- 30 Marks
AA – L2 – Q70 – Audit Reports
Question
(A) ISA 700 Forming an Opinion and Reporting on Financial Statements indicates the main elements that will ordinarily be included in an unmodified auditor’s report.
Required:
List SIX basic elements of an unmodified auditor’s report. Briefly explain why each element is included in the report.
(B). You are the audit manager in charge of the audit of Seaside Ventures Co for the year ended 28 February 20X7. Seaside Ventures Co is based in a seaside town and hires motor boats and yachts to individuals for amounts of time between one day and one week. The majority of receipts are in cash, with a few customers paying by debit card. Consequently, there are no trade receivables in the statement of financial position. The main non-current assets are the motor boats and yachts. The company is run by four directors who are also the major shareholders. Total income for the year was about $50 million.
The following issues have been identified during the audit:
Issue 1
Audit tests on revenue indicate a deficiency in the system of internal control, with a potential understatement of revenue in the region of $2.5 million. The weakness occurred because sales invoices are not sequentially numbered, allowing one of the directors to remove cash sales prior to recording in the sales day book. This was identified during analytical procedures of revenue, when the audit senior noted that on the days when this director was working, revenue was always lower than on the days when the director was not working.
Issue 2
During testing of non-current assets, one yacht was found to be located at the property of one of the directors. This yacht has not been hired out during the year and enquiries indicate that the director makes personal use of it. The yacht is included in the non-current assets balance in the financial statements.
Required:
For each of the issues above:
(i) List the audit procedures you should conduct to reach a conclusion on these issues. (8 marks for Issue 1, 6 marks for Issue 2)
For each of the issues above:
(ii) Assuming that you have performed all the audit procedures that you can, but the issues are still unresolved, explain the potential effect (if any) on the audit report. (8 marks for Issue 1, 6 marks for Issue 2)
Answer
(A)
Answer:
| Auditor’s report element | Reason for that element |
|---|---|
| Title of ‘independent auditor’ | To identify this as an auditor’s report and distinguish it from other reports on financial statements issued by others, directors, or management. |
| Addressee (according to local regulations) | To identify the person(s) who may use or rely on the report. |
| Introductory paragraph identifying: the entity audited, and the financial statements audited. | To make it clear which pages of which entity’s annual report have been audited. |
| Management’s responsibility | To make clear that the directors are responsible for: – preparing the financial statements in accordance with the applicable financial reporting framework – implementing appropriate internal controls such that the financial statements should be free from material misstatement. |
| Auditor’s responsibility | To state that the auditors follow international standards on auditing (ISAs). And to explain the scope of the audit so the standard of the auditors’ work is clear and other factors such as limitation of audit testing (for example, not tested all items) is known. |
| Opinion paragraph referring to the financial reporting framework followed and expressing the auditor’s opinion. | To provide the auditor’s opinion on the financial statements in terms of whether the financial statements have been prepared in accordance with the specified financial reporting framework and, where that is a “fair presentation” framework, whether the financial statements give a true and fair view. |
(Bi) . Issue 1: Understatement of revenue
(i) Audit procedures
- If possible, conduct day-by-day analytical review to determine the extent of the misappropriation.
- Discuss the situation with the other directors to ascertain their knowledge of the situation.
- Ask the other directors what action they will take regarding the director who appears to have misappropriated money from the company.
- Recommend in the management letter that strict numeric sequence is maintained over sales invoices and that two directors are always on duty to prevent misappropriation of revenue.
- Obtain written representations to confirm the directors’ estimate of the extent of the fraud and confirm that the directors are not aware of any other instances of fraud.
Issue 2: Director’s use of yacht
(i) Audit procedures
- Ask the director why the yacht is located at his house.
- Ask the director whether any payment was made for the yacht, confirm payment to the cash book and company bank statements.
- If the yacht is for private use only, check that disclosure of the benefit has been made in the directors’ emoluments note in the financial statements.
- Depending on the law of your jurisdiction, recommend to the director that any tax return clearly shows the benefit in kind derived from the company’s asset.
- Ensure the company has provided relevant information to the benefit authority and accrued any penalty for non-disclosure.
- Consider additional audit work to determine whether or not any other company assets have been used in a similar fashion.
(Bii) . Issue 1: Understatement of revenue
(ii) Potential effect on auditor’s report
The misappropriation is material, being about 5% of income for the year. Therefore:
- Qualify the auditor’s report (using the phrase ‘except for’) on the grounds of the auditor’s inability to obtain sufficient appropriate audit evidence in respect of revenue (limitation of scope).
- Explain the reason for the understatement of revenue in the basis of opinion paragraph which should precede the opinion paragraph in the auditor’s report.
Issue 2: Director’s use of yacht
(ii) Potential effect on auditor’s report
Assuming that disclosure of the benefit has not been shown in the financial statements then:
- Modify the audit opinion using a qualified (‘except for’) opinion on the grounds of a material misstatement in the financial statements (in respect of the amount of information disclosed).
- In the basis of opinion paragraph that precedes the opinion paragraph, explain the lack of disclosure.
- Topic: AUDIT REPORT, Financial Statements
- Uploader: Samuel Duah