Part III Audit of Operations and Balance Sheet Items

Chapter 13 Audit of Non-current Assets

Question 56
The firm of PQ & Co., in which you are employed as a junior audit trainee, is the external auditor of
Company A, which is an investment holding company. The audit manager in charge has asked you to
perform substantive procedures for the property, plant and equipment (PPE). The account clerk of
Company A provided the following schedule to you.

Leasehold Buildings Furniture & Motor Vessels

improvements fixtures & office vehicles
equipment
HK$000 HK$000 HK$000 HK$000 HK$000
Cost
At 1 April 2009 - - 1,935 1,724 13,997
Additions 3,323 2,217 146 600 -
Disposals - - (1,217) (524) -
At 31 March 2010 3,323 2,217 864 1,800 13,997

Depreciation
At 1 April 2009 - - 1,022 924 6,142
Provided for the year 646 89 74 900 2,799
Eliminated on disposal - - (620) (724) -
At 31 March 2010 646 89 476 1,100 8,941

Carrying value
At 31 March 2010 2,586 2,128 388 500 5,056
At 31 March 2009 - - 913 800 7,855

The above items of property, plant and equipment are depreciated on a straight-line method:

Leasehold improvements 5 years

Building 40 years
Furniture, fixtures and office equipment 5 years
Motor vehicles 3 years
Vessel 5 years

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Required:

(a) List out the substantive procedures you should perform on the furniture & fixtures &
office equipment. (10 marks)
(b) List out the audit work you should perform on the Vessels for the existence assertion and
rights and obligation assertion. (3 marks)
(c) You have just completed the analytical procedures.
(i) Excluding furniture & fixtures & office equipment, identify any issues with the PPE
schedule. (4 marks)
(ii) Explain how the issues can be resolved. (3 marks)
(HKIAAT PBE Paper III Auditing and Information Systems June 2010 Q3)

Question 57
The firm of VC & Co. in which you are employed is the external auditor of Company A which is a
company that operates a training centre providing IT engineers courses & photography courses. The
company leased a flat in a commercial building located in Mongkok under an operating lease. The
training centre promotes their IT engineers courses by providing powerful notebooks for students to
use in class. At the same time, photographic equipment is provided to students to use when attending
the classes of the photography courses. Recently, fewer and fewer students enroll on the photography
courses, the directors consider not to offer those courses in the coming future. The company adopts the
revaluation model for all the equipment.

Required:

(a) State and explain the assertions for the auditing of the account balances, additions and
disposals of notebooks and photographic equipment. (8 marks)
(b) What is inherent risk? (2 marks)
(c) What are the inherent risks for the auditing of the notebooks and photographic
equipment in this audit? (4 marks)
(d) What are the relevant assertions affected by these inherent risks? Explain. (6 marks)
(HKIAAT PBE Paper III Auditing and Information System June 2011 Q2)

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Question 58
FLK Limited is an existing client of ABC & Co, a CPA firm. FLK Limited has engaged in the
manufacturing business for more than 10 years. The company successfully developed a new product in
2011 and the board of directors determined to expand their business by investing in new machinery
and equipment. They acquired high valued machinery in 2011 and 2012 by means of finance leases. In
order to finance the launching of the product in more markets in 2013, the directors negotiated with
the bank for additional banking facilities. The bank requested the audited financial statements of the
company for such banking facilities approval. The directors proposed to ABC & Co an incentive
payment on top of the fixed audit fee for the successful application of the banking facilities.

Required:

(a) Should the audit firm, ABC & Co, accept the proposed incentive payment on top of the
fixed audit fee? Please explain. What are the threats to independence that may be created
to the audit firm, ABC & Co? (4 marks)
(b) What are the two major types of substantive procedures? Elaborate and provide one
example of each type for the auditing of the finance lease and interest expenses of FLK
Limited for the year ended 31 December 2012. (6 marks)
(c) What are the five assertions for the acquisition transactions for machinery? (5 marks)
(d) Describe five substantive audit procedures for the acquisition for machinery. (5 marks)
(HKIAAT PBE Paper III Auditing and Information System June 2013 Q2)

Question 59
HY Limited owns several (less than 10) expensive residential properties in Hong Kong and Mainland
China, all are used for earning rental income. This is the major operating activity of HY Limited. The
company is owned by six shareholders who engage two directors to operate the business. The director
plan to acquire more and more properties in the future, therefore, a lot of resources are allocated to set
up a good internal control system for the collection of rental income.

Required:

(a) Assess with reasons the inherent risk of material misstatement of the existence of HY
Limiteds investment properties. (2 marks)
(b) Assuming that the substantive approach is adopted, list four audit procedures that should
be performed in addressing the existence assertion of investment properties. (4 marks)
(c) The company adopts the Fair Value Model for the accounting of the investment properties.
The auditor has decided to use an experts services regarding the fair value of the
investment properties.

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 What matters should be agreed between the auditor and the auditors expert?
(6 marks)
(d) Assuming the substantive approach is adopted, what the audit procedures to be performed
for the rental income? (6 marks)
(e) Assuming the company maintained good internal control for the collection of rental
income, is it appropriate for the auditor to adopt the substantive approach for the audit of
rental income. (2 marks)
(HKIAAT PBE Paper III Auditing and Information System December 2010 Q4)

Question 60

What are the possible substantive procedures for the test of details of the acquisition of the new
karaoke system and the disposal of the old karaoke system? (7 marks)
(HKIAAT PBE Paper III Auditing and Information System December 2013 Q1(e))

Question 61 (20 marks approximately 36 minutes)

Fashion Limited is an existing client of ABC & Co. It has engaged in the clothing manufacturing
business for more than 10 years. The company successfully acquired all the shares of another
company, Trendy Limited, which operates clothing retailing chain stores, in cash. The consideration
paid is in excess of the fair value of the net assets of the company.

The board of directors of Fashion Limited determined to expand the companys business by opening
more shops in mainland China under the brand names of Trendy Limited. In order to finance the
launching of the new shops in the coming year, the directors negotiated with the bank for additional
banking facilities. The bank requested the audited financial statements of the company of current year
for such banking facilities approval. The directors proposed to ABC & Co an incentive system on top
of the fixed audit fee for the successful application of the banking facilities.

Required:

(a) Should the audit firm, ABC & Co, accept the fee arrangement with the proposed incentive
payment? Explain. (4 marks)
(b) What are the possible substantive audit procedures for the acquisition of Trendy Limited?
(6 marks)
(c) What are the possible substantive audit procedures for the auditing of purchased
goodwill? (4 marks)

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(d) The auditor has decided to use an experts services regarding the determination of fair
value of the assets of Trendy Limited.

What matters should be agreed between the auditor and the auditors expert? (6 marks)
(HKIAAT PBE Paper III Auditing and Information System June 2014 Q3)

Question 62 Tests of details of balances of non-current assets

(a) List out the steps for designing tests of details of balances of non-current assets. (5 marks)

(b) What audit procedures should be performed for the verification of carrying value of non-
current assets? (8 marks)

Question 63
Your firm is the auditor of Springfield Nurseries, a company operating three large garden centres
which sell plants, shrubs and trees, garden furniture and gardening equipment (such as lawnmowers
and sprinklers) to the general public. You are involved in the audit of the company's non-current
assets. The main categories of non-current assets are as follows:
(i) Land and buildings (all of which are owned outright by the company, none of which are leased)
(ii) Computers (on which an integrated inventory control and sales system is operated)
(iii) A number of large and small motor vehicles, mostly used for the delivery of inventory to
customers
(iv) Equipment for packaging and pricing products.

The depreciation rates used are as follows:

(i) Buildings 5% each year on cost

(ii) Computers and motor vehicles 20% each year on the reducing balance basis
(iii) Equipment 15% each year on cost

You are concerned that these depreciation rates may be inappropriate.

Required:

(a) List and explain the main financial statements assertions tested for in the audit of non-
current assets. (5 marks)
(b) Explain the main risks associated with the assertions relating to non-current assets.
(4 marks)

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(c) List the sources of evidence available to you in verifying the ownership and cost of:
(i) The land and buildings
(ii) The computers and motor vehicles. (10 marks)
(d) List the audit procedures you would perform to check the appropriateness of the
depreciation rates on each of the three categories of non-current asset. (6 marks)
(e) Describe the action you would take if you disagreed with any of the depreciation rates used
and explain the potential effect of the disagreement on your audit report. (5 marks)
(Total = 30 marks)

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 Chapter 14 Audit of Cash and Bank Balances

Question 64
You have worked on the audit for Company A for a few years and this year you are in charge of the
audit. A newly recruited accounting graduate who has no practical experience is assigned as your
assistant. You have already conducted tests of controls for the transaction cycles and control risks are
assessed as relatively low for these cycles. You decide the first task to set for your assistant is the
verification of cash at bank and in hand. A lead schedule stating all the bank balances and cash in hand
balance of the current and last years, bank statements and bank reconciliation statements are provided
by the client.

Required:

(a) The balance of cash account is relatively small compared to the balances of other assets.
Why is the audit of cash an important part of the audit? (4 marks)
(b) (i) List the audit objectives and related management assertions for cash at bank and in
hand. (4 marks)
(ii) List the audit procedures that should be performed on the bank reconciliation
statements. The items which appeared in the bank reconciliation statements are
mainly unpresented cheques and deposits in transit. (7 marks)
(c) To confirm the amount of the bank balances, bank statements are a reliable source of audit
evidence and no more further audit procedure is required.

Evaluate this statement by considering the circumstances under which evidence gathered
is in general considered to be reliable in accordance with HKSA 500 Audit Evidence.
(5 marks)
(HKIAAT PBE Paper III Auditing and Information Systems Pilot Q3)

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Question 65
Alex Horborn is the external auditor of Xiao Lo Ltd and is carrying out the audit of the financial
statements for the year ended 31 December 2001. He receives the following bank reconciliation
statement from an accounting clerk of Xiao Lo Ltd and is preparing to perform audit procedures (I) to
(VI).

Xiao Lo Ltd
Bank Reconciliation Statement at 31 December 2001
(HK Bank Account No. 123-456-001, Hong Kong Dollars Current Account)
$ $
Balance per bank (I) 23,750
Add: Deposits not yet credited by bank (II)
30 December 2001 62,000
31 December 2001 30,450 92,450
Less: Unpresented cheques (III)
No. 123256 80,000
No. 123457 40,000
No. 123458 30,000
No. 123459 1,400
No. 123460 20,000 (171,400)
Less: Items credit by bank (IV)
Direct credit by customer A 50,000
Direct credit by customer M 70,000 (120,000)
Add: Items debited by bank (V)
Autopay on electricity bills 750
Overdraft per cash book (VI) (174,450

Required:

(a) State the details of the audit procedures (I) to (VI). (6 marks)
(b) Give the reason for performing each of the audit procedures (I) to (VI). (6 marks)
(c) Apart from obtaining confirmation from bank on the balance per bank, state what other
audit evidence auditors can obtain from bank confirmation. (4 marks)
(d) What is the meaning of kiting? Suggest an audit procedure for the detection of kiting and
explain how it works. (4 marks)
(Total 20 marks)
(Adapted HKAAT Paper 8 Auditing December 2002)

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 Chapter 15 Audit of Operations and Other items of Statement of Financial Positions

Question 66
ABC Limited is an investment holding company. The company holds shares of several listed
companies and owns a property which was purchased several years ago and is used as its own office.
The company trades the shares of the listed companies frequently for profit. The company adopts the
cost model for the accounting of the property.

You are the manager in charge of the audit of ABC Limited for this year.

Required:

(a) What are the substantive audit procedures for the property held by the company?
(6 marks)
(b) What are the possible substantive audit procedures for the two assertions, occurrence and
cut off, of shares transactions? Provide one substantive audit procedure for each assertion.
(4 marks)
(c) What are the substantive audit procedures for test of details of the shares balances at the
year ending date? (10 marks)
(HKIAAT PBE Paper III Auditing and Information Systems December 2011 Q5)

Question 67 Rental income and deferred income

(a) Assuming the substantive approach is adopted, what are the audit procedures to be
performed for the rental income? (6 marks)
(b) Assuming the company maintained good internal control for the collection of rental
income, is it appropriate for the auditor to adopt the substantive approach for the audit of
rental income? (2 marks)
(HKIAAT PBE Paper III Auditing and Information Systems December 2010 Q4(d),(e))
(c) State FOUR substantive procedures for auditing deferred income (unearned income) and
state the audit objectives for the said procedures. (8 marks)
(HKIAAT PBE Paper III Auditing and Information Systems June 2011 Q1(c))

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Question 68
Sun Company Limited (Sun) is a company engages in the manufacturing and trading businesses.
Sun has different types of assets in its statement of financial position, and the asset items are as
follows:

(i) Land and building in HK and mainland China;

(ii) Motor vehicles;
(iii) Inventories in transit and in factory;
(iv) Investment in shares in private and listed companies presented as assets available for sale;
(v) Golf club membership;
(vi) Rental deposit paid;
(vii) Advances to employees; and
(viii) Cash at bank and in hand.

Required:

Design substantive procedures to test the existence assetion and the rights and obligations
assertion of the above assets. (20 marks)
(HKIAAT PBE Paper III Auditing and Information Systems June 2015 Q5)

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