Subject (SQ): Audit and Assurance

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  • 15 Marks

Question Title: AA – L2 – Q71 – Subsequent Events

Describe auditor's responsibilities for subsequent events between year-end and report signing, and post-signing to issuance.

You are an audit senior for an audit firm and are currently working on the audit of TechWorks Co, a company which produces sophisticated electronic laboratory equipment. The company imports a high proportion of the components it uses from China. The equipment is used by some laboratories dealing with hazardous chemicals.

As the audit draws to a close, the partner in charge has asked you to ensure that all procedures relating to subsequent events and going concern are properly performed. You are to consider the audit work to be performed in relation to ISA 560 Subsequent Events and ISA 570 Going Concern.

Required:
(a) Describe the auditor’s responsibilities for subsequent events occurring between:
(i) The year-end date and the date the auditor’s report is signed.
(ii) The date the auditor’s report is signed and the date the financial statements are issued. (6 marks)

(b) Going concern relates to the judgement that an entity will continue to trade for the foreseeable future.

(i) Explain the responsibilities of directors and auditors in relation to going concern. (3 marks)

(ii) Explain the audit procedures that audit could carry out when conducting the going concern review of TechWorks Co.

(c) TechWorks Co has an internal audit function. The partner in charge of the audit is seeking clarification regarding how any deficiencies in internal control should be identified and communicated to management. The partner feels the report produced by the external auditors may duplicate the produced by the internal audit function.

Required:
Explain how the purpose and content of an internal auditor’s report on internal control deficiencies differs from one prepared by the external auditor.

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  • 30 Marks

AA – L2 – Q70 – Audit Reports

List six elements of an unmodified auditor's report and explain their inclusion.

(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)

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  • 10 Marks

AA – L2 – Q69 – Audit Reports

Draft a management report addressing inventory and credit limit deficiencies at TechTrend Solutions, including implications and recommendations.

TechTrend Solutions sells personal computers (PCs) to independent shops. You are the external auditor of TechTrend Solutions. Your interim audit revealed the following issues:

(1) The half-year physical inventory count revealed that some PCs supposed to be in inventory were missing and that other machines which had been returned by customers were in inventory but had not been recorded as having been returned. A few of the missing PCs have been traced to directors who borrowed them for use at home.

(2) Two customers had been allowed to exceed their credit limits and new customers in the last year had not been allocated credit limits.

Required:

Draft the section of your report to management dealing with the above deficiencies. Set out the deficiencies, their implications, and your recommendations for improvement.

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  • 12 Marks

AA – L2 – Q68 – Going Concern

Identify further information needed for audit opinion on Luxe Scents due to supplier issues. Outline possible audit report forms for Luxe Scents given supplier financial issues.

Luxe Scents has been in existence, importing perfume, for a number of years. The managing director had built up the business using contacts he already had in the industry. The company imports only one brand of perfume, which is manufactured exclusively by one company. The perfume is distributed via ‘shops within shops’ at 20 branches of a well-known store. Under this agreement, Luxe Scents pays a percentage of its takings to the store, with a minimum annual payment of $50,000 per store.

The audit is nearing completion, but you have just heard that the Italian manufacturer is facing serious financial difficulties and that supplies have ceased.

Required
(a) Set out the further information the auditor would require before reaching an audit opinion.

(b) Set out the possible forms of report that the auditor may issue.

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  • 30 Marks

AA – L2 – Q67 – Internal Control Systems

List six audit procedures for Bertram Co's procurement and purchases system with reasons. List four audit procedures before attending Bertram Co's inventory count. Identify deficiencies in Bertram Co's inventory count at depot nine and explain how to address them.

Bertram Co
Bertram Co assembles fridges, microwaves, washing machines and other domestic appliances from parts procured from a large number of suppliers. As part of the interim audit work two weeks prior to the company year-end, you are testing the procurement and purchases systems and attending the inventory count.

Procurement and purchases system
Parts inventory is monitored by the stores manager. When the quantity of a particular part falls below re-order level, an e-mail is sent to the procurement department detailing the part required and the quantity to order. A copy of the e-mail is filed on the store manager’s computer.
Staff in the procurement department check the e-mail, allocate the order to an authorised supplier and send the order to that supplier using Electronic Data Interchange (EDI). A copy of the EDI order is filed in the order database by the computer system. The order is identified by a unique order number.
When goods are received at Bertram, the stores clerk confirms that the inventory agrees to the delivery note and checks the order database to ensure that the inventory were in fact ordered by Bertram. (Delivery is refused where goods do not have a delivery note.)
The order in the order database is updated to confirm receipt of goods, and the perpetual inventory system updated to show the receipt of inventory. The physical goods are added to the parts store and the paper delivery note is stamped with the order number and is filed in the goods inwards department.
The supplier sends a purchase invoice to Bertram using EDI; invoices are automatically routed to the accounts department. On receipt of the invoice, the accounts clerk checks the order database, matches the invoice details with the database and updates the database to confirm receipt of invoice. The invoice is added to the purchases database, where the purchase day book (PDB) and suppliers individual account in the payables ledger are automatically updated.

Required:

(a) List SIX audit procedures that an auditor would normally carry out on the purchases system at Bertram Co, explaining the reason for each procedure.

(b) List FOUR audit procedures that an auditor will normally perform prior to attending the client’s premises on the day of the inventory count.

(c) On the day of the inventory count, you attended depot nine at Bertram. You observed the following activities:

  • Pre-numbered count sheets were being issued to client’s staff carrying out the count. The count sheets showed the inventory ledger balances for checking against physical inventory.
  • All count staff were drawn from the inventory warehouse and were counting in teams of two.
  • Three counting teams were allocated to each area of the stores to count, although the teams were allowed to decide which pair of staff counted which inventory within each area. Staff were warned that they had to remember which inventory had been counted.
  • Information was recorded on the count sheets in pencil so amendments could be made easily as required.
  • Any inventory not located on the pre-numbered inventory sheets was recorded on separate inventory sheets – which were numbered by staff as they were used.
  • At the end of the count, all count sheets were collected and the numeric sequence of the sheets checked; the sheets were not signed.

Required:
(i) List the deficiencies in the control system for counting inventory at depot nine.
(ii) For each deficiency, explain why it is a deficiency and state how that deficiency can be overcome.

(d) (i) State the aim of a test of control and the aim of a substantive procedure.

(ii) In respect of your attendance at Bertram Co’s inventory count, state one test of control and one substantive procedure that you should perform.

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  • 30 Marks

AA – L2 – Q66 – Internal Control Systems

Explain steps to verify accuracy of prior year's internal control questionnaires for Lara Co's revenue system. List six tests of control for Lara Co's despatch and revenue system with reasons for each.

Introduction – audit firm
You are an audit senior in Heston & Co, a firm providing audit and assurance services. At the request of an audit partner, you are preparing the audit programme for the revenue and receivables systems of Lara Co.
Audit documentation is available from the previous year’s audit, including internal control questionnaires and audit programmes for the despatch and revenue system. The audit approach last year did not involve the use of computer assisted audit techniques (CAATs); the same approach will be taken this year. As far as you are aware, Lara’s system of internal control has not changed in the last year.

Client background – revenue system
Lara Co is a wholesaler of electrical goods such as kettles, televisions, rice cookers, fans etc. The company maintains one large warehouse in a major city. The customers of Lara are always owners of small retail shops, where electrical goods are sold to members of the public. Lara only sells to authorised customers; following appropriate credit checks, each customer is given a Lara identification card to confirm their status. The card must be used to obtain goods from the warehouse.

Despatch and revenue system
The despatch and revenue system operates as follows:

  • Customers visit Lara’s warehouse and load the goods they require into their vans after showing their Lara identification card to the despatch staff.
  • A pre-numbered goods despatch note (GDN) is produced and signed by the customer and a member of Lara’s despatch staff confirmingGOODStaken.
  • One copy of the GDN is sent to the accounts department, the second copy is retained in the despatch department.
  • Accounts staff enter goods despatch information onto the computerised revenue system. The GDN is signed.
  • The computer system produces the sales invoice, with reference to the inventory master file for product details and prices, maintains the sales day book and also the receivables ledger. The receivables control account is balanced by the computer.
  • Invoices are printed out and sent to each customer in the post with paper copies maintained in the accounts department. Invoices are compared to GDNs by accounts staff and signed.
  • Paper copies of the receivables ledger control account and list of aged receivables are also available.
  • Error reports are produced showing breaks in the GDN sequence.

Information on receivables
The chief accountant has informed you that receivables days have increased from 45 to 60 days over the last year.
The aged receivables report produced by the computer is shown below:

Number of receivables Range of debt Total debt ₵ Current ₵ 1 to 2 months old ₵ More than 2 months old ₵
15 Less than ₵0 (87,253) (87,253)
197 ₵0 to ₵20,000 2,167,762 548,894 643,523 975,345
153 ₵20,001 to ₵50,000 5,508,077 2,044,253 2,735,073 728,751
23 ₵50,001 or more 1,495,498 750,235 672,750 72,513
388 9,084,084 3,256,129 4,051,346 1,776,609

In view of the deteriorating receivables situation, a direct confirmation of receivables will be performed this year.

Required:

(a) Explain the steps necessary to check the accuracy of the previous year’s internal control questionnaires.

(b) Using information from the scenario, list SIX tests of control that an auditor would normally carry out on the despatch and revenue system at Lara Co and explain the reason for each test.

(c) State and explain the meaning of FOUR assertions that relate to the direct confirmation of receivables.

(d) (i) Describe the procedures up to despatch of letters to individual receivables in relation to a direct confirmation of receivables.

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  • 20 Marks

AA – L2 – Q65 – Audit of Financial Statements

Describe audit procedures to ensure completeness of income for Accra Sports Club.

The Accra Sports Club owns 12 tennis courts. The club uses ‘all weather’ tarmac tennis courts, which have floodlights for night-time use. The club’s year end is 30 September.

Members pay an annual fee to use the courts and participate in club championships. The club had 430 members as at 1 October 20X7.

Income is derived from two main sources:

Membership fees. Each member pays a fee of ₵2,000 per annum. Fees for the new financial year are payable within one month of the club year end.

Approximately 10% of members do not renew their membership. New members joining during the year pay 50% of the total fees that would have been payable had they been members for a full year. During 20X8, 50 new members joined the club. No members pay their fees before they are due.

Court hire fees: Non-members pay ₵50 per hour to hire a court. Non-members have to sign a list in the clubhouse showing courts hired. Money is placed in a cash box in the clubhouse for collection by the club secretary.

All fees (membership and court hire) are paid in cash. They are collected by the club secretary and banked on a regular basis. The paying-in slip shows the analysis between fees and court hire income.

The secretary provides the treasurer with a list of bankings showing member’s names (for membership fees) and the amount banked. Details of all bankings are entered into the cash book by the treasurer.

Main items of expenditure are:

Court maintenance including re-painting lines on a regular basis.

Power costs for floodlights.

Tennis balls for club championships. Each match in the championship uses 12 tennis balls.

The treasurer pays for all expenditure using the club’s debit card. Receipts are obtained for all expenses and these are maintained in date order in an expenses file. The treasurer also prepares the annual financial statements.

Under the rules of the club, the annual financial statements must be audited by an independent auditor. The date is now 13 December 20X8 and the treasurer has just prepared the financial statements for audit.

Required:

(a)  Describe the audit work that should be performed to determine the completeness of income for the Accra Sports Club.

(b)  Describe the audit procedures that should be performed to check the completeness and accuracy of expenditure for the Accra Sports Club.

(c) Discuss why internal control testing has limited value when auditing not-for-profit entities such as the Accra Sports Club.

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  • 30 Marks

AA – L2 – Q64 – Audit of Financial Statements

Identify the financial statement assertion with the greatest inherent risk for trade payables audit.

Peak Cycles is a small manufacturing company of which your firm of Chartered Accountants is the external auditor. You have been assigned to the audit of the payables.
The audit file indicates that control risk for purchases and payments transactions is assessed as slightly less than high because of limitations in the extent of segregation of duties due to the small number of accounts personnel. There are no other identified control problems or prior year audit problems.
Narrative notes on the accounting system contain the following descriptions.
Purchases are requisitioned by the user department and ordered, using prenumbered order forms, by the purchasing manager.
Raw materials and manufacturing supplies are delivered to the receiving department of the factory where the receiver issues pre-numbered goods inward notes (GINs).
Purchases of other goods and services are delivered directly to the requisitioning department and no GINs are issued.
The accounts department checks suppliers’ invoices with purchase orders, and

  • for production department purchases, with GINs
  • for other purchases, sends the invoices to the requisitioning department manager who initials the invoice to indicate that it is appropriate to pay.
    Invoices are then processed to the accounting records using proprietary software.
    All suppliers are paid at the end of the month following the month of receipt of the invoice.
    Payables at 31 October 20X8 therefore represent goods and services invoiced in October. In addition, invoices received between 1 and 15 November were divided into those relating to goods received or services provided before and after 31 October, the former being recorded in the accounting records before the October trial balance was produced. On 15 November, any unmatched GINs relating to deliveries before 31 October were posted to the accounts as at 31 October at the estimated amounts of the invoices.
    Suppliers’ invoices are filed alphabetically with supporting documentation, all of which is cancelled with the date of payment when the cheque is issued. Suppliers’ monthly statements are also filed with the invoices. These are scrutinised by the accounts department for unusual items, such as overdue invoices, but are not regularly reconciled with the company’s own records.
    Required:
    (a)  In your audit of trade payables in the 31 October 20X8 financial statements explain which of the financial statement assertions you would regard as presenting the greatest inherent risk.

(b)  Discuss the reasons for undertaking or not undertaking a payables’ circularisation.

(c) Outline substantive procedures you would apply in your audit of trade payables relating to production department purchases.

(d) Explain additional procedures you would perform in verifying the completeness of non-production department payables.

(e)  Set out the audit procedures you would perform on share capital and reserves.

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  • 20 Marks

AA – L2 – Q63 – Audit Evidence

Discuss audit evidence for sales, returns, certificates, building costs, company size, and auditing standards' pros, cons, and statutory impact.

(a)

(i) The file of copy credit sales invoices is the most pertinent evidence which the auditor can obtain of the credit sales figure in the accounts. Required: Explain why this is the case and discuss how the auditor would assess the validity of this evidence.

(ii) A mail order company invoices its customers with up to five ladies’ dresses. Most customers accept and pay for one or two dresses and return the rest. A credit note is then issued. The accounts incorporate a provision for returnable dresses at the year end. The audit is completed very quickly and subsequent events are not usable by the auditor as evidence. What evidence would the auditor regard as valid and pertinent in respect of the provision?

(iii) What factors would influence an auditor in considering the acceptability as evidence of certificates received from third parties?

(iv) A building contracting company has constructed an office block on its own land for its own use. State the evidence the auditor would require on the cost of the building.

(v) Discuss the different forms of audit evidence that would be available to auditors of very small companies and of very large companies.

(b) Discuss the advantages and disadvantages of auditing standards to auditors and the consequences of them being enforceable by statute.

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  • 20 Marks

AA – L2 – Q62 – Audit Evidence

Identify deficiencies in Elite Tableware Ltd's inventory count, their implications, recommendations, and audit procedures for inventory.

Your firm is the external auditor of Elite Tableware Ltd, and you recently attended the year-end inventory count at the company’s warehouse. The company manufactures high quality tableware (plates, cups and saucers etc.) and it maintains an integrated computerised system that shows the inventory held at any point in time.
At the year-end inventory count, reports showing the various categories of inventories (but not the quantities) are printed off the system and the quantities of inventories actually counted are inserted annually by the counters. Later the quantities are compared with those per the computer system.
The count instructions were received by both you and the counters the day before the count was due to take place. The instructions consisted of the following five points:
(1) Counters must arrive at 8 am on the morning of the count.
(2) They will work in teams of two people.
(3) Each team will be assigned a specific area of the warehouse to count. They will receive inventory sheets listing the products to be found in their area.
(4) The inventory sheets are pre-numbered.
(5) Once the counters have finished the inventory count, the inventory sheets must be handed to the warehouse manager.

Your notes from the attendance at the count include the following observations:
Many areas in which the count took place were untidy and inventory was sometimes difficult to find because it was not in the allocated area. The same categories of inventories were sometimes found in several different areas and some inventory was incorrectly labelled.
The count was conducted in a hurry in order to close the warehouse before a public holiday and there were insufficient counters to conduct the count properly in the time available. The issue and receipt of inventory sheets (on which the quantities were recorded by counters) was not properly controlled. It was difficult to reconcile the inventory quantities recorded at the count to the computerised records and some significant differences remain outstanding.
Although no finished goods were dispatched during the inventory count, a large delivery of raw materials was received into the warehouse.
Required:
(a) For the inventory count conducted by Elite Tableware Ltd:
(i) Identify and explain FOUR (4) deficiencies in the count.
(ii) Explain the possible implication of each deficiency and
(iii) Provide a recommendation to address each deficiency.

(b) Describe the audit procedures that auditor should perform at the year end to confirm each of the following:
(i) The existence of inventory

(ii) The completeness of inventory

(iii) The valuation of inventory.

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