Professional Documents
Culture Documents
Assurance
(INT)
Course Note
2017
1
Lesco Group Limited, April 2018
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the prior written
permission of Lesco Group Limited.
2
CONTENTS
CHAPTER1 ............................................................... 4
3
Chapter1
Before the engagement services
Contents
ETHICS ............................................................................... 28
EXAMPLE OF ISA250........................................................... 42
4
Advertisement issues
Rules Explanation
Any comments about the scale of the firm should
Evidence backed up be backed up with numbers such as number of
offices.
Cant criticise others such as Cant say for example, dont use the service from
competitors our competitors.
Ensure to comply with laws Advertisement cant break the laws and
regulations.
5
Advertising Case:(DEC2010 Q4) Neeson&Co
If you are unhappy with your auditors, we can offer a second opinion
on the report that has been given.
Introductory offer: for all new clients we offer a 25% discount when
both audit and tax services are provided. Our rates are approved by
the ACCA.
Required:
Evaluate each of the suggestions made above, commenting on the
ethical and professional issues raised.8marks
Answer to Neeson&Co
Back up
Definitely clear
The second opinion offered by Neeson&Co may imply that the audit
work done by Neeson&Co is low and as a result client would not be
happy with the first opinion given and hence second opinion would be
6
issued again. Also this comment in the advertisement is not
professional.
Fundamental ethics
Legal obligation
Low balling
The 25% of introductory fees is low balling and its not prohibited but
Neeson&Co need to make sure by charging such a low amount of fees
the quality of the work can be maintained, i.e., following ISAs to do
the audit work.
7
Advertising Case:(June 2004)Hawk Associate
(4marks)
Money back guarantees may mean they can help the company
save tax and if not they would give money back to them and this
will:
8
Tendering document
Our background
Our quality
The way we do the work is following ISAs.
What does the client require (e.g. services from audit
firm)?
Audit fees
How would you estimate the fee to include in a tender?
9
Professional appointment issues
Reputation of client If the auditors work for a client with a bad reputation
then this would damage the audit firms reputation
as well.
You are a senior manager in Unicorn & Co, a global firm of Chartered
Certified Accountants, with offices in over 150 countries across the
world. Unicorn & Co has been invited to tender for the Dragon Group
audit (including the audit of all subsidiaries). You manage a
department within the firm which specialises in the audit of retail
companies, and you have been assigned the task of drafting the
tender document. You recently held a meeting with Edmund Jalousie,
the group finance director, in which you discussed the current group
structure, recent acquisitions, and the groups plans for future
expansion.
Group structure
12
(ii) Minotaur Co, a large company, whose operations are distribution
and warehousing. This represents a diversification away from retail,
and it is hoped that the Dragon Group will benefit from significant
economies of scale as a result of the acquisition.
Other matters
The acquisitive strategy of the group over the last few years has led to
significant growth. Group revenue has increased by 25% in the last
three years, and is predicted to increase by a further 35% in the next
four years as the acquisition of more subsidiaries is planned.
The Dragon Group has raised finance for the acquisitions in the past
by becoming listed on the stock exchanges of three different
countries. A new listing on a foreign stock exchange is planned for
January 2010. For this reason, management would like the group
audit completed by 31 December 2009.
Required:
(a)Recommend and describe the principal matters to be
included in your firms tender document to provide the
audit service to the Dragon Group. (10 marks)
Professional marks will be awarded in part (c) for the clarity and
presentation of the evaluation. (4 marks)
Answer to June2009 Q2
(a)
Recourses
13
Detailed background of our firm should be included for example the
expertise and clients we serve.
Clients needs
We have offices in over 150 countries across the world so we can deal
with audit with your subsidiaries all around the world more effectively.
Extra benefit
Fees
Fees should be broken down into how its calculated by clearly laying
out different classes of staff involved, such as hourly rate for audit
manager and partner.
(b)
Overdue fees
Where a client hasn't paid their fees which have been outstanding for
some time and such overdue fees would be seen as a loan to the client
which may cause a self-interest threat, i.e., in order to keep the loan
the auditor may issue whatever opinion that client wants so that a
safeguard for this is not to seek re-election.
14
Resources
As the company expands the audit firm may not have enough
resources to do the audit any more. Such as the company is listing on
a stock exchange and the audit firm has a lack of relevant experts who
know the regulation of the stock exchange and so the firm may not
seek re-election.
Integrity
Conflict of interest
Another company is waiting for our firms tender but they are
competitors and if we audit both companies which would cause a
conflict of interest so we should resign the first company as by
continuing to be an auditor for this company would damage our firms
reputation.
(c)
Recourses
Management integrity
Previous auditor
Experiences
Time
There will only be 3 months for Unicorn&Co to complete the audit and
Unicorn&Co should consider whether to allocate more resources to
this engagement given this client is large and it needs to spend more
time on it.
16
Case: (June2008Q1(c)) Issues to consider
You are a senior audit manager in Mitchell & Co, a firm of Chartered
Certified Accountants. You are reviewing some information regarding
a potential new audit client, Medix Co, a supplier of medical
instruments. Extracts from notes taken at a meeting that you recently
held with the finance director of Medix Co, Ricardo Feller, are shown
below:
Company background
A considerable revenue stream is derived from agents who are not employed by
Medix Co. The agents earn a commission based on the value of sales they have
secured for Medix Co during the year. There are many suppliers into the market
and agents are used by all manufacturers as a means of marketing and
distributing their products.
The company has a bank overdraft facility and makes use of the facility most
months. A significant bank loan, which will carry a variable interest rate, is
currently being negotiated. The terms of the loan will be finalised once the audited
financial statements have been viewed by the bank.
After receiving permission from Medix Co, you held a discussion with
the current audit partner of Medix Co, Mick Evans, who runs a small
accounting and audit practice of which he is one of two partners. Mick
told you the following:
Medix Co has been an audit client for three years. We took over from
the previous auditors following a disagreement between them and the
directors of Medix Co over fees. As we are a small practice with low
overheads we could offer lower fees than our predecessors. We could
also do the audit very quickly, which pleased the client, as they like to
keep costs as low as possible.
During our audits we have found the internal systems and controls to
be quite weak. Despite our recommendations, there always seemed
to be a lack of interest in making improvements to the accounting
systems, as this was seen to be a waste of money. There have been
two investigations by the tax authorities, which we did not deal with,
as we are not tax experts. In the end the directors sorted it all out,
and I believe that the tax matter is now resolved.
We are resigning as auditors because the work load is too much for
our small practice, and as Medix Co is our only audit client we have
decided to focus on providing non-audit services in the future.
You have also found a recent press cutting regarding Medix Co:
18
Extract from local newspaper business section, 2 June 2008
It appears that local company Medix Co has breached local planning regulations by
building an extension to its research and development building for which no local
authority approval has been given. The land on which the premises is situated has
protected status as a greenfield site which means approval by the local authority
is necessary for any modification to commercial buildings.
A representative of the local planning office stated today: We feel that this is a
serious breach of regulations and it is not the first time that Medix Co has
deliberately ignored planning rules.
The company was successfully sued in 2003 for constructing an access road
without receiving planning permission, and we are considering taking legal action
in respect of this further breach of planning regulations. We are taking steps to
ensure that these premises should be shut down within a month. A similar breach
of regulations by a different company last year resulted in the demolition of the
building.
Required:
19
Answer: June2008 Q1(c)
Briefing notes
To: Audit partner
Introduction
Because this is the last month before the financial statement year end
we would question whether we have enough time to quickly build up
the knowledge of Medix company.
Expertise
Control system
Opening balance
Because this is a new audit client we should consider extra work done
on the opening balance of its financial statement given a weak internal
20
control system exists.
Management style
Medix company is being sued by the previous finance director and the
previous auditor resigned as a result of a disagreement with the
management so the history shows we may find it difficult to maintain
a good relationship with management.
Fee pressure
Reputation
Medix company has been in breach of laws and regulation and this has
impaired its reputation within the industry and if we were to become
its auditor then it will impact on our reputation as well.
Advocacy threat
Competence
Public interest
Time
21
It seems that there would be only 1 month before we start our audit
and given the complexity of the clients business activities we may not
have enough time to carry out such an audit service.
Integrity
Given there are two cash books presented by the managing director,
we can reasonably assume that fraudulent transactions may occur
here and hence we should question the integrity of management and
if they are lying then we shouldn't agree to be their auditor.
Easy
It seems that Medix company is going to raise finance from the bank
and the audit report may be relied on by the bank as well and this
creates higher risk for us because given time, resources, expertise
analysis maybe we don't have time to carry out this audit as expected.
Conclusion
22
Assurance Engagement Letter
Subject matter
3 parties
Standards
This explains what standard the auditor needs to comply with, e.g., for audit its
ISAs.
Evidence
This explains how much evidence the auditor needs to obtain, i.e., sufficient and
appropriate audit evidence if its audit.
Report
This explains if either positive audit assurance or negative audit assurance will
be given.
23
Quality control
Auditors need to make sure that the quality of the audit work is high.
This means that auditors need to follow the ISAs (International
Standards on Auditing) when performing the audit work.
Issues Explanation
Audit firm should set strict procedures to employ
Recruiting and training of staff suitable staff and make sure high quality training to
those staff.
Document policies of the audit During the audit, all of the work should be
work documented properly, for example, for training and
monitoring purposes.
24
Quality control from the individual engagement letter
Issues Explanations
Before auditing the clients company, we
Pre-appointment check need to make sure that this client involves
legal activities and its reputation is good.
25
Example of QC: DEC2007 Q1(c)
(i) Identify and describe FOUR quality control procedures that are
applicable to the individual audit engagement; and (8 marks)
(i)
Planning
Planning meeting
Audit work should be reviewed after the work has been done, i.e., hot
review on the work before the audit report is signed to identify any
mistakes within the audit work.
(ii) Competence
Problem:
Recommendation:
Review
Problem:
Recommendation:
An external review service may be purchased.
27
Ethics
5 Principles:
Professional behavior
Integrity
They should also follow rules to do the work and finish the work within
the reasonable amount of time.
Confidentiality
Money Laundering
Definition:
3 stages:
Placing
28
It seems that Heron co receives cash from the customer and this is
placing and cash may be illegal from customers.
Layering
Integration
Then getting money out from the financial institution of $2m then the
source of money would become legitimate.
Offences:
Doing tipping off meaning auditors would inform client about the
potential investigation of money laundering activities by other
departments and hence interrupt the investigation process.
29
Objectivity
1. Self-interest threat
In order for the auditor to keep benefit they help to cover up the fraud
by the client making its opinion not objective.
2. Self-review threat
Checking auditors own work would mean the auditor will lose
professional skepticism when trying to audit the client and the opinion
given wouldnt be objective.
3. Advocacy threat
It may seem that the auditor is trying to promote the status of the
clients company making any audit opinion subsequently issued not
objective.
4. Familiarity threat
5. Intimidation threat
30
6. Management threat
Ethics
Threats
Safeguards:
31
Case: Ethics June 2008 Q4 (Smith & Co)
You are an audit manager in Smith & Co, a firm of Chartered Certified
Accountants. You have recently been made responsible for reviewing
invoices raised to clients and for monitoring your firms credit control
procedures. Several matters came to light during your most recent
review of client invoice files:
Norman Co, a large private company, has not paid an invoice from
Smith & Co dated 5 June 2007 for work in respect of the financial
statement audit for the year ended 28 February 2007. A file note
dated 30 November 2007 states that Norman Co is suffering poor
cash flows and is unable to pay the balance. This is the only piece of
information in the file you are reviewing relating to the invoice. You
are aware that the final audit work for the year ended 28 February
2008, which has not yet been invoiced, is nearly complete and the
audit report is due to be issued imminently.
Required:
(17 marks)
Answer to June2008 Q4
(a)
Matters to consider:
In order to secure the payment, the audit firm would issue a wrong
audit opinion to maximise its benefit and hence creating a
self-interest threat to objectivity.
The audit firm is not chasing money from the client company which
would suggest there is a good relationship between them and a
familiarity threat exists meaning the audit firm may help the company
conceal some mistakes in the financial statements but still issue a
clean audit report.
Because Norman is suffering poor cash flows and is unable to pay for
an audit firm, this may create an intimidation threat meaning Norman
may threaten not to pay the firm unless a clean audit report is given.
Actions:
(b)
Matters to consider:
In order to keep the cheap rental expense of $100, the auditor would
issue a wrong audit opinion and hence this leads to a self-interest
threat.
This is about managers work and hence its senior so all its work done
would have a big impact on the overall opinion given.
Actions:
(c)
Matters to consider:
34
This will increase business risk because if the software quality is bad
then it would be seen that audit firms work quality would be bad as
well and hence leads to an impairment of audit firms reputation.
Actions:
2. Make written confirmation that the client knows about the referral
fees.
3. Make sure that other audit staff involved in the audit have no
further interest in the software company because if they do then any
other threats to objectivity would be created.
35
Case: Ethics DEC2008 Q4 (Becker & Co)
You are a senior manager in Becker & Co, a firm of Chartered Certified
Accountants offering audit and assurance services mainly to large,
privately owned companies.
The firm has suffered from increased competition, due to two new
firms of accountants setting up in the same town. Several audit clients
have moved to the new firms, leading to loss of revenue, and an over
staffed audit department. Bob McEnroe, one of the partners of Becker
& Co, has asked you to consider how the firm could react to this
situation. Several possibilities have been raised for your
consideration:
Required:
(d) I heard one of the audit managers say that our firm had
lost an audit client to a competitor because of lowballing.
What is lowballing and is it allowed?
(3 marks)
(23 marks)
Answer to DEC2008 Q4
(a)
1. Accept the offer but IFAC code of ethics says the threats to
objectivity making opinion not objective to be so significant and no
safeguard would put in place to minimise the threat and hence audit
firm would be better not doing audit services for this client.
2. Reject the offer and continue to provide audit service to this client.
(b)
Because Becker & Co would charge a fee for this service based on
the salary of the employee recruited, the higher salary that
Becker&co agrees then the higher the income stream which would
flow into the audit firm and hence producing a greater self-interest
threat.
(c)
The Audit firm would have an incentive to send higher level staff to
the company and hence earn more fees and this creates a higher
self-interest threat.
After the auditor works on this company they may have a good
relationship with staff there and hence a familiarity threat is
created meaning the auditor would lose professional skepticism
when doing the actual audit or ignore the mistakes staff have made
as well.
(d)
Low balling is when an audit firm charges a low fee to attract audit
service from client in the hope of winning the tender contract and
provide future services to the client.
This is not banned by the ACCA as long as the audit firm can
demonstrate they would complete the work with competence and
due care.
But as the fees are cut back then the auditor may not spend
enough time doing the work and stick to auditing standards and
hence the quality of the audit work would be compromised.
39
Case: Money Laundering (DEC2009 Q2(c))
Required:
Prepare briefing notes to be used at your training session in which
you:
Professional marks will be awarded in part (c) for the format of the
answer, and the quality of the explanations provided.
(2 marks)
40
Answer to DEC2009 Q2(c)
(i)
Definition:
3 stages:
Placing
Layering
Integration
Then getting money out from the financial institution of $2m then the
source of money would become legitimate.
Offences:
Doing tipping off meaning auditors would inform client about the
potential investigation of money laundering activities by other
departments and hence interrupt the investigation process.
(ii)
41
Due diligence review of clients company including their address,
directors register etc.
Example of ISA250
Required:
Answer to ISA250
If this is not applicable then the auditor should seek legal advice
first.
Audit Flowchart
Step5: Reviewing
43
Stage 2: Audit Planning
Auditors are required to use the risks based approach to audit. For
example, they will start from the business risks analysed within
clients company and then they will start analysing risks of material
misstatement or audit risks in the clients financial statements.
Contents
MATERIALITY ..................................................................... 50
44
Audit strategy
Audit strategy sets out the scope, timing, nature and direction of the
audit and it tells the auditor which audit approach should be used, i.e.,
system based or full substantive approach and how the resources
would be allocated.
IAS 315
External factors
45
Company structure and its accounting policy
Also auditors should understand its accounting policy and ensure they
are consistent with the applicable financial reporting framework
Performance measurement
The business strategy, plan and risk would have an impact on the
companys financial statements whether or not it will be misstated.
For example there is a business risk that the business strategy and
plan would fail leading to a decrease in shareholders wealth and as a
result management may have an incentive to overstate e.g., profit
within the company to make its figure look better and as a result a
misstatement in the profit figure.
Analytical procedure
Enquiry
For example:
Have any new competitors or products entered the market?
How does the company manage exposure to exchange rate
risk?
Have there been any changes in senior management during the
year?
Inspection
For example:
Organisation charts to identify changes in key staff;
Observation
47
For example:
Recalculation
Audit Plan
Audit plan sets out the risk assessment, materiality and potential
audit procedures to be used in stage4 of audit.
Risk equation
Inherent risk
E.g.:
48
Control risk
E.g.:
But there will still be a weakness since the control assumes that the
person operating the till records the cash sale. No recording of sales
means that cash is not included in the total and this could therefore
still be stolen.
Detection risk
E.g.:
Auditor lacks experience to deal with the issue and cant spot the
mistake.
Sampling risk means that the auditor cant spot the material
misstatements because of lack of time to audit or lack of knowledge.
49
Audit Risk Equation Relationship
Materiality
Per ISA 320 Materiality in planning and performing an audit sets out
the guidance for preliminary materiality as well as performance
materiality calculation.
Preliminary materiality
Performance materiality
50
Risk Question Exam Techniques
1. Business Risks
Step1: Sub heading telling examiner which area you are referring to
Inherent Risk
Step1: Sub heading telling examiner which are you are referring to
Control Risk
Step1: Sub heading telling examiner which are you are referring to;
Detection Risk
Step1: Sub heading telling examiner which are you are referring to;
Step2: Because it is the first time the auditor is auditing this company
and hence the auditor may not find out the material misstatements in
the clients financial statements resulting in giving a wrong audit
opinion.
51
Example of Audit Planning: June2009 Q1(a)
Required:
(a)
(i) Identify and explain the aspects of a clients business which should
be considered in order to gain an understanding of the company and
its operating environment; and
(6 marks)
(ii) Recommend the procedures an auditor should perform in order to
gain business understanding.
(4 marks)
Professional marks will be awarded in part (a) for the clarity,
format and presentation of the briefing notes.
(2 marks)
52
Answer to June2009 Q1(a)
(i)
External factors
Auditors need to review the laws and regulations as well because if the
clients companys activity is not fulfilling the current laws and
regulations then there might be risks that financial statements would
be misstated, e.g., failure to disclose contingent liability to the note of
the Financial statements.
Performance measurement
Auditors need to review its structure and its accounting policy and if
the companys structure is so complicated then during the actual
consolidation there would be potential misstatements to the financial
statements as well.
(ii)
54
Analytical Procedure: DEC2009 Q1(a)(b)
Required:
55
Answer to DEC2009 Q1(a)(b)
(i)
(ii)
It may not reflect the whole year figure because this is done based
on interim financial information.
(b)
Audit strategy sets out the scope, timing, nature and direction of
the audit and it tells the auditor which audit approach should be
used, i.e., system based or full substantive approach and how the
recourses would be allocated.
Audit plan sets out the risk assessment, materiality and potential
audit procedures to be used.
Any changes in the audit plan should lead to a change in the audit
strategy as well, e.g., during the audit a material risky balance is
omitted so further procedures should be planned and recourses
allocation schedule would also be changed.
You are a senior audit manager in Mitchell & Co, a firm of Chartered
Certified Accountants. You are reviewing some information regarding
a potential new audit client, Medix Co, a supplier of medical
instruments. Extracts from notes taken at a meeting that you recently
held with the finance director of Medix Co, Ricardo Feller, are shown
below:
Company background
57
There is currently one scientist working on the laser equipment,
subcontracted by Medix Co on a freelance basis. The building in which
the research is being carried out has recently been significantly
extended by the construction of a large laboratory.
The company has a bank overdraft facility and makes use of the
facility most months. A significant bank loan, which will carry a
variable interest rate, is currently being negotiated. The terms of the
loan will be finalised once the audited financial statements have been
viewed by the bank.
After receiving permission from Medix Co, you held a discussion with
the current audit partner of Medix Co, Mick Evans, who runs a small
accounting and audit practice of which he is one of two partners. Mick
told you the following:
Medix Co has been an audit client for three years. We took over from
the previous auditors following a disagreement between them and the
directors of Medix Co over fees. As we are a small practice with low
overheads we could offer lower fees than our predecessors. We could
also do the audit very quickly, which pleased the client, as they like to
keep costs as low as possible.
During our audits we have found the internal systems and controls to
be quite weak. Despite our recommendations, there always seemed
to be a lack of interest in making improvements to the accounting
systems, as this was seen to be a waste of money. There have been
two investigations by the tax authorities, which we did not deal with,
58
as we are not tax experts. In the end the directors sorted it all out,
and I believe that the tax matter is now resolved.
We are resigning as auditors because the work load is too much for
our small practice, and as Medix Co is our only audit client we have
decided to focus on providing non-audit services in the future.
You have also found a recent press cutting regarding Medix Co:
Required:
(a) Using the information provided, identify and explain the
principal business risks facing Medix Co.
(12 marks)
(b) (i) Discuss the relationship between the concepts of
business risk and risk of material misstatement; and
(4 marks)
59
Answer to June2008Q1(a+b)
(a)
Demand
R&D
There is a risk that given the poor liquidity position of the company
because the company seems to make use of the facility most months
and because R&D expenses are a huge cost to the company so the
company may not have enough money to invest in this area hence
making this unsuccessful.
License
There is a risk that the license may not be received by the company
given this is a highly regulated country and hence this will make the
future production not successful decreasing shareholders wealth as a
result.
Scientist
There is a risk that this scientist may leave the company and hence
stop researching and developing of products process and this will
result in the company suffering greater loss given huge expenses
input in the R&D process.
Agent
There is a risk that the agent may try to overstate the sales revenue
in order to maximise commission received and given a weak internal
control system exists within company, this may not be easily
detected.
Overseas location
There is a risk that quality of product may not be guaranteed and if the
quality of the product is poor then it will impact on the demand for
products and hence impair the profitability of company.
There is a risk that the company will have to pay high expenses to
import goods from other countries and hence this will decrease the
profit of the company.
There is a risk that the company will have to suffer foreign exchange
rate risk and hence it will decrease its profit given an increase in the
expenses.
Aged asset
There is a risk that given the assets are too old, it may not have
sufficient future capacity to produce new products in the future and
hence decrease profit of the company.
Bank overdraft
The Company relies very much on the bank overdraft and this is more
61
expensive than other bank loans.
There is a risk that it will further impair its profitability because the
company has to pay more as a result of the expensive expense.
Tax authority
There is a risk that the company may not comply with tax regulations
which would result in further penalties paid by the company as a
result and hence impair its profitability position.
Shut down
There is a risk that the building may be shut down and as a result the
company needs to find another place to build the building which may
be expensive to the company and hence impair its profitability
position.
Regulations
There is a risk that the company will need to pay a related penalty
which would impair its liquidity position.
Reputation
62
Impairment of building
There is a risk that the company may find it more difficult to raise
finance because of a worsened position in its non-current assets.
(b)
(i)
Business risk is the risk that the business fails, i.e., as a result of
this risk the company will have to pay more expenses.
63
June2012 Q1 (Risk of material misstatement/Audit risks)
You are a manager in Magpie & Co, responsible for the audit of the CS
Group. An extract from the permanent audit file describing the CS
Groups history and operations is shown below:
Ten years ago, Crow Co made its first acquisition by purchasing 100%
of the share capital of Starling Co. Both companies benefited from the
newly formed CS Group, as Starling Co itself had a strong brand name
in the pottery market. The CS Group has a history of steady
profitability and stable management.
Acquisition of Canary Co
The most significant event for the CS Group this year was the
acquisition of Canary Co, which took place on 1 February 2012. Crow
Co purchased all of Canary Cos equity shares for cash consideration
of $125 million, and further contingent consideration of $30 million
will be paid on the third anniversary of the acquisition, if the Groups
revenue grows by at least 8% per annum. Crow Co engaged an
external provider to perform due diligence on Canary Co, whose
report indicated that the fair value of Canary Cos net assets was
estimated to be $110 million at the date of acquisition. Goodwill
arising on the acquisition has been calculated as follows:
$m
Fair value of consideration:
Cash consideration 125
Contingent consideration 30
Less: fair value of identifiable net assets (110)
acquired
Goodwill 45
64
To help finance the acquisition, Crow Co issued loan stock at par on 31
January 2012, raising cash of $100 million. The loan has a five-year
term, and will be repaid at a premium of $20 million. 5% interest is
payable annually in arrears. It is Group accounting policy to recognise
financial liabilities at amortised cost.
Other matters
Required:
Evaluate the risks of material misstatement to be considered in the
audit planning of the individual and consolidated financial statements
of the CS Group
(18 marks)
Answer to June2012 Q1
Step2: This is more than 1% of total group assets and hence this is
material to the group statement of financial position.
Step2: The fair value of net asset worth of $110m is more than 1% of
total group assets and hence this is material to the group statement of
financial position.
66
Step4: There is a risk that $110m hasn't included deferred tax
implication, i.e., net of deferred tax liability resulting in misstatement
in identifiable net assets figure.
Step1: Goodwill
Step4: There is a risk that an impairment test has not been done
resulting in overstatement of goodwill in statement of financial
position and understatement of expenses in the statement of profit or
loss.
Step4:There is a risk that this is not done which would impact on the
calculation of finance cost and hence resulting in understatement of
expenses in statement of profit or loss and financial liability in the
67
statement of financial position.
Step 2: Finance cost should be accrued at the year end, i.e., half a
year amounts to $2.5m ($100mX5%X1/2) by DR P/L $2.5m, CR
Interest payable $2.5m.
Step3: This is material to the statement of profit or loss since its more
than 0.5% of sales in Crow.
Step4: There is a risk that this is not done which would result in
understatement of expenses in the statement of profit or loss and
liability in the statement of financial position.
Step4: There is a risk that the company may not record the sales
revenue correctly given complexity in online sales system which
would result in the revenue figure being misstated in statement of
profit or loss and relating assets such as receivable or cash being
misstated in statement of financial position.
68
Step1: Canary revenue and profit before tax
Step 2: Canary Co revenue and profit before tax are $16m and $2m
and this is a significant component to the group since its more than
15% of group sales.
Step 3+4: There is a risk that Canary Co may overstate its revenue
and profit before tax figure in order to argue for a better price.
Step1: Grant
Step4: There is a risk that Starling Co may recognise the full $35m at
inception and hence this would result in overstatement of revenue in
the statement of profit or loss and understatement of liability in
69
statement of financial position.
Step2: Starling Co has not spent the rest of the grant of $10m and this
is more than 1% of total assets and hence its material to the
statement of financial position.
Step4: There is a risk that this is not done resulting in either under
disclosure or understatement of expenses in the statement of profit or
loss and liability in the statement of financial position.
71
Step 3: Assessing internal control system
of clients company
We know that the internal control systems in the clients company will
include:
If auditors find out that there are some significant internal control
deficiencies, then auditors should report these to the audit
committee.
In the P7 exam, the examiner will not test you about the different
cycles in the F8 so this means you are not required to revise sales;
purchases; wages; cash; inventory cycle in the P7 exam.
72
Case: (June2010 Q2) Internal Control System
You are a manager in the business advisory department of Flack & Co.
Your firm has just been engaged to provide the internal audit service
to Mac Co. In your initial conversation with Danny and Stella, you
discovered that currently there is a small internal audit team, under
the supervision of Lindsay Montana, a recently qualified accountant.
Before heading up the internal audit department, Lindsay was a junior
finance manager of the company. The members of the internal audit
team will be reassigned to roles in the finance department once your
firm has commenced the provision of the internal audit service.
The internal audit team has three employees, including Lindsay, who
reports to the finance director. The other two internal auditors are
currently studying for their professional examinations. The team was
set up two years ago, and initially focused on introducing financial
controls across all of Mac Cos offices. Nine months ago the finance
director instructed the team to focus their attention on introducing
operational controls in order to achieve cost savings due to a cash flow
problem being suffered by the company. The team does not have time
to perform much testing of financial or operational controls.
Danny and Stella are considering taking legal action against Mac Cos
external audit provider, Manhattan & Co, because their audit
procedures did not reveal the fraud.
Required:
Answer to June2010 Q2
(a)
Roles assigned
External expertise
Because currently there are two internal auditors within the clients
company not being qualified so a decision of outsourcing the internal
audit function will have extra expertise to do the internal service for
client and this will improve the overall internal audit quality as well.
Focus
It seems that the team currently lacks a consistent focus. They are
directed by the finance director, who has changed the focus from
financial reporting controls to operational controls, and it seems the
team is too small to do both. Outsourcing the function will provide as
many staff as necessary to cover a range of activities.
Time
Because currently there are two internal auditors within the clients
company therefore if it outsources the internal audit function it will
have extra resources to focus on other areas of the company.
(b)
Audit strategy
If the internal control system changes, this will impact on the amount
of work done by the audit firm and hence impact on its fees as well.
Report
If the external auditor replies on type 2 report then this will decrease
its work load and hence fees charged as well.
(c)
Enquire with the police and lawyer to verify if the amount can be
reimbursed with the clients permission.
(d)
Auditor would be responsible for the fraud which happened within the
company if they are material to the financial statements. This means
auditors would focus more on the fraud impact on the accounts rather
than its operational issues.
Auditor would assess the internal control system at the planning stage
of audit to determine its audit strategy.
(ii)
Benefits
This can improve the overall internal control system within the clients
company because originally Lindsay reports the internal control
system weaknesses to the finance director and if the control
environment is weak then it will have an impact on the quality of the
internal control system if the finance director refuses to change the
internal control system required by Lindsay.
The audit committee would have more power and status not like
Lindsay who is just the current junior financial manager then they
may adopt the internal control recommendations more easily.
Drawbacks
Its difficult in the real world to recruit staff who are independent and
with relevant skills.
They may not have time to devote to their role as a member of the
committee. This could be a problem for Mac Co, whose business
activities are quite specialised.
77
The audit committee members should expect to receive a fee
commensurate with their level of experience and knowledge, so the
fees may be significant. This could be an issue for Mac Co due to its
cash flow problem.
Conclusion
78
IFRS Recap with Audit Knowledge
Contents
80
IAS28 INVESTMENTS IN ASSOCIATES .............................. 133
AUDIT QUESTION [JUNE2010 Q1] IAS28 ......................... 134
81
AUDIT QUESTION [DEC2011 Q1] IAS 38 .......................... 170
IAS40 INVESTMENT PROPERTY ........................................ 171
82
IAS1 Presentation of Financial Statements
Accounting Issues
Audit Works
83
IAS2 Inventories
Accounting Issues
Initial measurement:
Subsequent measurement:
Value at the lower of cost and net realisable value (estimated selling
price-Estimated costs to sell). Costs are usually measured using FIFO,
Weighted average cost. (LIFO is banned)
Audit Works
Initial measurement:
Subsequent measurement:
84
Audit Question (DEC2009 Q2) IAS2
After the year end, Cherry Co, a major customer with whom Banana
Co has several significant contracts, announced its insolvency, and
that procedures to shut down the company had commenced.
Required:
Comment on the matters to be considered relating to the above
inventory.
Materiality
The inventory of $50,000 accounts for 10% of total asset and its
material to statement of financial position.
Accounting treatment
Audit opinion
(Tutor tips: this is at the review stage of audit and hence any matters
to be considered should be taking into account the impact on audit
report if the adjustment is not done properly)
85
Audit Question (DEC 2011 Q2) IAS 2
Required
Assess the audit implications of the issue related to audit work raised
by the audit senior. Your assessment should consider the sufficiency of
evidence obtained, explain any adjustments that may be necessary to
the financial statements, and describe the impact on the audit report
if these adjustments are not made. You should also recommend any
further audit procedures necessary.
(5Marks)
86
Answer from ACCA DEC 2011 Q2
Review any invoices raised after the year end for evidence that the
items have been sold, to determine whether a net realisable value
exists.
87
Audit Question (DEC 2014 Q5) IAS 2
Required:
88
IAS8 Accounting Policies, Changes in
Accounting Estimates and errors
Accounting Issues
Accounting Policy:
Accounting estimates:
Audit works
Inspect the changes in accounting estimate and verify the nature and
the amount have been disclosed properly.
Required:
90
Answer to audit question [DEC2011 Q3] IAS 8
Materiality
Accounting treatment
Auditor should explain the reasons why a qualified audit opinion would
be given in the basis of opinion paragraph.
91
IAS10 Events after the Reporting Period
Accounting Issues
This is the event happened between financial statement year end and
the financial statements are authorised to be issued to the
shareholders to be discussed at the AGM (annual general meeting).
They will be either adjusting events or non-adjusting events
Adjusting events
Non-adjusting events
1: Fire destroyed the inventory after the year end (cant predict!)
2: Dividends are declared after the year end or share issues after the
year end (no link between figures and events)
92
Audit works
Required:
Explain the auditors responsibility in relation to subsequent
events. (6 marks)
(b) You are the manager responsible for the audit of Lychee Co, a
manufacturing company with a year ended 30 September 2009. The
audit work has been completed and reviewed and you are due to issue
the audit report in three days. The draft audit opinion is unmodified.
The financial statements show revenue for the year ended 30
September 2009 of $15 million, net profit of $3 million, and total
assets at the year-end are $80 million.
Required:
(a)
If any events occurred which would materially affect the FS then this
matter should be discussed with management.
If any events occurred which would materially affect the FS then this
matter should be discussed with management.
(b)
(i)
Materiality:
Accounting:
A note detailing the nature of the event and the amount should be
provided according to IAS10.
Audit procedures:
Inspect the note to the financial statements which should disclose the
non-adjusting event, providing a brief description of the event, and an
estimate of the financial effect.
(ii)
If misstatement still exists then the auditor should modify his audit
report by giving a qualification of audit opinion due to material
misstatement in the financial statements.
Auditor should explain the reasons for the qualification in the basis
of opinion paragraph and this is before the actual opinion
paragraph.
96
IAS12 Income Taxes
Accounting issues
Current tax
Since the amount paid is likely to differ from the estimated tax charge
originally recognised, a balance will be left on the taxation liability
account being an under or over provision of the tax charge.
Deferred tax
Audit Works
So we usually focus on the profit forecast, management accounts for
the company performance to estimate the company future profit
making ability to establish if it can utilise the deferred tax asset
(unutilised losses) to set against the future profit.
97
Audit question: [DEC2008 Q1] IAS 12
98
IAS16 Property, Plant and Equipment
Accounting Issues
Initial measurement
Capital expenditure
Initial cost (purchase price); Import duty not refundable (if asset is
bought from other country); Installation costs; Intended use relating
costs (lawyer, surveyor costs); Delivery costs; Finance cost.
Revenue expenditure
And this is used to reconcile the NCA in the NCA register to the
individual asset in place, i.e., an example of control procedure by
company.
Subsequent measurement
IAS 16 the test was whether the expenditure was Capital or Revenue
e.g. an improvement could be capitalised but maintenance or repair
could not be capitalised.
Revaluation
Audit work
Accounting issues
Any gains or losses after the lease contract, lessee would accrue
(responsible for it);
Land is normally to be operating lease unless the title of the land has
been transferred to the lessee.
101
Risks and rewards
But the idea behind it is when the majority risks and rewards has been
transferred from the lessor to lessee then its considered to be a
finance lease.
Risks Rewards
Costs of repairing, maintaining and Use of assets for almost all of its
insuring the assets. useful life.
Risk of obsolescence Use of the assets is not disrupted.
Risks of losses from idle capacity of
the asset (if machine breaks down
then lessee bears the loss)
Accounting Treatment
Lessee Lessor
Finance lease:
Initial measurement DR PPE (include DR lease receivable
transaction cost and CR CR lease asset
cash)
CR lease liability
Subsequent measurement PPE:
DR P/L-depreciation
expense
CR accumulated
depreciation
Discount rate= implicit interest rate at the start of the lease contract
(IRR) or lessees borrowing costs.
SP=FV>CA
103
(b) Sale above fair value:
Defer the additional gain and spread over the lease period.
SP>FV>CV
If the seller has the benefit of below market rentals for the lease
of the asset then defer the loss over the lease period.
SP<FV>CV
Accounting question
Finco Ltd has 4 sale and leaseback transactions during the year which
can be shown as follows:
Required:
Show how to deal with the above transactions.
104
Answer
1.
DR Bank 50 2.
CR Deferred income 18 DR Bank 80
CR PPE 32 CR P/L 25
CR PPE 55
DR PPE 50
CR Finance Lease Liability 50
3. 4.
DR Cash 85 DR Bank 65
DR P/L (Impairment) 5(FV-BV) DR Prepayment 20(85-65)
CR PPE 70 CR PPE 60
CR Deferred Income 20(85-65) CR P/L 25 (FV-BV)
Audit work
1. The main piece of audit evidence is the lease agreement, as this will
allow the auditor to:
105
Audit question [June2009Q3] leases
Two matters have been brought to your attention by the audit senior,
both of which relate to assets recognised in the statement of financial
position for the first time this year:
Leases
In July 2008, Robster Co entered into five new finance leases of land
and buildings. The leases have been capitalised and the statement of
financial position includes leased assets presented as non-current
assets at a value of $3 6 million, and a total finance lease payable of
$3 2 million presented as a non-current liability.
Required:
Matters to consider
Materiality
Accounting treatment
3. The lease period is almost the same as useful life of the assets
Audit evidence
The Adder Group (the Group) has been an audit client of your firm for
several years. You have recently been assigned to act as audit
manager, replacing a manager who has fallen ill, and the audit of the
Group financial statements for the year ended 31 March 2015 is
underway. The Groups activities include property management and
the provision of large storage facilities in warehouses owned by the
Group. The draft consolidated financial statements recognise total
assets of $150 million, and profit before tax of $20 million.
(a) The audit engagement partner, Edmund Black, has asked you to
review the audit working papers in relation to two audit issues which
have been highlighted by the audit senior. Information on each of
these issues is given below:
(i) In December 2014, a leisure centre complex was sold for proceeds
equivalent to its fair value of $35 million, the related assets have been
derecognised from the Group statement of financial position, and a
profit on disposal of $8 million is included in the Group statement of
profit or loss for the year. The remaining useful life of the leisure
centre complex was 21 years at the date of disposal.
The Group is leasing back the leisure centre complex to use in its
ongoing operations, paying a rental based on the market rate of
interest plus 2%. At the end of the 20-year lease arrangement, the
Group has the option to repurchase the leisure centre complex for its
market value at that time.
Required:
108
Answer to June 2015 Q2 Sale and Leaseback
Matters to consider:
109
DR Property, plant and equipment $35 million
The finance charge which has accrued since the inception of the lease
should be quantified, its materiality determined, and the appropriate
adjustment communicated to management.
Audit Evidence:
A copy of the lease, signed by the lessor, and a review of its major
clauses to confirm that risk and reward remains with the group, and
that the arrangement is a finance leaseback.
111
IAS 19 Employee Benefit
Accounting Issues
Monetary benefit:
Wages and salary (Accounting: easier than pension
Paid sick leave accounting. Only to show costs,
Compensated absence asset and liability if company has
invested their money in other
Non-monetary salary: instrument before paying for
Medical care, housing, cars cash.)
etc.
Audit work
Agree the valuation figure, e.g., closing assets and liabilities to the
112
most recent actuarial valuation.
Snipe Co has in place a defined benefit pension plan for its employees.
An actuarial valuation on 31 January 2012 indicated that the plan is in
deficit by $105 million. The draft financial statements recognise
revenue of $8 5 million, profit before tax of $1 million, and total
assets of $175 million
Auditors opinion
In our opinion, because of the significance of the matter discussed
below, the financial statements do not give a true and fair view of the
financial position of Snipe Co as at 31 January 2012, and of its
financial performance and cash flows for the year then ended in
accordance with International Financial Reporting Standards.
113
Answer to June2012 Q5(b)
And the auditor needs to state whether this $10.5m would be material
to the financial statement.
Also the auditor needs to state if the deficit has been recognised then
liabilities would increase by $10.5m and equity would decrease by
$10.5m.
The word deliberate is not professional and auditor should use The
plan may have been omitted in error and an adjustment to the
financial statements may have been suggested by the audit firm and
is being considered by management.
114
DEC 2012 Q2 Defined Benefit Plan
No other audit work has been performed other than to agree the
figure from the financial statements to supporting documentation
supplied by Axle Co.
Required
Assess the implications of the key audit findings for the completion of
the audit. Your assessment must consider whether the key audit
findings indicate a risk of material misstatement. Where the key audit
findings refer to audit evidence, you must also consider the adequacy
of the audit evidence obtained, but you do not need to recommend
further specific procedures. (2marks)
The procedures that have been conducted so far are not sufficient, as
written confirmation and agreement to Axle Cos records do not
provide evidence as to the basis of the valuation of the pension plan,
which has a material impact on the group financial statements. The
audit team themselves should perform procedures to provide
evidence as to the measurement of the plan and the actuarial loss,
115
and not simply rely on the accounting records of the service
organisation.
116
IAS 20 Accounting for Government Grants and
Disclosure of Government Assistance
Accounting Issues
Grants which are made to Grants which are made for other
contribute towards the acquisition purposes like paying wages.
of the asset.
When recognised?
Disclosure
117
Audit work
Hodges Co
118
Answer to [June2010 Q1 (c)(ii)]
4. Enquire with employees about their views on how well the packing
lines are performing to verify whether the conditions have or would be
breached by company.
119
IAS 21 The effects of Changes in Foreign
Exchange Rates
Accounting issues
Audit works
120
2, Inspect exchange differences and check they have been recognised
in the correct place (statement of profit or loss or equity as
appropriate).
Brass Co
This company is a new and significant acquisition, purchased in
January 2010. It is located overseas, in Chocland, a developing
country, and has been purchased to supply cocoa beans, a major
ingredient for the goods produced by Willows Co. The company uses
local currency to measure and present its financial statements.
Required:
Answer to June2010 Q1
There is a risk that the company has used the wrong rate to translate
the above resulting in misstatement of assets, liabilities, income and
expense.
3. Goodwill should be retranslated using the closing year end rate and
gains or losses should be taken into equity.
121
There is a risk that this is not done resulting in a misstatement of the
goodwill figure.
122
IAS 23 Borrowing Costs
Accounting issues
The asset takes a substantial period of time to get ready for its
intended use or sale. Examples:
Inventories that require a substantial period of time to bring
them to a saleable condition, e.g., a big ship DR Inventory CR
Cash/Financial Liability
Manufacturing plants- DR PPE CE Cash / Financial Liability
Power generation facilities
Investment properties - DR Investment property CR Cash/
Financial Liability
General funds raised not specific for the asset? (use weighted average
borrowing cost X asset value)
When to capitalise?
Ceased to be capitalised
When the asset is intended for use, not necessarily actually for use.
Disclosure
Audit work
123
Agree interest payments to bank statements and cash book.
You are currently reviewing the audit working papers and draft audit
report on the financial statements of Snipe Co for the year ended 31
January 2012. The draft financial statements recognise revenue of
$85 million, profit before tax of $1 million, and total assets of $175
million.
The new processing area was ready for use on 1 September 2011, and
began to be used on 1 December 2011. Its estimated useful life is 15
years.
Required:
124
Answer to June2012 Q5
Matters to be considered
Materiality
The total cost of the new processing area of $5 million represents
2 9% of total assets and is material to the statement of financial
position. The borrowing costs are not material to the statement of
financial position, representing less than 1% of total assets; but they
are material to profit because it represents 10% of profit before tax.
Accounting
According to IAS23 the borrowing costs should be capitalised if its a
qualifying asset and the period to capitalise would be during the
period of construction and when construction is substantially
completed then it should be ceased to be capitalised.
Evidence
125
IAS 24 Related Party Transactions
Accounting issues
Parties are related if one party has control or significant influence over
the other party.
If A have significant influence over B&C then A&B, A&C are related
parties but B&C are not related parties because A cant control over B
or C to do something.
Key management
Close family
126
Examples of Related Parties
127
Audit work
At an odd time
Transaction
Parties
Relationship
Value
Date
128
Audit question:[June2008 Q3]RPT
(3) That the balance is likely to be received six months after Pulp Cos
year end.
The receivable was also outstanding at the last year end when an
identical management representation was provided, and our working
papers noted that because the balance was immaterial no further
work was considered necessary.
Required:
129
(i) Comment on the matters you should consider. (5 marks)
Answer to june2008 Q3
(a)
Definition
Accounting system
Disclosure
Apply
Concealment
130
(b) (i)
Matters to consider:
Accounting standards
The receivable balance has been over 1 year and current assets are
within 1 year and so management should consider the
recoverability of this receivable and write off as a bad debt
expense.
Materiality
(ii)
Inspect the board minutes for evidence of the transaction with Jarvis
co relating to its recoverability.
(c)
Because they failed to spot the weakness of management
representation and it implies there was an inadequate independent
review of work done last year.
132
IAS28 Investments in Associates
Accounting issues
Audit work
133
Audit Question [June2010 Q1] IAS28
Grissom Co
Required:
Evaluate the principal audit risks to be considered in your planning of
the final audit of the consolidated financial statements for the year
ending 30 June 2010.
Non-controlling interests
134
Financial instruments IAS32,39 IFRS7,9
Accounting issues
Initial Recognition
135
Measurements
To A Company:
To B Company:
Since B Company has bought the shares from A company:
Subsequent measurement:
Take the gains or losses of fair value directly to the OCI or P/L.
136
Situation2: Company provides Finance
137
Financial asset de-recognition
No obligation
This means that the entity has settled their contractual obligations to
deliver cash and in other words, when they pay the loan back.
I.e., we have borrowed $10m from the bank and we have repaid the
loan.
DR financial liability
CR cash
138
Compound financial instrument (IAS 32)
Initial Measurement
DR Cash
CR Loan (Fair value of future cash flows)
CR Equity (Balancing Figure)
Subsequent Measurement
SOFP: P/L:
Other information:
139
2: Information about risks of financial instrument
Derivatives
Company uses derivatives such as future, forward contract etc. to:
140
Audit work
141
Audit question IAS32,39 IFRS7
Required:
Assess the risks of material misstatement to be addressed when
planning the final audit for the year ending 31 December 2009.
1. Debentures:
2. Forward contracts:
142
According to IFRS 7 financial instruments disclosures about the
significance and risks relating to forward contract must be made.
Required:
Explain the procedures that should be performed in evaluating the
adequacy of the auditors experts work.
(5 marks)
Required:
The auditor may also find that there is a lack of evidence in relation to
financial instruments, or that evidence tends to come from
management. For example, many of the financial reporting
requirements in relation to the valuation of financial instruments are
based on fair values. Fair values are often based on models which
depend on management judgement. Valuations are therefore often
subjective and derived from management assumptions which
increase the risk of material misstatement.
145
It is important that the resources needed to audit the financial
instruments are carefully considered. The competence of members of
the audit firm to audit these transactions should be assessed, and it
may be that an auditors expert needs to be engaged. If so, this
should be explained to the client. Instructions will have to be drawn up
and given to the expert to ensure that the work performed is in line
with audit objectives and follows the relevant financial reporting
requirements, for example, in relation to valuing the financial
instruments.
146
IAS33 Earnings Per share
Accounting issues
EPS means how much each share of company may earn. If EPS=10,
this means that for every share within a company then it can earn
$10.
Audit work
Ensure any necessary restatements of prior year EPS have been done,
and suitably disclosed.
147
Audit Question (June2015 Q1) IAS 33 EPS
EPS calculation:
Required:
Answer to June2015 Q1
Inspect any other supporting documentation for the share issue, such
as a share issue prospectus or documentation submitted to the
relevant regulatory body.
Confirm that the share issue complies with the companys legal
documentation (e.g. the memorandum and articles of association).
148
Audit question[June2009 Q5 Pluto] IAS 33
Required:
Answer to June2009 Q5
1. Yes it has done something wrong because for listed companies EPS,
Diluted EPS and its comparatives should be disclosed in the note of
the financial statement to make information comparable.
149
IAS 36 Impairment of Assets
Accounting issues
Impairment indicators:
Internal: External:
Asset obsolete or damage; Adverse change in the
Operating losses for the commercial environment
current period; (decrease demand for the
Loss of key employees; asset)
Reconstructions.
Impairment reversal
If the asset has been impaired before and then been revalued, the
company needs to reverse the impairment loss adjusting for the
additional depreciation saving and charge the remaining amount to
revaluation reserve.
151
Audit work
152
Audit question: Impairment IAS36
You are the manager responsible for the audit of Aspersion, a limited
liability company, which mainly provides national cargo services with
a small fleet of aircraft. The draft accounts for the year ended 30
September 2008 show profit before taxation of $2.7 million (2007
$2.2 million) and total assets of $10.4 million (2007 $9.8 million).
(b) Aspersion owns two light aircraft which were purchased in 2005 to
provide business passenger flights to a small island under a
three-year service contract. It is now known that the contract will not
be renewed when it expires at the end of March 2009. The aircraft,
which cost $450,000 each, are being depreciated over fifteen years.
(7 marks)
Required:
Comment on the matters that you would consider and the audit
evidence you should find.
(i)Matters to consider:
Materiality
Accounting
(ii)Audit evidence
154
Audit question: [DEC2010 Q3] IAS36
You are the manager responsible for the audit of Clooney Co. The final
audit is nearing completion, and the following points have been noted
by the audit senior for your attention:
Required:
Comment on the matters that you should consider, and state the
audit evidence you should expect to find in your review of the audit
working papers for the year ended September 2010 in respect of:
Shellys Cruises
(7 marks)
155
Answer to DEC2010 Q3(b)
Matters to be considered
Accounting
Materiality
Evidence
156
IAS 37 Provisions, Contingent liabilities and
Contingent Assets
Accounting Issues
Provision
You can only recognise the provision if these 3 criteria are met:
(Mnemonics: POR)
Double entry
157
Provision for restructuring
Valid expectation
It should create valid expectation that the company either
starts to restructure or announce its plans.
Contingent liabilities
Situation1
A possible obligation that arises from past events and existence will
only be confirmed by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the
entity.
When it comes to consolidation of the subsidiary, this subsidiarys
158
contingent liability doesnt need to be written off against the
subsidiarys net asset.
Situation2
A present obligation that arises from past events but it fails criteria P
and R (above) of a provision and hence the provision is not
recognised.
Contingent assets
Situation
159
Audit work
2. Use CCTRAIN
Claims- correspondence with customer obligation
Required:
Explain the principal audit procedures to be performed during the final
audit in respect of the estimated warranty provision in the balance
sheet of Island Co as at 30 November 2007. (5 marks)
160
Answer to [DEC2007 Q1(b)] Provision
161
Audit question DEC2014 Q5(b) IAS37
The audit of Bradley Cos financial statements for the year ended 31
August 2014 is nearly complete, and the audit report is due to be
issued next week. Bradley Co operates steel processing plants at 20
locations and sells its output to manufacturers and engineering
companies. You are performing an engagement quality control review
on the audit of Bradley Co, as it is a significant new client of your firm.
The financial statements recognise revenue of $2 5 million, and total
assets of $35 million.
2. DR P/L $10,000
CR Slowing moving inventory
Required:
162
Answer to DEC2014 Q5(b)
(i)
Restructuring provision
Inventory provision
164
IAS38 Intangible Assets
Accounting issues
Initial recognition
Subsequent measurement
If the life is finite, we should amortise it over its useful life using
straight line method.
Double entry
Research expenses: This means that you search the internet and
other information to see whether the plan is workable. So it should be
expensed to P/L not capitalised as an asset because its not probable
that this can help the company generate into future economic benefit.
If the development costs can be capitalised as the asset and put into
commercial production, then we can amortise the asset over its life.
Disclosure
166
Audit work for other intangible assets
167
Audit question [June2008 Q5] IAS 38
Required:
Materiality
Accounting treatment
Although the company can use the brand to generate into future
economic benefit and it seems to fulfill the asset definition.
168
Those charged with governance, i.e. an audit committee, should
co-operate with an external auditor to require management to correct
that material misstatement.
169
Audit question [DEC2011 Q1] IAS 38
Maple & Co
Required:
Answer to DEC2011 Q1
170
IAS40 Investment Property
Accounting issues
Considerations
From price
Audit work
172
Inspect investment property physically to determine condition of the
properties supporting the valuation.
Inspect valuers method used to determine fair value and ensure its
consistent with by IAS40.
Inspect the date of the valuation report and ensure its close to the Co
financial statement year end so that fair value used would be
reasonable.
173
Audit question [DEC2008 Q3] IAS40
You are the manager responsible for the audit of Poppy Co, a
manufacturing company with a year ended 31 October 2008. In the
last year, several investment properties have been purchased to
utilise surplus funds and to provide rental income. The properties
have been revalued at the year-end in accordance with IAS 40
Investment Property, they are recognised on the statement of
financial position at a fair value of $8 million, and the total assets of
Poppy Co are $160 million at 31 October 2008. An external valuer has
been used to provide the fair value for each property.
Required:
(i) Enquiries
Competence
Does the valuer have any necessary licence to carry out valuations
for companies?
174
Objectivity
Does the valuer have any financial benefit in Poppy Co, e.g. shares
held in the company?
Does the valuer have any personal relationship with any director or
employee of Poppy Co?
Is the fee paid for the valuation service reasonable and a market
based price?
Inspect valuers method used to determine fair value and ensure its
consistent with IAS40.
176
IAS 41 Agricultural Accounting
Accounting Issues
Raising livestock
Cropping
Forestry
Floriculture
The recognition criteria are very similar to those for other assets, in
that animals or plants should be recognised as assets in the following
circumstances.
The fair value or cost of the asset to the entity can be measured
reliably
E.g., small apples may become big apples and it has a biological
transformation process. Initial and year end: FV-estimated
point-of-sale costs
178
Government grants
Audit procedures
180
IFRS2 Share-based Payment
Accounting issues
Basic idea
Calculation
Obligation
Vesting condition
Companies may require employees to stay within the company for the
next 5 years (vesting period) and hence employees can get the share
option. Or perhaps companies may require employees to achieve
market related performance conditions, for example, share price
should reach $5/share before you can get those share options. Or
perhaps you need to achieve 25% of return on capital employed
before you can get those share options.
181
A change in the estimated number of employees or the vesting
conditions would be a change in accounting estimate and it should be
accounted for using prospective adjusting method.
1. Settled by Equity
(Share option, i.e., exercise price is $5/share to buy a share and the
current share price is $6/share, hence employees need to pay
$5/share to the company in order to buy a share. And after an
employee has bought a share from the company, the employee can
either be the shareholder, i.e., holding that share or sell that share at
$6/share directly onto the market and hence enjoy $1 of capital gain.)
If the fair value of option can be reliably measured then we should use
fair value of the share option at the grant date (written in the contract)
to measure it.
But if the fair value of the option cannot be measured reliably then we
should use intrinsic value of the option to measure it. Intrinsic value
would be calculated as using fair value of the share price exercise
price of the option (written into the contract).
2. Settled by Cash
Share Appreciation Right, i.e., exercise price is $5/share to buy a
share and the current share price is $6/share, hence company would
directly give $1 to employees.
If its settled in cash which means the company will pay cash to the
employees based on the future share price. So if the share price at the
end of the vesting period (the end that employee has worked for the
company) is $50m then CR liability 50m. So the Fair value here will be
the FV of options at the end of each year.
Settlement
If this is equity settled, the company should remove all of the reserve
relating to the share options that it has previously recognised when
receiving money from the employees by:
DR Bank
DR Other components of equity
CR Share capital
CR Share premium
182
If this is cash settled, i.e., share appreciation rights, then the
company should remove all the financial liabilities that it has
previously recognised and pay cash to the employees:
DR Financial liabilities
CR Cash
Audit work
Agree that the fair value calculated is at the grant date if this is
share options.
Agree that the fair value calculated is at the each year end if this is
share appreciation right.
183
Audit question [DEC2008 Q1(b)(i)] IFRS2
2008($m) 2007($m)
Share-based payment expense(i) 138 -
Damaged property repair 100 -
expenses(ii)
Required:
184
Agree fair value of share options to specialists report and
calculation.
Agree that the fair value calculated is at the grant date because
this is share options not share appreciation rights.
185
IFRS5 Non-current Assets Held for Sale and
Discontinued Operations
Accounting issues
Classification
The idea behind the criteria is that you should prove that this sale is
probable:
If the above criteria are proven then the company can reclassify the
non-current asset into non-current asset held for sale under current
asset.
186
Presentation
Non-current Assets
PP&E $100
Investment Property $200
Current Assets
Inventories $10
Receivables $20
Cash $10
Non-current assets held for $40
sale
Total assets $380
The non-current asset held for sale can also be referred to the
disposal group which is a group of assets together with liabilities. It
can either be a single machinery (asset) together with account
payable (liability) or it can be the subsidiary.
PP&E $500
Receivable $30
Payable $20
Non-current asset
PP&E $500
Current Assets
Inventory $100
$600
Non-current asset held for sale($500+$30) $530
Equity $400
187
Initial measurement
Subsequent measurement
No depreciation or amortisation:
Because we are not consuming the asset any more-not for continued
use but for sale.)
DR P/L
CR non-current asset held for sale
Discontinued operations
Audit work
189
Audit question [DEC2007(a) ] IFRS 5
Required:
190
Answer to [DEC2007(a)] IFRS 5
Accounting treatment
Materiality
191
Audit question2 [June2011 Q1a]IFRS 5
The second issue concerns one of Bill Cos specialist divisions, which
trades under the name Treasured Homes and which deals exclusively
in the redevelopment of non-industrial historic buildings such as
castles and forts.
There is a specific office building and some other tangible assets that
will be sold as part of the deal. These assets are recorded at $7 6
million in the financial statements.
Required:
192
Answer to [June2011 Q1(a)] IFRS 5
Materiality
Accounting
There is a risk that the classification of non-current asset held for sale
is not made leading to overstatement of non-current asset and
understatement of current asset in the statement of financial position.
Also misstatement in the expenses as well if depreciation continues to
be charged.
193
Audit procedures
194
IFRS8 Operating Segments
Accounting issues
Reporting
Firstly,
Secondly,
Once it fulfills the definition of operating segment then you will need
to decide whether this would be reportable?
Thirdly,
195
Once the operating segments are classified but they do not add up to
75% in total then we need to break the other operating segments
down in order to make the total up to 75%.
Fourthly,
Fifthly,
M**
Regulatory requirements
Products/services
Production process
Customer base
Sixthly,
We need to decide if there are any central incurred costs, i.e., head
office costs, how do they be allocated to each segments?
Per IFRS8, this is all up to managements discretion. Lets take a look
at an example of this in the later questions.
196
Audit work
You are the manager responsible for the audit of Papaya Co, a listed
company, which operates a chain of supermarkets, with a year ending
31 December 2009. There are three business segments operated by
the company.
Required:
197
Assess the risks of material misstatement to be addressed
when planning the final audit for the year ending 31 December
2009. (2marks)
198
IFRS10,11,12
Accounting issues
When Control:
Power instrument:
Activities (relevant).
I like to think about relevant activities which are based on the purpose
of the organisation. Such as if your company is going to manufacture
high fashion clothes then a relevant activity would be to determine the
selling price of the high fashion clothes in the whole market etc.
Participation in preparation of accounts for the company is just an
irrelevant activity.
Also the returns are variable which means that if the company is doing
a good job so it earns a larger amount of profit then it will distribute a
larger amount of dividend to shareholders and this is called variable
which is against fixed.
199
IFRS 11 Joint Arrangements
This means that parties do business together using their own assets
and settling their liabilities. The accounting for this follows the
substance over form which means the assets and liabilities remain in
each parties FS and just a sharing of revenue, expense, assets and
liabilities.
Parties may set up a business together and put their assets and
liabilities in then the assets and liabilities belong to the business
rather than belong to their own. The accounting for this is to use
equity accounting which means the growth of business goes into the
income statement and SOFP where its added to the cost.
Audit work
200
Audit question [Shire DEC2005] IFRS11
Required:
Answer
201
IFRS13 Fair Value Measurement
Accounting issues
Market approach
Income approach
Cost Approach
Inputs requirements
Financial asset is the unconditional right to receive the cash and cash
equivalent.
These are inputs (with adjustments) other than the quoted price in
the level 1 input and they are observable either directly or indirectly.
This is more general than the level 1 since the level 1 refers to the
specific transaction.
For example, interest rates and yield curve and credit spread used in
conjunction with the valuation multiples when valuing the financial
asset.
For example, own data from the company, e.g., for cash generating
units value, we would use our own cash flows forecasts to determine
it. Also for decommissioning liability, we would use our own data, i.e.,
the estimated cash outflow in order to fulfill the obligation used to
estimate the present value of that future obligation would be the fair
value as well.
If there is principal market exists, then we should use the value from
the principal market (considering transportation costs only) to
determine the fair value.
203
Audit work
204
Audit question [DEC2008 Q3(a)]Fair Value
Required:
Discuss this statement. (7 marks)
Inherent risk
(For example when management tries to use a fair value model for
the asset they may assess the market condition of that asset and
the future intention of how to use that asset to generate into future
economic benefit and they can base on this to give a fair value to
the asset and this is subjective.)
Control risk
Detection risk
206
IFRS 15 Revenue from Contracts with
Customers
Accounting Issue
1: Contract Identification
Make sure that this is a contract. For example, it has commercial
substance and the price can be determined.
2. Obligation identified
Obligation can either be explicit or implicit. This means for example, I
say to you, I will do the service for you and charge you $300 then
$300 needs to be recognised as sales; Or perhaps I havent said to
you that I will provide the service (Implicit Obligation) but according
to the companys record, the company has provided service to others
as well, even though the company hasnt said this then we also need
to establish the sales value for this.
5. Recognise Revenue
207
Audit procedures
Inspect the contract and make sure that the obligation has been
identified, for example, Party B has the responsibility to provide the
service so that we can recognise associated revenue later on.
Recalculate the sales value and make sure that the taxes etc. will not
be included in the total sales revenue calculation.
Recalculate the sales value and make sure that the sales revenue will
be based on standard alone selling price for the goods or services.
208
Group audit
Contents
209
Components
Significant Component
The group auditor may not be able to access all the information it
needs about components or component auditors, e.g. because of laws
relating to confidentiality or data privacy. The effect on the group
audit opinion depends on the significance of the component.
If the component is not significant, then it may be sufficient just to
have a complete set of financial statements, the component auditor's
report, and information kept by group management.
Comfort/Support letter
If the subsidiary is not a going concern entity any more but the
subsidiary manager has informed the external auditor that the parent
company within the group is going to help it out. For example, the
parent company will provide sufficient cash to help with its cash flow
210
problems and the subsidiary may refuse to redraft its financial
statements under the break up basis. In order to support this, the
group auditor needs to obtain the comfort letter from the parent
company to get them confirmed that they will help with the
subsidiary.
211
Complex Group
This means that the ownership of the group changes and it can be
divided into the following circumstances:
212
Total Business at the date of disposal X
Cash in
Reduction in NCI
Remaining(Simple Investment/Associate etc)
Gains/loss= X-Y
213
Case June2012 Q1(a(i+iii)): Group audit
You are a manager in Magpie & Co, responsible for the audit of the CS
Group. An extract from the permanent audit file describing the CS
Groups history and operations is shown below:
Permanent file (extract) Crow Co was incorporated 100 years ago. It
was founded by Joseph Crow, who established a small pottery making
tableware such as dishes, plates and cups. The products quickly grew
popular, with one range of products becoming highly sought after
when it was used at a royal wedding. The companys products have
retained their popularity over the decades, and the Crow brand enjoys
a strong identity and good market share.
Ten years ago, Crow Co made its first acquisition by purchasing 100%
of the share capital of Starling Co. Both companies benefited from the
newly formed CS Group, as Starling Co itself had a strong brand name
in the pottery market. The CS Group has a history of steady
profitability and stable management.
Acquisition of Canary Co
The most significant event for the CS Group this year was the
acquisition of Canary Co, which took place on 1 February 2012. Crow
Co purchased all of Canary Cos equity shares for cash consideration
of $125 million, and further contingent consideration of $30 million
will be paid on the third anniversary of the acquisition, if the Groups
revenue grows by at least 8% per annum. Crow Co engaged an
external provider to perform due diligence on Canary Co, whose
report indicated that the fair value of Canary Cos net assets was
estimated to be $110 million at the date of acquisition. Goodwill
arising on the acquisition has been calculated as follows:
$m
Fair value of consideration: 125
Cash consideration 30
Contingent consideration 155
Less: fair value of identifiable net assets (110)
acquired
Goodwill 45
The Group has performed well this year, with forecast consolidated
revenue for the year to 31 July 2012 of $135 million (2011 $125
million), and profit before tax of $8
5 million (2011 $8
4 million). A
breakdown of the Groups forecast revenue and profit is shown below:
Other matters
Required:
(a) (i)
Auditors should consider the time to start their audit work to avoid
any delay in work because now its June 2012 and the financial
statement year end is July 2012 then its just 1 month away before
auditors start their audit.
216
Consolidated financial statements:
(iii) (actions+document(what)+reasons(why/assertions))
217
Example of Changes in group structure
DEC2013 Q1(b)
Required:
Inspect shareholder register of Stow Group and confirm that the Stow
Group is no longer listed as a shareholder of Zennor Co.
218
Inspect managements estimate of the tax due on disposal,
re-perform the calculation and confirm the amount is properly
accrued group financial statements.
Confirm that $180 million is the fair value of proceeds on disposal and
that no deferred or contingent consideration is receivable in the
future.
219
Public Sector Audit
Contents
220
There are 2 types of audit
Performance Audit
221
Assets and liabilities summary: (Taken from UK Government)
Aim
We need to make sure that the money spent by the government is for
its appropriate target set.
222
Performance Audit
223
3Es
Economy
Efficiency
Not extravagance
No tantamount to waste
Effectiveness
Performance Measures
Hospital performance
Reduce the number of medical errors.
measures
224
Real life Cases
Case1:
Government allows the agent to sell the land to the public.
Auditors considerations:
Whether this is the best price sold to the public? For example,
corruption activities may take place and hence government may sell
the land at a low price to that individual but this is not fair to other
people in the society.
Case2:
Government has spent $20m to buy a machinery but this does not
exist when auditors are performing the audit.
Auditors considerations:
Whether the asset is stolen by somebody in the government?
Case3:
Government spent $2m to buy a chocolate and a teddy bear.
Auditors considerations:
This is not economic at all and perhaps this may involve corruption
activities.
Case4:
People borrowed books from the library but they did not return them
to the library and hence the library decided to charge $5m as the
penalty to those people. But nobody in the library decided to chase
the money back from those people and subsequently they wrote it off
as bad debt expense.
Auditors consideration:
225
Since the library has not implemented the plan, so auditors can advise
the government to cancel this penalty policy since this is not effective
at all.
Case5:
A college has spent lots of money into refitting the classroom into the
hotel accommodating the overseas students. But there are few
students check-in.
Auditors consideration:
This is not economy (government has spent lots of money into
refitting the classroom) and not efficient (Input is less than output)
and this issue should be disclosed.
Case6:
The fuller faucet is made of up gold and cost the government lots of
money.
Auditors consideration:
This is an example of extravagance and this is not efficient at all.
226
Q Country A
Required:
(8marks)
Suggested Answer
(a)
Review overall project expenditure and compare with budgeted
expenditure.
Ascertain any knock-on effects that the delays may have, and
enquire of management what actions they have taken to
mitigate these effects.
Review of results of any internal challenges to management in
relation to the delays, i.e. how management responded.
228
Q Hospital
Suggested Answer
229
Public Sector Audit Reporting
Title
Address
Introductory paragraph
230
Stage 5 Review Stage
Contents
231
Audit findings
During this stage, auditors have obtained quite a lot of audit evidence
relating to clients financial statements. Its important for auditors to
think about whether they have obtained sufficient and appropriate
audit evidence before auditors express the opinion on the clients
financial statements.
Auditors would also need to think about whether there are any
additional risks of material misstatements that exist in the clients
financial statements as well and if the answer is yes, then additional
audit procedures will be required.
Opening balance
Since the opening balance will affect the closing balance in the
financial statements.
When the financial statements for the prior period were not
audited
When the financial statements for the prior period were audited
by a predecessor auditor
In all cases where there is a new auditor, the audit report must
contain an Other Matter paragraph immediately below the Opinion
paragraph. This applies whether or not the audit opinion being
expressed is modified.
232
Example:
The financial statements of Jesco plc for the year ended 31 December
2015 were audited by another auditor who expressed an unmodified
opinion on those statements on 31 March 2015.
This means auditors are not required to perform any further audit
procedures to identify any subsequent events.
233
Other information
Examples
Material inconsistencies
234
Final analytical procedures
Going Concern
Per ISA570 Going Concern, it explains that the auditor should ensure
that the entity being auditing is a going concern + audit procedures
relating to going concern assumption + reporting problems with going
concern.
The possibilities are extensive but auditors should look out for
potential indicators such as:
Net liabilities
Operating losses
Major litigation
235
Ways to see whether company is still a going concern entity
Auditor can enquire with management and obtain their future plan
based on going concern assessment.
Steps
236
Contents: Mnemonics: Briefl
237
Case: DEC2012 Q2 Audit findings
(a) You are a manager in Sambora & Co, responsible for the audit of
the Jovi Group (the Group), which is listed. The Groups main activity
is steel manufacturing and it comprises a parent company and five
subsidiaries. Sambora & Co currently audits all components of the
Group.
You are working on the audit of the Groups financial statements for
the year ended 30 June 2012. This morning the audit engagement
partner left a note for you:
Hello,
The audit senior has provided you with the draft consolidated financial
statements and accompanying notes which summarise the key audit
findings and some background information.
Required:
(i) Explain why auditors may need to reassess materiality as the audit
progresses.
(4 marks)
(ii) Assess the implications of the key audit findings for the
completion of the audit. Your assessment must consider whether
the key audit findings indicate a risk of material misstatement.
Where the key audit findings refer to audit evidence, you must also
consider the adequacy of the audit evidence obtained, but you do
not need to recommend further specific procedures. (18 marks)
Thank you
1. Revenue has been stable for all components of the Group with the
exception of one subsidiary, Copeland Co, which has recognised a
25% decrease in revenue.
239
3. The property revaluation relates to the Groups head office. The
audit team have not obtained evidence on the revaluation, as the gain
was immaterial based on the initial calculation of materiality.
30 June 30 June
2012 2011
Draft Actual
$000 $000
Assets
Non-current assets
Property, plant and equipment 81,800 76,300
Goodwill 5 5,350 5,350
Investment in associate 6 4,230 4,230
Assets classified as held for sale 7 7,800 -
Current assets
Inventory 8,600 8,000
Receivables 8,540 7,800
Non-current liabilities
Defined benefit pension plan 10,820 9,250
Long-term borrowings 9 43,000 35,000
240
Deferred tax 1,950 1,350
Current liabilities
Trade payables 6,200 7,300
Provisions 2,700 2,800
Total liabilities 64,670 55,700
Total equity and liabilities 118,420 104,100
7. The assets held for sale relate to a trading division of one of the
subsidiaries, which represents one third of that subsidiarys net assets.
The sale of the division was announced in May 2012, and is expected
to be complete by 31 December 2012. Audit evidence obtained
includes a review of the sales agreement and confirmation from the
buyer, obtained in July 2012, that the sale will take place.
Required:
Respond to the note from the audit engagement partner. (22
marks)
Note: The split of the mark allocation is shown within the partners
note.
(22 marks)
241
Answer to DEC2012 Q2
(a) You can also talk about change in risk; change in internal control
system; outsourcing its ICS to 3rd party; departure of NEDs during
the year like audit committee collapse; fraud has been found
during the audit etc.
(i)
(b)
Operating expenses
Revaluation
242
The audit evidence relating to this is not sufficient.
Actuarial losses
Goodwill
The goodwill doesn't change but from the evidence of decline in sales
revenue of one subsidiary of 25%, this may mean that there would be
impairment in the goodwill.
Associate
Assets held for sale should be disclosed under current assets rather
than non-current assets in the statement of financial position.
The $7.8m is unclear about whether it would be just the asset or net
of assets and liabilities as a result of the assets held for sale and the
IFRS5 requires there should be a split between assets and liabilities
not to net them off.
It seems that the assets held for sales meet the definition of
243
discontinued operation and so according to IFRS5 there should be a
single line figure disclosed on the face of the statement of profit or
loss and other comprehensive income about the post-tax profit or loss
of the discontinued operation.
Further audit work should be done to ensure the above are corrected.
NCI
Loan
244
Case: June2011 Q3 Opening balances
(ISA510&ISA710) (b)
The financial year will end on 31 July 2011, and this will be the first
year that an audit is required, as previously the company was exempt
from audit due to its small size.
(b) Wexford Cos financial statements for the year ended 31 July
2010 included the following balances:
Required:
In relation to opening balances where the financial
statements for the prior period were not audited:
245
Answer to Q June2011 Q3
(b)
Genera procedures:
Specific procedures:
246
DEC2010 Q2 Newman & Co(C) [ISA720 other
information]
(c) You have a trainee accountant assigned to you, who has read the
notes taken at your meeting with Ali Monroe. She is unsure of the
implications of the charitable donations being disclosed as a different
figure in the financial statements compared with the other
information published in the annual report:
Required:
247
Answer to DEC2010 Q2(c)
(i)
Auditors should read the other information and compare to financial
statements to establish whether financial statements are misstated
or another information paragraph is misstated.
(ii)
If $9m is correct then auditors should present the audit work result
to management telling them the $10m in the sustainability report is
wrong.
248
Stage 6 Audit report
Contents
249
ISA700
If all the above answers are yes, then unmodified audit report would
be issued.
250
Content of audit report
251
Opinion paragraph
The basis for opinion paragraph must state that the audit was
conducted in accordance with the ISAs, and refer to the Auditors
responsibilities for the audit of the financial statements section which
describes the auditors responsibilities under the ISAs.
The auditor must also state that they are independent of the audited
entity, in accordance with the relevant ethical requirements relating to
the audit.
Finally, the auditor must state that they believe the audit evidence
obtained is sufficient and appropriate to provide a basis for the audit
opinion.
Emphasis of matter
Examples include:
An EoM paragraph is not used when the issue has been covered as a
key audit matter. The auditor must choose whether a matter is simply
a key audit matter, or whether it needs an EoM paragraph.
Example:
Emphasis of Matter
Other Matter
Example:
Other Matter
The financial statements of Besco plc for the year ended December
31, 2015, were audited by another auditor who expressed an
unmodified opinion on those statements on March 31, 2016.
The Other Matter paragraph is included after the Basis for Opinion
paragraph, after any Emphasis of Matter paragraph and after any Key
Audit Matters section.
The definition in paragraph 8 of ISA 701 states that KAM are selected
from matters which are communicated with those charged with
governance. Matters which are discussed with those charged with
governance are then evaluated by the auditor who then determines
those matters which required significant auditor attention during the
course of the audit. There are three matters which the ISA requires
the auditor to take into account when making this determination:
KAMs are part of every listed company auditor's report, and can be
included by other auditors if needed. KAMs do not constitute a
modification of the report or of the opinion. They are a part of the
standard report which must be tailored to each company's
circumstances.
KAMs are not a substitute for disclosures, for EoM/OM paragraphs, nor
for modified opinions. KAMs must always relate to matters already
included within the financial statements.
No KAMs:
Other information
ISA 720 states that the auditor shall read the other information to
identity material inconsistencies with the audited financial
statements. If a material inconsistency is identified, the auditor shall
determine whether the audited financial statements or other
information is misstated.
257
Example of Audit Report:
Opinion
Revenue Recognition
The amount of revenue and profit recognised in the year on the sale of
Product A and aftermarket services is dependent on the appropriate
assessment of whether or not each long-term aftermarket contract for
services is linked to or separate from the contract for sale of Product
A. As the commercial arrangements can be complex, significant
judgment is applied in selecting the accounting basis in each case.
Other Information
259
Our opinion on the financial statements does not cover the other
information and we do not express any form of assurance conclusion
thereon.
[The form and content of this section of the auditor's report would
vary depending on the nature of the auditor's other reporting
responsibilities prescribed by local law, regulation, or national
auditing standards. The matters addressed by other law, regulation or
national auditing standards (referred to as 'other reporting
responsibilities') shall be addressed within this section unless the
other reporting responsibilities address the same topics as those
presented under the reporting responsibilities required by the ISAs as
part of the Report on the Audit of the Financial Statements section.
[Signature in the name of the audit firm, the personal name of the
auditor, or both, as appropriate for the particular jurisdiction]
[Auditor Address]
[Date]
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Types of Audit Report
264
Critique Style Audit Report Question
Q Hesco plc
Hesco plc has in place a defined benefit pension plan for its employees.
An actuarial valuation on 31 January 2016 indicated that the plan is in
deficit by $105 million. The deficit is not recognised in the statement
of financial position. An extract from the draft audit report is given
below:
Auditors opinion
The amount of revenue and profit recognised in the year on the sale of
Product A and aftermarket services is dependent on the appropriate
assessment of whether or not each long-term aftermarket contract for
services is linked to or separate from the contract for sale of Product
A. As the commercial arrangements can be complex, significant
judgment is applied in selecting the accounting basis in each case.
Other Matter
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We draw attention to Note 3 to the financial statements which
describes the uncertainty related to the outcome of the lawsuit filed
against the company by Hesco plc. Our opinion is not modified in
respect of this matter.
Required:
Note: you are NOT required to re-draft the extract of the audit report.
(7 marks)
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Answer to Hesco plc
The paragraph does not say whether the pension plan is in surplus
or deficit, i.e. whether it is an asset or a liability which is omitted
from the financial statements.
Key audit matter paragraph does not include how the matter was
addressed in the audit. For example, Our audit procedures to
address the risk of material misstatement relating to revenue
recognition, which was considered to be a significant risk, included:
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Testing of controls, assisted by our own IT specialists, including,
among others, those over: input of individual advertising
campaigns terms and pricing; comparison of those terms and
pricing data against the related overarching contracts with
advertising agencies; and linkage to viewer data
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Matter to be Considered Style Question
You are the manager responsible for the audit of the Nassau Group,
which comprises a parent company and six subsidiaries. The audit of
all individual companies financial statements is almost complete, and
you are currently carrying out the audit of the consolidated financial
statements. One of the subsidiaries, Exuma Co, is audited by another
firm, Jalousie & Co. Your firm has fulfilled the necessary requirements
of ISA 600 Special Considerations Audits of Group Financial
Statements (Including the Work of Component Auditors) and is
satisfied as to the competence and independence of Jalousie & Co.
You have received from Jalousie & Co the draft audit report on
ExumaCos financial statements, an extract from which is shown
below:
In our opinion, except for effects of the matter described in the Basis
for Qualified Opinion paragraph, the financial statements give a true
and fair view of the financial position of Exuma Co as at 31 March
2011...
Note 12 (extract)
Figures extracted from the draft financial statements for the year
ending 31 March 2011 are as follows:
Required:
(10 marks)
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Answer to June2011 Q5
Matters to consider
Significant component
A significant component is defined as a component identified by the
group audit engagement team that is of individual significance to the
group. Exuma Co meets the definition of a significant component
because it contributes 20% of group profit before tax, and 235% of
group total assets. Exuma Co is therefore material to the group
financial statements.
Materiality
The legal case involves a claim of $2 million. This is material to the
Exuma Co financial statements as it is 50% of profit before tax, and
10% of total assets. This is also material to the group financial
statements because its 10% of group profit before tax, and 24% of
group total assets.
Qualified opinion
An except for qualification opinion is issued by auditors because they
believe that the cash outflow for this is probable rather than possible
and as long as there is enough audit evidence shows this is the case
then this opinion is appropriate.
Group auditors
Because the individual financials statements are material to the group
and so Jalousie&Cos work should be carefully reviewed by group
audiotrs.
Actions
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Non Audit Engagement Services
Contents
273
Overview of Assurance Engagements
1. Review engagement
Forensic investigation/audit;
3. Compilation service
This means to prepare the account for the client or doing tax
computation for the client.
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Interim financial information (ISRE 2410)
Read prior year files relating to the audit and interim financial
statement review to enable auditor to identify matters that may
affect the current year interim financial information.
275
Interim financial information DEC2012 Q5(b)
You are also responsible for the audit of Squire Co, a listed company,
and you are completing the review of its interim financial statements
for the six months ended 31 October 2012. Squire Co is a car
manufacturer, and historically has offered a three-year warranty on
cars sold. The financial statements for the year ended 30 April 2012
included a warranty provision of $1 5 million and recognised total
assets of $27 5 million. You are aware that on 1 July 2012, due to
cost cutting measures, Squire Co stopped offering warranties on
cars sold. The interim financial statements for the six months ended
31 October 2012 do not recognise any warranty provision.
Required:
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Answer to DEC2012 Q5(b)
Materiality:
Accounting:
Implications:
277
Prospective financial information (Negative
Assurance Given)
PFI can be
Forecast
Projection
3. The nature of the assumptions, that is, whether they are best
estimate or hypothetical assumptions
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Procedures
Letter of engagement
Knowledge of client
Letter of representation
Report
Examples
Compare the
reasonableness of
available finance to Confirm sources
Working capital: cash flow forecasts. of short-term and
long-term finance
Assess the to evidence from
reasonableness of external finance
projected working providers.
capital ratios such as
trade receivables days
and the assumptions
made in calculating
these.
Addressee
Standard of work
Management responsibility
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Distribution of report
Negative assurance
Results achievable?
Date
Practitioner
(a) You are a manager in Lapwing & Co. One of your audit clients is
Hawk Co which operates commercial real estate properties typically
comprising several floors of retail units and leisure facilities such as
cinemas and health clubs, which are rented out to provide rental
income.
Statement of Financial
Position:
FORECAST UNAUDITED
31 May 31 May
2013 2012
$000 $000
Assets
Non-current assets
Property, plant and equipment 2 330,150 293,000
Current assets
Inventory 500 450
Receivables 3,600 3,300
Non-current liabilities
Long-term borrowings 2 82,500 52,500
Deferred tax 50,000 50,000
Current liabilities
Trade payables 5,600 5,400
Total liabilities 138,100 107,900
Total equity and liabilities 336,500 300,500
Notes:
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2. Hawk Co is planning to invest the cash raised from the bank loan in
a new retail and leisure park which is being developed jointly with
another company, Kestrel Co.
Required:
(a) You can add other points such as time to finish, time to build up
knowledge, fees calculation, report to whom, follow which standards
etc.
Managements responsibilities
It should be confirmed that the report will be provided to the bank and
that it will not be distributed or made available to other parties. This
will establish the potential liability of Lapwing & Co to third parties.
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This should be confirmed when agreeing the terms of the engagement,
as assumptions become vague as the length of the period covered
increases, e.g., it should confirm whether a 12-month forecast period
is sufficient for the banks purposes.
(b)
General procedures
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Due Diligence Review
Financial
Non-Financial
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Due diligence review Chapter 2 June2008 Q2
Rosie Co
Timber Co Ben Co
Dylan Co
Acquired Jan 2001 Acquired July 2005
Acquired Jan 2008
The management of Rosie Co has provided the audit team with some
information about Maxwell Co to aid business understanding, but little
audit work is considered necessary as the acquisition, if it goes ahead,
will be after the audit report has been issued. Information provided
includes audited financial statements for the year ended 31 January
2008, an organisational structure, several customer contracts, and
prospective financial information for the next two years. This seems to
be all of the information that the directors of Rosie Co have available.
The finance director, Leo Sabat, is hoping that the other directors will
agree that an externally provided due diligence investigation should
be carried out urgently, before any investment decision is made,
however the other directors feel this is not needed, as the financial
statements of Maxwell Co have already been audited. Leo has asked
you to prepare a report to explain to the other directors the purpose of
due diligence, and the difference between due diligence and an audit
of financial statements, which will be presented at the next board
meeting.
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Goodwill on the acquisition of Dylan Co is recognised in the
consolidated statement of financial position (balance sheet) at
$750,000. The calculation provided by the client is shown below:
$000
Cost of Investment:
Cash consideration 2,500
Deferred consideration payable 31 January 2009 1,500
All of the figures in the schedule above are material to the financial
statements of Rosie Co and the Rosie Group.
Required:
288
Answer to June2008 Q2
(a)
Report
To: finance director
From: auditor
Date: exam date
Subject: due diligence
Introduction:
The report details the objective and benefit of due diligence review as
well as the comparison between it and audit.
Management representation
Information gathering
Time
Assurance
Direction
Systems
Due diligence does not require auditors to test the client system.
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An audit assurance service would require auditors to test client
systems because this forms a basis of whether auditors would use a
system based approach to audit or full substantive testing approach.
Conclusion
291
Case DEC2013 Q2 (b) Due Diligence Review
Company background
293
Required:
To help me brief the other directors and using the information I have
provided, I would like you to identify and explain the matters which
you would focus on in your due diligence review and recommend the
additional information which you will need to perform your work.
(16 marks)
It appears that the original founders of Mizzen Co, Vic Sandhu and Lou
Lien, are crucial to the success of Mizzen Co and it would be in
Baltimore Cos interests to keep them involved with the business.
However, Vic and Lou may wish to focus on further work involving IT
innovation rather than Baltimore Cos planned website and without Vic
and Lous expertise the acquisition may be much less worthwhile.
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However, there could be other employed personnel with the necessary
skills and experience to meet Baltimore Cos needs, or much of the
skill and expertise could be provided from freelancers, who will not be
part of the acquisition.
Premises
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Accounting policy on revenue recognition
Mizzen Co has some fairly complex revenue streams, and the due
diligence review should establish that the accounting policies in place
are reasonable and in line with IFRS15 Revenue from contracts with
customers. The revenue generated from website development and
maintenance should be split into two components, with the revenue
for website development recognised once the website has been
provided to the customer, but the revenue for maintenance spread
over the contract period. There is a risk that revenue is recognised too
early, inflating Mizzen Cos profit. The revenue recognition policy for
annual subscriptions should also be scrutinised, with revenue relating
to future periods being deferred.
Operating expenses
With the exception of 2010, the finance cost has remained static at
$250,000 per annum. The due diligence review must uncover what
this finance cost relates to, and whether it will continue
post-acquisition. It may be a bank loan or it could be a payment made
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to BizGrow, as venture capitalist companies often impose a
management charge on companies which they have invested in.
Baltimore Co will need to understand the nature of any liability in
relation to this finance charge.
A list of employees and their roles within the company, and their
related obligations including salary, holiday entitlements, retirement
plans, health insurance and other benefits provided by Mizzen Co, and
details of compensation to be paid in the case of redundancy.
A copy of all contracts with customers for review of the period for
which maintenance is to be provided.
The full set of financial statements and auditors reports for each
year since the companys incorporation, to:
Confirm the assets and liabilities recognised
Agree the level of dividends paid each year
Review all of the accounting policies used in preparing the
financial statements
Find the details of any related party transactions that have
occurred
Review the statement of cash flows for each year.
298
Any agreements with banks or other external providers of finance,
including finance advanced and relevant finance charges, or
confirmation that no such finance has been provided to Mizzen Co.
299
Forensic Accounting
Forensic accounting
Forensic investigation
This involves planning stage, testing stage, review stage and report
produced.
Forensic auditing
Examples
1. Fraud Investigations
Payroll fraud
Either it can be a ghost employee, i.e., employee left the company but
still getting paid with the amount goes into account managers
account.
Then another customer pays for the company and the manager would
use the cash to cover up the first receivable balance etc.
Fictitious customers
The manager would create a fake customer and sells the goods to him
and then send the goods to him (fake customer=manager himself)
without actually getting paid.
The manager would sell the goods to the customer and then send to
him without actually getting paid.
The after a short while both customer and manager disappear or the
customer goes into liquidation with the goods being shared between
customer and the manager.
Fake supplier
The manager created a fake supplier and pays the money from the
company to him.
Normally the bank details of the fake supplier would be same as the
manager.
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Paying for goods not received
Manager ordered the goods but the supplier hasnt supplied the goods
to the company.
Then managers would pay for them using money from the company
and then the supplier went away, with money shared between the
manager and the supplier.
For example, within the cash book there has been a cash outflow of
$500 to supplier Abut that supplier is the manager! And this means
the manager would transfer the cash out to his own account.
The asset is ok and can be used by the company but the manager
states that the company should replace this old asset with the new
one and hence dispose of the old asset to employees with a very low
price.
4. Partnership disputes
For example, funds being distributed. The forensic accountant can
perform the work such as analysis of recent years accounting records
to quantify the assets value as well as profits being made.
Objectives (HOPE)
Fraud happened
It should make sure that this is a fraud happening and not a mistake.
Obtain evidence
Planning
Type of fraud.
303
Scrutinise the terms of the insurance contract.
Make sure that we can have access to the full information in the
clients company and being able to discuss with police and the
insurance company without fear of breaching confidentiality.
Evidence gathering
Investigative skills
Report produced
Advice
Ethics requirements
Professional behaviour
304
avoid damaging the reputation of the firm.
Integrity
The forensic accountant should not lie to the court and his client, and
should retain the highest integrity when carrying out the work.
Confidentiality
But outside the court the forensic accountant should retain faultless
confidentiality by not disclosing the clients information without their
permission.
Objectivity
Four months ago Crocus Co shut down one of its five factories, in
response to deteriorating market conditions, with all staff employed
at the factory made redundant on the date of closure.
Gita says that the senior accountant, Miles Rutland, has been absent
from work since she conducted her initial investigation last week, and
it has been impossible to contact him. Gita believes that he may have
been involved with the suspected fraud.
Required:
(b)
(i) Describe the objectives of a forensic investigation; and
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(ii) Explain the steps involved in a forensic investigation
into the payroll fraud, including examples of procedures
that could be used to gather evidence.
(11 marks)
(a) (i)
Forensic accounting
Forensic investigation
This involves a planning stage, a testing stage, a review stage and the
production of a report.
Forensic auditing
307
(b) (i)
Fraud happened
It should make sure that this is a fraud, i.e., a ghost employee not a
mistake made within company.
Obtain evidence
(ii)
Type of fraud
Evidence gathering
308
The investigation needs to gather sufficient and appropriate evidence
of a fraud that has happened, who committed the fraud, and the
economic losses as well.
Investigative skills
This is to establish how the controls that should have been operating
in the payroll system were breached.
Report produced
Expert witness
Advice
The investigator would give advice to the company of how to avoid the
same problems happening in the future by improving its internal
control system.
(C)
Professional behavior
309
Integrity
The forensic accountant should not lie to court and his client and
should retain the highest integrity when carrying out the work.
Confidentiality
Objectivity
310
Social and environmental audit
This means that a company should not only focus on profit but also
focus on people (society) and planet (environment). The examiner
may ask you to come up with different KPIs relating to society and
environment as well as the evidence in the exam.
Social Audits
Environmental Audits
Discussion
Observation
Thirdly, systems and controls are often not established well enough to
allow accurate measurement, and the measurement of
socio-environmental matters may not be based on reliable evidence.
Impact on audit
Accounting Example
In the exam, the examiner may test you about the social and
environmental audit with practical audit procedures relating to the
above elements.
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Social & Environmental Audit DEC2008 Q1(C)
Briefing Note
To: Bluebell co
From: Auditor
Date: exam date
Subject: KPI
Introduction: This briefing note will detail eight KPI and nature of
evidence relating to KPIs.
Social customers
Increase in Customer satisfaction rates of Surveys or questionnaires completed by
30% with service provided from last year to customers
this year
Increase in Level of repeat bookings of 15% Customer account details from the sales
from last year to this year system would indicate multiple
bookings.
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Decrease in level of complaints by customer Management log book of complaints
by 20% from last year to this year. received
Social community
Increase in donation of 35% from last year Cash book will show value of any
to this year expressed as value/profit. donations
Environment
35% decrease in water use from last year to Comparison of utilities costs using
this year. suppliers bills received.
35% decrease in carbon footprint from last Board authorisation of any payments
year to this year. made for carbon footprint.
Conclusion:
Its very important to quantify every KPIs measures and keep control
over them.
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June2012 Q2(b)(ii): Social & Environmental
Audit
(b) You are also responsible for the audit of Osprey Co, which has a
financial year ended 31 May 2012. The audit engagement partner, Bill
Kingfisher, sent you the following email this morning:
Hello
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Answer to June2012 Q2(b) (ii)
Firstly, targets and KPIs are not always precisely defined. For example,
Osprey Co may state a target of reducing environmental damage
caused by its operations, but this is very vague.
Thirdly, systems and controls are often not established well enough to
allow accurate measurement, and the measurement of
socio-environmental matters may not be based on reliable evidence.
In Osprey Co it may not be possible to quantify how much toxic
chemical has been leaked from the factory.
317
DEC2010 Q2(b) Social & Environmental Audit
(ii)
Review Eastwood Cos approved training budget comparing to
previous years to ascertain the overall level of planned spending on
training.
318
Integrated report
Content
Organisational overview
Governance
Business model
Performance
Future outlook
319
June 2015 Q5 (c)
For the first time this year, the financial statements are presented as
part of an integrated report. Included in the integrated report are
several key performance indicators, one of which states that Darren
Cos profit before tax has increased by 20% from the previous year. (6
marks)
Required:
It is most likely that the KPI included in the integrated report should
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be changed in agreement with the movement in profit shown in the
adjusted financial statements, and management should be asked to
make the necessary change to the KPI. If management refuses to do
this, and the material inconsistency remains, the auditor should
include an Other Matter paragraph in the audit report to describe the
material inconsistency. The Other Matter paragraph should be placed
immediately after the Opinion paragraph and the Emphasis of Matter
paragraph.
321
Chapter3 Current Issues
Contents
322
Joint audit
Transnational audit
Also within the group, there are lots of different components from all
around the world that need to be audited. Since the auditing
standards, accounting standards, as well as corporate governance
requirements are different from countries to countries, its possible
that the audit will be performed according to different standards and
this could lead to inconsistency and poor quality for the group audit as
a whole.
Audit guidance
This would include rules based to audit and if this is the case auditors
need to follow detailed rules in every situation with no judgment.
Another one would be principle based to audit where auditors follow
the regulatory framework to audit rather than detailed rules and
hence auditors would use their judgment in different situations for
different clients.
Auditors Independence
Auditors liability
Auditors know who uses it and their plan. For example, they
know shareholders would use the audit report to make their
investment decision so they are liable to shareholders. But if
auditors dont know who is going to use their audit report and
their plan then surely they are not liable to those guys.
If the above criteria are fulfilled, then auditors are liable to those
ones.
1. Disclaimers;
3. Joint audit;
4. Quality control.
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June2009 Q2(d) Transnational Audit
You are a senior manager in Unicorn & Co, a global firm of Chartered
Certified Accountants, with offices in over 150 countries across the
world. Unicorn & Co has been invited to tender for the Dragon Group
audit (including the audit of all subsidiaries). You manage a
department within the firm which specialises in the audit of retail
companies, and you have been assigned the task of drafting the
tender document. You recently held a meeting with Edmund Jalousie,
the group finance director, in which you discussed the current group
structure, recent acquisitions, and the groups plans for future
expansion.
Group structure
The parent company owns 20 subsidiaries, all of which are wholly owned. Half of
the subsidiaries are located in the same country as the parent, and half overseas.
Most of the foreign subsidiaries report under the same financial reporting
framework as Dragon Co, but several prepare financial statements using local
accounting rules.
Two companies were purchased in March 2009, both located in this country:
(i) Mermaid Co, a company which operates 20 furniture retail outlets. The audit
opinion expressed by the incumbent auditors on the financial statements for the
year ended 30 September 2008 was qualified by a disagreement over the
non-disclosure of a contingent liability. The contingent liability relates to a court
case which is still on-going.
(ii) Minotaur Co, a large company, whose operations are distribution and
warehousing. This represents a diversification away from retail, and it is hoped that
the Dragon Group will benefit from significant economies of scale as a result of the
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acquisition.
Other matters
The acquisitive strategy of the group over the last few years has led to significant
growth. Group revenue has increased by 25% in the last three years, and is
predicted to increase by a further 35% in the next four years as the acquisition of
more subsidiaries is planned. The Dragon Group has raised finance for the
acquisitions in the past by becoming listed on the stock exchanges of three
different countries. A new listing on a foreign stock exchange is planned for
January 2010. For this reason, management would like the group audit completed
by 31 December 2009.
Required:
326
Answer to June2009 Q2 (d)
(d)
(i)
Definition:
Transnational audit is the audit of a clients financial statement which
would be relied on by investors outsider the home country for the
purpose of raising finance, investment or regulatory issues.
Relevance:
Because Dragon is seeking listing on the stock exchange, and clearly
its audited financial statement would be used by investors outside the
home country, this is a transnational audit.
(ii)
Features:
Application of ISAs
For some countries they are using their own auditing standards and
these may be different from ISAs and hence when auditing those
countries risks arises because different rules exist, i.e., ISA requires
to gain an understanding of the client first to better identify risks
within the clients company while local auditing standards may not
include this.
327
DEC2009 Q4 Audit Approaches
Required:
328
Answer to DEC2009 Q4
(i)
(ii)
For:
Because of rules based to audit auditors must follow detailed rules
and hence this will improve clarity of auditing standards.
This will improve audit quality as well since auditors follow all of the
rules during the actual audit.
Against:
This will lead to over or under auditing because for small companies
their transactions are relatively simple and hence there is no need to
carry out a variety of procedures but just focus on those simple
transactions. Under auditing means for some businesses auditors just
follow the rules and they may ignore performing additional
procedures to audit some more risky balances.
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June2008 Q2(c) Joint Audit
Required:
330
Answer to June2008 Q2(c)
Definition:
This means two or more audit firms would have the same
responsibility in giving the audit opinion to the financial statements.
Advantages:
This will help two firms get together and build up knowledge of the
new subsidiary especially for the high risk areas they have identified
before.
Allowing two or more firms to work together and this would enable
new blood to come into the audit, meaning this will help auditors find
out more risky areas by holding a discussion among audit firms and
hence increase the overall opinion given.
Disadvantages:
Its more expensive for the client to pay these two audit firms rather
than just one.
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DEC2010 Neeson&Co(b) Q4
Required:
332
Answer to Dec2010 Q4(b)
(i)
(ii)
Advantages:
It can also be argued that clients would benefit from a fresh pair of
eyes after a number of years. A new audit firm can offer different
insights from a fresh point of view.
Disadvantages:
From the audit firms perspective, there will be a loss of fee income
when forced to resign as auditor.
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June2010 Q5(b) Auditors liability
(b) You are also responsible for providing direction to more junior
members of the audit department of your firm on technical matters.
Several recent recruits have asked for guidance in the area of
auditors liability. They are keen to understand how an audit firm can
reduce its exposure to claims of negligence. They have also heard that
in some countries, it is possible to restrict liability by making a liability
limitation agreement with an audit client.
Required:
334
Answer to June2010 Q5(b)
(b) (i)
Disclaimers
Audit firms can include a disclaimer paragraph in the audit report. This
is an attempt to restrict the duty of care of the audit firm to the
shareholders of the company, thereby attempting to restrict legal
liability to that class of shareholders.
Auditors can buy the PII before providing the audit service in case
something goes wrong then the company can reimburse the expense
from the insurance company.
Joint audit
By engaging two audit firms to do the audit they have the same
responsibility in giving the audit opinion, so this reduces the risk
exposure to litigation claims if it happened.
Quality control
(ii)
Audit quality
Auditors could become less concerned with the quality of their work,
in the knowledge that if there was a claim against them, the financial
consequences are limited.
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Reduction on audit fees
Firms may be under pressure from clients to reduce their audit fees if
the risk exposure is reduced.
Reduce competition
The ability to set a cap on an auditors liability could distort the audit
market because bigger audit firms may have the ability to set a high
cap, which creates a disadvantage to smaller audit firms.
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