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ACP7OFM10 (INT)

ACCA
Paper P7
Advanced Audit and Assurance
(INT)
Online Final Mock Examination
Question Paper
Time allowed
3 hours plus 15 minutes reading time
This paper is divided into two sections
Section A These questions are BOTH compulsory and must be attempted
Section B TWO questions ONLY to be attempted

Instructions:
Please attempt this exam under test conditions and attach the frontsheet complete with your name and address
to your script. The completed package should be sent to BPP Marking Department.
Take a few moments to review the notes on the inside of this page titled, Get into good exam habits now! before
attempting this exam.
DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER
EXAMINATION CONDITIONS
2
Get into good exam habits now!
Take a moment to focus on the right approach for this exam.
Effective time management
Watch the clock, allow 1.8 minutes per mark. Work out how long you can spend on each question
and do not exceed that time.
Take a few moments to think what the requirements are asking for and how you are going to
answer them.
Effective planning
This paper is in exactly the same format as the real exam. You should read through the paper and
plan the order in which you will tackle the questions. Always start with the one you feel most
confident about and take time to choose the questions you will answer in sections with choice.
Read the requirements carefully: focus on mark allocation, question words (see below) and
potential overlap between requirements.
Identify and make sure you pick up the easy marks available in each question.
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Section A - The following two questions are compulsory
1 Ridleys Bank
Ridleys Bank is a UK listed high street bank, with over 250 branches in the UK and twenty branches
across fifteen different countries in Europe. Ridleys Bank has both retail and corporate customers in the
UK and although it traditionally served its corporate customers only in Europe, this past year it has also
expanded operations and invested heavily in the retail markets. All customers are served through the
branches and the online banking service, www.ridleybank.com, the bank provides. The online banking
service was also launched in the last year after being planned and developed for the past three years.
Although it has been successful overall, it has encountered some security problems.
In terms of its retail customers, Ridleys Bank targets young professionals and families. It offers the
cheapest home and personal loans on the market and very competitive interest rates on credit cards.
The bank is currently reviewing the sustainability of offering these products on the market. Services
offered to corporate customers include banking, treasury and financial product services.
In order to finance further expansion, Ridleys Bank is considering issuing further shares or loans.
The banks head office is in London and it houses a well-resourced internal audit department. Internal
controls are effective overall but the banks name was recently mentioned in a high profile scandal last
year which involved a corporate customers involvement in money laundering.
This is the first year of the audit of Ridleys Bank.
Required
(a) Describe the audit risks involved in the audit of Ridleys Bank and the procedures required to
address those risks satisfactorily.
(15 marks)
(b) What particular financial statement risks are associated with the banks online facility and what IT
controls would you expect to find in operation?
(8 marks)
(c) What are the auditors duties with regards to money laundering and their audit clients?
(7 marks)
(Total: 30 marks)
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2 Hair Fashions
The directors of Hair Fashions are planning a management buy-out from their parent company Lambley
Products. Your firm has been asked:
(a) To review the audited accounts of Hair Fashions for the year ended 31 October 20X6, and
(b) To report on the accuracy of the profit forecasts and statements of financial position of Hair
Fashions for the following five years.
The accounts of Lambley Products and its subsidiaries are audited by another firm of accountants. From
your knowledge of the auditor's reputation, you believe there could be material errors in Hair Fashions'
audited accounts.
Hair Fashions buys hairdressing products from manufacturers and sells them to hairdressers mainly on a
cash basis, from about twenty retail outlets in large towns.
The management buy-out is expected to have the approval of Lambley Products, as Hair Fashions'
business is incompatible with the long-term plans of Lambley Products. However, the price for the
purchase of shares of Hair Fashions has still to be agreed.
The management is planning to finance the buy-out from their own resources and from funds provided by
financial institutions. It is expected that:
(a) The ordinary shares will be purchased by the directors and a financial institution
(b) The current account loan between Hair Fashions and Lambley Products will be repaid and be
replaced by loans to banks and financial institutions. Some of these loans will have the option of
conversion into equity at a later date.
The directors of Hair Fashions have prepared a business plan, which includes a profit and cash flow
forecast. A detailed monthly profit forecast and budgeted statement of financial position has been
prepared for the first year's trading, and an annual forecast income statement and statement of financial
position have been prepared for the following four years.
Assume that today is 1
st
February 20X7.
Required
List and describe the work you will carry out in:
(a) Reviewing the accounts of Hair Fashions for the year to 31 October 20X6, and, in particular:
(i) Checking the accuracy of the profit for the year, particularly the gross profit margin and
expenses (4 marks)
(ii) Checking the accuracy of valuation and the ownership of assets and liabilities in the
statement of financial position. (8 marks)
(b) Checking the company's profit forecast and statement of financial position:
(i) For the year after the management buy-out, including the differences you would expect
from the previous years' accounts (10 marks)
(ii) For the following five years. (3 marks)
(c) Given the inherent uncertainties associated with prospective financial information, discuss the
extent of the credibility and helpfulness associated with auditor assurance in this area.
(5 marks)
(Total: 30 marks)
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Section B Answer two of the following questions only
3 RH Manufacturing
Your audit firm has been invited to tender for the audit of RH Manufacturing, a private family-owned
company that is a leading computer parts manufacturer. Its customer base includes a significant number
of branded customers. The company has eighteen factory plants across the world and employs over
3,000 employees.
RH Manufacturing wish to change their auditor, as they believe that they are being overcharged for their
annual audit.
Required
(a) Discuss the likely reasons for the objections displayed by some companies about the cost of the
statutory audit.
(7 marks)
(b) How can existing auditors help their clients to keep audit fees at a level acceptable to the client?
(6 marks)
(c) What are the commercial and ethical implications of your firm lowballing on the audit fee in order
to secure the audit assignment for RH Manufacturing?
(7 marks)
(Total: 20 marks)
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4 Topper
(a) Critically evaluate the use of standardised auditors' reports included in ISA 700 Forming an
opinion and reporting on financial Statements. (5 marks)
(b) You are the manager responsible for the audit of four clients. The year end in each case is 30
September 20X6.
You are currently reviewing the working paper files produced by the audit teams and the seniors
recommendations for the auditors reports. Details are as follows:
(1) Topper, a limited liability company is a subsidiary of Laser, a public company. Serious
going concern problems have been noted during this years audit. It will be unable to trade
for the foreseeable future unless it continues to receive financial support from the parent
entity. A letter of support has been received from Laser.
The senior has suggested that, due to the seriousness of the situation, the auditors
opinion must be modified. (4 marks)
(2) The Chairmans statement of Mouse, a public company, states that property rental now
forms a major part of operating income. From the trading profit note in the financial
statements, property rental income represents only 0.4% of total revenue. The audit senior
is satisfied that the revenue figure in the financial statements is correct. He has noted the
discrepancy but states that, since the opinion in the auditors report does not extend to the
Chairmans statement, an unmodified opinion should be issued. (3 marks)
(3) During the year Rocky, a limited liability company, entered into the following transactions.
(i) A loan of $2,000 to Mr Wright, a director of Rocky.
(ii) A loan of $15,000 to Mr Oldfield, a director of Rocky.
Neither of these has been disclosed in accordance with IAS 24 Related Party Disclosures
in the companys financial statements. The audit senior suggests that, as the amounts are
small, an unmodified opinion should be issued. (3 marks)
(4) One of your clients, a global listed group, Mighty Group, has the following outstanding
points.
(i) It has decided not to consolidate the subsidiary, Minor, acquired during the year as
it claims that the subsidiary was purchased with the intention to only exercise
temporary control.
(ii) On purchasing another subsidiary Merry, Mighty Group has recognised negative
goodwill under Intangible Non-current Assets.
The audit senior suggests that the points above should lead to some change to the standardised
audit report, but is unclear what type. (5 marks)
Required
For each situation, comment on the suitability or otherwise of the seniors' proposals for the
auditors reports and specify the type of modification required, where it is required. Where you
disagree, indicate what kind of audit modification (if any) should be given instead.
The marks for each scenario are shown beside the seniors suggestions.
(Total: 20 marks)
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5 Auditor liability
Auditor liability is an ongoing issue affecting the auditing profession. A number of measures can be taken
by the auditors themselves and via statutory legislation to limit this liability.
Required
(a) Explain the need for a disclaimer letter to third parties and whether or not it affects the credibility
of the audit report.
(7 marks)
(b) What steps can be taken by the auditor to reduce the likelihood of a negligence claim?
(6 marks)
(c) A number of amendments to legislation have been proposed which would restrict the liability of
the auditor in the event of a negligence claim. Two such proposals are a move to Proportionate
Liability or Capping Liability. It has been argued that such proposals would end the auditor being
a scapegoat for management fraud and collusion. Describe the advantages and disadvantages of
the above auditor liabilities and discuss whether they would effectively address the problems
faced by auditors today.
(7 marks)
(Total: 20 marks)
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Student self assessment
Having completed this paper take a few minutes to consider what you did well and what you found difficult. Use
this as a basis to focus your future study on effectively improving your performance.
Common problems Future emphasis if you answer Yes
Timing and planning
Did you finish too early? Y/N Focus your planning time on generating more ideas.
Use models to help develop width to your thinking.
Did you overrun? Y/N Focus on allocating your time better.
Practise questions under strict timed conditions.
If you get behind leave space and move on.
Did you waffle? Y/N Focus your planning time on developing a logical structure to
your answer.
Layout
Was your answer difficult to follow? Y/N Use headings and subheadings.
Use numbering sequences when identifying points.
Leave space between each point.
Did you fail to explain each point? Y/N Show why the point identified answers the question set.
Were some of your workings unclear? Y/N Give yourself time and space to make the marker's job easy.
Content
Did you struggle with:
Interpreting the questions? Y/N Learn the meaning of question words (inside front cover).
Learn subject jargon (study text glossary).
Read questions carefully noting all the parts.
Practise as many questions as possible.
Understanding the subject? Y/N Review your notes/text.
Work through easier examples first.
Contact a tutor for help.
Remembering the notes/text? Y/N Quiz yourself constantly as you study. You need to develop your
memory as well as your understanding of a subject.






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ACP7OFM10 (INT)
ACCA
Paper P7
Advanced Audit and Assurance
(INT)
Online Final Mock Examination
Commentary, solutions and marking
scheme

2
Commentary
Tutor guidance on improving performance on the exam paper.
Q1 Ridleys Bank
This question deals mainly with audit risks present in the first year audit of a high street bank and how
these risks can be addressed. It also requires you to think specifically about the financial statement risks
presented by the recently-developed online banking facility as well as the IT controls you would expect to
find in operation, and the auditors duties with regards to money laundering.
Q2 Hair Fashions
This question deals with applying audit procedures to a non-statutory audit. The question is very practical
and requires you to think carefully about how to test historical and prospective financial information,
particularly items of income and expenses. You will also need to comment on the credibility of assurance
provided for prospective financial information.
Q3 RH Manufacturing
This question deals with the audit tendering and fee-setting process. To score well, you will need to
consider the commercial, ethical and practical implications of audit fee-setting.
Q4 Topper
This question deals with auditors' reports.
Section (a) of the question starts with basic knowledge of the auditor's report but then challenges you into
a discussion as to whether standard auditors' reports are sufficient.
To score well you must come up with some advantages, disadvantages and have a conclusion.
Section (b) tests detailed knowledge of the type of audit opinion which should be issued in a series of
questions.
Q5 Auditor liability
This question deals with auditor negligence, liability and the potential developments in legislation in this
area.
3
Section A
Q1 Ridleys Bank
Marking scheme
Marks
(a) For identification and full explanation of each audit risk.

For explanation of the procedures required to address each type of audit risk

1.5 each

1.5 each
15 marks
max

(b) Misstatement of software planning 1
Development costs and related amortisation 2
Website operational costs 1
Misstatement of Domain name cost accounting 1

IT controls
General controls (two) 2
Application controls (two) 2
8 marks

( c) Appoint MLRO 1
Implement internal reporting procedures 1
Train staff in legislation and auditor obligations on recognising money
laundering cases
2
Establish internal procedures to forestall and prevent money laundering 1
Verify the identity of new clients and maintain evidence of identification and
all client transactions
1
Report suspicions to relevant national authority (e.g. SOCA in the UK) 1
7 marks
30 marks
Suggested solution
(a) The audit risks and the procedures required to address them are set out below:
IR - The bank is listed and intends to list further shares or loans this is an inherent risk
(IR) as it may lead to manipulating the financial statements
Procedure Take steps to identify areas which are more subjective or subject to
management discretion
IR The bank has recently expanded operations to overseas countries which exposes it to
the specific business and market risks
Procedure Check the performance of these overseas units against expectations. Discuss
with management the issues encountered in the retail market in each territory.
CR The online banking facility has encountered some security problems in the past year,
indicating increased risk of controls (Control risk = CR) not being effective.
Procedure Discuss the nature and extent of the security issues and whether these
issues have since been addressed.
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IR Some services currently offered are of questionable sustainability
Procedure Discuss with management the financial effect of these services and how
changing the terms will affect the level of operations
CR The bank has a well-resourced internal audit department which may serve to reduce
control risk and create efficiencies in the audit process
Procedure Meet and evaluate the quality of the outputs and status of the internal audit
department and whether any reliance can be placed on their work
CR Money laundering case of a banks customer may indicate a lack of controls
effectiveness or legal compliance in this area. It may also mean that the bank has been
involved in money laundering.
Procedure Discuss with management the exact nature of the banks involvement (if this
has not already been done on client acceptance) and ascertain whether the controls in this
area have been improved
DR This is the first year of the audit of Ridleys Bank and so there is increased risk of
error on the part of the auditor (Detection risk = DR).
Procedure Ensure that a thorough planning process takes place to gather full information
on the client
(b) The financial statement risks with regards to the online banking facility include:
Website development costs Those costs that satisfy the condition of IAS 38 Intangibles
should be capitalised and amortised over the life of the website. All planning costs should
have been treated like research costs in the year they were realised. All website
development costs should have been capitalised and written off over the useful life of the
website (which the standard says should be short).
Domain name cost the cost of obtaining the domain name should be treated in the same
way as permission to use a licence capitalised and amortised.
The IT controls I would expect to find in operation are:
General controls: Around the protection of access to the banks records from unauthorised
persons/ hackers (firewalls) and access controls, so as to ensure only those authorised
have access to the website (through passwords, security checks, etc).
Application controls: Input and output controls - reasonableness triggers to ensure that
transactions inputted by customers are input correct and that they are sure they wish to
proceed. Items that appear outside the reasonable range should be checked on an
exception basis.
(c) The auditors duties with reference to money laundering legislation and to their clients are as
follows:
To appoint an internal MLRO and to design and implement internal reporting procedures
To train staff in the relevant money laundering legislation, how to recognise cases of
money laundering and the action they should take
To establish internal procedures to forestall and prevent money laundering that may affect
the audit office
To verify the identity of new clients and maintain all evidence of identification and all client
transactions
To report suspicions to the relevant national authority (e.g. SOCA in the UK)

5
2 Hair Fashions
Marking scheme
Marks
(a) (i) Reasonableness of gross profit margin 1
Reasons for variances 1
Compare other expenses to prior year 1
Depreciation charge 1
4
(ii) Inspect title documents 1
Check lease agreements on leasehold property 1
Check valuation of revalued properties 1
Check correct depreciation 1
Check assets owned and used by company 1
Inspect vehicle registration documents 1
Lease correctly treated 1
Ensure inventory count performed 1
Receivables circularisation 1
Supplier statements test 1
Check bank reconciliation/obtain bank letter 1
Parent company confirmation 1
Check tax liability to tax computation 1
Available 13
Maximum 8
(b) (i) Income Statement
Revenue reasonable 1
Gross margin review 1
Analytical review of other expenses 1
Internal consistency management charge, capital structure 3
Check directors remuneration for consistency 1
Statement of financial position
Value of non-current assets 1
Ageing of current assets 1
Other items 2
Available 11
Maximum 10
(ii) 1 mark per sensible well explained point to a maximum of. 3
(c) Assurance provided on PFI engagements covers:
Negative assurance as to whether the assumptions provide a
reasonable basis for the PFI
An opinion as to whether the PFI is properly prepared on the basis
of the assumptions and the relevant reporting framework
Appropriate caveats as to the achievability of forecasts
1

1

1
How credible and helpful?
Very credible and helpful as provide an insight to the reader on the
forecast results, as reviewed by an independent auditor
Not so credible and helpful given the limited nature of the review
and the caveats in place.

1


1
max 5
Maximum for the question
30

6
Suggested solution
(a) (i) Accuracy of the income statement
(1) I will check the reasonableness of the gross profit margin as compared with
previous years. Planned gross profit may differ from that actually achieved for
various reasons, such as the selling of inventory at a discount, wastage greater
than planned, misappropriation of inventory, or cut-off errors.
(2) I will compare other expenses incurred with those incurred in previous years in
order to check they are reasonable. Any unusual fluctuations or differences will be
investigated. Depreciation charges made should be reasonable. Any categories of
expenses included in previous years but omitted in the year under review should
be subjected to investigation.
(3) It should be noted that management charges and interest in the current account
balance will affect any comparison with the profit forecast for the period after the
change in ownership.
Most of the errors discussed in the answer to part (ii) will also have an effect on the income
statement but are not separately discussed in the answer to this part.
(ii) Accuracy of valuation and the ownership of assets and liabilities in the statement of
financial position
(1) For land and buildings, I will check ownership of the properties by inspection of the
title documents, ensuring that the company's name is shown in any registration
certificates and the most recent conveyance.
(2) I will check leases on leasehold properties, and ascertain the date of the next rent
review to check against figures included in the profit forecast. Properties may be
inspected in the course of branch visits. The valuation of properties at cost or at
professional valuation should be checked.
(3) I will also check that the properties are being depreciated over their estimated
useful life or over the term of the lease (if shorter).
(4) I will check that the value of non-current assets appears reasonable. I will check on
branch visits that a sample of the non-current assets included in the non-
current asset register are in the custody of and are being used by the company.
Any obsolete non-current assets should be written down to their impaired value.
(5) I will select a sample of motor vehicles from the non-current asset register and
inspect the vehicle registration documents, ensuring the company's name
appears on the document. On branch visits, I will check that a sample of the motor
vehicles appears to be in use.
(6) For non-current assets which are leased or are being bought on hire-purchase
terms, I will examine the leasing agreements in order to ascertain whether the
leases are finance leases or operating leases. I will check that the assets have
been treated in accordance with IAS 17 Leases, which provides that assets
purchased under finance leases should be capitalised.
(7) I will check that a complete physical inventory count has been performed, and
that the procedures adopted will ensure accuracy of the count and correct cut off.
(8) I will check that reconciliation of the total of individual receivables' accounts with
the receivables ledger control account, and carry out a positive circularisation of
receivables. I will review the allowance for doubtful debts for reasonableness, and
review the ageing of receivables and amounts of cash received after the year end
as shown in the cash book. Prepayments will be reviewed for reasonableness.
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(9) Suppliers' statements will be reconciled to payables' accounts in order to
check whether invoice accruals are reasonable. Accruals will be checked for
omissions and for reasonableness.
(10) I will check the bank reconciliation and send a standard letter to the bank
requesting confirmation of the balance and of any loans outstanding.
(11) I will arrange for a letter to be obtained from the parent company confirming their
current account balance, and will obtain confirmation of any dividend to be paid to
the parent company.
(12) I will check the companys tax computation in order to confirm the tax liability
shown.
(b) (i) Are the forecast income statement and statement of financial position realistic and
achievable?
Income Statement
(1) I will check that levels of revenue appear reasonable in the light of seasonal
factors and in comparison to previous years' revenue figures, taking into account
any planned expansion or contraction of operations, inflation and anticipated
inflation.
(2) I will review gross profit margin in comparison with recent years' experience: any
significant change should be discussed with the directors.
(3) I will check other expenses for reasonableness by comparing with previous years
and investigating any significant fluctuations or changes in the expenses included.
(4) In the budget, no management charge to the current parent company will be
required, but it is possible that more staff may need to be employed to carry out
work now done by the parent company. The capital structure of the new business
should be considered. Finance charges may increase because of a reduction in the
security on loans. Dividends may need to be paid following the buy-out.
(5) Directors' remuneration should be checked for reasonableness. The directors
may include a bonus in their remuneration package. They will have the extra
expense of interest charges to pay from their salaries or other personal income.
Statement of financial position
(1) I will check that the value of non-current assets appears reasonable, allowing for
the effects of additions and disposals.
(2) I will check whether there is any significant change in the age of inventory,
receivables or payables compared with before the sale.
(3) I will check other items in the statement of financial position for reasonableness,
including the bank overdraft and loans.
(ii) Work carried out on the following four years' budgeted accounts will be similar to that
described above in part (b)(i).
Again, the level of revenue will be checked as to its realism and apparent achievability, taking the
effects of projected inflation into account. It will be necessary to ascertain the plans of the
directors in order to see what expansion or contraction of operations is intended.
(c) Assurance provided on PFI engagements covers:
Negative assurance as to whether the assumptions provide a reasonable basis for the PFI
An opinion as to whether the PFI is properly prepared on the basis of the assumptions and
the relevant reporting framework
8
Appropriate caveats as to the achievability of forecasts
With respect to the credibility and helpfulness to the user:
The assurance is very credible and helpful as it provides an insight to the reader on the
forecast results, as reviewed by a professional accountant
The assurance is not so credible and helpful given the limited nature of the review and the
caveats in place.
9
SECTION B
3 RH Manufacturing
Marking scheme
Marks
(a) Reasons for price sensitivity:
For each well-explained point 1.5
max 7
(b) Auditors can help the clients keep the audit fee low by:
For each well-explained measure to keep fees low 1
Max 6
(c) Implications of lowballing:
For each well-explained point 1.5
max 7
Total 20
Suggested solution
(a) The likely reasons for such objections on the part of the client include:
Audit regarded by some companies as a commodity
Unhelpful especially for private companies who do not report to the public
Audit may not be perceived as value for money unlike other consulting services
Audit fee may be regarded as uncompetitive
In times of economic recession, audit fee is expected to fall
Audit is not regarded as wealth creating
(b) Auditors can help to keep the audit fee at an acceptable level, by:
Cooperating with the companys internal audit department (if one exists) as much as is
possible
Advising the client to improve its internal control systems so as to enable reliance on
internal control systems, reducing substantive procedures
Explaining the fee structure to the client so that there is no misunderstanding
Highlighting the areas to the client where the auditor adds value and hence removing the
perception that the audit is simply a necessary evil
Advising companies to simplify their structures to keep the audit fee low
Advising clients to use one audit firm to maximise any efficiencies
(c) Commercial implications:
Distorts the market for audits, meaning that fees and resources required to earn them are
not matched
Forces smaller audit firms out of tender processes (as they do not have the efficiencies or
profits from other areas to cross-subsidise audits).
Ethical implications:
Affects the independence of the auditor, as lowballing a client may be done with the
intention to gain profits from other services
Client may have a distorted impression about the extent of audit work required
The auditor may carry out the audit with less than the due skill and care required.
10
4 Topper
Marking scheme
Marks
(a) Standardised auditors reports:
easy to follow/familiar
common language
ensure all items mentioned/expectation gap
inflexible
won't read same as last year
conclusion

Credit should be given for all sensible arguments
1 mark should be awarded for a clearly explained point
(half marks may be awarded) Max 5
(b) (1) Topper
No letter of support
modified opinion
material misstatement (disagreement)
going concern issues
adverse/material and pervasive

Letter received
sufficient appropriate evidence
can parent support Topper?
unmodified + emphasis of matter paragraph referring to note
insufficient disclosure?
qualified 'except for'

Doubts over ability to finance subsidiary
significant uncertainty
Unmodified + emphasis of matter paragraph referring
to note discussing doubt

if doubt inadequately disclosed qualified 'except for'

Conclusion
opinion unmodified, possibly + emphasis of matter
paragraph


Generally 1 mark per developed point to a maximum of 4 marks
(half marks may be awarded)

Max

4
(2) Mouse
no opinion given on Chairmans statement
ISA 720 (need to consider effect of material inconsistencies)
0.4% not the same as major = material inconsistency
reworded/resolved unmodified, no comment
not resolved unmodified but other matter paragraph
conclusion

Generally 1 mark per developed point to a maximum of 3 marks
Specific mention of ISA 720 scores mark
(half marks may be awarded)
Max 3
11

(3) Rocky
duty to check disclosure in accordance with ISA 550
IAS 24 requires disclosures re: key management personnel
materiality zero for sensitive areas such as directors
not disclosed = qualified except for
material misstatement over inadequate disclosure
detail included in explanatory paragraph
conclusion
Specific mention of ISA 550 and IAS 24 scores mark each
Generally 1 mark per developed point to a maximum of 3 marks

(half marks may be awarded)

3

(4) Mighty
subsidiary acquired with the intention to sell has exemption from
IAS 27 and consolidation
1
Provided it satisfies the conditions of IFRS 5 1
Under IFRS 5, the asset should be classified under Current
assets
1
If IFRS 5 is satisfied, then no modification is required 1
BUT Any form of control leads to consolidation surely? Further
discussion with client suggested?

1
Negative Goodwill per IFRS 3 should be rechecked for
occurrence
1
If confirmed, should be credited directly to Income Statement 1
Modification is required opinion should be qualified on grounds
of material misstatement
1
Specific mention of reporting standards scores mark each
Max 5

Total 20
Suggested solution
(a) Standardised auditors' reports assist the reader by helping them to follow and understand the
content of the report. In particular the use of common language, with which the user should be
familiar, aids the understanding of the report.
A standardised auditor's report ensures that all necessary areas of content have been included,
for example details of auditor's responsibilities, and information regarding the basis of opinion, in
addition to the actual opinion. This helps to address the problem of the expectation gap.
Standardised auditors' reports are, on the other hand inflexible and cannot be tailored to specific
circumstances. In most situations this should not cause problems, however unusual
circumstances may warrant the provision of additional information which a standardised auditor's
report cannot incorporate.
Although readers should be aided by standardised auditors reports the use of a standard report
may result in the user not thoroughly reading the report in the belief they know what it contains
and under the impression that it is the same as in previous years. Readers may therefore miss a
modification or an explanatory paragraph.
To conclude, the advantages arising from the use of standardised auditors' reports outweigh the
limited drawbacks.
12
(b) (1) Topper
If a letter of support had not been received, then an auditor's opinion modification on the
grounds of material misstatement (disagreement about the appropriateness of the going
concern presumption) would be required. An adverse opinion would be appropriate if the
effect of this misstatement was considered both material and pervasive (the financial
statements are seen to be seriously misleading because the company is not considered a
going concern at the reporting date, i.e. will not continue to trade for more than one year
from that date due to lack of finance).
However, the company has received a letter of support from its parent to the effect that it
will enable Topper to continue trading. If this evidence (together with other evidence, such
as management representations) is considered sufficient and appropriate to support the
appropriateness of the going concern assumption, a modified opinion will not be
necessary (provided that the support is adequately disclosed in a note to the financial
statements) but the audit opinion may require an emphasis of matter paragraph to
highlight this note (stating that the opinion is not qualified in this respect). If the evidence
is sufficient and appropriate but the disclosure inadequate, a qualified
"
except for
"

opinion based on material misstatement (disagreement) over disclosure is required.
If there are doubts about Lasers ability to provide the required finance, the significant
uncertainty arising would be highlighted by adding an emphasis of matter paragraph at
the end of the auditors report (i.e. after the opinion) referring to the note to the financial
statements discussing the letter of support and the doubts over the future finance. This
would still be an unmodified opinion, but highlighting the significant uncertainty to the user.
If the disclosure of the doubt over finance was considered inadequate though, a qualified
opinion would then be necessary.
Conclusion
The audit seniors proposal is unsuitable. The audit opinion should be unmodified
(assuming that disclosures are adequate and the support letter is genuine). An emphasis
of matter paragraph will probably be necessary as well to draw attention to this issue,
regardless of the circumstances.
(2) Mouse
The auditor expresses an opinion on the truth and fairness of the financial statements
(i.e. income statement, statement of financial position, cash flow statement and associated
notes), of which the Chairmans statement is not a part. However, it is an implied opinion
of an unmodified auditor's report that the Chairmans statement is not inconsistent with the
financial statements.
Under ISA 720 The auditors responsibilities relating to other information in
documents containing audited financial statements, if there is 'material
inconsistency' between information in the Chairmans statement and the financial
statements, as in this case, the auditor needs to consider the effect on the auditor's report.
Clearly,
"
major
"
is inconsistent with 0.4% and gives a misleading view of the state of the
company.
If the inconsistency is resolved (e.g. because the Chairmans statement should state
"
...
major part of other income ...
"
and is corrected) an unmodified opinion will be given.
If the inconsistency is not resolved, the auditor should report any uncorrected information
in the Chairmans statement in an other matter paragraph which should be added after
the opinion paragraph to highlight the issue. This does not affect the auditor's opinion.
If such a material error had been in the financial statements themselves, this would result
in a modified opinion over material misstatement if not corrected - the extent of this would
have depended on the circumstances, but is likely to have been material but not pervasive,
leading to a qualified except for opinion.
13
Conclusion
An unmodified opinion on the financial statements is appropriate. If, however, the
inconsistency is not resolved, it should be reported in an other matter paragraph.
(3) Rocky
The auditor has a responsibility under ISA 550 Related Parties to ensure that all
transactions with directors, which require disclosure under IAS 24 Related Party
Disclosures, have been adequately disclosed.
Consequently, the details of the loans of $2,000 to Mr Wright and of $15,000 to Mr Oldfield
should be disclosed in the financial statements of Rocky as key management personnel
are related parties under IAS 24. The amounts may be considered immaterial, but
materiality is reduced to zero when dealing with sensitive transactions such as directors'
transactions.
If these details are not fully disclosed, then it is the auditors responsibility to detail the
missing information in an explanatory paragraph in the auditor's report. The opinion would
be qualified

except for

on the grounds of material misstatement or disagreement over


disclosure.
Conclusion
The audit seniors proposal is not suitable. If the necessary disclosures are not made by
the client, the auditor's opinion should be modified ("except for") due to material
misstatement over inadequate disclosure.
(4) Mighty
The decision to not consolidate a subsidiary on the grounds that only temporary control is
exercised is acceptable under the provisions of IFRS 5, Non-current assets Held For
Sale, provided the conditions of accounting under IFRS 5 are satisfied. The main
conditions include managements commitment to sell the subsidiary within twelve months,
the active search for a buyer, the active marketing of the subsidiary, the sale should be
probable and the subsidiary should be available for immediate sale. If all these conditions
are satisfied, then the subsidiary held for sale should be classified under Current Assets.
It could be argued that any form of control indicates a desire to make use of the subsidiary
for more long term purposes than making a profit on immediate resale, so consolidation is
the only option - perhaps discussions with the client to clarify their intentions would be
more appropriate before deciding on the most appropriate form of audit report.
Accounting for negative goodwill as a negative asset is unacceptable per IFRS 3
Business Combinations. Where negative goodwill is calculated, IFRS 3 stated that this
calculation should be checked for accuracy. When the amount of negative goodwill is
confirmed, this amount should be credited to the income statement as a non-recurring gain
a bargain.
Given the above, there appears to be material misstatement (disagreement) on the basis
of the accounting for negative goodwill. If this matter is not resolved with management, an
explanatory paragraph will need to be added to the audit report (before the Opinion
paragraph). The opinion will also be qualified (except for).
Conclusion
The audit seniors proposal is correct for the second case only. The auditors opinion
should be qualified on the grounds of material misstatement.
14
Q5 Auditor liability
Marking scheme
Marks
(a) Duty of care owed to shareholders 1
No implied duty of care to those with whom there is no contract (Caparo) 1.5
Despite the Caparo case, other stakeholders continue to place reliance 1.5
Banks and other lenders often depend on audited accounts to continue
financing or issue fresh financing. This is known to auditors and a duty of
care is thus created
1.5
A disclaimer is one way the auditor can disclaim responsibility to parties
other the direct contractual party, namely the shareholders
1.5
Disclaimers do however have the effect of reducing the credibility of
audited accounts overall
1.5
7

(b) 1 mark for each well-explained step to avoid litigation 6

(c) Current situation auditor easy target and amount of claim not restricted 2
Explanation of proportionate liability
Advantage and disadvantage
3
Explanation of capping liability
Advantage and disadvantage
3
7
Total 20
Suggested solution
(a) The auditor only owes a duty of care to parties other than the audit client if one has been
established. Hence, where third parties have no contract with the audit firm, there is no implied
duty of care (e.g. in the UK Caparo). However, the fact that audited accounts are filed means that
the public and other stakeholders apart from shareholders (suppliers, customers, employees,
bankers), continue to place reliance. The case with bankers is further complicated by the fact that
loans and overdrafts often depend on audited accounts and auditors are aware of this
dependency. As such, where the auditor knows that such a reliance exists, they can issue a
disclaimer to alert readers that the auditor will not accept any responsibility from any perceived
duty of care other than those established already.
The ACCAs Council has a point of view on this matter, that the standard feature of a disclaimer
on the audit report could devalue the report, hence directly reducing the credibility associated with
the report.
(b) The auditor can take the following steps to avoid litigation:
Enforce more thorough client screening procedures at the stage of Client Acceptance
Ensure that the engagement letter is effectively communicated to the client to avoid future
misunderstandings
Train staff in updates in the auditing standards so that the latest auditing and accounting
standards and best practice is applied
Apply quality control procedures to each individual assignment
Apply quality control on an overall firm basis
Issue disclaimers where appropriate to limit the exposure of the auditor
15
(c) It appears that the current legislation has lent itself to many negligence claims against auditors for
considerable amounts that has even lead to their collapse as firms. When a scandal takes place
at a company and shareholders are defrauded, shareholders often look to the auditor to shoulder
the blame, even though they may not be entirely at fault for the fraud that has taken place.
Despite this the payouts sought are often for 100% of the blame.
Proportionate liability goes some way to address this issue as claims arising from successful
negligence claims are split between the auditors and the company directors, the split being
determined by a judge on the basis of where the fault is seen to lie. This has the advantage of
according to the auditor no more than his share of the blame (and payout). The disadvantage is
that there are some difficulties faced with regards to measuring how the blame is split and what
the respective financial liability is.
Capping the auditors liability would set a maximum limit on the amount that the auditor would
have to pay under each claim. This would have the advantage of creating some certainty with
regards to the worst possible liability, which would also facilitate the level of professional
insurance taken. One disadvantage relates to the level of the cap. If it is too low, it may act as a
disincentive to sue and may affect audit quality in the long run.
Although neither of the above mechanisms have been adopted explicitly within UK legislation, for
example, the UK Companies Act 2006, does allow for liability limitation agreements between
the auditor and his client. This would mean that the agreement between the auditor and his client
would specify the type of liability in place and it would be authorised by shareholders accordingly.
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