenditure
– Obtain and verify explanations for variances
– Review at group as well as local level
– Comparison to other subsidiaries
– Rationalisation of costs such as commission when compared to sales
– Rationalisation of payroll costs compared to headcount
– Items checked to ensure business expenses
 Rotation of staff between subsidiaries
 Ensuring staff take holidays
 Obtaining references for staff
 Internal audit department reviews
(b) Discussion of expectations gap
Auditor’s responsibility
 Aiming to identify a material misstatement of the financial statements
– This includes material fraud
– A material fraud would result in a qualification of the audit report
 ‘Watchdog, not blood-hound’
– No responsibility to seek out immaterial fraud
– Should report it to management once identified
 Expectation that will raise management letter points where control weaknesses noted
– Much more likely to identify such weaknesses if controls based audit
 No obligation to prevent fraud
Directors’ expectations
 Lot of focus on value added
 Auditors ‘promise’ relevant management letters
 Also expect consistent quality and approach at different locations
 Often rely on auditors for monitoring they should do themselves
 Should ensure aware of locations which will not be visited
 Audit could be deterrent

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Public perception
 General perception that audit will find fraud
 Indeed often seen as primary purpose
 Implicit assumption that auditor has been negligent if fraud not found
 Implicit assumption that auditor should report discovered fraud to external agencies (would
breach auditor’s duty of confidentiality)
 Auditor typically blamed
 No concept of materiality
Example of Beeches Technologies Ltd
 Fraud was not material to group
 Therefore no requirement for group auditors to design audit processes which would be
expected to identify it
 Local entity did not require an audit
 Should look at what management letter points were raised in past re control over overseas
subsidiaries
 Would expect controls based approach given number of small subsidiaries and geographical
spread
 Management unlikely to want to pay for audit work which included visits to all subsidiaries

© The Institute of Chartered Accountants in England and Wales, March 2009 69

 Section1: Legal, ethical and current issues

70 © The Institute of Chartered Accountants in England and Wales, March 2009

 ANSWER BANK

Section 2: Accepting and

managing engagements

8 Short form questions

1 Information to be included
 Name of preparer/date of preparation
 Name of reviewer/date of review
 Client/year/title
 Objectives of test/work
 Conclusion
2 Objectives of cold reviews
 Confirm appropriateness of audit reports
– Audits conducted in accordance with Auditing Standards
– Firm’s procedures followed
 All audit partners subject to review
 Review process must be independent of audit partners reviewed
 Action taken where deficiencies found
3 Working paper re matter of judgement
 Facts known at time
 Criteria determining outcome of judgement
 Reasoning for conclusion
 Conclusion reached
 When and with whom the discussions took place
 Cross references to other supporting documentation
4 Considerations
 The integrity of the principal owners, management and those charged with corporate governance
 Whether the engagement team is competent and has necessary time and resources
 Can the firm and engagement team comply with ethical requirements (e.g. independence,
objectivity)?
5 Principal items
 The objective of the engagement
 The scope of the work to be carried out by the assurance firm
 The form of the report to be delivered/level of assurance
 The responsibilities of the various parties involved
 The fact that due to the limitations of the assurance process, assurance cannot be absolute
 Liability cap
6 Professional enquiry
 Unlawful acts or defaults by the client
 Serious doubts re client’s integrity
 Information required by auditor being deliberately withheld by client
 Client’s reasons for change not in accordance with the facts
 Important differences of principle or practice behind the proposed change
 A ‘statement of circumstances’ to be brought to attention of members/creditors

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 Section 2: Accepting and managing engagements

Tutorial note
The existence of unpaid fees is not of itself a reason for not accepting nomination.

7 Rights on removal
 Copy of notice of resolution proposing removal
 Representations in writing notified to members
 Attendance at general meeting
 Hearing at general meeting
8 Before accepting appointment as auditors
Matters to consider
 Whether the going concern issue likely to be present for future accounting periods
 Whether the going concern disclosures made were warranted
 Whether Meldrew will give permission to contact incumbent auditors
 Whether current auditors agree with reason given by Meldrew for not wishing to reappoint
 Likely independence from Meldrew and therefore able to carry out objective audit
 Nature of Meldrew’s business
– Whether any special expertise required
– Whether have necessary expertise
 Timing/resource requirements to be able to perform audit competently
Procedures to follow
 Discuss with directors current going concern status
 Review prior year’s accounts re whether going concern disclosures were necessary
 Request permission to contact incumbent auditors
 If permission refused decline appointment
 Write to incumbent auditors enquiring if any matters that affect appointment of firm as auditors
 Review response received for any relevant matters. Are their reasons for non-appointment in
accordance with those of Meldrew?
 If significant matters which affect appointment with which firm does not feel it can deal, then do
not accept engagement
 If incumbent does not respond, telephone or fax to request a response. If no response is
forthcoming, send a recorded delivery letter stating that ‘no matters’ will be assumed unless
advised otherwise, within a specified time
 In absence of any response, consider refusing appointment
 Review prior year accounts to ascertain amount of work likely to be necessary, whether any
technical expertise likely to be required and probable level of fee income
 Compare estimated time required with current resources to ascertain whether sufficient staff
available at required times
 Compare estimated level of fee income with current recurring fee income to ascertain whether
the fee income would become a large portion of the total annual fee income of the firm
9 Why recorded
 Evidence in case partner's judgement is questioned subsequently (e.g. defence in litigation)
 Particularly by a third party who may have the benefit of hindsight

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 To demonstrate:
– The relevant facts that were known at the time he reached his conclusion
– That, based on the facts, the conclusion reached was reasonable
 Facilitates review
 Required by Auditing Standards
10 Reasons for review
 Confirm work properly recorded in accordance with
– Firm’s procedures (quality control)
– Engagement plan
 Confirm all contentious/judgemental areas have been highlighted for consideration
 Assurance work carries duty of care to client
 Audit work carries duty of care to 3rd parties/protection against litigation
 Audit is regulated activity and governed by BSAs
11 Functions of an audit committee
 Monitor the integrity of financial information
 Oversee the company’s internal control and risk management systems
 Monitor and review the effectiveness of the company’s auditors
 Monitor the implementation of agreed auditor recommendations
 Facilitate communication between internal and external auditors
 Set performance indicators for internal and external auditors
 Make recommendations in relation to the appointment, re-appointment and removal of
external auditors
 Approve the remuneration and terms of engagement of the auditors
 Develop and implement a policy on the engagement of the external auditor to supply non-audit
services
 Review and monitor external auditors independence
 Feedback to main board (including annual report on its activities)
 Oversee investigation of suspected fraud and value for money initiatives

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 Section 2: Accepting and managing engagements

9 Sleeper Ltd

Marking guide
Marks

(a) Confidentiality 1½
Conflict of interest 1½
Safeguards 3
Intimidation 1½
Safeguards 2
Marks available 9½
Maximum 6

(b) Rights 2
Responsibilities 1½
Marks available 3½
Maximum 3

(c) Management’s responsibilities 3

Auditors’ responsibilities 3
Maximum 6

(d) Assertions (each) ½

Procedure per assertion (each) 1
Maximum 6
Total marks available 21

(a) Professional ethical issues

Confidentiality
 Sleeper and Zelig may perceive threat of disclosure/use of information
Conflict of interest
 May not act in the best interest of both clients
Safeguards
 Ensure staff are aware of confidentiality issues
 Staff confirm awareness in writing
 Obtain informed consent of both companies
 Use different partners and teams
 Chinese walls/staff assigned from different offices
 Independent review of arrangements for ensuring confidentiality maintained
Intimidation by management/ fear of losing a client
 Auditor may be forced into giving inappropriate opinion through fear management may remove
them
Safeguards
 Firm's own procedures for accepting new clients/do not accept if threat too high
 Firm's annual review procedures/review of threat to independence
 Overall control environment within the audit firm
 Notify your firm's audit compliance principal of potential threat

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 ANSWER BANK

(b) Rights
 May make written representations
 Request management circulate these to members
 Right to attend general meeting
 Right to speak at general meeting
Responsibilities
 Obtain written permission from client to discuss its affairs with new auditor
 Reply promptly to incoming auditor’s communication
 Statement of circumstances specifying whether or not any circumstances should be brought to
the attention of the members or creditors
(c) Duties
Management
 Directors are responsible for the prevention and detection of fraud
 Directors should implement a system of internal control suitable for the size of the
entity/safeguard assets
 Directors should monitor the system of internal control
Auditors
 Auditor has no responsibility for the prevention of fraud
 Auditor is responsible for detecting material misstatements in the financial statements resulting
from fraud
 Auditors should plan, perform and evaluate their work so that there is a reasonable expectation
of detecting material misstatements
(d) Assertions and procedures
Valuation
 Trace sample of mobile phone inventory to supplier invoice
 Examine after date sales to ensure stated at lower of cost and net realisable value
 Discuss with management/review sales after date for slow moving or obsolete inventory
Rights and obligations
 Consider whether any inventory held for third parties or on consignment/sale or return basis
 Confirm inventory fully paid for and owned by client
Completeness
 Carry out cut off testing
 Consider other location/inventory held by third parties
 Attend year end inventory count
 Test counts agreed to inventory records
Presentation and disclosure
 Review financial statements to ensure inventory correctly disclosed

Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the style of
this answer is appropriate for use by students in the examination.

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 Section 2: Accepting and managing engagements

10 Gemini Ltd

Marking guide
Marks

(a) Purposes (each) 1

Maximum 6

(b) (1)
Internal audit services
Identification and explanation of self-review threat 2½
Discussion of degree of reliance 2
Quality control measures 5
(2) Advisory services
Explanation of conflict of interest 2½
Quality control measures 5
Marks available 17
Maximum 12
Total marks available 18

(a) Purpose of quality control measures

 To ensure engagements are carried out in such a manner that
– They meet users’ expectations/provide a reliable service
– The work undertaken is performed to a high standard/provides value for money/in an
efficient and cost-effective manner
– The requirements of Monitoring Units/Auditing Standards are satisfied
– They enhance the reputation of/increases confidence in the profession.
 To protect the assurance provider against
– Negligence claims
– Disciplinary procedures
 To ensure that engagements are only accepted for services for which the firm has the necessary
competencies
(b) Ethical and professional issues and quality control measures to mitigate any threats to
objectivity
(1) Gemini Ltd
Ethical and professional issues
 External auditors are entitled to rely on the work of internal audit provided they are
satisfied with the standard of work (in particular risk assessment and evaluation of internal
controls) (BSA 610).
 Where internal and external audit services are provided by the same firm, a self-review
threat exists.
 The external auditor may place too much reliance on the work of internal audit and not
rigorously test that work.
 Internal audit may gear its work towards enabling external audit to reduce its workload.

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 ANSWER BANK

 Per IFAC Code of Ethics, as adopted by ICAB, the self-review threat will be unacceptably
high where the auditors cannot perform the audit without placing significant reliance on the
work performed on the internal audit services engagement.
Quality control measures to mitigate threats to objectivity
 The engagement to supply internal audit services should only have been accepted where
– The auditors would not place significant reliance on the internal audit work performed
by the audit team, and
– The audit firm would not undertake a management role as part of providing internal
audit services.
 If the auditor was not satisfied re the above the only adequate safeguard would be to refuse
the audit client’s internal audit engagement.
 The auditor cannot therefore rely on the outcomes of the internal audit services for
statutory audit purposes in pervasive areas such as internal controls and risk assessment.
 Assuming that the appointment can be continued, specific safeguards might include
– The use of different partners and teams with separate reporting lines
– A review of the audit by a partner not involved in the audit engagement
– The designation of ‘informed management’ by the audit client in respect of the internal
audit services.
(2) Taurus Ltd and Sagittarius Ltd
Ethical and professional issues
 Conflict of interest/self-interest threat.
 Can the one firm act in the best interests of all parties? (One party’s gain is the other’s loss.)
 May be tempted to favour one party over the other (in particular Sagittarius Ltd in order to
protect future interests).
Quality control measures to mitigate threats to objectivity
 Use of different partners and staff with separate reporting lines.
 Use of specialist/competent staff with experience in advisory matters.
 If adequate safeguards cannot be put in place – advise one party only/ withdraw.
 Disclosure to clients of the circumstances.
 Advise clients that they may wish to seek alternative independent advice.
 Obtain the informed consent of the clients.
 Confidentiality is of paramount importance. Standing instructions and all other steps will be
necessary to prevent the transfer of confidential information.
 Regular review of the situation by a senior partner or compliance partner not personally
involved with either client.

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 Section 2: Accepting and managing engagements

11 Hairsay Ltd

Marking guide
Marks

(a) Each matter ½

Maximum 5
(b) Auditor’s responsibilities 2
Managing director’s expectations 3
Materiality 2
Maximum 5
(c) Each question ½
Question format 1
Maximum 6
Total marks available 16

(a) Matters to be included in letter of engagement

 Confirmation of acceptance of the appointment
 Summary of the responsibilities of the directors and of the assurance provider
 Disclaimer in respect of the limitations of internal control systems
 Scope of the engagement/work to be performed/limited to review of cash handling procedures
 Form of report (not audit)
 Restriction on circulation of report
 Fees and billing arrangements
 Timetable
 Complaints procedures
 Cap on liability
(b) Responsibilities re fraud
The auditors’ responsibility is to identify material misstatements in the financial statements. To fulfil
this responsibility auditors should plan, perform and evaluate their work in order to obtain reasonable
assurance that the financial statements are free from material misstatements.
There is no obligation on auditors to prevent fraud, although the audit may act as a deterrent.
The managing director’s perception that the auditors are responsible for discovering all fraud shows a
lack of
 Appreciation of the directors’ own responsibility in respect of fraud
 Understanding of the concept of materiality.
Directors often rely on auditors for monitoring they should undertake themselves.
Because the fraud was not material to Hairsay Ltd there was therefore no requirement on the
auditors to design audit processes which would be expected to identify such a fraud.
(c) Checklist of questions – risk of misappropriation of cash
 Does the company have a policy of obtaining references for staff?
 Is there segregation of duties between
– Recording cash (restricted access)
– Banking cash
– Reconciling takings records to bankings?
 Is the appointments diary cross-referenced with takings records?

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 Are cancellations of appointments reviewed?

 Are cash takings banked intact on a daily basis?
 Are staff supervised?
 Do all staff take holidays?
 Are staff rotated?
 Are independent cash counts undertaken on a surprise basis?
 Are till records reconciled to bankings on a daily basis?
 Are margins reviewed against budget/subject to inter-branch comparisons?

12 Wrapper Ltd

Marking guide
Marks

(a) Matter to consider/procedure (each) ½

Reason (each) 1
Maximum 8
(b) Identification of factor (each) ½
Explanation of why factor to be taken into account (maximum for each) 2
Maximum 10
Total marks available 18

(a) Matters/procedures prior to acceptance of audit

 Check adequacy of resources to enable
– Work to be completed to a high standard on a timely basis/use of competent staff
– Provision of tax/accountancy services without compromising independence (i.e.. safeguards
can be put in place) e.g.:
 Use of separate personnel to perform accountancy and tax
 Review by an independent partner/senior staff member with appropriate expertise if
tax computation prepared by audit team
 Review of the audit by an audit partner who is not involved in the audit engagement
 Establish/document existence of informed management
– To ensure auditor does not take management role
 Consider relationships/familiarity threat
– To ensure independence/objectivity not impaired
 Consider potential conflicts of interest (e.g. competing clients)
– To ensure act in the best interest of clients
 Consider integrity of client
– To reduce risk of misstatements due to fraud/misrepresentation
 Client identification procedures
– To reduce exposure to money laundering/comply with money laundering requirements

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 Section 2: Accepting and managing engagements

 Send letter of engagement

– To ensure client understands nature and scope of the work to be undertaken/narrow
expectation gap
(b)

Factors Why taken into account

 New client  Lack of familiarity - may not identify events

and transactions which have an impact on
the financial statements/higher detection
risk
 Start-up  Going concern risk
 Doubts/material uncertainty will require
disclosure in the financial statements
 Lack of going concern status will require
financial statements to be prepared on a
break up basis
 Lack of prior year figures  Lack of comfort/corroboration from use
of analytical review procedures
 Require more extensive use of tests of
detail (substantive tests)
 Bank covenant  Risk that profits may be overstated in
order to preserve the debt equity ratio
 Trading with IT Systems Ltd  Need to ensure complete disclosure of
related party transactions
 Customised accounting software  May not be reliable, resulting in errors
 Lack of segregation of duties  Misstatements may not be prevented or
detected and corrected on a timely
basis/higher control risk
 Determine the audit approach which is
likely to be substantive based

Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the style of
this answer is appropriate for use by students in the examination.

80 © The Institute of Chartered Accountants in England and Wales, March 2009

 ANSWER BANK

13 Waverley Ltd

Marking guide
Marks

(a) Scope of work – assurance engagement 4

Scope of work – audit 4½
Report – assurance engagement 3
Report - audit 2½
Marks available 14
Maximum 11
(b) Professional clearance 3
Client’s response to assurance report 2
Eligibility under Companies Act ½
Independence 2½
Resources and expertise 1
Client identification and integrity 2
Company search and filing 1
Marks available 12
Maximum 7
Total marks available 18

(a) Contrast
Scope of work
This assurance engagement
 Work carried out in accordance with specific agreed terms.
 Resultant work plan based on evidence required, restricted to
– A review of accounting policies for compliance with accounting standards
– Testing that policies have been applied as stated
– A review of treatment and disclosure.
Statutory audit
 Work carried out in accordance with
– Companies Act
– Audit regulations
– Auditing standards
 Audit plan based on risk assessment of material misstatement.
 Detailed work will include
– Tests of control
– Substantive testing
– Consideration of going concern
– Consideration of subsequent events
– Obtaining of a letter of representation from the directors.
Report to be issued
This assurance engagement
The report will be
 Addressed to the directors
 Covering accounting policies only

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 Section 2: Accepting and managing engagements

The format of the report is wholly discretionary but

 Will include the agreed scope of work
 Will be signed as accountants
This is a private report.
Statutory audit
This report is
 Addressed to the members
 Giving an opinion on the true and fair view
The format is prescribed and the report will be signed as practising Chartered Accountants.
This report is in the public domain (although is likely to include a disclaimer re third parties in
accordance with Institute guidance).
(b) Matters to consider and procedures to follow before accepting appointment as auditors
 Explain to the client your professional duty to communicate with the current auditors.
 Ensure the client authorises them to respond.
 If the client refuses to give such authorisation, the firm should not accept the appointment.
 Write to the current auditors for information which could influence the decision whether or not
to accept appointment.
 Discuss the client’s response to your assurance report.
 If the client rejects conclusions, the firm should not accept appointment.
 Confirm eligibility to act under the Companies Act, i.e. no partners or staff are officers or
employees of the client.
 Consider whether as auditor any threats to objectivity/independence exist, e.g.
– Undue dependence on client (fee level)
– Closely connected (personal relationship)
– Beneficial or mutual interest (shareholding)
– Conflict of interest.
 Consider whether the firm is competent to carry out the assignment (i.e. have sufficient
resources and expertise).
 Confirm the identity of the client under the money laundering rules.
 Assess the integrity of management.
 Carry out a company search.
 Ensure the resolution of removal is filed with the Registrar of Companies.

82 © The Institute of Chartered Accountants in England and Wales, March 2009

 ANSWER BANK

14 Wavenden Ltd

Marking guide
Marks

(a) Steps undertaken by Wavenden 7

Steps undertaken by auditor 11
Marks available 18
Maximum 13
(b) Identification of limitation on scope and reason 2
Materiality and type of modification 3
Problems concerning opening inventories only 2
Reporting by exception 2
Marks available 9
Maximum 8
Total marks available 21

(a) Steps to complete the appointment of your firm as auditors

By Wavenden Ltd
 Remove existing auditor by passing an ordinary resolution in general meeting. Such a resolution
requires special notice of 14 days.
 Send notice of the meeting to the existing auditor.
 Circulate any written representations from the auditor with the notice to the members unless it
is received too late or is defamatory.
 Grant the right of the auditor to attend and speak at the meeting.
 Appoint new auditor by ordinary resolution (this also requires special notice).
 Authorise the previous auditor to communicate with your firm.
By your firm
 Undertake client identification procedures
 Obtain permission from the directors to communicate with the previous auditor.
 If the directors refuse, your firm should not accept appointment.
 Write to the previous auditor asking for any professional reasons why the appointment should
not be accepted.
 If a letter elicits no response, try telephone, fax or registered delivery.
 If there is no response at all, assume there are no reasons why the appointment cannot be
accepted.
 If the response casts doubt on the directors’ integrity, do not accept appointment.
 If an issue of conflicting viewpoints becomes apparent, discuss with the directors.
 Confirm that Wavenden Ltd is an appropriate client to take on.
– The firm is eligible to act under the Companies Act.
– There are no threats to objectivity/conflicts of interest.
– The firm is competent to undertake the assignment.
 Notify the Registrar of Companies within 30 days of appointment as an auditor.

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 Section 2: Accepting and managing engagements

 Obtain company search.

 Obtain signed letter of engagement.
(b) Audit report re Wavenden Ltd
A limitation on scope has arisen because the auditors were unable to perform procedures which
would quantify the true figure.
The matter is material, but not pervasive.
Hence the audit report should be qualified ‘except for’.
In accordance with the Companies Act the auditor needs to report on certain matters by exception
only. In this case the auditor will need to report that, in respect of the limitation on his work relating
to opening inventories alone
 He has not obtained all the information and explanations that he considered necessary for the
purpose of his audit
 He was unable to determine whether proper accounting records had been maintained.

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 ANSWER BANK

15 Benson Ltd

Marking guide
Marks

(a) Professionally qualified to act 3

Adequate resources 1½
Client identification and references 3
Professional clearance 2
Legal requirements 1
Marks available 10½
Maximum 8
(b) Consideration of situation prior to acceptance of audit 3
Importance of independence, threats and safeguards 6
Acceptance procedures 5
Fee issue – non-listed v listed 5
Marks available 19
Maximum 15
(c) Combined Code on Corporate Governance 1
Auditors’ responsibility 1
Maximum 2
(d) Documentation, direction, supervision and review issues 4
Hot review issues 4
Monitoring procedures 4
Marks available 12
Maximum 8
Total marks available 33

(a) Requirements relating to accepting audit appointment

Ethical requirements
The auditor is required to ensure that there is no ethical barrier to his accepting appointment.

Ensure professionally qualified Consider whether disqualified on legal or ethical grounds. In

to act terms of ethics, the following issues are relevant:
 Does anyone in the audit firm own shares in Benson?
 Is the nature of the relationship between the auditor and
the client more personal than business?
 Would the audit fee constitute too high a percentage of
gross practice income?
 Is there a conflict of interest with existing clients?
All these issues would affect the independence of the audit
firm.
Ensure existing resources Consider
adequate  Available time
 Staff
 Technical expertise
Obtain references Make independent enquiries if the directors are not personally
known to the audit firm.
Communicate with outgoing Enquire whether there are reasons or circumstances behind

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 Section 2: Accepting and managing engagements

auditors the change which the new auditors ought to know.

This is also a courtesy to the outgoing auditors.

Legal requirements
The auditor must also ensure that the outgoing auditor's removal or resignation was conducted in the
correct manner, once they have accepted appointment.
(b) ABC's dealings with Benson
ABC has had the following dealings with Benson and its directors.
 Advice given during the management buy out
 Taxation advice (company and directors)
 Management consultancy
 Special projects, comprising:
– Fraud investigation
– Expansion, budgets and investigations
The question tells us that this has resulted in significant fee income for ABC. It mentions one statistic,
that in the year of the expansion investigation, the fee income was 20% of the full office income.
ABC have now been asked to provide audit services to the company in addition to the other services
they provide. They have agreed to take on the audit of the company.
Standard of conduct
Up until the point where ABC were asked to become auditors of the firm for the second time, there
were no ethical issues arising.
Accountants are entitled to provide any number of services to a client, unless one of the services is an
assurance service to which rules on independence apply. The services discussed above do not
constitute threat to the independence of an assurance service. A firm of accountants may take on the
combined roles of tax advice, management advice, and specialist investigations, with no independence
issues.
Independence
The most recent step in the relationship between ABC and Benson is that the directors of Benson
have asked the firm to provide audit services to the company.
However, audit is an assurance service and the independence of that service may be affected by the
provision of other services.
Codes of Ethical Conduct generally require that an auditor is, and is seen to be, independent.
The auditor must be objective in his dealing with audit clients. The IFAC Code of Ethics states that
provision of additional services to audit clients may result in objectivity being impaired.
The IFAC Code also states that a large portion of fee income derived from a single audit client
(private or public) would create dependency on the client and a threat to objectivity of the audit work.
Application to ABC and Benson Ltd
The fact that ABC already undertake so much work for Benson represents a significant barrier to
them being able to maintain objectivity on the audit. When asked to take on the audit, the partners
should have considered whether it was appropriate to take on the audit in addition to the other work.
The question does not establish whether this has been done or not. However, the firm has clearly
taken some steps to preserve some independence for the audit service. The firm has appointed a
different partner to be audit engagement partner in addition to the partner who has dealt with the
client previously. This indicates that they have considered the issue and decided that there is no
barrier to independence.
Another key factor to consider is the level of fees that the auditors gain from the client.

86 © The Institute of Chartered Accountants in England and Wales, March 2009

 ANSWER BANK

The only references to fees in the question are that the fee income from the client is high, and that in
one year, when a special assignment was taken on, they represented 20% of the fee income.
This does not necessarily mean that the fee income including the audit fee will be a large portion of
the total annual fees of the firm, but it certainly suggests that it is possible. As a minimum, it suggests
that it may no longer be appropriate to undertake the special assignments, and that a review of fee
income will be required.
It is impossible to conclude precisely whether ABC were acting unethically in accepting the audit
work. However, the indication is strong that the firm is not independent in relation to the audit due to
the high level of other services, and the fees that they bring in. This is despite efforts which have been
made to preserve independence, notably appointing a different audit engagement partner.
If Benson were to float on a Stock Exchange, then the rules of independence would become more
stringent. In such a case, fee income would have definitely been large enough for the audit to be
refused.
Maintaining independence from such companies is considered extremely important and it appears
unlikely that ABC would be able to justify that they were independent of Benson Ltd for the purposes
of its audit. Were it listed, and hence if it achieves a listing, they will have to re-appraise their
relationship with the client.
(c) Quality control procedures and policies
The audit engagement partner is a key feature in quality control processes in relation to individual
audits. ICAB guidance on quality control focuses on two aspects of quality control:
 General firm-wide policies to establish quality control at a firm level
 Specific quality control requirements for individual audit assignments
We shall consider the latter in this answer.
It is important for the audit engagement partner who has been appointed to both consider and
document his considerations of the ethical issues raised in the answer to part (b), above. He
must be assured that he is independent with regard to the audit.
Specifically with regard to the assignment, he must ensure that the audit work is directed,
supervised and reviewed in an appropriate manner. He may delegate much of these tasks to an
audit manager, who will be responsible for undertaking planning meetings with the audit team and
liaising with them on site, perhaps undertaking an on site review of their work.
However, the audit engagement partner cannot delegate the responsibility for drawing the audit
conclusion, and must ensure that he has reviewed the audit file to ensure that he draws the correct
conclusion, and that sufficient work has been undertaken to support that conclusion.
The engagement partner must consider the engagement risk attaching to the assignment, and consider
the need for a 'hot review' prior to the issue of the audit opinion. If Benson does become listed, such
a hot review will be essential.
The audit engagement partner is responsible in the first instance for ensuring that any disputes
within the audit team arising over issues relating to the Benson audit are resolved
appropriately. The firm should have clear guidelines as to how such disputes should be resolved.
Lastly, the firm should have a practice of monitoring audits undertaken for quality. It is likely
that the audit of Benson should be monitored by the firm team this year for several reasons:
 It is the first year of a new audit
 It is a substantial client
It is a client which had significant ethical issues to consider in relation to accepting the audit, and
therefore the audit (engagement) risk is higher on this audit than others.

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 Section 2: Accepting and managing engagements

16 Healey Ltd

Marking guide
Marks

(a) (i) Adequacy of resources 4½

Ability of client to pay fee 1
Integrity of client 5½
Marks available 11
Maximum 8
(ii) Identification of threat (each) ½
Identification and explanation of threat (each) 1
Maximum 6
(iii) Purchase consideration
Conflict of interest 1½
Safeguards 2
Ongoing advice
Identification and explanation of self interest threat 1½
Safeguards for self interest threat 2
Identification and explanation of self review threat 1½
Safeguards for self review threat 1
Identification and explanation of management threat 1½
Safeguards for management threat 2
Current clients conflict of interest and safeguards 2
Marks available 15
Maximum 7
(b) Duty of care and negligence 6
Importance of quality control procedures 3
Liability cap 3
Use of disclaimers 3
Use of contracts/engagement letters/legal advice 4
Marks available 19
Maximum 15
(c) Direction, supervision and review 1
Independent reviews 2
Separate teams 1
Maximum 4
Total marks available 40

(a) (i) Suitability of Healey Ltd as an audit client

Adequacy of resources
 Ensure that competent staff are available to complete the job in the timescale required.
 Ability to provide a professional service without detriment to existing clients.
 For the fee that has been agreed, whether a full service can be provided.
 Whether the firm is familiar with the industry in which the client operates, and is competent
to advise in key areas.
 Will the client pay agreed fees?
Integrity of the client
We would need to consider the integrity of the client by reference to the following.
 Examining previous dealings with Healey Ltd.

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 Consider what we know about Healey Ltd from other sources such as newspaper cuttings
and information obtained from the Internet.
 Consider the frequency with which Healey Ltd has changed advisors.
 Examine previous accounts and statutory returns, particularly looking for unusual policies or
accounting treatments, and the adequacy of accounting records reported upon.
 Consider the financial stability of the company, particularly with regard to payment of fees
and going concern implications for audit purposes.
 Look at any other companies with which the directors are associated to assist in identifying
related party transactions.
 In the case of problems, consider Healey Ltd’s previous businesses, and consider obtaining a
reference. This could, for example, be from the company’s bankers.
Professional clearance
Write to the previous auditors asking for reasons why the appointment should not be accepted.
The client’s permission will be required for this. If it is not forthcoming the appointment would
normally be turned down.
(ii) The five general threats to independence
(1) Self-interest threat – where the auditors have a vested interest in the client, such as a
financial interest in that client and may be reluctant to take actions that would be adverse to
the interests of the audit firm.
(2) Self-review threat – where the results of non audit services performed by the firm are
reflected in the amounts included or disclosed in the financial statements.
(3) Advocacy threat – where the auditors take the client’s side, for example in a lawsuit.
(4) Familiarity threat – where the auditors have a close relationship with client staff and may
lose professional scepticism.
(5) Intimidation threat, where the auditor’s interests are threatened, for example where they
encounter an aggressive and dominating individual.

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(iii) Additional services requested

Threat Safeguard

(1) Advice on purchase consideration

 There may be a conflict of interest in  Suggest that Mr Morgan obtains
advising on the sale of the shares independent advice, or at least that
because as auditor there may be a another partner advises Mr Morgan. If
temptation to favour Mr Allard as he is the latter course is taken, then ‘Chinese
the ongoing client. walls’ may be needed to safeguard the
client.
 At the extreme, advise neither party.
(2) Ongoing advice
 There will be an increased risk of fee  Ensure fees are kept other than a large
dependency which may impair portion of total audit fees as stated in
objectivity. Judgement may be clouded the ethical guideline.
by the promise of future consulting
 Instigate a system of second partner
fees.
reviews.
 There may be a self-review problem,  The audit work in relation to the
as investigative work will be followed investigative work should be undertaken
by audit work, and the partner may by separate personnel and reviewed by
not want to reveal problems found to an independent partner.
the client.

 Investigations may involve current  Different teams should carry out the
clients. work, possibly involving specialists.
 Advisory work may turn into decision  The advisory role should be constantly
making. and carefully reviewed to ensure that
this does not happen.
 ‘Informed management’ should be
appointed at Healey Ltd.
 The advisory work should be carried
out by a different team.

(b) Potential liability

(i) Audit
In respect of the audit, the firm has a duty of care to Healey Ltd and, if it breaches this duty of
care and is found to have carried out a negligent audit causing loss to Healey Ltd, it may have to
pay damages to Healey Ltd. This liability cannot be excluded. However, the firm can take the
following steps to restrict liability due to negligence:
 Implementing quality control policies and procedures to ensure that the firm does not carry
out a negligent audit
 Negotiating a liability cap with Healey Ltd as part of the terms of the engagement so that, in
the event of the firm being found liable to Healey, damages are limited to a pre-agreed
amount
As per case law, generally, auditors can only be found liable to third parties in respect of
negligent audits in very limited circumstances, such as when the audit firm knew that the third
party would rely on audited accounts and did not expressly disclaim liability to that party.
The firm should consider whether it knows of any parties who may rely on the audited accounts,
such as Mr Allard, for example, who might rely on the audited accounts in relation to

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determining a purchase price for Mr Morgan’s shares, and should expressly disclaim liability to Mr
Allard in respect of that use for the audited accounts.
In addition, to be certain of no other liabilities in respect of the audit arising, the firm could insert
a disclaimer of liability to all parties other than Healey Ltd in its audit report (known as a
Bannerman clause).
(ii) Other services
In respect of the other services Mr Allard is inviting the firm to accept, liability will be determined
by the contract agreed between the various parties – as follows:
 Contract between Mr Allard and firm re purchase price
 Contract between Mr Morgan and firm re purchase price
 Contract between Healey Ltd and firm re acquisitions
The firm should seek legal advice in respect of these contracts and ensure that their liability
exposure is not too great. As the work is not audit work, they are entitled to negotiate
limitations on their liability and should do so.
In particular it may be necessary to limit liability in the event of the company making acquisitions
which then go wrong. The firm should make clear that any investigations they carry out are
restricted to the present time and that they cannot be held liable for the results of future, unknown
events.
(c)  Direction, supervision and review of audit work (this is mandatory under BSA 220)
 Hot review by an independent partner of the audit file before audit report signed
 Separate team used for audit and other services
 Cold reviews of audits with points forward for improvements in future years.

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Section 3: Planning assurance

engagements

17 Short form questions

1 Principal auditor
The auditor with responsibility for reporting on the financial statements of an entity when those
financial statements include financial information of one or more components audited by another
auditor.
Other auditor
An auditor, other than the principal auditor, with responsibility for reporting on the financial
information of a component which is included in the financial statements audited by the principal
auditor. Other auditors include affiliated firms, whether using the same name or not, and
correspondents as well as unrelated auditors.
2 The nature and significance (materiality) of the matter which is the subject of the modification to the
financial statements of Narberth Group Ltd.
Whether the matter which is the subject of the modification can be resolved when preparing the
financial statements of Narberth Group Ltd.
3 Information to evaluate risk

Type of risk Information used to evaluate

 Audit  Risk level acceptable to reporting partner

 Inherent  Characteristics of company and circumstances of audit
 Control  Information regarding client’s system of internal controls
 Detection  Designated level of detection risk set using the audit risk model, as
determined by the other three types of risk

4 Matters
 Whether internal audit work is performed by persons having adequate technical
training/proficiency as internal auditors
 Whether internal audit work is properly planned, supervised, reviewed and documented
Procedures
 Review policies for hiring and training staff
 Review experience and professional qualifications of staff
 Ensure adequate audit manuals exist
 Review work plans and working papers, e.g. for evidence of review

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5 Use of internal audit work

Use Effect on work

(1) Can be used to make initial evaluation  Walk through tests to confirm
(2) If relevant to audit, can be used to reduce  But testing for April to September 20X6 must
own tests of controls be done
(3) If the weaknesses are confirmed by own  Hence more substantive procedures
audit work, will lead to less reliance on
controls
(4) May be useful info for confirming  But head of department still responsible for
consistency of financial statements with July and August 20X6 accounts
other information (management accounts)
 Head of department may not be fully
independent since promotion

6 Factors re balance of procedures

Tests of control (conditions)
 Assessment that control systems are good
 Operation of controls evidenced
 Cost effective compared with substantive procedures
Analytical procedures (conditions)
 Availability/reliability of relevant data
 Predictability/comparability of amounts to analyse
 Previous experience of effectiveness of approach
Substantive procedures
 Balance of work required to obtain sufficient evidence
7 Procedures re non-compliance with laws and regulations (BSA 250 paras 18 and 23)
 Enquire of management whether entity is in compliance with laws/regulations
 Inspect correspondence with relevant licensing/regulatory authorities
 Obtain written representations that management has disclosed to the auditor all known actual or
possible non-compliance with laws/regulations whose effects should be considered when
preparing financial statements
8 Analytical procedures
 It helps to identify areas of risk
 It enables you to plan your audit approach / to determine nature, timing and extent of work
9 Sources of knowledge
 Discussion with management of acquiring company (your existing client)
 Review of documents connected with acquisition
 Discussion with management/staff of Jade
 Tour of company premises
 Review of Jade’s accounting records/Management accounts/Trial balance
 Review trade press and journals
 Internet search for industry intelligence
 Enquiries of previous auditors/Jade’s current lawyers
 Review brochures/documents produced by Jade/Jade website
 Companies House searches/prior year accounts

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10

Effect on GP% Helps to explain fall?

(1) Would reduce gross profit %  Yes – could explain fall

(2) Revenue decline irrelevant  No – maintained prices = same gross profit %
(3) Increased purchases matched by closing  No – no effect on gross profit %
inventory increase

11 Reliance on internal audit

 Organisational status – objectivity/reporting lines/lack of constraints
 Scope of function – assignments/management responses
 Technical competence – qualifications/training/experience
 Due professional care – manuals/programmes/procedures
12 Unexpected variations
Errors indicated
 Inventories, receivables, or cash and cash equivalents could be understated
 Payables or bank overdrafts could be overstated
 Revenue could be understated
 Purchases could be overstated
Areas re extra work
 Inventories, receivables and payables
 Particularly
– Cut off
– Provisions/write downs
13 Sources of info re related parties
 Prior year working papers and disclosures
 Statutory books and returns
 Enquiry of management
 Minutes of board meetings
 Work on directors’ personal tax
14 Audit work – ‘advances’
 Item is material by nature.
 Item needs to be disclosed regardless of value.
 Director transactions if not disclosed in financial statements, must be disclosed in audit report.
 Balance may indicate other related party transactions that need to be disclosed in financial
statements.
 May be tax liabilities not provided for in financial statements.
 Item not quantitatively material.
15 Audit risks and procedures to address
Audit risks
 Non disclosure
 Transactions not at arm’s length
Procedures to address
 Identify full list of related parties at commencement of audit from prior year working papers
 Review minutes of meetings of shareholders and directors
 List names from statutory books
 Make enquiries with directors and staff during audit
 Obtain written representations on completeness of disclosure

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 Section 3: Planning assurance engagements

 Review loan agreements for guarantors

 Review transactions between the two parties to ensure arm’s length basis
16 Impact on audit approach
 Little or no reliance can be placed on management representations/increased professional
scepticism
 Reassess audit risk in light of doubts about integrity of management
 As a result sample sizes may need to be increased
 Scrutinise related party transactions more carefully to ensure at arm’s length
 Implications of management attitude to control environment/substantive approach
 More external evidence
17 Management accounts in planning
Uses
 Identify significant changes in trading/balance sheet/solvency
 Highlight new/increased areas of risk/uncertainty
 Direct audit effort
 Preliminary assessment of materiality
Limitations
 Do not cover whole year/subject to seasonality
 May incorporate budgeted/estimated figures, e.g. inventories, expenses
 Accounting policies may not be strictly applied
 May not include year end adjustments/provisions
18 Risk control strategies
(1)  Ensure contracts with sub contractors specify deadlines for each piece of work completed
 Include penalty clauses in all contracts for financial recompense for any overruns
(2)  Take out insurance cover against flooding. (Premiums likely to be high given recent flooding
problems in Bangladesh)
 Build responsibility for flood protection into contracts of subcontractors as far as possible
and ensure compensation for flooding is agreed
(3)  Consider finding a joint venture partner to join the project. Additional funding would be
made available and the risks of the project would then be shared (although the returns
would then also be shared)
19 Effect on planning
 Not material in itself, if isolated incident
 But, less reliance on effective operation of control system
 Particularly involving chief accountant (CA)
 Extra testing where CA has authorised payments
 Doubt cast on representation made by CA in all areas
20 Reliance on internal audit – effect of incidents
 Likely less reliance placed on control/systems tests
 Due to lack of availability/accountability of persons responsible
 But could mitigate effect by checks on work done
 Must conduct own tests of controls for last three months
 Systems evaluation useful to own assessment for planning
 Provided records confirmed by walk-through tests
 Reasons for departures, e.g. lack of independence, recommendations not implemented
 Qualifications of new members
 Recruitment internal or external (independence)

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21 Audit objectives of tests of controls

 That controls as recorded exist
 And are operated effectively
 Throughout the period
 To ensure system adequate as basis for preparing accounts
22 Steps to determine combination of tests
 Obtain understanding of accounting system and control environment
 Document accounting and control systems
 Confirm by walk-through tests
 Make preliminary assessment of control risk
 Incorporate assessment of inherent risk
 Determine cost effectiveness of tests of controls
23 Using experts
Planning
Assess the experts’
 Independence
 Objectivity
 Professional qualifications
 Experience
 Resources
 Scope of assignment
Assessing results of work
Assess appropriateness of audit evidence re financial statement assertions, especially
 Source data – sufficient, relevant, reliable?
 Assumptions and methods – reasonable?
 Reasons for changes since prior period
 Results of work in light of auditors’ own knowledge of business
24 Risks
 One off jobs/minimal repeat customers
 Reliant on brand name identity
 Reliant on word of mouth recommendations
 Customers price sensitive
 Credit worthiness of customers
 Credit period taken by customers
 Customer satisfaction reliant on quality of work supplied by subcontractors
 Image presented by subcontractors
25 Components of audit strategy and plan influenced by knowledge of business
 Risk assessment
 Initial materiality
 Reliance on controls v substantive procedures
 Analytical procedures v detailed testing
 Level and time of staff required/budget
 Nature, timing and extent of procedures
 Specific areas of attention
 Use of CAATs

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26 Material accounting cycles

 Wages and salaries (as consultancy business)
 Work in progress/cost ledger
 Revenue/receivables
 Purchases/payables
27 Effect of journal entries
 Level of risk increased
 Materiality reduced
 More substantive procedures, fewer tests of controls
 More external evidence desirable (e.g. receivables)
 More evidence from post BS period (e.g. write downs/provisions)
 More attention to areas amended by journals
 More time allowed for audit work and PBSEs review
 More time allowed for review
 Probable less reliance on management representations
 Larger sample sizes
28 Suspected fraud
 Look for evidence of weaknesses in the systems (e.g. from previous management letter)
 Increase professional scepticism
 Evaluation/testing of controls over payroll system to identify weaknesses
 Increase substantive work/sample sizes on wages/payroll costs (e.g. leavers deleted properly,
existence checks on employees)
 Investigate any apparent override/circumvention of procedures
 Engage payroll clerk in conversation and query lifestyle
 Consider impact on other areas (e.g. bank payment approvals)
29 Consideration re reduction in substantive procedures
 Reasons for deviations (e.g. person responsible on holiday  isolated error)
 Whether deviation indicates
– Lack of operation of control, i.e. control failure
– Or just lack of evidence, e.g. no initials evidencing check performed
 Whether quantitative error(s) arose as a result of the deviations (confirming lack of operation of
control)
 Whether extended tests prove satisfactory, i.e. no further deviations found
 Whether compensating control exists – so monetary errors did not arise
30 Risks re payroll processing
Risk
 Misstatements of payroll costs and liabilities to NBR
 Unrecorded interest for late payment
 Unrecorded provision for damages/breach of contract or disclosure as contingent liability for
damages
How addressed
 Evaluate and test controls over payroll processing
 Detailed analytical review procedures
 Confirm payments in respect of withholding tax and other deductions made on time
 Confirmation of status of any litigation with legal advisers
 Inspect correspondence

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18 Santander Ltd

Marking guide
Marks

(a) Each reason ½

Maximum 3
(b) Each source ½
Maximum 4
(c) Revenue issues 3½
Gross margin issues 2
Operating costs issues 2½
WIP and inventory issues 5
Trade receivables issues 2½
Effect of new legislation 2
Foreign exchange issues 3
Personal injury claims 2
Marks available 22½
Maximum 16
Total marks available 23

(a) Reasons for planning

 Enables the audit to be performed in a timely and effective manner
 Ensures appropriate attention is directed to important areas of the audit/significant issues
 Potential problems are identified
 Work is completed expeditiously/controls audit costs
 Assists in proper assignment of work to assistants and co-ordination of work done by others
 Facilitates review
 To reduce risk of inappropriate opinion/reduce detection risk
(b) Main sources of information
 Prior year audit file and audit team/permanent file
 Discussion with management
 Industry information/Financial Press
 Companies House search
 Management accounts/other financial information
 Internal correspondence and tax files
 Firm’s staff who have had client involvement during the year e.g. audit partner.
 Client information e.g. website
 Management letter
(c) Notes for planning meeting
Reasons for increase in revenue/increase by 20%
 Volume increase from new overseas markets
 Change in pricing/inflation
 Revenue recognition policy
 Revenue may be overstated
 Increased activity may give rise to errors

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Reasons for fall in gross profit margin

 Increased cost of new materials
 May indicate cut-off errors
 May indicate new loss making contracts - overstatement of WIP
Reasons for increase in operating costs
 Costs in financial statements may be overstated/cost of implementing new legislation
 May be misclassification/misallocation
Why have inventories increased?
 May mean inventory overstated
 Due to cut-off/inappropriate currency conversion
 May be inadequate provision for obsolete/slow moving inventory
 Increased costs on new material may not be recoverable from customer – NRV issues
Basis for calculating WIP and FG
 WIP may be overstated
 May be errors in estimating stage of completion
 Large claim may lead to insolvency
Reason for increase in trade receivables
 May be element of irrecoverable debt/inadequate provision for bad debts
 New customers ability to pay – going concern risk
 New customer extended credit terms?
 Credit checking of new customers
Effect of new legislation
 Long term effect on Santander profitability – going concern
 Early implementation puts company at a financial disadvantage
Procedures in place for hedging against adverse foreign currency exposure
 May give rise to losses in financial statements
System in place for translating foreign currency transactions
 May be translation errors leading to errors in accounts
 Currencies may be particularly volatile in South America
Whether company involved in any personal injury claims
 May be liabilities not provided for
 May damage company reputation – going concern

Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the style of
this answer is appropriate for use by students in the examination.

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19 Apparel Ltd

Marking guide
Marks
(a) Revenue issues 3
Gross margin issues (including calculations) 5
Operating margin issues (including calculations) 4
Inventory issues (including calculations) 2½
Receivables issues (including calculations) 3½
Payables issues (including calculations) 3½
Marks available 21½
Maximum 16
(b) Consistency/corroboration 2
Presentational/disclosure issues 3
Additional work 1
Marks available 6
Maximum 4
Total marks available 20

(a) Planning notes

 Reason for 16% increase in revenue
– Volume/new product
– Inflation/pricing policy
– Any new outlets opened
– Any new wholesale customers
– Any change in income recognition policy/cut off
 Reason for increase in GP margin: 51.6% to 53%
– Lower cost base due to sourcing from China
– Increase in sales of Elite (higher margin) brand
– Increase in selling price over and above increase in cost of Elite products
– Impact of exchange rates
 Reason for increase in operating margin: 4.4% to 6.3% (operating costs to revenue 47.2% to
46.7%)
 Over and above GP margin
 Impact of new warehouse management system
 Increased efficiencies
 Reason for reduction in inventory days: 131 to 126 (increase in inventory turnover 2.80 to 2.89)
 Reason for increase in receivables days: 37 to 42
– Relaxed credit terms to wholesale customers
– Credit control problems/bad debts
 Reason for increase in payables days: 51 to 55
– New suppliers’ credit terms
– Cash flow/working capital problems
(b) Conclusions
Whether

 Financial statements are consistent with the auditor’s understanding of the business

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 Review procedures corroborate conclusions formed during the course of the audit

 Any previously unrecognised risk of material misstatement/ financial statements give a true and
fair view/can issue unmodified audit report

 Auditor may need to re-evaluate planned audit procedures/post balance sheet date work

 Any new factors which may affect the presentation/disclosures in the financial statements

 Presentation adopted in the financial statements may have been unduly influenced by the desire
to present matters in a favourable/unfavourable light (prepared using
acceptable/consistent/appropriate accounting policies)
Potential impact on the financial statements of the aggregate of uncorrected misstatements

Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the style of
this answer is appropriate for use by students in the examination.

20 Holly Ltd

Marking guide
Marks

(a) Each factor ½

Maximum 5
(b) New client 2½
Cash sales 1½
Different locations 2½
Overseas branches 1½
Internal audit 3½
Managers local buying power 3½
Casual staff 1½
Incentive scheme 1½
Leases 1½
Marks available 19½
Maximum 12
Total marks available 17

(a) Factors to take into account when evaluating an internal audit function and its work
 Organisational status/no operational responsibilities/free to communicate with external auditor
 Scope of the function – is it wide enough to be useful/no limitation of scope?
 Do management act on the recommendations of internal audit?
 Do internal audit personnel have adequate training/competence/qualifications?
 Internal audit sufficiently independent/senior level reporting lines/access to board/audit
committee

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 Work of assistants is properly supervised, documented, reviewed

 Existence of internal audit manuals
 Is sufficient appropriate evidence obtained by internal audit/programmes/working papers?
 Are conclusions reached appropriate/reports consistent with results of work?
 Any exceptions or unusual matters disclosed by internal audit are properly resolved
(b) Circumstances with reasons
New audit client
 Lack of cumulative audit knowledge
 Misstated opening balances
Mainly cash sales
 Risk of misappropriation of cash/understatement of sales
Many different locations
 Different locations increase risk of breakdown in controls/limited monitoring by head office
 Do we have sufficient resources to cover geographical spread?
Branches located overseas
 Overseas branches risk of incorrect foreign currency translation
Internal audit function
 Internal audit function limited reliance as first year of operation
 Internal audit staffed from main finance department – how independent/self-review risk
 Do they have appropriate internal audit experience if not worked in internal audit before?
Manager local buying power
 Sourcing consumables locally could lead to buying at too high a price/ collusion with suppliers
 Lack of consistent quality of purchases could damage company’s reputation
 Expenses met in cash increase risk of misappropriation/lack of adequate documentation for
expense
Casual staff paid in cash
 Casual staff could lead to breach of withholding tax rules – fines/interest
Incentive scheme for managers
 Incentive scheme could lead to understatement of costs/overstatement of profit
Assets held under leases
 Check for appropriate accounting treatment of leases

Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the style of
this answer is appropriate for use by students in the examination.

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 Section 3: Planning assurance engagements

21 Garments Ltd

Marking guide
Marks

Retail operations - risks 3½

Retail operations – factors 2½
Retail operations – audit work 8
Overdraft facility - risks 1½
Overdraft facility – factor ½
Overdraft facility – audit work 1½
New computer system – risks 1½
New computer system – factor ½
New computer system – audit work 3½
Marks available 23
Maximum 17

(i) Factors Audit risks (ii)Outline audit work

Expansion of retailing
operations
 The company has increased  With multiple locations  Perform branch visits
the number of its locations there is a risk of non- (including cash counts),
from 2 to 12. adherence to
 Review and test check
management policies.
procedures/ controls.
 This side of the business is  Management may lack
relatively new. experience and a track
record such that
controls may not yet be
in place.
 The business is conducted on  There is a risk of  Reconcile till records with
a cash basis. unrecorded bankings.
revenue/understatement
 Carry out analytical
of income and
procedures involving
consequently
understatement of VAT – Inter-branch
and corporation tax. comparisons of takings
on a month-by-month
basis
– Comparison of actual
with expected margins
(established by
obtaining details of
cost and selling
prices).

104 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

(i) Factors Audit risks (ii)Outline audit work

 The company retails fashion  The risk of shrinkage  Attend physical inventory
clothing. These represent may mean that inventory count (at year end if
desirable goods susceptible to records do not reflect undertaken; alternatively,
theft. In addition, fashion actual inventories. observe counting
inventories are susceptible to procedures if system of
 Risk of inventory
trends. continuous or periodic
obsolescence.
counting).
 Review adequacy of count
instructions, in particular
identification of
– Differences between
physical and book
inventories
– Slow-moving lines.
   Ascertain level of
differences between
physical and book
inventories.
 Obtain evidence of action
taken in respect of
differences.
 Review inventory
movement reports/age
analysis.
 Review post year end
movements and selling
prices.
Increase in overdraft facility
 The company is at its  The overriding risk is  Monitor negotiations with
overdraft limit and is seeking that the bank may the bank/ inspect
to increase its facility. withdraw the overdraft correspondence with the
facility. bank.
 This could lead to  Review management’s
window-dressing and, if plans, including cash flow
the company is unable to and profit forecasts.
pay its debts as they fall
 Obtain written evidence of
due, to going concern
management’s strategy for
problems.
alternative sources of
funding.

© The Institute of Chartered Accountants in England and Wales, March 2009 105
 Section 3: Planning assurance engagements

(i) Factors Audit risks (ii)Outline audit work

New computer system

 The company has installed a  If the new system does  Review arrangements in
new computer system not function properly respect of setting up the
requiring modification. there may be systematic system, especially re
errors, leading to
– Transfer of data (test
unreliable accounting
check if necessary)
records.
– Training of staff.
 The non-current asset
may be materially
misstated.
  Confirm that a parallel run
has been undertaken, and
review results of the post-
implementation review.
  Consider the use of
CAATs.
 Inspect invoice/contract in
respect of the purchase of
the computer.

22 Curson Ltd

Marking guide
Marks

Shrinkage – risk 1½
Shrinkage – controls 5
Cash – risk 1
Cash – controls 4½
Logistics/reorder levels - risks 2½
Logistics/reorder levels - controls 3
Computer system – risks 1
Computer system – controls 3
Asset management – risk 1
Asset management – controls 1
Laws/regulations – risk 1½
Laws/regulations – controls 1½
Profitability – risks 2
Profitability – controls 2
Personnel – risks 2
Personnel – controls 4
Marks available 36½
Maximum 22

106 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

Risk
 Shrinkage
– Theft of inventories
– Damaged or poor quality/obsolete products.
Control procedures
 Security measures in place on vehicles and in stores.
 Inventories checked for quantity and quality for acceptance to retail site.
 Staff trained in correct and careful handling techniques.
 Managers only allowed to change inventory quantities and locations on privilege access codes,
and such transactions logged and reviewed by higher level management/security personnel.
 Electronic tagging used for higher value goods.
 Store detectives patrol sites.
 CCTV used to keep high value items under surveillance.
 Packaging designed to minimise damage.
 Insurance policy taken out against theft of inventories.
 Independent review of inventory ageing reports.
Risks
 Theft of cash.
 Fraudulent consideration accepted in exchange for goods.
Control procedures
 Physical security over cash office, safe and cash collection equipment.
 CCTV used to keep tills under surveillance.
 Each cashier to have user ID and access password.
 Floats checked at beginning and end of shifts.
 Cash counted independently and held securely until collected.
 Bankings carried out by protected security personnel and not retail staff.
 Staff informed of floor limits for cheques, guarantee cards and credit/debit cards.
 Consideration not to be accepted without on-line validation and checking of signatures to
credit/debit cards.
 Regular independent reconciliations between amounts banked and sales data, and discrepancies
followed up.
Risks
 Logistics processes fail to deliver the right inventory to the right place at the right time in the
right condition.
 Re-order levels not set at appropriate levels resulting in stockouts/overstocking.
Control procedures
 Computerised planning and forecasting systems based on prior experience and monitoring of
current trends.
 Regular review of re-order levels by head office.
 Orders over a given size must be authorised by an experienced manager.
 Inventories are physically counted at intervals and results used to correct book records.

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 Section 3: Planning assurance engagements

 Differences investigated.
 Approved suppliers with service level requirements included in contracts.
Risk
 Loss of computerised systems resulting in business interruption.
Control procedures
 A business contingency plan which is tested periodically.
 Redundancy built into computer systems and physical security over them strictly enforced.
 Maintenance contract.
Risk
 Property, plant and equipment not managed effectively, economically and efficiently (not acquired
on a cost-effective basis).
Control procedures
 Analytical procedures performed on lease/buy decision.
 Repairs and maintenance policy and monitoring procedures to ensure compliance.
Risks
 Non-compliance with laws/regulations, particularly in respect of opening hours (e.g. employment,
Sunday trading local authority, lease restrictions).
 Failure to open in busy periods.
Control procedures
 Monitoring procedures by head office to ensure
– Managers are aware of restrictions and comply with them
– Stores are open during busy periods.
Risks
 Falling profitability/losses due to tight margins.
 Under-performing branches.
Control procedures
 Head office control over pricing policies.
 Use of performance indicators to monitor branches.
Risks
 Insufficient experienced staff to service retail processes (losing staff because of low pay).
 Failure of remuneration policy to result in increased revenue.
Control procedures
 Operations and methods studies used to determine staff requirements.
 Labour market surveys used to benchmark pay and conditions.
 Performance of staff measured regularly and compared to company benchmarks.
 Training and instruction provided on regular basis.

Tutorial note
A columnar approach could have been adopted. However, since there are more controls than risks this
may not have worked very well.

108 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

23 Builda Ltd

Marking guide
Marks

(a) Factor indicating low inherent risk (each) ½

Explanation of why low risk (each) 1
Maximum 8
(b) Non current assets 1
Inventories 6
Receivables 2
Cash at bank 3
Payables 4
Revenue 2
Wages 5
Purchases and expenses 1
Marks available 24
Maximum 11
Total marks available 19

(a)

Factor indicating low inherent risk Why indicates low inherent risk

 The nature of the business.  The business is stable with high demand.
 There is active involvement by the owner.  The MD acts as a control.
 The company has no borrowings, there is no  These factors reduce
outside interest in the company and the
– Going concern risk
MD’s attitude is very prudent.
– The risk of manipulation of the figures in
the financial statements.
 The MD is the sole signatory.  This reduces the risk of unauthorised
payments.
 There are no cash transactions.
 This reduces the risk of unrecorded
transactions.
 The nature of receivables (a receivable is  This means that recoverability is unlikely to
only created once contracts have been be a problem.
exchanged).
 Revenue/number of houses sold are easily  Reduced risk of inappropriate revenue
reconciled (the transactions are not recognition.
complex).
 There is no history of VAT problems.  Reduced risk of errors or private (non-
business) expenditure.
 Use of accountant for bookkeeping/use of  Reduced risk of errors.
firm to prepare payroll.

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 Section 3: Planning assurance engagements

 Performance of bank reconciliations/invoices  Internal controls appear to be sufficient for

matched to delivery note. size/nature of business.
 Bank reconciliation likely to ensure basic
errors identified and corrected.

(b) Audit work re key balance sheet and income statement items
Non-current assets
 Sample check additions per cash book to invoices and physical inspection.
Inventories
 Check deeds to confirm title to land.
 Check cost of land properly brought forward.
 Physical inspection of houses at year end.
 Analytical review re allocation of overhead for reasonableness.
 Check WIP calculations.
 Written representation from Eddy Brick.
Receivables
 Inspect correspondence with Local Authority/seek direct confirmation.
 Compare VAT receivable balance with amount per day book/after-date receipts.
Cash at bank
 Check year end bank reconciliation, including dates of clearance of outstanding items.
 Obtain bank letter.
 Direct confirmation of money market balances.
Payables
 Inspect unpaid invoices file and suppliers’ statements for invoices relating to year.
 Reconcile deposits to legal correspondence.
 Reconcile amounts owed to National Board of Revenue (NBR) with payroll and cash book.
 Check after-date payments.
Revenue
 Check revenue figure to legal correspondence.
 For transactions close to year end – check dates to ensure appropriate cut-off.
Wages
 Sample check payroll calculations.
 Analytical review of payroll costs (e.g. number of employees multiplied by estimated average
monthly payroll costs).
 Agree accruals to post year end payments.
 Ensure appropriate treatment of starters and leavers.
 Check bonus accrual included.
Purchases and expenses
 Sample check entries in cash book to supporting invoices.

110 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

24 Lusco Ltd

Marking guide
Marks

(a) Inherent risk 1

Control risk 1
Detection risk 2½
Reasons for considering risk 2½
Marks available 7
Maximum 4
(b) Factors indicating risk (each) ½
Explanation of why a risk (each) 1
Maximum 10
(c) Controls re completeness of recording and safe custody (each) ½
Maximum 6
Total marks available 20

(a) Risk
Different elements of audit risk
Inherent risk: the risk of material error arising regardless of related internal controls/risks associated
with the nature and characteristics of the business.
Control risk: the risk that internal controls fail to prevent or detect a material error.
Detection risk
 The risk that the auditor’s substantive procedures will fail to detect a material error.
 Detection risk is split into sampling and non-sampling risk.
 Sampling risk is the risk that the sample is not representative of the population.
 Non-sampling risk is the risk that all other work by the auditor fails to detect a material error.
Why auditor needs to consider
Risk assessment
 Enables the auditor to plan his audit effectively
 Ensures audit attention is devoted to appropriate areas.
The higher the risk, the greater the amount of assurance work required. If inherent risk is high, then
the auditor must take steps to reduce detection risk. Steps taken will affect the nature, timing and
extent of audit procedures.
(b) Factors contributing to high audit risk
 New audit to your firm.
 Fashion is a volatile/seasonal business, especially ‘out-of-fashion’ inventory.
 Large chain of stores.
 Company sells luxury goods.
 Small number of suppliers.
 Large number of cash transactions (sales/wages).
 Company deals in foreign currency.
 Dominant/majority shareholder managing director.
 Managing director’s extravagant lifestyle.
 Managing director is 60, may retire soon.
 Company’s customer returns policy.
 Large bank borrowings.

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 Section 3: Planning assurance engagements

 Casual staff employed.

Why a risk
 Risk of obsolete inventory as company may be stuck with last year’s trend (difficult to determine
inventory values).
 Inventory control issue with respect to number of stores/inventory lost in transit or double
counted.
 Luxury items first to go in event of economic downturn – this puts the company at risk.
 Risk of stock-outs/loss of supplier/large borrowings causing going concern problems.
 Risk of incomplete recording of sales.
 Risk of misappropriated cash.
 Exposure to foreign exchange risk resulting in misstated inventory/purchases.
 Over-dependence on managing director – if unable to work and no succession in place.
 Managing director’s desire for profit may lead to manipulation of results.
 Casual staff resulting in misstated withholding tax liabilities/fines/interest/misstated payroll figure.
 Customer returns could give rise to misstated balances in accounts/inventory valued at greater
than its net realisable value or may be obsolete.
(c) Internal controls re complete recording of sales and safe custody of cash
 Sales discount only permitted with manager authorisation.
 Use of, and maintenance of electronic till and till rolls (EPOS system).
 Inventory system linked to EPOS system to identify ‘missing’ inventory items.
 Takings to be banked intact/banked daily.
 Restricted access to tills/each staff member has unique ID and logs on at start of shift.
 Floats checked at beginning and end of shift.
 Cash takings collected/counted by at least two staff members/CCTV monitoring of tills.
 Two staff members to bank cash/use security firm.
 Adequate on-site security for cash, e.g. overnight safe.
 Daily reconciliation of till rolls to cash takings/bankings.
 Regular bank reconciliations.
 Management review of all reconciliations.
 Staff references taken up.
 Spot checks on cash balances.

112 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

25 Wrapak Ltd

Marking guide
Marks

(a) Factors (each) ½

Policies and procedures (each) 1
Maximum 12
(b) Audit procedures (each) 1
Maximum 6
18

(a) Factors which may have contributed to cash flow problems, and policies and procedures
to be implemented to improve cash flow
Factors
 Monthly loan instalments/interest costs.
 New customer base/increased volume of business.
 Poor credit control procedures.
 Receivables taking longer to pay.
 Delays in invoicing (converting work-in-progress into receivables).
 Anna’s heavy workload may impede effective chasing of slow payers.
 Removal costs.
Policies and procedures
 Prompt invoicing.
 Initial credit checks on new customers.
 Imposition of credit limits with regular review thereof.
 Checking of age of existing receivable before new work commenced.
 Delinquent customers put ‘on stop’.
 Daily/weekly review of aged receivables analysis with follow-up letters.
 Interest on overdue amounts.
 Discount for early payment.
 Bonus incentive for improvement in cash collection/targets for cash collection.
 Referral of overdue debts to debt collection agency.
 Use of debt factoring.
(b) Audit procedures to ensure the loan has been properly accounted for
 Inspect loan agreement and ensure compliance with terms and conditions/covenants.
 Consider the consequences and possible reclassification of liabilities.
 Direct confirmation from the lender of
– Principal and unpaid interest at the year end
– Details of security.
 Ensure proper split between current and non-current liability (split between 2–5 and over 5
years).
 Confirm correctly disclosed
– Dates and terms of redemption
– Security.
 Ensure up to date with interest and repayments in post balance sheet period.
 Recalculate loan interest/analytical procedures and ensure accrued interest properly accounted for.

© The Institute of Chartered Accountants in England and Wales, March 2009 113
 Section 3: Planning assurance engagements

26 Electra Ltd

Marking guide
Marks

(a) Wages and salaries (including calculations) 2

Gross margin (including calculations) 2
Interest cover 2
Work in progress (including calculations) 2
Receivables (including calculations) 3
Overdraft 1½
Other payables 1
Marks available 13½
Maximum 7
(b) Measures taken 2
After date receipts 1
Supplier relationships 1
Review of forecasts 4
Covenants 1
Marks available 9
Maximum 6
(c) Modified on grounds of disagreement 3
Modified with emphasis of matter 5
Modified on grounds of limitation on scope 1
Marks available 9
Maximum 6
Total marks available 19

(a)

Matter giving rise to concern Why gives rise to concern

 Wages and salaries as a % of revenue have  This impacts on the net profit margin and
increased from 60% to 70%. subsequently on cash flow.
 The gross profit margin has fallen from 30%  This means a reduction in the company’s
to 21%. ability to cover operating expenses.
 Interest cover has fallen.  This affects the company’s ability to service
its debt and could result in foreclosure.
 WIP has increased from 17.5 days to 22  This may indicate possible problems/delays
days. with invoicing ultimately impacting on cash
flow.
 The trade receivables collection period is  This may indicate
up from 38.7 days to 67 days. – Possible bad debts
– An adverse impact on cash flow.
 The cash position (cash and cash  This indicates a risk of inability to pay debts
equivalents to overdraft) has deteriorated. as they fall due (going concern risk).
 There has been a build up of other  The delay in payments may be due to
payables. shortage of funds/inability to pay debts.

114 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

(b) Post balance sheet matters relevant to (a)

 Measures taken to
– Control labour costs
– Speed up invoicing and cash collection.
 Review after-date receipts from customers.
 Review actions by payables and whether relationships maintained.
 Review cash flow and profit forecasts.
 Assess whether the company can pay its debts as they fall due (in particular loan repayment).
 Has the company
– Stayed within the overdraft limit?
– Not breached its covenants?

(c) Possible forms of audit report

The report should be qualified on grounds of disagreement if
 Receivables or WIP are materially overstated
 The company is not a going concern and the directors insist on preparing accounts on a going
concern basis.
The report should be unqualified (with an emphasis of matter paragraph) if
 The auditor remains uncertain about going concern
 But there is adequate disclosure in the notes to the accounts.
An additional paragraph will be required stating that the audit report is not qualified in this respect.
If disclosure (in a note to the accounts) is inadequate – the audit report should be qualified on grounds
of disagreement.
The report should be qualified on the grounds of limitation of scope if evidence reasonably expected
to be available has not been obtained and evaluated (e.g. the directors have not taken adequate steps
to satisfy themselves that it is appropriate for them to adopt the going concern basis).

© The Institute of Chartered Accountants in England and Wales, March 2009 115
 Section 3: Planning assurance engagements

27 WHAT

Marking guide
Marks

(a) How it differs 1

Agreement and confirmation of terms 2
Planning issues 3
Evidence ½
Review and reporting 1
Marks available 7½
Maximum 5
(b) Deeds of covenant 2
Postal donations 4
Collections 5
Capital donations 3
Grants 2
Sales of refreshments 4
Fund raising events 4
Marks available 24
Maximum 15
20

(a) Differences between this engagement and the statutory audit engagement
The statutory audit is carried out under the Companies Act 1994 (CA94) or equivalent legislation.
Under the CA94 the statutory auditor has a duty to carry out whatever work he deems appropriate in
order to reach an opinion on whether the financial statements of a company give a ‘true and fair view’.
The auditor’s opinion is then reported to the shareholders in a predetermined form of report (as set
out in BSA 700).
Here, the auditor has been asked to perform additional work over and above that of the statutory
audit. The scope of this work will be agreed with management and a particular format of report
(addressed to management) will also be agreed.
Approach for assurance engagements
 Agree the scope of work to be performed and the basis of the report to be given.
 Issue written engagement terms detailing the responsibilities of the parties to the engagement,
the scope of the work and the basis of the report to be presented.
 Plan the work to be performed, including
– Assessment of the risks of error and misstatement
– Determination of the quantity of evidence needed to give the report required.
 Determine the testing plan to be performed.
 Collect and test the detailed evidence.
 Review the results of the testing of the evidence and form an overall conclusion on the
engagement.
 Prepare and present the assurance report.
The approach to the engagement and all the testing and results must be properly documented in a set
of working papers.

116 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

(b) Controls over income

(1) Deeds of covenant
 Regular review by a responsible official to ensure that all amounts are duly received (most
deeds of covenant will probably be paid by bankers’ order and this method of payment
should be encouraged).
 Regular monitoring to ensure that all the payments covenanted are obtained, including
income tax refunds.
(2) Postal donations
 At least two persons to be present at opening of mail.
 Immediate recording of receipts on a post list.
 Prompt banking of the money to ensure maximum interest earned.
 Independent reconciliation of cash book receipts with post list.
(3) Door-to-door and work-place collections
 Pre-numbering and sealing of collecting boxes and tins.
 Provision of identification to collectors.
 Prompt collection and removal of proceeds from boxes.
 At least two persons to be involved in counting and recording.
 Prompt banking of cash intact (i.e. without using the money collected to pay expenses).
(4) Capital item donations
 Safe-keeping of documents of title or registration (e.g. vehicle registration form).
 Safe custody of donated assets (e.g. vehicles should be fitted with alarms and locked).
 Use restricted to company business by
– Having authorised drivers
– Installing tachographs.
(5) Local authority grants
 Regular discussion with local authority officials to ensure all available grants are obtained
and that specific payments are received.
 Authorisation, by directors, of disbursement of grants to ensure expenditure complies with
the terms of the grant.
(6) Sales of refreshments at the social centre
 If level of sales justifies it, a till should be used for all takings which should be banked daily
and intact.
 Inventories of confectionery, sweets, etc should be securely held.
 Overall tests on gross profit percentage should be made at (say) monthly intervals by the
finance director.
 Some degree of supervision may need to be present to prevent losses of inventory through
staff pilferage. ‘Spot checking’ may suffice.
(7) Fund-raising events
 Approval by the board of directors.
 Adequate records of income for each event.
 Clear responsibility for cash handling allocated to two persons.
 Takings to be banked promptly and intact, with separate authorisation and payment of expenses.

© The Institute of Chartered Accountants in England and Wales, March 2009 117
 Section 3: Planning assurance engagements

28 Pubgames Ltd

Marking guide
Marks

(a) Overseas suppliers 1½

Ferganto 1½
Merger 1½
Computer problem 1½
Tight deadline 1
Marks available 7
Maximum 4
(b) Normal checking 1
Analytical procedures 3
Tests of controls 1
Cut-off 1
Supplier statement reconciliations 1
Ferganto 3
Overseas suppliers 2
GRNI 2
Other 2
Implications for report 1
Marks available 17
Maximum 10
(c) Testing controls and substantive procedures 2
Cut-off 1
Analytical procedures 1
Supplier statements 1
Marks available 6
Maximum 3
Total marks available 17

(a) Main audit risks for payables

Overseas suppliers (24% of total trade payables)
Given that the clerk retired without replacement, it is possible that controls have declined both during
and subsequent to her illness. Purchases from overseas may involve foreign exchange considerations as
well as problems of late invoicing – all may result in difficulties in obtaining sufficient evidence in the
time available. Recognition of year end goods in transit as inventories may depend on whether
shipments are ‘free on board’ (FOB) or ‘carriage, insurance, freight’ (CIF).
Ferganto Ltd (51½% of total trade payables)
Absence of a year end balance suggests that this major supplier does not provide statements against
which the completeness of Pubgames Ltd’s recorded trade payable can be checked.
Heavy dependence (economic?) on one supplier may be risky, especially given the new retention
clause, which may indicate a lack of stability on the part of either Pubgames Ltd or Ferganto Ltd. If
there are concerns about the appropriateness of the going concern basis for Pubgames, the extent of
raw material inventories and indebtedness subject to reservation of title clauses must be disclosed in
the notes.
Merger
Third parties may be seeking to rely on this year’s audited financial statements as a result of the
merger – any pressure to manipulate results (e.g. suppressing liabilities and expenditure) increases
inherent risk.

118 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

Computer problem/GRNI accrual (9.8% of total trade payables)

This may be further evidence of a slippage in controls generally (see above) and may render both cut-
off work and the GRNI provision difficult to audit. If the problem in the week after the year end
amounted to a breakdown, inherent risk (as well as control risk) may be increased.
Tight deadline
The very tight deadline increases audit risk, as the timescale for identifying unrecorded liabilities (e.g.
through after-date payments) will be significantly reduced.
(b) Outline audit approach
General
Normal checking – of amounts from schedule provided back to supporting schedules, nominal and
purchase ledger balances, and through to financial statements (including checking of casts and cross
casts on a sample basis). Also purchase ledger control account reconciliation to the purchase ledger
list of balances.
Analytical procedures – on all four areas with as much disaggregation as possible, subject to availability of
information. Month-on-month analyses should be examined wherever possible with reference to prior
year levels, inventory levels and production schedules. Any significant change in the trade payables
payment period should be justified. Particular attention should be paid to old items.
Tests of controls – will be of greater significance, given the preliminary indications of control
breakdowns and the tight deadlines which will make gathering of sufficient substantive evidence re year
end balances difficult.
Cut-off – the combination of computer breakdown, retirement of the overseas clerk, and inherent
problems with overseas suppliers will result in a need for significantly increased volume of substantive
procedures on cut-off. Management may try to manipulate this area, so errors should be carefully
investigated before being dismissed as isolated.
Supplier statement reconciliations – will be useful in substantiating the GRNI accrual and goods in transit.
Ferganto Ltd
The reason for the new retention clause should be ascertained at an early stage in order to assess any
impact on going concern and/or disclosure. Circularisation is not possible but responses to requests
may confirm specific invoices outstanding. This should be the initial line of approach supplemented
with analytical procedures, review of after-date cash, reconciliations to available statements (if any) and
checking of individual invoices to GRNs, the GRNI provision and inventory records. Old unmatched
purchase orders should be investigated to confirm that they have not resulted in unrecorded liabilities.
Overseas suppliers
It may be possible to fax/phone/email these suppliers as a speedier alternative to formal circularisation.
A significant proportion of the GRNI provision may be made up of foreign invoices, and cut-off
warrants particular attention. The effect of the loss of the overseas clerk on controls must be
evaluated and the approach and sample sizes adjusted accordingly. Foreign exchange accounting
policies should be ascertained at an early stage in order to assess their appropriateness, the adequacy
of disclosure, and compliance with stated policies.
GRNI
Analytical procedures and substantive procedures on individual invoices accrued for should be
supplemented by management representations. This may also apply to other areas depending on the
strength of other evidence available. It may be possible to circularise individual invoices.
Other (14.9% of total trade payables)
Individual balances represent 0.1–0.15% of total trade payables. As they are not material, detailed
testing should be limited.
It may be possible to circularise a small sample of the largest ‘other’ payables before the year end and
perform a ‘roll-forward’ to save time for more risky areas at the year end.

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 Section 3: Planning assurance engagements

Any likelihood of a qualification

Given the above, an ‘except for’ qualification on the grounds of limitation of scope is possible, and this
should be discussed with the client as this may affect merger negotiations. The client may prefer to
delay rather than present qualified financial statements.
(c) Understatement errors
Audit techniques which may help to identify understatement errors in the payables cycle include the
following.
 Testing of authorisation and approval controls with regard to purchase orders, to ensure that all
items authorised are then recorded.
 Substantive procedures, tracing from a goods received note to purchase invoice, to the purchases
and suppliers account in the nominal ledger (via a purchase day book).
 Careful review of cut-off regarding purchase invoices around the year end, specifically with regard
to invoices for goods received prior to the year end but where no liability has been recognised.
Cut-off testing would stem initially from auditors’ physical inventory count procedures and test
counts.
 Analytical procedures on year end balances, using purchases turnover by supplier as an indication
of the likely level of year end balance (as well as last year’s balances).
 Suppliers’ statement reconciliations with purchase ledger account balances.

120 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

29 Nosh Ltd

Marking guide
Marks

(a) Financial statements 3

Budgets 2
Sales analyses 2
Limitations 4
Marks available 11
Maximum 10
(b) Self-review issues/procedures 4
Conflict of interest 3
Management threat/procedures 3
Self-interest threat/procedures 1½
Opening balances 3
Going concern 3
Related party issues 4
Revenue/margins 2
Forex 2½
Accounting records 2
Marks available 28
Maximum 17
(c) Reports under Companies Acts 4
Other reports under legislation or regulation 4
Other reports with agreed scope 4
Marks available 12
Maximum 9
(d) Each benefit 1
Maximum 4
Total marks available 40

(a) (i) Information required

 Draft financial statements and financial statements from previous years in order to be able
to compare the financial position this year with previous years and to be able to compare
management accounts (already obtained) with draft financial statements to highlight any
major differences between internal and external reporting (accounting policies, possible
errors and possible adjustments that require investigation)
 Budgets for all sections of business (branded/supermarket/gourmet/export) and to ascertain
if the director’s comments about sales and margins appears correct
 Detail sales information on all ranges, month by month, preferably for current and previous
year to investigate the finance director’s comments about margins.
(ii) Limitations
One limitation of analytical procedures at the planning stage of an audit is that the auditor needs
a good understanding of the business to interpret the results of analytical procedures. If analytical
procedures are performed mechanically, a consistency of results from one year to the next may
in fact conceal a material error which may not be identified. Effective analytical procedures need
to be carried out by experienced members of staff and they rely upon good quality and reliable
information being available from the client which may not always be available.

© The Institute of Chartered Accountants in England and Wales, March 2009 121
 Section 3: Planning assurance engagements

(b) File note

Professional issues Factor Procedures to address

 This constitutes a self-  Prior to appointment we  Use a different audit team to

review threat. If the have advised Nosh Ltd as that which advised on the
computer system is found to which computer system computer system.
to be unreliable, it may be to introduce.
 Close scrutiny of new system
difficult for the auditor to
so as no reliance
report the weaknesses to
on/appearance of reliance on
management. If the
work carried out before
weakness were to result
appointment as auditors.
in material errors in the
financial statements, the  Second partner review of the
auditor may be audit.
compromised in
formulating his audit
opinion.
 IFAC Code of Ethics does
not recommend an audit
firm to design, provide or
implement IT systems
which
– Would be important
to any significant part
of the accounting
system, and
– On which the
auditors would place
reliance
 Potential future conflict of  Advisory work includes  Ensure that existing audit
interest if we are asked to advice on expanding the clients are excluded from
advise on the suitability of business by the acquisition advisory work in respect of
Nosh Ltd acquiring of similar businesses. This acquisitions.
another of our clients. could potentially include
the acquisition of another
audit client.
 As we are very involved  We may become too  Restrict all work to advisory
with the client, there may involved with this client due work only and ensure that no
be the risk of becoming to the other services of tax management decisions are
too familiar with Nosh and advice which we are to made/appear to be made.
Ltd. This could reduce our offer.
Ensure ‘informed
objectivity.
management’ is designated by
 There is a management Nosh Ltd.
threat implicit in non-audit
 Obtain a second partner
services.
review of the audit.
 The auditor may become  The auditor is to perform  Constantly review fee level to
too dependent on the additional work of tax and ensure that it does not
regular fee income of advisory services as well as exceed 15% of gross fee
Nosh Ltd, which may the annual audit. income
impair objectivity and
independence.

122 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

Professional issues Factor Procedures to address

 Opening balances may be  Nosh Ltd is a new audit  Check opening balances have
misstated, resulting in client. been brought forward
incorrect closing balances correctly from last year’s
and comparatives. closing position.
 Enquire of management how
opening balances were
calculated.
 Review prior period’s
accounting records and
control procedures to see if
any errors are apparent.
 Perform substantive
procedures on opening
balances if other procedures
are unsatisfactory.
 Nosh Ltd may not be a  Nosh Ltd has a one year  Establish what proportion of
going concern if it loses renewable contract with a sales is made to the
the supermarket as its national supermarket chain. supermarket by examining
customer. Financial sales figures for the year in
statements may be the sales day book.
incorrectly drawn up on a  Scrutinise correspondence
going concern basis. with supermarket for any
signs of dissatisfaction.
 Perform sensitivity analysis on
forecasts to assess impact of
loss of contract.
 Ascertain if contract has been
re-signed post year end and
physically inspect a copy of
the contract.

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 Section 3: Planning assurance engagements

Professional issues Factor Procedures to address

 The financial statements  The managing director has  Review purchase day book
may fail to disclose a controlling interest in a and cash payments book for
material related party major supplier.  transactions with Plasco Ltd.
transactions.  Check that notes to financial
 Purchases may not be on statements disclose the
normal commercial terms. related party transactions.
 Compare Plasco Ltd’s prices
and terms to the industry
average.
 Check that the engagement
terms include either auditing
both companies or access to
the auditor of Plasco Ltd.
 Obtain a management
representation that all
transactions included are in
the normal course of business
and at arm’s length.
 Revenue and margins may  Revenue and margins have  Perform extensive cut-off
be overstated. improved in the year due procedures.
to significant expansion.
 Extend procedures for testing
overstatement.
 Revenue, receivables and  The company’s export  Check correct translation
foreign exchange market has grown, and this rates are used by agreeing
differences may be is likely to involve them to the Financial Times.
misstated. transactions in foreign
 Perform sensitivity analysis on
currencies.
forecasts to assess impact on
currency fluctuations.
 Check ability of computer
system to deal with foreign
currencies.
 Accounting records may  New computer system  Review controls exercised
be unreliable, resulting in introduced in the year. over changeover.
incorrect figures in the
 Review outcome of post-
financial statements.
implementation review.
(c) Comparison of different forms of assurance
(i) Audit reports under the Companies Act
The Companies Act 1994 (CA94) requires all companies to prepare annual financial statements for
circulation to their shareholders and for filing with the Registrar of Joint Stock Companies. The
financial statements must be audited by a ‘Chartered Accountant’ who makes his audit report to
the shareholders, not the management.
In the opinion given in the audit report, the auditor makes a positive assertion whether the
financial statements give a ‘true and fair’ view and have been properly prepared in accordance
with the detailed rules on financial statement disclosures which are set out in the CA94.
The opinion given by the auditor therefore conveys a high level of assurance about the financial
statements, but not an absolute level. An absolute level of assurance is probably impossible; even
if all the transactions of the company were examined (and this would be prohibitively time
consuming and expensive to perform), could there be confidence that no transaction had been

124 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

omitted entirely? Therefore, in relation to the timeliness (users want up-to-date information) and
cost, the audit report gives a satisfactorily high level of assurance to the normal user of the
financial statements.
(ii) Other reports under legislation or regulation
Assurance firms may be engaged to prepare a report on the financial statements and other
information presented by organisations which are required to report under special legislation or
regulations.
The assurance firm will approach the engagement in much the same way as performing an audit
on a company under the CA94. It would need to understand the special nature of the
organisation and the relevant legislation and regulations, as well as considering any specific
guidance on the sector which has been developed by the accountancy profession. In addition to
reporting on the financial statements, the assurance firm may also be required to give a report
direct to a regulator, in accordance with instructions issued by the regulator.
As with an audit opinion on a company, the resulting opinion will usually give a positive assertion
about the ‘truth and fairness’ and ‘proper preparation’ of the financial statements. This report
also gives a high, but not absolute, level of assurance about the financial information. The opinion,
and any report to a regulator, may also refer to more specific matters such as the organisation’s
compliance with rules on accounting systems and record keeping, or compliance with solvency
rules set by the regulator. The report on these specific matters is a positive assertion about
compliance with these aspects of the rules, and will convey a high level of assurance to the
regulator and other readers of the information.
(iii) Other reports where the scope of the work and of the report to be provided are
agreed between the two parties
‘Other reports’ embraces the many other circumstances where an assurance firm is engaged by
another party to provide a report on a piece of information. The scope of the engagement is not
set down by regulation, so the assurance firm and the client must agree on the terms of
engagement. In particular, the engagement letter must specify
 The scope of the work to be performed by the assurance firm
 The form of the report to be given by the assurance firm.
The level of assurance given by the final report will be dependent upon the amount of work
performed by the assurance firm and the agreed wording of the report. This can vary from a high
level of assurance (very extensive testing needed) to a limited level (less detailed examination).
(d) The principal benefit of an audit is that the shareholders are given independent, professional
verification that the financial statements give a true and fair view. Although some might consider this
to be of limited value to Mr Tuck, who owns and manages Nosh Ltd (and hence is legally responsible
for the financial statements), it may be of value in respect of Nosh Ltd for the following reasons:
 Nosh Ltd may have minority shareholders not involved in management
 Mr Tuck may not be an accounting expert (indeed he is likely not to be) so while he is
responsible for the financial statements he may not have prepared them, and will appreciate
assurance on them from an expert.
In addition, the audit gives credibility to the financial statements which may be used for various
purposes, such as to raise finance for expansion from the bank or other sources or by overseas
customers trying to determine if Nosh will be a reliable supplier.
Lastly, there may be subsidiary benefits to Nosh Ltd of having an audit, such as professional advice on
control systems or accounting issues through audit communications.

© The Institute of Chartered Accountants in England and Wales, March 2009 125
 Section 3: Planning assurance engagements

30 Medical Diagnostics Ltd

Marking guide
Marks

(a) Net assets implications 2

Sales issue 1
October margin 4
Staff costs 1
Establishment costs 2
Inventory 1
Deferred revenue 2
Non-current assets 1
Interest 1
Marks available 15
Maximum 13
(b) Revenue recognition 2½
Inventory 2½
Management manipulation 4½
Compressed timetable 1½
Sales cut-off 2½
Consistency of accounting policies 3½
Accruals/provisions 2½
Generic risks – identification (each) ½
Generic risks – why key to MDL (each) 1
Maximum 21 20
(c) Each procedure 21
Maximum 9
Total marks available 42

(a) Items identified from review of management accounts

 Year end net assets are almost exactly CU1.2 million warranted in the sale and purchase
agreement.
 Could be indication that results have been manipulated to meet but not exceed target.
 Sales for October 20X3 are low compared to monthly average and much lower than predicted
 Overall margin for October 20X3 is very low
 Appears to be due to:
– Higher than usual subcontract manufacture costs
– Additional inventory provisions made in month
– (To lesser extent) higher other costs
 Sales staff costs for month appear high even though sales for month are low, total cost for year is
above budget even though budgeted sales target not met
 Establishment costs for month are high and result in total for year above budget
 Would expect such costs to be highly predictable
 Year end inventory is on budget despite higher than forecast provision implies degree of
inventory build up at year end
 Increase in deferred revenue requires investigation, would expect deferred maintenance balance
to be reasonably steady (although increasing as revenue increases)

126 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

 Significant increase more likely to be due to deferral of equipment sales

 Movement in non current assets may suggest high depreciation charge or impairment provision in
last month
 Odd no interest income given high cash balance

(b) Risks
Revenue recognition
Question of when revenue should be taken involves significant judgement, and it is necessary to
ensure that revenues have been correctly and consistently accounted for.
Inventory
The products are high tech so may become obsolete leading to inventory overvaluation. Also need to
check labour and overhead absorption rates are appropriate.
Management manipulation of results/fraud
 MD and FD own entire issued share capital and will benefit personally from sale
 Accounts to be used to determine/confirm purchase price
 In their interests to meet but not exceed net assets figure of CU1.2 million
 Substantial contingent consideration dependent on growth in future years – hence motivation to
defer profits once target net assets met.
Compressed timetable for issue of accounts
 May be difficult to complete work and gain sufficient evidence in time available
Sale cut-off
 Some indication that sales may have been deferred into next year
 Need to ensure that where this has occurred is in line with revenue recognition policy – i.e. that
equipment requires customisation etc and no acceptance certificate has been received.
Consistent application of accounting policies generally
 Inventory provision increased at year end. May be valid reasons but may be indicative of
inconsistent and more prudent approach
 Need to ensure increase justified and will not merely reverse in next year
 Also seems to be high depreciation/impairment provision in last month – again need to ensure
entries justified and not simply manipulation of results
General accruals/provisions
 Need to ensure all provisions/accruals relate to real obligations
 Areas for particular focus are
– Establishment costs accruals
– Subcontract labour accruals
– Sales commission accruals (given low end of year sales)
– Bonus accruals (given results below budget)
Completeness of prepayments/sundry receivables
 Need to ensure all payments relating to 20X3/X4 expenses are properly deferred
 Also that sundry income re interest etc is completely recorded and not understated
Other (more generic risks but nevertheless valid)
 Receivable collectability
 Adequacy/reasonableness of tax accrual

© The Institute of Chartered Accountants in England and Wales, March 2009 127
 Section 3: Planning assurance engagements

 Adequacy of warranty provisions

 Related party transactions with directors or their associates
 Compliance with relevant laws and regulations given equipment supplied
 Adequacy of systems to cope with growth
 Lack of adequate segregation within accounts function given number of staff

(c) Audit work in the area of revenue recognition

 Review client controls over the point at which sales are recognised in the accounts and over
communication between sales and accounts departments
 Obtain analysis of equipment sales revenue recognised in the year
 Perform cut-off tests on items recognised close to year end
 Select a sample for testing and ensure that equipment was delivered before year end
 Review contract with customer for unusual customisation/integration, review acceptance
certificate and ensure signed and dated pre year end
 Review other sales to the same customer and ensure that there is no evidence of
customisation/integration work which has been billed separately rather than included with the
initial equipment sale
 Consider any equipment revenues which have been deferred at year end and ensure that either
the equipment was delivered post year end or that customisation work was required and was not
completed until after year end
 Consider level of sales post year end and investigate if abnormally high
 Test a sample of revenues from installation/training work
 By reference to engineers’ time sheets, course attendance revenues etc, ensure revenue
recognised in correct period
 Obtain full explanations for any other types of ‘consulting’ work and ensure appropriate revenue
recognition
 Select a sample of invoices for ongoing support and ensure included on client’s spreadsheet used
to calculate service revenues
 Ensure deferred element correctly calculated
 Check clerical accuracy of client’s spreadsheet
 Test check a sample of items from spreadsheet to copy invoices/cash receipts
 Circularise a sample of customers to ensure existence/accuracy of year end receivables
 Could also include confirmation of terms of sale and point of completion
 Review post year end cash receipts
 Review year end receivables ledger for old and unpaid items and consider whether this is
indicative of premature or inappropriate revenue recognition
 Review post year end credit notes
 Review year end inventory for completed machines in which revenue recognition has been
deferred. Obtain evidence of post year end delivery/completion of customisation work etc

128 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

31 Sporticus Ltd

Marking guide
Marks

(a) Style and presentation of letter 2

Organisational status 3
Scope of function 3
Technical competence 3
Due care 3
Marks available 14
Maximum 10
Systems documentation 3
Tests of control sales and cash 3
Tests of control purchases 3
Substantive testing 3
Marks available 12
Maximum 8
(b) Benefits to management 3
Cost savings 2
External audit costs 1
Marks available 6
Maximum 4
(c) Design and operation of systems and controls 4
Reliability of management information 3
Prevention and detection of fraud 4
Compliance with laws and regulations 3
Money laundering 3
Marks available 17
Maximum 13
Total marks available 35

© The Institute of Chartered Accountants in England and Wales, March 2009 129
 Section 3: Planning assurance engagements

(a) Letter to David Campbell

ABC Auditors
1 Long Lane
Leamington Spa
Warwickshire
CV32 2EX

D Campbell Esq
Sporticus Ltd
Maple House
Worthing Street
Cannock
Staffordshire
ST47 2BA 2 October 20X9

Dear David

Audit year ended 30 September 20X9

As requested, I have detailed below how we will be able to make use of your internal audit
department in our assessment of control risk for this year’s audit.
(i) Factors that could limit our ability to use the work of the internal audit department
in our assessment of control risk
Organisational status
For the work of the internal audit function to be effective it is important that it has access to the
highest level of management and is allowed to communicate freely with the external auditor. The
department currently reports to yourself, but ideally it should report to a director independent
of the finance function or the board of directors as a whole.
If our ability to discuss key issues with the internal auditors were restricted this could limit the
way in which we use their results. Based on the relationship we have developed with yourself and
your fellow directors I do not anticipate that we will have a problem in this respect.
Scope of functions performed
We will need to assess the nature of the work specifically performed.
We have been informed that the company's control system has been evaluated and documented
and that control procedures have been tested, all of which would be relevant to our audit work.
We will also consider the extent of the procedures covered and the ability of the three staff
members in the department to deal adequately with the 50 separate locations.
If we conclude that the department is under-resourced either in terms of manpower or
computer facilities, our reliance would be limited.
Management’s response to recommendations made by the department is also a key part of the
process overall. If the board fails to respond to the reports produced by internal audit, the
relevance of the work of the department is reduced.
Technical competence
While the department does seem to include a good balance of accounting and computer
expertise, the three staff members are all relatively new to the roles which they are now
performing. We would need to assess whether they are clear as to their terms of reference and
the overall aim of the tasks.
We would also be concerned about their independence. In this case two of the staff have been
transferred internally and while the advantage of this is their background knowledge, they may

130 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

well be in a position where they are reviewing systems they have put in themselves and work
which they have performed themselves. The extent to which this is the case may affect our ability
to rely on their work.
Whether the work has been carried out with due professional care
The work should be properly planned, supervised, reviewed and documented. Working papers
must be made available to us. We will assess these to determine, for example, whether sufficient
evidence has been collected to support conclusions and whether these conclusions seem logical,
based on the evidence collected. The adequacy of audit manuals and work programmes would
also be considered.
(ii) The effect on our audit and the extent to which we may make use of the work of the
internal audit department
Systems documentation
Effect on the audit
As the internal audit department has evaluated and documented the system, we will not need to
repeat this process. Instead we can confirm the system as recorded by them using walk through
checks.
Extent of reliance
This will depend on the depth of the documentation, e.g. how detailed it is, whether it includes
records of key controls. It will also depend on the skill and competence of the individual
producing the information, particularly if information is in flowchart form. If Peter Adams has
been responsible for this work there is a risk that he will have described the system as he
believes it to be from his previous experience in the accounts department, rather than as it is
operating in practice.
Tests of controls: sales and cash
Effect on the audit
We will need to assess the results of the work performed on sales and cash. Where controls
have been satisfactorily tested our independent testing can be reduced.
Extent of reliance
This will depend on the competence of the work, whether sufficient evidence has been obtained
to draw conclusions and whether the conclusions appear in line with the evidence. However,
even if this is the case, because sales is a particularly high risk area of the audit, we will not be
able to rely solely on this evidence. Some independent work will need to be undertaken.
Tests of controls: purchases
Effect on the audit
As this work has still to be performed we will liaise with internal audit re the audit coverage, test
levels, sample selection, documentation and review procedures.
Extent of reliance
As we will have had an input in the way in which this work has been performed, provided it is
carried out as discussed we will be able to rely on the results more heavily. Nevertheless, while
this will reduce the amount of work which we need to perform, some independent testing will
still be required.
Substantive testing
Effect on the audit
With your agreement it may be possible for us to use your staff to carry out substantive
procedures. This would result in a more efficient audit and a reduction in costs.

© The Institute of Chartered Accountants in England and Wales, March 2009 131
 Section 3: Planning assurance engagements

Extent of reliance
Any substantive work would be carefully selected. Your staff may safely be involved in low risk
areas. High risk areas, areas of judgement and any conclusions on audit evidence would be dealt
with independently by us.
I hope that these points have answered your query. If you would like to discuss this further please do
not hesitate to contact me.
Yours sincerely
Max Bobath

(b) Advantages of an effective internal audit function

 Provides management with
– A positive assurance as to the adequacy of the control systems and their operation
– Objective analyses, appraisals, recommendations and information concerning the activities
reviewed
– A body of expertise and knowledge of best practice (a form of internal management
consultancy).
 Should lead to quantifiable cost savings where recommendations are implemented and lead to
– A reduction in inefficiencies
– A reduction in costs
– An improvement in receipts
– An improvement in effectiveness.
 May lead to a reduction in external audit time (and costs) where the external auditor is able to
rely on the work of the department and it is cost-effective for him to do so.
(c) Responsibilities of management, internal auditors and external auditors
(i) The design and operation of systems and controls
Management is responsible for putting in place an effective internal control system.
Internal auditors contribute to the ongoing effectiveness of the internal control system by
reviewing it and making recommendations for improvement. However, they do not have primary
responsibility for establishing or maintaining it. They are themselves one element of the internal
control system established by management.
External auditors are not responsible for the effectiveness of, nor are they a part of, the
company’s internal control system. Their responsibility is to report in ‘true and fair’ terms to
shareholders on the financial statements. However, their findings during that work often provide
management with useful comments on and recommendations for improvements in the internal
control system (via the report to management).
(ii) The reliability of management information
Management has ultimate responsibility for ensuring that there are systems in place to provide
reliable information to enable them to run the business effectively. As above, the appointment of
an internal auditor may well help them to ensure that such systems are in place.
Internal auditors have a responsibility for reporting on whether the systems that have been put in
place by management to produce reliable financial and non-financial information are working
effectively.
External auditors, in reporting to shareholders, will consider the reliability of the information but
have no responsibility for it.

132 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

(iii) The prevention and detection of fraud

Management is ultimately responsible for the prevention and detection of fraud, and employing an
internal audit party can fulfil part of that duty as the existence of an internal audit department
could both
 Act as a deterrent to frauds being carried out in the first place
 Uncover fraud as part of routine or special investigations
External auditors are not responsible for the prevention or detection of fraud at their clients.
However, they are responsible for planning and performing audits in a way that seeks to identify
material misstatements in financial statements. Of course, if a fraud has been perpetrated then it
may have had material impact on financial statements, however, as fraud is by its nature
concealed, it may be that however well the audit is planned and performed it does not uncover
fraud.
(iv) Company compliance with laws and regulations
Management is responsible for ensuring that the company complies with laws and regulations that
apply to it. This is another area where an internal audit department may assist management in
carrying out its duties as the job of keeping up to date on what laws and regulations apply to the
company and monitoring whether the company does comply may be delegated to the internal
audit department.
External auditors are responsible for ensuring that any lack of compliance does not have a
material impact on financial statements. As auditors are supposed to have an understanding of the
entity and its environment they should be aware of the types of laws and regulations applicable to
the company, even if they are not experts in all those laws themselves.
(v) Money laundering
As outlined above management is responsible for ensuring that the company complies with the
law and this would include the criminal activities that constitute money laundering.
Internal auditors who discover money laundering at their place of work should seek legal advice
about their position. Disclosure of money laundering to central bank would constitute a
disclosure so they should be protected from suffering a detriment at work for making the
disclosure and would be protected from possible criminal charges for not making disclosures.
External auditors are required under ‘Financial Institutes Act 1993’, section 24 to report
suspicions of money laundering to central bank.

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32 Atlantis Ltd

Marking guide
Marks

(a) Importance of obtaining an understanding of the business 3

Sources of information 5
Procedures to obtain the information 3
Marks available 11
Maximum 10
(b) Central processing 4
Inventory movements 4½
Discounts and bonuses 7½
Invoicing 4
Marks available 20
Maximum 11
(c) Approach to audit of revenue 4
Audit work – inventories 5
Audit work – revenue 6
Audit work – receivables 3
Audit work – general 2
Marks available 20
Maximum 14
Total marks available 35

(a) Importance of obtaining an understanding of the business

Auditors are required by BSA 315 Understanding the Entity and its Environment and Assessing the Risks of
Material Misstatement to obtain an understanding of the entity and its environment, including its
internal control.
The purpose of obtaining the information is to identify problem areas which might cause difficulties in
collecting evidence or drawing conclusions and identifying risky areas so that audit work can be
directed at those areas. In addition, having an understanding of the entity provides a frame of
reference for the auditor when exercising audit judgement, for example, when setting materiality or
determining sample sizes to use.
Sources of information
The auditors would use external sources of information about the general industry (kitchenware and
bathware), their own sources for example, prior year audit files and the permanent audit file, audit
personnel who know the client and client sources.
In the case of Atlantis, client sources might include:
 A company website
 Company staff
 Internal control procedures manual
 Company marketing material
 Company price lists
 Company correspondence (for example, with customers, solicitors, etc)

134 © The Institute of Chartered Accountants in England and Wales, March 2009
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Procedures to obtain the information

Auditors must carry out a combination of the following procedures to obtain an understanding of the
business:
 Analytical procedures
 Observation and inspection
 Inquiries of client personnel
In addition it is a requirement of BSA 315 that the audit team discuss the client’s business and the
susceptibility of the financial statements to fraud.
(b)
Potential risks Possible consequences

(1) Central processing

 Returns from branches may be lost or  Figures available to management may be
delayed. inaccurate or out of date, resulting in accounting
errors and poor decision making.
 Inventory levels recorded by head office  Inventory losses may go unnoticed.
may be inaccurate.
  Inaccurate information may be given to
customers re inventory availability.

(2) Inventory movements

 Items in transit between branches at the  Inventory levels may be misstated.
year end may not be correctly
accounted for.
 Inventory movements and revenue may  Gross profit may be misstated due to cut-off
not be recorded in the same accounting errors.
periods.
 Incorrect deliveries may be made if  May result in loss of customer goodwill.
deliveries are not controlled by branch
taking original order.

(3) Discounts and bonuses

 A bonus based on revenue does not  Managers may offer excessive discounts resulting
necessarily lead to higher profits. in lower profits.
 The bonus may be an incentive to  May lead to window dressing, raising bogus
misstate revenue deliberately. invoices pre year end, matched by bogus credit
notes post year end.

  Managers may be overpaid.
 Accounting errors may result, e.g. sales cut-off.

 Delegating decisions over discounting to  Performance appraisal is difficult where budgets

managers makes it more difficult to are unreliable.
prepare budgets/forecasts centrally.
  The company may misjudge its cash flow
requirements.

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 Section 3: Planning assurance engagements

Potential risks Possible consequences

(4) Invoicing
 There is a significant time delay between  Lengthens the time taken to receive payment,
delivery and billing. and hence increases working capital
requirements.
 There may be up to two weeks’ accrued  Management accounts may be out of date.
income at any point in time
 Greater risk of cut-off errors resulting in
understatement of profit.

(c) Approach to audit of revenue

There are various potential approaches to the audit of revenue. The auditor could take a wholly
substantive approach and carry out tests of details on a sample of sales invoices. However, as revenue
consists of a large number of items this is unlikely to be an efficient approach.
Realistically the auditor is likely to take a mixed approach to auditing revenue if the client appears to
have effective controls over revenue and sales.
In a mixed approach, the auditor would ascertain and test the controls existing over sales and
conclude whether the system was capable of producing a reliable figure for revenue.
As it is not appropriate to rely on controls testing alone in respect of a material figure in financial
statements, and as revenue is extremely likely to be material, some substantive procedures would then
be carried out.
These could take the form of analytical procedures. These are often used in conjunction with revenue
as businesses often have substantial amounts of information available about sales, and there are often
detailed budgets and projections as well as breakdowns of actual figures.
However, in this case, management discretion in relation to pricing means that revenue is less
predictable than might otherwise be the case and tests of details are likely to be more appropriate.
Substantive audit work
Inventory quantities
 Attend physical inventory counts at branches on a rotational basis.
 Agree a sample of physical quantities to branch records, and vice versa.
 Inspect inventory movement dockets raised around year end, and ensure the inventory item has
been recorded only once if goods not yet despatched to customer by the year end.
 Agree deliveries recorded around the year end to inventory records and invoices raised to
identify cut-off errors.
 Reconcile branch inventory levels to head office records.
Revenue
 Perform a sequence check on all documentation to ensure completeness.
 Follow through a sample of transactions from sales order through to delivery notes and sales
invoices.
 Check calculations of invoices.
 Match sales invoices raised around year end to despatch notes to ensure correct cut-off.
 For a sample, compare discounts offered to the parameters set out by head office.
 Review post year end credit notes raised to ensure those relating to pre year end sales are
identified.

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Trade receivables
 Circularise a sample of year end receivables weighted towards the larger balances.
 Include copies of customers’ sales ledger accounts to have best chance of detecting fraud.
 Agree after-date cash received and remittance advices to year end receivables.
General
 Perform analytical procedures by comparing gross profit margins branch by branch and to budget
and previous years.

33 Pallas Ltd

Marking guide
Marks

(a) Recent appointment 2½

Nature of business/equipment 3½
Telephone orders 1½
Bonus scheme 1½
Changes in software 3½
Agents 2½
Overseas suppliers 2½
Matters to discuss - ½ mark each 6
Marks available 23½
Maximum 14
(b) Internal controls – non current assets 8
Internal controls – non recoverability of trade receivables 7
Marks available 15
Maximum 8
(c) (i) Different risks 4
Restricted funds 2
Reports to NGO Affairs Bureau 2
Additional work 2
Marks available 10
Maximum 8
(ii) Public money/accountability 2
Wider scope 8
Directorate of Audit 2
C & AG Office 2
Marks available 14
Maximum 10
Total marks available 40

(a) Potential audit risks

 Recent appointment as auditor
– Lack of cumulative audit knowledge/knowledge of business
– Possible misstatement of opening balances
 Nature of business/nature of non-current assets
– Equipment susceptible to theft
– Five year straight line basis may not be applicable to all assets
– Obsolete/damaged equipment may affect carrying value

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 Section 3: Planning assurance engagements

 Pallas takes customer orders by telephone

– May give rise to disputed orders
 Bonus scheme/management bias
– The scheme provides an incentive for directors to overstate income/understate expenditure
 Changes in software
– Misstatements may increase as a result of manual transfer of information/loss of data
– Custom written software may contain bugs causing errors
– Lack of staff familiarity with system may cause errors
 Sales agents have authority to discount/chase up receivables
– May lead to fraudulent activity if discounts offered in return for cash (or other e.g.)
– May give rise to bad debts if sales agent not chasing up debts appropriately
 Camera equipment sourced from overseas
– May lead to incorrect values in financial statements if incorrectly translated
– Unrecognised foreign exchange loss may occur
Matters to discuss
 Security procedure taken to ensure that assets securely held
 Discuss rationale for depreciation policy/level of losses/profit on disposal of equipment
 The nature of any conditions attached to the bonus scheme
 The effect on profits since the introduction of the scheme
 The anticipated level of bonus payable this year
 The procedures used to ensure that all accounting information correctly transferred from old
system to the new
 Was there any parallel running of the old system to ensure operating correctly?
 The extent and nature of any problems with the new system
 Adequate backup arrangements in place
 The extent of any training given to staff in the new system’s use
 Discuss procedures used for translation of foreign exchange translations
 Establish whether management monitoring procedures are in place
(b) Control procedures
 Log serial number of each non-current asset so they can be separately identified
 All equipment to be security tagged/monitored by CCTV at warehouse/kept under lock and key
when not on hire
 All movements of equipment to be supported by authorised booking out sheet
 Segregation of duties between warehouseperson and person signing booking out sheet
 Periodic physical checking of items not out on hire to asset register
 For items on long term hire, periodic confirmation with customer that they have the asset
 Pallas to maintain appropriate insurance cover for equipment
 Ensure customer’s signature obtained for all courier deliveries/collections as proof they have
received equipment
 Checking of all new customers (ID) to ensure bona fide
 Credit check customers/set credit limits with regular review for appropriateness of the level set

138 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

 Request to see copy of customer insurance policy for more expensive hired items
 Request security deposit from customers for more expensive items
 Formal debt collection procedures to be carried out by staff other than sales agents
 For longer hire periods, invoice each month rather than wait until end of hire period
 Ensure all orders are confirmed in writing
(c) Differences between a non specialised profit orientated entity audit and the audits of
NGOs
(i) Caring Hands Bangladesh Ltd, a registered NGO
The key initial thing to note is that Caring Hands Bangladesh Ltd is a company (as denoted by the
Ltd in its name) and therefore, if it meets the statutory requirement limit, it will require a
statutory company audit in the same way that Pallas does.
Caring Hands Bangladesh Ltd will be at liberty to appoint its own auditors, in the same way that
Pallas Ltd is. The NGO is likely to appoint auditors that are enlisted with the NGO Affairs
Bureau and have experience and a good reputation with NGOs in the same way that Pallas will
seek to appoint auditors with experience and reputation in its industry.
The statutory audit will not differ largely from the audit of Pallas, except in the ways that all
statutory audits differ from one another as they are tailored to the particular client and set of
financial statements. For example, the audit will differ because:
 The risks facing Caring Hands Bangladesh are likely to be different from the risks facing
Pallas
 The financial statements of Caring Hands Bangladesh are likely to be prepared under a
different framework than Pallas, that is, as per the requirements of NGO Affairs Bureau
 Therefore, the risk of misstatements in the financial statements will be different, for
example, the auditors will have to consider matters such as foreign donations, restricted
funds, Form FD4 and Form FD6
 The auditor might have requirements to make reports to the NGO Affairs Bureau if any
breaches of regulatory requirements are discovered.
In addition, an NGO may have items that it wants the auditor to address, in addition to statutory
requirements. For example, it may want assurance work carried out on whether the NGO is
achieving its objectives.
Where the NGO engages the auditor to provide services in addition to the statutory audit, the
auditor must ensure that these terms are clearly clarified in the engagement letter and must
ensure that he carries out procedures appropriate to provide assurance in those areas. Although
the Trustees may feel this aspect of the work to be more important than the statutory audit, the
statutory audit is a legal requirement, and must be carried out properly, regardless of any other
objectives being met by the auditor.
(ii) Public audits
An Upazila Parishad and a central government department are both entities in the public sector,
spending public money under mandate from Parliament. As such, they will both be subject to a
public audit.
Public audits differ from private company audits (such as the audit that Pallas has) because they
are generally wider in scope. A public audit will generally address the following issues:
 An audit of the financial statements (this is the same as a private audit, although the public
sector entity may have different reporting requirements depending on its nature)
 A regularity audit which ensures that money is being spent according to the legislation
governing the entity

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 Section 3: Planning assurance engagements

 A propriety audit which ensures that money is being spent in an appropriate manner, that is
ethically and in accordance with public expectations (for example, that contracts are not
merely granted to councillors’ family members)
 A value for money audit which ensures that money is being spent appropriately, that is, a
good balance is struck between spending less, spending well and spending wisely. Value for
money is important in all public audits, but particularly in local government audits, such as
the audit of the Upazila Parishad.
Public audits are carried out in accordance with the principle of independence, as are private
company audits.
However, public sector organisations are not entitled to appoint their own auditors, but are
audited by particular bodies.
Upazila Parishad
The audit of the Upazila Parishad will be carried out by the Directorate of Audit, either by its
own employees, or it will appoint an approved private firm of auditors to carry out the audit to
its principles.
The Directorate of Audit is a public body which is independent of the government.
Central government department
The central government department will be audited by the Comptroller and Auditors’ General
(C & AG) Office. The C & AG is also independent of the government and reports to Parliament
on the result of its audit of the government department. This process is scrutinised by the Public
Accounts Committee, a special committee set up by Parliament.

140 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

Section 4: Concluding and

reporting on assurance
engagements

34 Short form questions

1 Letters
 Inclusion in letter to management?
(1) Yes – lack of physical control over premises
(2) No
(3) Yes – lack of control over cash receipts
 Inclusion in letter of representation?
(1) No
(2) No
(3) Yes – completeness of income
2 Incorrect classification last year
 Comparatives form part of financial statements
 But no opinion on comparatives as such
 No effect on current year figures
 If comparatives not adjusted, should consider implications for report
 If comparatives adjusted and adequately disclosed, no qualification
3 Misclassification of expenses
Form
 Qualified ‘except for’ opinion on income statement
 Unqualified opinion on balance sheet and ‘standard’ basis of opinion paragraph
Explanation
 Matter is material disagreement but not pervasive
 Does not affect balance sheet
4 Effect on audit report
(i)  Unqualified opinion
 Emphasis of matter paragraph on going concern uncertainty
(ii)  Qualified ‘except for’ if considered material without being pervasive
 Adverse opinion if considered material and pervasive
 Disagreement over non-disclosure

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5 Meaning and purpose of statement

 Directors are responsible for the preparation, presentation and disclosures of financial
statements
 Auditors’ responsibility is to express an opinion on those FSs, on the truth and fairness of the
financial statements.
6 Chairman’s statement
Action
 Normally no statutory responsibility for auditor to review chairman’s statement (CS) for
consistency with accounts
 If a non-statutory responsibility, auditor needs to consider if CS undermines credibility of financial
statements
 Unlikely this will be the case; however, auditor should encourage chairman to revise contents of
his statement
 If a statutory responsibility, auditor should encourage client to change CS
 If refused, a reference to the non-consistency with the accounts will be required
Impact on audit report
 Audit report will not be qualified
 Statement referring to the inconsistency should appear after opinion paragraph immediately
above auditor’s signature
7 Conclusions from review of financial statements
 Accounts prepared using acceptable/consistent/appropriate accounting policies
 Accounts are compatible with knowledge of the business
 Directors’/chairman’s report consistent with accounts
 Disclosures are adequate and suitable
 Accounts comply with statutory requirements
 Conclusions drawn from tests support opinion
8 Effect on audit report
(i)  Significant uncertainty
 Emphasis of matter paragraph
 Unqualified
(ii)  Disagreement – lack of disclosure
 Disclosure given in report
 Adverse opinion
 Accounts do not give true and fair view
9 Breach in company policy
Consequences
 Duplicate orders
 Use of unauthorised suppliers
 Terms/prices negotiated with unauthorised suppliers generally less favourable
 Purchase of unauthorised non-business goods and services
 Goods may not be to appropriate standards or requirements

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 ANSWER BANK

 May result in breach of budgets and loss of control by buying department

 Invoices may not be entered in purchase ledger, resulting in understated liabilities
Recommendations
 All significant purchase orders over pre-determined limit to be placed by buying department
except for small orders (say under CU1,000)
 Employees in breach of company procedures to be informed in writing
 Circulate company policy to all staff, and staff to confirm in writing that they understand company
policy
 All suppliers to be informed in writing of company policy
10 Matters to be considered
 Check opening balances correctly brought forward
 Review client working papers for prior year
 Check appropriateness of accounting policies/accounting policies consistently applied year to year
 Any changes appropriately accounted for/disclosed
 Substantive work on opening balances (where no alternative available)
 State in audit report that comparative figures not audited (BSA 710)
 Ensure disclosure of lack of audit in prior year in financial statements
 Integrity of accounting system/strength of control environment
11 Additional procedures
 Discuss with management implications of relegation/management plans
 Obtain and review updated cash flow forecasts based on playing in a lower division
 Reconsider the going concern basis, e.g. loan covenants, overdraft limits
 Assess whether financial statements need amending
 Ensure fact that team has been relegated has been adequately disclosed
 Review board minutes
 Analytical review of forecast revenues with published third division revenues
12 Further information and why required
(1)  Amount of cheque confirms balance outstanding
 Cheque received, banked and posted after year end
 To confirm as acceptable timing difference in conclusion
(2)  Provided for at year end = acceptable timing difference
 Not provided for = error in conclusion of test
 Whether isolated occurrence or not
 For need to extrapolate or not in conclusion

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 Section 4: Concluding and reporting on assurance engagements

13 Effect on audit report

Fletcher Ltd  Qualified opinion

 ‘Except for’
 Limitation on scope
Dervish Ltd  Disclaimer of opinion
 Unable to form opinion on true and fair
Both  Description of circumstances/amounts

14 Going concern
 Going concern is fundamental underlying assumption
 Assumption that business can continue operating for foreseeable future
(i)  Disclosure of
– Statement of relevant facts
– Nature of concern
– Assumptions made in using going concern basis
– Plans and actions taken
(ii)  Statement that accounts not prepared on going concern basis i.e. prepared on a break up
basis
 Assets written down to recoverable amounts
 Liabilities re-assessed
 And reclassified from long to short term
15 Differences: assurance v audit report
 Addressee – Finch Inc not members
 Responsibilities – refer to terms of engagement, not law
 Basis of opinion – state not an audit
 Opinion – no reference to
– True and fair
– CA94
16 Reports to those charged with governance
BSA 260 requires that auditors should communicate matters of governance interest that arise from
the audit to those charged with governance. Auditors are required to take the following steps.
Listed company audit clients (BSA 260 para 11-5)
 General approach and scope of audit
 Selection and changes in accounting policies
 Risk and exposures
 Audit adjustments
 Material uncertainties
 Disagreement with management
 Expected modification to the audit report

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17 Post balance sheet tests

 Consider whether provision in place
 Whether any monies re amount outstanding received from Gamlec since balance sheet date
 Correspondence from receiver/likelihood of receipts
 Whether any additional goods despatched to Gamlec
 Whether receivership of major customer will impact on going concern status of Beacon/provides
evidence of problems in the industry

18 Effect on audit report

 Unqualified opinion if note considered adequate
 If note inadequate or disagree with basis of preparation – qualified opinion
 Modified - emphasis of matter paragraph included in audit report
 Drawing users’ attention to note
 Statement that report not qualified in this respect

19 Other reports under legislation or regulation

Four examples from the following.

Example Why subjected

 Local authorities  Have special accountability to their local communities

 Insurance companies  Hold large sums of money on behalf of customers
 Banks  Hold large sums of money on behalf of customers
 Insurance brokers  Hold large sums of money on behalf of customers
 Pension schemes  Hold people’s retirement savings
 NGOs  The public donate money in good faith
 Lawyers’ firms  Handle large amounts of clients’ monies

20 Further information re disagreed balance

 Whether received/banked prior to year end to establish whether a cut-off error
 Whether received and posted to ledger shortly after year end to assess whether an acceptable
timing difference

21 Whether to rely on written representation

 Internal controls in place over cash sales/segregation of duties
 Whether independent analytical review of GP%/reconciliations
 Whether GP% in line with industry sector
 Integrity/attitude of MD/well informed
 Lifestyle of MD in relation to stated income
 Whether audit testing consistent with representations

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 Section 4: Concluding and reporting on assurance engagements

22 Why investigate further

 Cash book may have been left open after year end (inappropriate cut-off)/overstatement of
cash/impact on trade receivables collection period
 Management to be informed of delay in banking
– Poor cash management/cash flow
– Teeming and lading

35 Anagram Ltd

Marking guide
Marks

(a) Each component ½

Maximum 4
(b) Post year end sales to Japanese customer 1
Forecast issues 2
Contractual issues 2
Inventory issues 2
Post year end management accounts 1
Japanese customer status 1
Enquiry of management/Minutes 1
Post year end receipts 1
Suppliers/payables issues 1
Funding issues 1
Non current asset issues 1
Marks available 14
Maximum 7
(c) Modification/qualification 5
Modification/emphasis of matter 3
Marks available 8
Maximum 7
Total marks available 18

(a) Principal components of completion memo

 Significant changes to the business.
 Review of financial statements.
 Weaknesses identified in company’s systems.
 Comparison of actual audit costs to budget.
 Scope for provision of other services.
 Significant issues arising/management letter points.
 Work still outstanding/unresolved matters.
 Proposed audit opinion.
 Changes to original audit strategy.
 Pending litigation/material uncertainties.
 Summary of aggregate effect of likely misstatement.

146 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

(b) Subsequent events review

 Review post year end sales to see if in line with contract.
 Review cash flow forecast for Anagram.
 Can they stay within overdraft?
 Can they make bank loan repayments/ability to meet liabilities as fall due.
 Ensure bank covenants adhered to.
 Review sales contract for any compensation re breach of contract/damages available in event of
non performance.
 Review any legal correspondence/speak to company solicitor/correspondence with customer.
 Enquire as to alternative use for raw materials.
 Are there alternative customers for finished goods?
 Review post year end inventory levels.
 Review post year end inventory write offs.
 Review post year end trading results/management accounts.
 Obtain market info/accounts for Japanese customer – assess status.
 Enquire of management as to situation with contract/customer/discuss advances in industry.
 Review meeting minutes.
 Review post year end cash receipts from customer.
 Review post year end payables days for evidence of strain.
 Any action by suppliers post year end.
 Identification of alternative funding sources.
 Correspondence with bank.
 Non-current asset impairment review.
 Assess equipment second hand value.
(c) Impact on audit report
Modify:
 Going concern unresolved and inadequate disclosure.
Disagreement due to:
 Inventory overstated.
 Trade receivables overstated.
 Non-current assets require impairment provision.
Company not going concern and directors insist on preparing on this basis.
If adequate disclosure re going concern:
 Emphasis of matter/significant uncertainty.
 Audit report not qualified.

Tutorial note
This answer is the marking plan produced by the examiner. The examiner has confirmed that the style of
this answer is appropriate for use by students in the examination.

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 Section 4: Concluding and reporting on assurance engagements

36 Garb Ltd

Marking guide
Marks

(a) Meaning of going concern 1

Why auditor should consider going concern 6
Marks available 7
Maximum 5
(b) Profit forecasts - reasonableness of assumptions 3
Post year end management accounts 1
Profits profile 1
Cash flow forecasts – reasonableness of assumptions 2½
Ability to meet debts/stay within overdraft facility 1
General points (each) 1
Marks available 9½
Maximum 9
(c) Significant uncertainty/emphasis of matter 4½
Failure to disclose uncertainty 1½
Marks available 6
Maximum 4
Total marks available 18

(a) What is meant by the going concern concept, and why the auditor should consider
whether a company is a going concern
The going concern basis presumes that the entity will continue in operational existence for the
foreseeable future.
Accounting standards require financial statements to be prepared on the going concern basis.
BSA 570 requires auditors to consider the entity’s ability to continue as a going concern, and ensure
appropriate disclosure in the financial statements.
If the going concern basis is inappropriate, a company may need to ascribe different values to items in
the financial statements (i.e. prepare the financial statements on a break-up basis).
 Assets may need to be written down to recoverable amounts or reclassified.
 Liabilities may need to be restated to reflect changes in amount or date of maturity.
 Additional liabilities for losses/redundancies may arise.
(b) Matters to be considered when reviewing the profit and cash flow forecasts in order to
assess whether the company is a going concern
Profit forecast
 Reasonableness of assumptions, particularly in respect of
– Anticipated level of revenue taking into account new contracts/loss of major customer
– Whether margins reflect terms of historical/new sales contracts
– Whether terms of contract agreed with major supplier
– Penalties in respect of late payments to NBR
– Projected exchange rates.
 Consider the extent to which forecasts for expired periods are supported by management
accounts/events after the balance sheet date.

148 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

 Consider profits profile (i.e. quality of profits) – ensure profits are from trading and not from sale
of non-current assets.
Cash flow forecast
 Reasonableness of assumptions, in particular
– Expected cash collection performance/status of receivables
– Basis of payment terms to existing suppliers (may indicate tightening by suppliers).
 Company’s ability to meet its debts as they fall due and stay within overdraft limit.
General
 Susceptibility of key components to sensitivity analysis.
 Any unanticipated costs of closure incurred in the post balance sheet period have been
accounted for.
 Competence of preparers of forecasts by reference to previous forecasting.
 Accuracy of additions and calculations/consistency between cash flow and profit forecasts.
 Whether any of the projections would result in debt covenants being breached.
(c) Implications for the audit report if the negotiations for the replacement loan are not
completed by the time the audit report is signed
This would constitute a material matter re a going concern problem which should be highlighted in the
audit report.
The audit report should be unqualified if there is adequate disclosure in the accounts. The report
should include
 An emphasis of matter paragraph referring to the disclosure
 With specific reference to the fact that the report is not qualified.
The audit report should be qualified if the uncertainty is not adequately disclosed in the notes to the
accounts.

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 Section 4: Concluding and reporting on assurance engagements

37 Plumb Ltd

Marking guide
Marks

(a) Each matter ½

Explanation (each) 1
Maximum 6
(b) Modified/emphasis of matter 2
Qualified/except for disagreement 2
Adverse opinion 1½
Qualified limitation on scope/disclaimer 2
Marks available 7½
Maximum 6
(c) Income 2
Expenditure 7
Receipts 2
Payments 3
Consistency between cash flow and profit forecasts 1
Marks available 15
Maximum 8
Total marks available 20

(a) Matters Explanation

 Fixed price contracts  Cost overruns may result in losses

 Retentions  May not be paid if work is faulty/adverse
impact on cash flow
 Sale of retail operations  Unable to generate funds from operations to
repay loan
 Proceeds may not be sufficient to cover loan
 Operating loss  Adverse impact on cash flow
 Legal claim/dispute  Substantial damages may have to be paid
 Loss of business as unlikely to retain major
customer
 Trading at overdraft limit  May not obtain the increased facility
 Going concern status in doubt  If not a going concern the basis of the
preparation of the accounts will be affected
 May require disclosure in the audit report as
an emphasis of matter

(b) Audit reports

 Modified, but unqualified, with emphasis of matter/explanatory paragraph

– Material uncertainty about the going concern status and
– Adequate disclosure in the financial statements of the uncertainty

150 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

 Qualified except for disagreement

– Disagreement over disclosure details
– But happy about basis of preparation

 Adverse - do not give true and fair view

– Disagreement over basis of preparation

 Except for/disclaimer of opinion/limitation of scope

– Evidence reasonably expected to be available is not available
– Management unwilling to make or extend assessment of going concern
(c) Matters to consider

 Income
– Includes income from retail operations to date of disposal/excludes income from retail
operations following disposal
– Allows for loss of income from major customer

 Expenditure
– Allowance made for any loss of bulk discounts due to reduction of purchase of consumables
– Includes legal costs of fighting legal action
– Wages to reflect reduction in operations due to loss of major customer
– Additional overdraft interest but no loan interest following repayment of loan
– Costs of rectification work
– Profit or loss on disposal of retail operations included
– Accounting policies are consistent with historical financial statements

 Cash flow
Receipts
– Timing allows for retentions
– Reflects disposal proceeds
Payments
– Loan repayment made in February
– Includes costs of disposal
– Suppliers paid in accordance with their terms of trading

 General
– Items in cash flow are consistent with profit forecast

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38 Delux Hotels Ltd

Marking guide
Marks

(a) Room lettings - discounts 8

Room lettings – credit limits 6
Property, plant and equipment 4
Computer system – file server 3
Computer system - passwords 3
Marks available 24
Maximum 18
(b) Each attribute 1
Maximum 5
(c) Independence issues 3
Nature, scope of work and form of report 2
Marks available 5
Maximum 3
Total marks available 26

(a) For inclusion in a report to management

(1) Room lettings – corporate customers
Discounts
Possible consequences
 As a direct result, Delux Hotels Ltd is losing income so that margins will be eroded.
 Indirectly, the granting of large discounts not backed up by company policy could lead to
customer dissatisfaction with inconsistent pricing.
 A general ethos of non-adherence to management policies could lead to a loss of
management control/respect.
Recommendations
 Range/limit checks should be exercised by software (with authorisation linked to identity).
 Exception reporting of discounts granted with independent review thereof.
 All exceptions should be cleared by the reservations manager.
 All breaches of company policy should be investigated by a responsible official.
 Employees should be made aware of the importance of adhering to company procedures.
Credit limits
Possible consequences
 Bad debts could arise because of sales being made without reference to credit limits.
 Working capital may be unnecessarily tied up, with adverse interest implications.
Recommendations
 Credit limits should be introduced for all customers with credit accounts.
 These limits should be regularly reviewed by head office in conjunction with hotel managers
and credit ratings.
 Independent review of aged receivable analysis.
 Follow up of slow payers.

152 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

(2) Property, plant and equipment

Possible consequences
 Property, plant and equipment may not be acquired on the most favourable terms.
Recommendations
 Independent review of quotes by estates/property manager who should evidence review by
signature.
 Employees involved to be informed in writing in respect of breach of company policy.
(3) Computer system
File server
Possible consequences
 Increased risk of theft and damage.
 Loss of file server will result in systems breakdown/business interruption.
Recommendations
 File server should be sited in a lockable room with access restricted to authorised
personnel by use of keys/PINs.
Passwords
Possible consequences
 Long intervals between password changes increase likelihood of password becoming known,
increasing risk of unauthorised access.
Recommendations
 Company should have a policy which requires passwords to be changed every 30/60/90 days
(or after a specified number of accesses) and when staff leave.
 Change should be systems-enforced and disallow re-use of former passwords and use of
common words.

(b) Attributes for effective communication to those charged with governance

Timing – Communication should be on a sufficiently prompt basis to enable those charged with
governance to take appropriate action. For example, findings from the audit that are relevant to the
financial statements should usually be communicated before those financial statements are approved.
Extent, form and frequency – must be appropriate. This will vary depending on the size and nature of the
entity and the way in which those running the entity operate.
Expectations – In order that effective communication is established, the expectations of both the
auditors and those charged with governance re the form, level of detail and timing of communications
should be established at an early stage in the audit process. This should limit the scope for
misunderstandings.
Addressee – The auditor will need to use his judgement to decide who is the appropriate addressee. In
some cases it may be appropriate to communicate to a committee. In others it may be necessary to go
directly to the board of directors.
Form of communication – Communication may be made orally or in writing. Which is appropriate
depends on factors such as the size of the entity, communication lines, nature of the matters being
reported, statutory requirements and specific arrangements made.
Comments made by management – should be incorporated in the communication where those
comments will aid the understanding of those charged with governance.

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Previous year’s points – If there is no new relevant information to communicate, the auditors should
make those charged with governance aware that this is the case. Alternatively, if the auditors feel that
appropriate action has not been taken, they may decide to repeat the point in a current
communication.
A disclaimer – should be included to remind third parties who see the communication that it was not
prepared with third parties in mind.
.

39 Salmonoid Ltd

Marking guide
Marks

(a) Each factor ½

Consequential risk (each) ½
Each feature ½
Significance of each feature ½
Maximum 14
(b) Audit reports under the Companies Acts 4
Other reports under legislation or regulation 4
Other reports 4
Marks available 12
Maximum 8
Total marks available 22

(a) Assurance assignment

(i) Factors and consequential risks re inventory values

Factor Consequential risk

 Water is supplied from bore holes.  If the water supply runs low or is contaminated
the fish may die.
 The fish are susceptible to disease  Even a moderate deterioration in water supply
related to inventory levels. may reduce the usable capacity of the cages
below 300,000 fish.
 If parasites etc cannot be properly controlled,
the true maximum inventory levels will have to
be reduced if quality is to be maintained.
 Poor quality inventories will have a lower net
realisable value.
 Inventories held in poor conditions may attract
legal action from animal welfare groups leading
to possible fines and loss of reputation.

154 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

 Chemicals are used to control disease.  Potential side effects for public health may
reduce attractiveness of the inventories to the
marketplace leading to a fall in their saleable
value.
 Feed pellets can deteriorate.  If fish inventory levels cannot be maintained at
expected levels then an excess of pellets will
arise, the value of which deteriorates over
time.
 This situation would be worsened by accidental
or deliberate damage to the silos breaching the
airtight conditions as this would further
shorten the life expectancy of these
inventories.
 Salmonoid Ltd sells to the major  If the supermarket chains were to find an
supermarket chains. alternative supplier for prepared fish, then
inventories held for despatch would have no
value unless an alternative customer of
equivalent size can be found.
 Frozen inventories are held.  The company holds up to one month’s supply
of frozen fish. Failure to maintain temperatures
at the required level would lead to the loss of
these inventories.
 Insurance cover over frozen  With policies due for renewal it is essential that
inventories is due for renewal. these are adequate to cover potential claims,
otherwise the going concern status of the
business could be threatened.

(ii) Features of assurance report on inventory values and significance

Feature Significance

 Title/addressee  An assurance report is not a legal

requirement, but is commissioned by an
individual or organisation for a particular
purpose. It is important that this party is
identified (i.e. the Sterndale Bank).
 Description of engagement  It is important that the report clarifies the
purpose for which the work was undertaken,
namely the risk that inventory values may fall.
 Responsibilities  The responsibilities of each party must be
clearly stated so that the user(s) of the
report does not misunderstand the role of
Bingt & Co.
 Restricted purpose  Some assurance reports are for a restricted
purpose, such as exclusively to support a
loan. This must be stated.

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 Section 4: Concluding and reporting on assurance engagements

Feature Significance

 Standards applied  When undertaking an audit assignment the

ground rules are clear, financial statements
should have been prepared using accounting
standards and the auditors should have
conformed with auditing standards.
 Assurance work will often be conducted with
reference to other standards, such as the
bank’s own lending criteria.
 Conclusion/reservations  The assurance report is not reporting on
truth and fairness, but a conclusion from the
practitioner is still required. In the case of
Salmonoid Ltd this should indicate the
sensitivity of inventory values and the threat
to loan security of adverse changes.
 Name of firm/signature  Ultimately it is this signature that gives the
commissioner of the report confidence, or
otherwise, in the issue reviewed.
 Date  This is vital to the practitioner to ensure he
is not held liable for events after the report
has been completed.

(b) Comparison of different forms of assurance

(i) Audit reports under the Companies Act
The CA94 requires all companies to prepare annual financial statements for circulation to their
shareholders and for filing with the Registrar of Joint Stock Companies. The financial statements
must be audited by a ‘Chartered Accountant’ who makes his audit report to the shareholders,
not to the management.
In the opinion given in the audit report, the auditor makes a positive assertion whether the
financial statements give a ‘true and fair’ view and have been properly prepared in accordance
with the detailed rules on financial statement disclosures. The auditor also makes a positive
assertion whether the directors' report is consistent with the financial statements.
The opinion given by the auditor therefore conveys a high level of assurance about the financial
statements, but not an absolute level. An absolute level of assurance is impossible; even if all the
transactions of the company were examined (and this would be prohibitively time-consuming and
expensive to perform), could there be confidence that no transaction had been omitted entirely?
Therefore, in relation to the timeliness (users want up-to-date information) and cost, the audit
report gives a satisfactorily high level of assurance to the normal user of the financial statements.
(ii) Other reports under legislation or regulation
Assurance firms may be engaged to prepare a report on the financial statements and other
information presented by organisations which are required to report under special legislation or
regulations.
The assurance firm will approach the engagement in much the same way as performing an audit
on a company under the CA94. It would need to understand the special nature of the
organisation and the relevant legislation and regulations, as well as considering any specific
guidance on the sector which has been developed by the accountancy profession. In addition to
reporting on the financial statements, the assurance firm may also be required to give a report
direct to a regulator, in accordance with instructions issued by the regulator.
As with an audit opinion on a company, the resulting opinion will usually give a positive assertion
about the ‘truth and fairness’ and ‘proper preparation’ of the financial statements. This report

156 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

also gives a high, but not absolute, level of assurance about the financial information. The opinion,
and any report to a regulator, may also refer to more specific matters such as the organisation’s
compliance with rules on accounting systems and record keeping, or compliance with solvency
rules set by the regulator. The report on these specific matters is a positive assertion about
compliance with these aspects of the rules, and will convey a high level of assurance to the
regulator and other readers of the information.
(iii) Other reports where the scope of the work and of the report to be provided are
agreed between the two parties
‘Other reports’ embraces the many other circumstances where an assurance firm is engaged by
another party to provide a report on a piece of information. The scope of the engagement is not
set down by regulation, so the assurance firm and the client must agree on the terms of
engagement. In particular, the engagement letter must specify
 The scope of the work to be performed by the assurance firm
 The form of report to be given by the assurance firm.
The level of assurance given by the final report will be dependent upon the amount of work
performed by the assurance firm and the agreed wording of the report. This can vary from a high
level of assurance (very extensive testing needed) to a limited level (less detailed examination).

40 Betta Networks Ltd

Marking guide
Marks

(a) Role of materiality 6

Problems 7
Marks available 13
Maximum 8
(b) Betta Networks:
Conclusion ½
Reasons 3½
Effect 1
Rayton:
Conclusion ½
Reasons 3
Viva:
Conclusion ½
Reasons 2
Effect 1
Marks available 12
Maximum 9
Total marks available 17

(a) The role of the concept of materiality in the conduct of an audit and why it can be a
difficult area for auditors
Role
A matter is material if its omission or misstatement would reasonably influence the decisions of an
addressee of the auditors’ report.

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 Section 4: Concluding and reporting on assurance engagements

Preliminary materiality is established at the planning stage and revisited at the completion stage in the
light of potential adjustments.
Materiality influences
 The nature, timing and extent of audit work
 Whether or not an error is corrected before the financial statements are published
 Whether an item/policy/change in policy is separately disclosed
 Whether the audit report is qualified.
Problems
The difficulties of the concept of materiality for the auditor arise from the following.
 The diverse nature of the addressees of audit reports.
 The fact that materiality is not capable of mathematical definition: it is both qualitative and
quantitative.
– It should only be considered in relation to context and not applied indiscriminately without
regard to the particular circumstances.
– It requires the use of professional judgement or is determined by a responsible individual.
Yardsticks are used in practice, e.g. % of pre-tax profit, % of assets etc (including the aggregation of
individually immaterial items) but these are not suitable for items which may be material by nature, e.g.
if the Companies Act requires an item to be accounted for or disclosed in a particular manner, it is
more likely to be regarded as material than an item for which there is no such requirement or where
a profit is turned into a loss or net assets into net liabilities.
Lower yardsticks may be required for unusual/non-recurring items.
(b) Type of audit report and reasons
Betta Networks Ltd
 Qualified/adverse audit report due to disagreement over accounting treatment.
 Since CU8.5m exceeds pre-tax profits, the matter is material.
 It is also likely to be considered pervasive as capitalisation of repairs and maintenance costs
results in a reported profit instead of a loss.
 An adverse opinion would probably therefore be given, as the accounts as a whole may be
considered misleading (pervasive).
 The report would state that the financial statements do not give a true and fair view with the
reason and the amount stated in a paragraph before the opinion paragraph.
Rayton Ltd
 An unqualified audit report would be given.
 This is because the difference between cost and NRV is CU60,000 (240,000 – 180,000). At 2.5%
of pre-tax profits this is unlikely to be considered material unless there are other uncorrected
errors.
Viva Ltd
 Qualified audit report due to disagreement over lack of disclosure.
 The size of the error is irrelevant as this is a related party transaction.
 An ‘except for’ report would be given as the financial statements otherwise give a true and fair
view.
 The reason and amount involved would be stated in a paragraph before the opinion paragraph.

158 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

41 Audit report phrases

Marking guide
Marks

(a) Independent auditors’ report 2

Which comprise 2
We do not accept responsibility to 2
Our opinion 1
In accordance with BSAs 2
Test basis 1
Reasonable assurance 2
Free from material misstatement 2
True and fair view 2
Registered auditors 1
Marks available 17
Maximum 13
(b) Each point 1
Maximum 4
Total marks available 17

(a) Meaning and purpose of underlined phrases

Independent auditors’ report
Shareholders appoint directors to run the company on their behalf. They want an independent report
to make sure that the directors are preparing the financial statements on a true and fair basis. An
auditor is appointed to go in and review on this basis.
The auditor must be independent of the company otherwise his report has no worth. He must be
unbiased, objective and not subject to any influence by the directors.
Financial Statements
The financial statements refer to the income statement, balance sheet, statement of changes in equity,
cash flow statement and notes. It is only these financial statements which are subject to audit.
The annual report which contains the financial statements also contains a great deal of other
information which is not subject to audit.
Some people may interpret financial statements in different ways. To clarify matters the audit report
states explicitly which pages contain the financial statements and hence what has been audited.
While the auditor has a professional duty to read the ‘other information’ to ensure that it is not
misleading, he does not need to audit it. This is stressed again in the ‘responsibilities’ section of the
report.
Our opinion
As explained above, the independent auditors’ report gives credibility to the financial statements. By
stressing that it is an opinion, the auditor conveys that judgement has been used and it is not a
guarantee that there are no errors whatsoever.
In accordance with Bangladesh Standards on Auditing
Auditing Standards are basic principles and essential procedures with which auditors are required to
comply. The fact that these standards have been followed gives users of financial statements
reassurance that high quality standards have been followed during the course of the audit, and the
audit has been conducted properly.

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 Section 4: Concluding and reporting on assurance engagements

On a test basis
Auditors do not test every single transaction during an audit, as this would be an inefficient way of
reaching an opinion. Auditors test a sample of transactions and use these results to draw conclusions
about whole populations. This is highlighted in the report to dispel the misconception that the auditor
checks everything.
Reasonable basis
An unqualified audit report is not an absolute guarantee that a set of financial statements is free from
all error. There is always a small audit risk that the wrong opinion has been reached.
It is not possible to be certain that there are no errors, since there are estimates in the financial
statements which involve the use of judgement. In addition, not all transactions have been tested, so it
is possible that some will be recorded incorrectly. However, the auditor will do sufficient work to give
a user reasonable assurance that the financial statements are true and fair.
A true and fair view
There is no formal definition of what ‘true and fair’ means. ‘True’ implies accurate and ‘fair’ implies
free from bias. The financial statements should not be misleading and all disclosures should be
adequate. Preparing financial statements in accordance with generally accepted accounting principles
will imply that they are true and fair. The auditor has a specific duty under the Companies Act to report
as to the truth and fairness of the financial statements.
Chartered Accountants
This demonstrates that the auditor is qualified, skilled and expert on the subject matter as well as a
member of a recognised supervisory body and therefore has the authority to perform an audit.
(b) Objectives of requiring unqualified audit reports to be published in a standard form
 To promote the use of common language to assist the user’s understanding of the meaning of the
report.
 To promote comparability between reports so it is easier to recognise when a report is qualified.
 To attempt to narrow the expectation gap – the difference between the public’s perception of
the auditor’s responsibilities and the legal and professional reality.
 To limit scope for litigation.
 To convey to the reader the nature and context of the audit opinion.
 To indicate the type of assurance concerning the financial statements the auditor feels is
warranted, based on the evidence obtained.

160 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

42 CCEP Ltd

Marking guide
Marks

(a) Completing a checklist 3

Final analytical review 2
Marks available 5
Maximum 4
(b) Each matter to consider 1
Maximum 6
(c) CCEP:
Conclusion ½
Reasons 2
Effect 1
Prime Volunteers:
Conclusion ½
Reasons 3
Effect 1
Worldwide:
Conclusion ½
Reasons 2½
Effect 3
Marks available 14
Maximum 10
Total marks available 20

(a) Reasons and benefits of completing a disclosure checklist and carrying out final analytical
procedures when conducting final checks on the financial statements
The completion of a disclosure checklist ensures that
 The financial statements have been prepared using acceptable accounting policies
 Disclosures in the financial statements are complete and appropriate
 The financial statements are in compliance with statutory requirements and accounting standards.
The checklist also
 Provides an efficient method of checking
 Provides a quality control procedure
 Ensures that information in the directors’ report is consistent with the financial statements.
By carrying out final analytical procedures the auditor
 Ensures the financial statements reflect his knowledge of the business
 Looks for any changes in ratios that are unexpected
 Checks consistency with the results of his other audit work
 Ensures that he has all the information and explanations to allow him to form an opinion on the
financial statements.

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 Section 4: Concluding and reporting on assurance engagements

Tutorial note
The maximum number of marks available for part (a) in the exam was 4 marks. The above answer reflects 5
marks worth of material.

(b) Matters to consider as part of a going concern review of CCEP

 Whether the going concern basis of preparation is appropriate.
 The adequacy of disclosures regarding going concern.
 Management’s plans to deal with any going concern threat and the likelihood of success of those
plans.
 Whether management has prepared budgets and cash flow forecasts for at least the next year.
 Whether forecasts indicate the ability of the company to pay debts as they fall due.
 Consider the reliability of previous budgets/cash flows and the proficiency of the preparer.
 Bank facilities and date of renewal.
 Ability to comply with terms of covenants in loan agreements.
 Forward order book/new customers.
 Ability to sell inventory at full price (forced sale of inventory).
 Recoverability of receivables (including timescale).
 Post balance sheet events which may indicate whether a tax liability will arise.

Tutorial note
The maximum number of marks available for part (b) in the exam was 6 marks. The above answer reflects
11 marks worth of material.

(c) Impact on audit report and explanation

CCEP Ltd
Type of report and reason
The report would be unqualified because
 Full disclosure has been given of the contingent liability
 Which is a material uncertainty which may affect the going concern status.
Effect on report
An additional ‘emphasis of matter’ paragraph should be added to the report, drawing users’ attention
to the note to the accounts with a specific statement that the report is not qualified in this respect.

Prime Volunteers Ltd

Type of report and reason
An adverse opinion should be given due to
 Disagreement over accounting treatment
 Of a material amount way in excess of profit
 Which is therefore likely to be pervasive to the financial statements.

162 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

Effect on report
 In an additional paragraph before the opinion paragraph state the reason (disagreement over
accrual for freehold property) and amount of CU170,000.
 In the opinion paragraph state that the financial statements do not give a true and fair view.

Worldwide Ltd
Type of report and reason
A qualified audit report should be given on the grounds of limitation on scope because
 Evidence reasonably expected to be available is not available in this instance
 The issue is material as it represents 60% of inventory.
Effect on report
 Give an ‘except for’ report if the matter is not pervasive.
 Give a disclaimer of opinion (‘we do not express an opinion’) if the matter is considered
pervasive.
 State that there was a limitation on scope in the basis of opinion paragraph.

Tutorial note
The maximum number of marks available for part (c) in the exam was 10 marks. The above answer reflects
14 marks worth of material.

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 Section 4: Concluding and reporting on assurance engagements

43 Vista Ltd

Marking guide
Marks

(a) Threshold 1
Expectation gap 4
Independence issues 4
Advantages of legal requirement 4
Disadvantages of legal requirement 4
Conclusion 1
Marks available 18
Maximum 12
(b) Each condition 1
Maximum 5
(c) Vista:
Conclusion ½
Reasons 3
Effect 1
Expo:
Conclusion ½
Reasons 3
Effect 3
Pharm:
Conclusion – disclosure adequate ½
Conclusion – inadequate disclosure ½
Reasons 3
Effect 2
Mog:
Conclusion ½
Reasons 2
Hubbard:
Conclusion – disclosure adequate ½
Conclusion – inadequate disclosure ½
Reasons 3
Effect 2
Marks available 25½
Maximum 20
Total marks available 37

(a) Value of an audit

Expectation gap
The audit profession currently defines an audit by reference to BSA 200 Objective and General Principles
Governing an Audit of Financial Statements. An auditor’s responsibilities are limited to those expressed by
statute or other authority.
The shareholder group and other users of the financial statements have always had a wider
expectation of the audit function. For instance, many people expect auditors to prevent and detect
fraud and all errors. There is also a belief that the auditors should give a guarantee as to the company’s
ability to continue as a going concern.
Deregulation of the audit would mean that auditors and their clients could reach mutual agreement on
responsibilities, thereby closing the ‘expectation gap’.

164 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

The APB has indicated that compromise on responsibilities is the most preferable outcome. However,
it would not be appropriate to extend the auditor’s duties to cover those which are already the
responsibility of management.
The users of financial statements must understand that prevention and detection of errors and fraud
and the ability of the company to continue as a going concern are management responsibilities. The
auditor is an independent expert forming an opinion, not the person performing the work in the first
instance.
Independence
The audit process arose from an independent review of the directors’ stewardship of companies in
which shareholders had invested. Other users of financial statements have come to regard the audit
opinion as credible because the auditors are separate from the persons responsible for preparation of
the accounts.
The Auditing Practices Board has taken responsibility for ensuring independence through the issue of
ethical standards, including the instruction to firms to rotate the engagement partners of listed
companies every five years.
It is unlikely that deregulating the audit function further will enhance independence. In fact it could
make the situation worse. The auditors would spend even more time with the directors and thereby
familiarity could potentially be increased.
Advantages and disadvantages of a legal audit requirement
Advantages
The existence of a statutory requirement for audit generally reflects the view that there is a public
interest in ensuring proper accountability by those who direct or manage companies.
The current statutory audit requirement (‘true and fair view’ and ‘properly prepared’) may be
regarded as the minimum statutory ‘benchmark’ for a company audit. Additional requirements can
then be contracted for, where cost is justified by benefit. An argument for such a benchmark for all
companies is that it provides a uniform and reliable quality of assurance (essential to public confidence
in auditing).
A further problem is that many auditors, at present, do not have the skills and experience necessary
for extending their role, for example in relation to value for money and forensic audits. The
professional bodies would need to educate and train auditors in such additional aspects.
Creditors and/or potential investors would still have the benefit of a statutory audit.
Disadvantages
The scope of the statutory audit cannot be flexible. A feature of the initial relaxation was that it gave
shareholders of the very smallest companies the option of not having an audit. Large businesses run by
professional managers, with highly developed internal audit operations and boards of independent non-
executive directors, have no choice. If the current statutory audit were abolished for these companies,
audit committees could agree audit scope to maximise value to their shareholders.
Companies with an effective internal audit department reporting to non-executive audit committees
could opt for a ‘light-weight’ audit concentrating on financial statement disclosures. If shareholders
thought it worth paying for, they could impose explicit obligations, for example, to detect fraud.
A further option may be a value for money (VFM) audit, which involves the assessment of
management’s performance in making the best use of the resources available, in terms of economy,
efficiency and effectiveness.
A VFM audit is already provided for local authorities.
All shareholders would, no doubt, welcome independent advice on the quality of their management.
However, an assessment would still need to be made as to whether the auditor had the requisite skills
to provide such a service.

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 Section 4: Concluding and reporting on assurance engagements

Auditors already provide advice on internal controls and their effectiveness, as part of their
management letter produced after the audit. This is already an important ‘value added’ output from
the audit process.
However, within the context of a statutory audit auditors may be inhibited from expressing all of their
concerns, especially those which are more judgemental, such as a view on management, as this could
widen their liability and increase the chances of litigation.
Conclusion
To bring the current statutory requirement to an end would not bring audits in ‘true and fair’ and
‘properly prepared’ terms to an end (as many companies would still think them worth having). As
neither the government, the accounting profession, large companies nor shareholders seem likely to
press for total abolition, the most likely scenario for the future scope of audit is a statutory minimum
audit with additional contractual agreements in the form of other assurance engagements.
(b) Companies Acts conditions for an unmodified audit report
 The financial statements give a true and fair view/are not materially misstated/are not misleading.
 The financial statements have been properly prepared in accordance with the Companies Act 1994.
 The directors' report is consistent with the financial statements.
 Information in respect of directors’ remuneration and transactions has been disclosed.
 The auditor has received all the information and explanations considered necessary for the audit.
 Proper accounting records (including returns from branches) have been maintained.
 The accounts are in agreement with the accounting records.
(c) Type of audit reports
Vista Ltd
 Qualify on grounds of a material disagreement.
 The matter is material as the amount of the loss exceeds the pre-tax profit.
 Give an ‘except for’ qualification if the matter is not considered pervasive/misleading.
 Give an adverse opinion if considered material and pervasive, i.e. the financial statements do not
show a true and fair view.
 An additional paragraph, in the opinion section, should include details of the reason for the
qualification and the impact on the financial statements.
Expo Ltd
 Qualify on grounds of a material limitation on scope, i.e. evidence reasonably expected to be
available is not available in this instance.
 The matter is material as it affects 75% of inventories.
 Give an ‘except for’ qualification if the matter is not considered pervasive/misleading.
 Give a disclaimer (of opinion) if considered pervasive/misleading (i.e. do not express an opinion).
Pharm Ltd
 Give an unqualified opinion if disclosure is adequate.
 Constitutes a material matter re going concern which should be highlighted as the matter is likely
to have a significant impact on the business.
 An emphasis of matter paragraph is required explaining the matter and stating that the opinion is
not qualified in this respect.
 If the note to the accounts is inadequate, qualify on the grounds of disagreement.

166 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

Mog Ltd
Give an unqualified opinion.
The write-down of inventory to its NRV would reduce profit by 4% and reduce net assets and
inventory by less than 1% each. It is therefore unlikely that the misstatement would be considered
material. The auditor might, however, be put on guard to ensure that CU35,000 is the maximum
misstatement and that all other categories of inventory are correctly valued. Significant departures
from accounting standards are required to be disclosed in the financial statements. Because the impact
on the financial statements of this accounting departure is limited, the auditor is unlikely to consider it
to be significant.
Hubbard Ltd
Give a modified but unqualified report.
The outcome of the legal action is still a long way off. At this stage the case has not come to court and
only limited facts are known.
This matter therefore constitutes a significant uncertainty. A provision will not need to be made in the
accounts but full disclosure should be given.
Providing the auditor is satisfied that the directors’ disclosure of the action is sufficiently detailed to
highlight all of the circumstances as they are known, no qualification will result though he should
consider modifing his report by adding an emphasis of matter paragraph drawing attention to the
uncertainty.
If, however, the auditor takes the view that the disclosure of the action in the notes to the accounts is
unclear, he should qualify his report ‘except for’ on the grounds of a disagreement as to the extent of
disclosure of a material fact.

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 Section 4: Concluding and reporting on assurance engagements

44 Ironco Ltd

Marking guide
Marks

(a) Each benefit ½

Maximum 4
(b) Each indicator ½
Specific procedures 3
Management discussion/confirmation 1
Implications for financial statements 4
Implications for report 3
Maximum 15
(c) (i) Loss of customer 1
Net current liabilities 1
Increase in inventories 2
Increase in receivables 2
Increase in borrowings 2
Increase in payables 3
(ii) Review of forecasts 2
Other points (each) 1
(iii) Unmodified report 1
Modified/unqualified 2
Modified - disagreement 3
Modified – limitation on scope 1
Maximum 19
Total marks available 38

(a) Benefits to the company and its management of having a full audit
 Enhanced credibility of the financial information/lack of bias.
 More reliable information results in more informed decisions.
 The audit may act as a deterrent to fraud/stop management abusing assets.
 Provides management with assurance that they are complying with statutory responsibilities/
information filed meets statutory requirements.
 By-products of the audit such as
– Identification of weaknesses and recommendations
– Reducing risk and improving performance.
 An audit imposes discipline (encourages best practice) which is useful when companies grow.
 When audit exemption limits are exceeded, may avoid
– The cost of extra work, and
– Potential future qualification over opening balances.
 Where a company has plans to sell the business/offer its shares publicly within the next few
years, audited accounts will assist that process (such an offering may not be possible without
audited accounts for the past three years).

168 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

(b) (i) Indicators of going concern problems

Ten from the following.
Financial indicators
 Net liabilities or net current liability position
 Necessary borrowing facilities have not been agreed
 Fixed-term borrowings approaching maturity without realistic prospects of renewal or
repayment, or excessive reliance on short-term borrowings
 Major debt repayment falling due where refinancing is necessary to the entity's continued
existence
 Major restructuring of debt
 Indications of withdrawal of financial support by creditors
 Negative operating cash flows indicated by historical or prospective financial statements
 Adverse key financial ratios
 Substantial operating losses or significant deterioration in the value of assets used to
generate cash flows
 Major losses or cash flow problems which have arisen since the balance sheet date
 Arrears or discontinuance of dividends
 Inability to pay creditors on due dates
 Inability to comply with terms of loan agreements
 Reduction in normal terms of credit by suppliers
 Change from credit to cash-on-delivery transactions with suppliers
 Inability to obtain financing for essential new product development or other essential
investments
 Substantial sale of non-current assets not intended to be replaced
Operating indicators
 Loss of key management without replacement
 Loss of key staff without replacement
 Loss of a major market, franchises, licence, or principal supplier
 Labour difficulties or shortages of important supplies
 Fundamental change in the market or technology to which the entity is unable to adapt
adequately
 Excessive dependence on a few product lines where the market is depressed
 Technical developments which render a key product obsolete
Other indicators
 Non-compliance with capital or other statutory requirements
 Pending legal proceedings against the entity that may, if successful, result in judgements that
could not be met
 Changes in legislation or government policy
 Issues which involve a range of possible outcomes so wide that an unfavourable result could
affect the appropriateness of the going concern basis

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 Section 4: Concluding and reporting on assurance engagements

(b) (ii) Auditors’ responsibilities in respect of going concern

The auditor has to satisfy himself that the financial statements have been prepared on the correct
basis, that is, that the company is a going concern. This will partly be satisfied by routine audit
work, such as ensuring that receivables are paying their debt after the year end but the auditor
will also carry out specific going concern procedures, such as:
 Reviewing the future plans of the business and budgets for the forthcoming year.
 Reviewing the company’s borrowing facilities and ensuring any related covenants will not be
breached.
 Reading relevant minutes and correspondence to ensure that there are no indications of
going concern problems.
The auditors should also discuss the going concern assumptions with management and obtain
written representations of their opinions.
BSA 570 requires the auditor to consider the appropriateness of management’s use of the going
concern assumption in the preparation of the financial statements because this has implications
for the basis of preparation of the financial statements and or disclosures in the financial
statements. If the going concern basis is not appropriate, then the break up basis will have to be
used and this will have to be disclosed in the notes to the financial statements. This will have
implications for the amounts at which items are included in the financial statements, in particular:
 Assets may need to be written down to recoverable amounts or reclassified
 Liabilities may need to be restated to reflect changes in amount or date of maturity
 Additional liabilities for losses may arise.
If there is a material uncertainty about the going concern basis, then there will be implications for
the audit report. If the uncertainty has been disclosed in the financial statements, the auditor will
issue an unqualified report but include an emphasis of matter paragraph drawing attention to the
disclosures on going concern.
If going concern uncertainties are not adequately disclosed or the financial statements are
prepared on an inappropriate basis, the auditor will issue a qualified audit report.
(c) (i) Matters which give cause for concern and why they give cause for concern
Loss of major customer/loss for year
 This will have an adverse impact on cash flow.
Current liabilities exceeding current assets
 The company may not be able to meet its debts as they fall due (going concern).
Increase in inventories – 22%
 This is despite the fall in revenue.
 There may be obsolete, slow moving or damaged inventory where net realisable value is
less than cost.
 There may be inventory relating to the lost customer which needs to be written down.
Increase in trade receivables – 11%
 Again, this is despite the fall in revenue.
 There may be possible bad/doubtful debts.
Short-term finance dependency/increase in borrowings – 21%
 Any overdraft may be called in at any time.
 The bank may foreclose if loan repayments are not repaid or interest is not paid.

170 © The Institute of Chartered Accountants in England and Wales, March 2009
 ANSWER BANK

Increase in trade payables – 4% /increase in tax payable

 Coupled with delayed payments to NBR.
 Creditors may petition for a winding up.
 Late payment of tax will attract penalties in the form of interest.
(ii) Post balance sheet review work
 Review profit and cash flow forecasts
– Assess whether the company can pay its debts as they fall due (in particular the loan
repayment), and
– Stay within its overdraft facility.
 Ensure compliance with any covenants.
 Review after date inventory movements/selling prices after the year end.
 Review after date receipts from receivables.
 Review after date sales/new contract agreements.
 Review actions by creditors/ensure relationships maintained.
 Monitor negotiations with prospective customers/bank.
(iii) The different types of audit report and the circumstances in which they are
appropriate
 Unqualified (with no modification) if the issues have been resolved and there is no uncertainty
about going concern.
 Unqualified with an emphasis of matter paragraph if uncertain about going concern but there
is adequate disclosure in the notes to the accounts. The emphasis of matter paragraph will
explain the situation and state that the audit report is not qualified in this respect.
 Qualified on the grounds of disagreement if
– Disclosure (note to accounts) regarding the uncertainty is inadequate
– Receivables or inventory are materially overstated
– The company is not a going concern and the directors insist on preparing the accounts
on a going concern basis.
 Qualified on the grounds of limitation on scope if evidence reasonably expected to be
available has not been obtained.

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 Section 4: Concluding and reporting on assurance engagements

172 © The Institute of Chartered Accountants in England and Wales, March 2009
REVIEW FORM – AUDIT AND ASSURANCE

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