Financial Statement Assertions

AA – L2 – Q69 – Audit Reports

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

Question

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.

Answer

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Topic: AUDIT REPORT

AA – L2 – Q64 – Audit of Financial Statements

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

Question

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.

Answer

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Tags: Completeness, Financial Statement Assertions, Inherent Risk, Trade Payables
Level: Level 2

Topic: Audit of Financial Statements

AA – L2 – Q57 – Internal Audits

Explain the usefulness of internal audit work, quality factors, and audit evidence for outsourced functions at SkyHigh Airlines.

Question

SkyHigh Airlines is an airline. The company owns some of its fleet of aircraft. Other aircraft are leased from third parties. SkyHigh Airlines has an internal audit function that has recently expanded. Your firm is the external auditor to SkyHigh Airlines. Your firm has been asked to investigate the extent to which it may be able to rely on the work of internal Angelfire International

Required:

(a) Explain why the work of internal auditors, in the three areas noted above, is likely to be useful to you as the external auditor. (9 marks)

(b) Explain how the quality of the internal audit function is likely to influence the extent of your reliance on internal audit work. (5 marks)

(c) Describe the audit evidence you will seek relating to internal controls over the outsourced functions (in-flight catering and payroll). (6 marks)

Answer

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Tags: Audit Evidence, Audit Procedures, External Audit, Financial Statement Assertions, Internal Audit, Internal controls, Outsourcing
Level: Level 2

Topic: Internal Audits

AA – L2 – Q55 – Audit Evidence

List and describe six financial statement assertions, excluding completeness, used in auditing financial statements. Describe substantive audit procedures for payroll balances and transactions in Blossom Textiles' financial statements.

Question

Auditors may use two categories of assertions to form a basis for risk assessments and the design and performance of further audit procedures. The two categories suggested by ISA 315 relate to (i) classes of transactions and events and related disclosures and (ii) account balances and related disclosures. One assertion applicable to both categories is completeness: that all transactions, events, assets, liabilities, equity interests and disclosures that should be included, are included in the financial statements.

Required:
(a) List and describe SIX financial statement assertions, other than completeness, used by auditors in the audit of financial statements. (6 marks)

(b) Describe the substantive audit procedures you will perform on:

(i) the payroll balances in the statement of financial position of Blossom Textiles. (7 marks)

(ii) the payroll transactions in the statement of comprehensive income of Blossom Textiles. (7 marks)

Answer

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Tags: Audit Procedures, Financial Statement Assertions, Payroll Audit
Level: Level 2

Topic: Audit Evidence

AA – L2 – Q53 – Audit Procedures for Non-Current Assets

Audit procedures for verifying property, plant, and equipment schedules, additions, revaluation, and depreciation correction for Oakwood Enterprises.

Question

As a staff member of Reed and Spencer Chartered Accountants, you are assigned the audit of tangible non-current assets of Oakwood Enterprises for the year ended 31 March 20X8. Reed and Spencer have been the auditors of Oakwood Enterprises for many years. You obtain the following schedule of movements on property, plant, and equipment and analysis of additions from the company’s accountant.

	Property	Plant and machinery	Total
Cost or valuation	C’000	C’000	C’000
1 April 20X7	340	275	615
Additions	–	123	123
Disposals	–	(72)	(72)
Revaluations	120	–	120
31 March 20X8	460	326	786
Accumulated depreciation
1 April 20X7	24	213	237
Provision	5	30	35
Written back on disposal	–	(65)	(65)
Adjustment on revaluation	(24)	–	(24)
31 March 20X8	5	178	183
Carrying amount
31 March 20X7	455	148	603
31 March 20X8	316	62	378

Schedule of additions (plant and machinery)

Supplier	Description	Cost
New Models	Milling machine Model 38	55,000
Drill Suppliers	Power drill Type 45C	34,000
Hoist Co	Electric hoist no 722	18,000
Sundry below $1000		16,000
Total		123,000

The company’s accountant also advises you that the property was revalued following a valuation by the company’s property manager who is a professionally qualified valuer.
During your verification of depreciation, you discover that most plant and machinery is fully depreciated. Moreover, you discover that, due to oversight, depreciation has continued to be provided on fully depreciated items. As at the beginning of the year, the amount of overstatement was $43,000. The accountant suggests the correction be made by reducing the current year’s charge for depreciation.

Required:
(a) State, with reasons, the initial audit procedures you would perform on the schedules provided by the company’s accountant. (3 marks)
(b) Outline the substantive audit procedures you would apply in verifying additions to plant and machinery. Your answer should identify procedures applicable to each of the financial statement assertions. (8 marks)
(c) Describe the audit procedures applicable to verifying the revaluation of property. (5 marks)
(d) With respect to the correction to accumulated depreciation, and assuming the amount to be material, discuss the accountant’s proposed treatment. If you disagree with the accountant’s proposal, state, with reasons, the correct accounting treatment. (4 marks)

Answer

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Tags: Audit Procedures, Depreciation, Financial Statement Assertions, Non-current Assets, Property Plant and Equipment, Revaluation
Level: Level 2

Topic: Audit Evidence

AA – L2 – Q41 – Audit Evidence

List four examples of external confirmations and explain one supported and one unsupported audit assertion for each.

Question

ISA 500 Audit Evidence identifies seven main testing procedures. One of these is external confirmation.
Required:
(a) List FOUR examples of external confirmations.
(2 marks)
(b) For EACH of the examples in (a) above explain:

ONE audit assertion that the external confirmation supports, and
ONE audit assertion that the external confirmation does NOT support.
(8 marks)
(Total: 10 marks)

Answer

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Tags: Audit Evidence, Audit Procedures, External Confirmations, Financial Statement Assertions
Level: Level 2

Topic: Audit Evidence

AAA – L3 – Q27 – Audit Evidence

Identify audit risks for Asante Motors, a multi-site car retailer with inventory and warranty issues.

Question

Asante Motors (AM) sells motor vehicles and spare parts, and also provides servicing and repairs for vehicles. It operates from eight locations, having expanded recently from just four locations. Each location has a showroom for new and used automobiles, a store for spare parts and a service workshop.

Many of the second-hand vehicles sold by AM are vehicles that have been traded in by customers in part-exchange for a new or newer vehicle. Many used cars are sold for cash.

New cars are imported from a single supplier and are delivered on consignment. AM pays the agreed purchase price plus 2.5% interest four months after delivery. AM has a legal right to return unsold cars to the supplier, but in practice never does so.

New cars are sold with a two-year warranty from the supplier and used cars are sold by AM with a one-year guarantee. All repairs under warranty or guarantee are carried out by AM in its service workshops.

Each location carries a large amount of spare parts in its parts workshops. These operate under the brand name ‘StrongSpares’ and many parts are actually labelled with the StrongSpares brand name. A perpetual inventory system is used, and storekeepers continually check inventories of parts.

The car service workshops try to complete all jobs on the same day that they are started, and are successful in about 80% of cases. Jobs are usually invoiced immediately after completion, and are usually paid for by customers when they come to collect their vehicle.

The senior sales representative at each location is able to use a new car, selected from each consignment delivered from the supplier. These cars are used for business purposes and as demonstration models. They are eventually sold second-hand as ex-demonstration models.

AM purchased the StrongSpares brand name for its parts stores. Senior management believe that the cost of the brand name should not be amortised because they consider that the asset has an indefinite useful life.

AM has recently established an internal audit function, although this has not yet done much work.

Required
Using the information provided, identify and explain the audit risks that will have to be considered and dealt with when planning the final audit of Asante Motors for the financial year just ending.

Answer

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Tags: Audit Risk, Consignment Inventory, Financial Statement Assertions, Going Concern, Internal Audit, Inventory, Provisions, Related Party Transactions, Retail Audit, Revenue Recognition
Level: Level 3

Topic: Audit Evidence, Planning

AAA – L3 – Q26 – Audit Planning and Risk Analysis

Identify high-risk areas in the audit of Kumasi Playthings, a toy retailer with inventory and management issues.

Question

Kumasi Playthings is a prestigious toy retailer trading from a single urban retail district. The accounts and administration offices are above the shop. The company is the wholly-owned subsidiary of a prominent retail group. Kumasi Playthings is headed by its dynamic managing director, Kofi Mensah, aged 70.

At Kofi Mensah’s insistence, your firm, as local to Kumasi Playthings, has recently been appointed as the auditor. Kumasi Playthings is now the only group company not to be audited by the group auditors.

The following matters have come to light during the preliminary discussions with Kofi Mensah and those members of his staff to whom he has allowed you access:

(1) The parent company wishes Kumasi Playthings to develop operations in a number of out-of-town shopping centres. Kofi Mensah regards this as unacceptable because it would destroy the goodwill and prestige built up over 150 years of quality retailing.

(2) The company has approximately 30,000 lines of inventory. Contrary to group accounting instructions, no physical count is planned for the year end. The company intends to rely on the continuous inventory system which commenced operation in March 20X8. Two major problems have occurred with the system to date. Firstly, a trainee failed to enter all the inventory lines before the system went live. Secondly, due to a dispute with the IT provider, there has been no maintenance service for five months.

(3) Kofi Mensah has just returned from a toy fair at which he placed an order for 50,000 dolls produced by a little-known youth cooperative led by his only niece. The chief buyer is said to be fuming over the incident.

(4) In the year to 31 January 20X8, Kofi Mensah received a bonus of C2m, but you were unable to obtain any information in respect of the calculation and authorization of the bonus. No other director of Kumasi Playthings received a bonus in that year and the next highest paid director received a total emoluments package of C300,000.

(5) There is a dispute with a major supplier over the credit facilities offered to Kumasi Playthings. The supplier manufactures and supplies 30% of Kumasi Playthings’ purchases and claims that Kumasi Playthings has continually exceeded its credit period and that its accounting staff are impatient and incompetent.

(6) The company’s overdraft limit of C2.5m is due for renegotiation in April 20X5.

Required
Identify the potentially high risk areas of the audit.

Answer

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Tags: Audit Risk, Control Risk, Financial Statement Assertions, Going Concern, Inventory, Management Override, New Client, Related Party Transactions, Retail Audit, Substantive Procedures
Level: Level 3

Topic: Audit Evidence, Planning

Tag (SQ): Financial Statement Assertions

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AA – L2 – Q69 – Audit Reports

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

AA – L2 – Q64 – Audit of Financial Statements

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

AA – L2 – Q57 – Internal Audits

Explain the usefulness of internal audit work, quality factors, and audit evidence for outsourced functions at SkyHigh Airlines.

AA – L2 – Q55 – Audit Evidence

List and describe six financial statement assertions, excluding completeness, used in auditing financial statements. Describe substantive audit procedures for payroll balances and transactions in Blossom Textiles' financial statements.

AA – L2 – Q53 – Audit Procedures for Non-Current Assets

Audit procedures for verifying property, plant, and equipment schedules, additions, revaluation, and depreciation correction for Oakwood Enterprises.

AA – L2 – Q41 – Audit Evidence

List four examples of external confirmations and explain one supported and one unsupported audit assertion for each.

AAA – L3 – Q27 – Audit Evidence

Identify audit risks for Asante Motors, a multi-site car retailer with inventory and warranty issues.

AAA – L3 – Q26 – Audit Planning and Risk Analysis

Identify high-risk areas in the audit of Kumasi Playthings, a toy retailer with inventory and management issues.

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AA – L2 – Q69 – Audit Reports

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

You're reporting an error for "AA – L2 – Q69 – Audit Reports"

AA – L2 – Q64 – Audit of Financial Statements

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

You're reporting an error for "AA – L2 – Q64 – Audit of Financial Statements"

AA – L2 – Q57 – Internal Audits

Explain the usefulness of internal audit work, quality factors, and audit evidence for outsourced functions at SkyHigh Airlines.

You're reporting an error for "AA – L2 – Q57 – Internal Audits"

AA – L2 – Q55 – Audit Evidence

List and describe six financial statement assertions, excluding completeness, used in auditing financial statements. Describe substantive audit procedures for payroll balances and transactions in Blossom Textiles' financial statements.

You're reporting an error for "AA – L2 – Q55 – Audit Evidence"

AA – L2 – Q53 – Audit Procedures for Non-Current Assets

Audit procedures for verifying property, plant, and equipment schedules, additions, revaluation, and depreciation correction for Oakwood Enterprises.

You're reporting an error for "AA – L2 – Q53 – Audit Procedures for Non-Current Assets"

AA – L2 – Q41 – Audit Evidence

List four examples of external confirmations and explain one supported and one unsupported audit assertion for each.

You're reporting an error for "AA – L2 – Q41 – Audit Evidence"

AAA – L3 – Q27 – Audit Evidence

Identify audit risks for Asante Motors, a multi-site car retailer with inventory and warranty issues.

You're reporting an error for "AAA – L3 – Q27 – Audit Evidence"

AAA – L3 – Q26 – Audit Planning and Risk Analysis

Identify high-risk areas in the audit of Kumasi Playthings, a toy retailer with inventory and management issues.

You're reporting an error for "AAA – L3 – Q26 – Audit Planning and Risk Analysis"

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