Ac08 (CN) Feb19 LR PDF
Ac08 (CN) Feb19 LR PDF
Ac08 (CN) Feb19 LR PDF
Course Notes
For exams in September 2019, December 2019,
March 2020 and June 2020
ISBN: 9781509780471
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2
Audit and Assurance (AA)
Study Programme
Taught Phase Study Programme
Page
Introduction to the exam and the course........................................................................................... 5
1 The concept of audit and other assurance engagements ..................................................... ..15
2 Statutory audit and regulation.................................................................................................. 27
3 Corporate governance............................................................................................................. 37
4 Internal audit............................................................................................................................ 53
Achievement Ladder Step 1 71
3
INTRODUCTION
4
INTRODUCTION
The syllabus
The broad syllabus headings are:
Main capabilities
On successful completion of this exam, candidates should be able to:
Explain the concept of audit and assurance and the functions of audit, corporate
governance, including ethics and professional conduct.
Demonstrate how the auditor obtains and accepts audit engagements, obtains an
understanding of the entity and its environment, assesses the risk of material misstatement
(whether arising from fraud or other irregularities) and plans an audit of financial statements.
Describe and evaluate internal controls, techniques and audit tests, including IT systems to
identify and communicate control risks and their potential consequences, making
appropriate recommendations. Describe the scope, role and function of internal audit.
Identify and describe the work and evidence obtained by the auditor and others required to
meet the objectives of audit engagements and the application of the International Standards
on Auditing (ISAs).
Explain how consideration of subsequent events and the going concern principle can inform
the conclusions from audit work and are reflected in different types of auditor's report,
written representations and the final review and report.
5
INTRODUCTION
This diagram shows where direct (solid line arrows) and indirect (dashed line arrows) links exist
between this exam and other exams that may precede or follow it.
Although ACCA's diagram shows Financial Reporting feeding into Audit and Assurance, the
accounting knowledge assumed in the Audit and Assurance exam will only be that covered within
Financial Accounting.
6
INTRODUCTION
C Internal control
7
INTRODUCTION
D Audit evidence
8
INTRODUCTION
The Examination
Computer-based exams
From exams in June 2019, it will only be possible for candidates to sit Applied Skills exams as a
computer-based exam (CBE). Paper-based exams will no longer be run in parallel.
Exam duration
The Applied Skills module examinations for PM–FM contain a mix of objective and longer type
questions with a duration of 3 hours for 100 marks.
This syllabus is assessed by a computer-based exam (CBE) format. With effect from June 2019 for
TX and September 2019 for all Applied Skills exams, seeded questions have been removed from
CBE exams and the exam duration is 3 hours for 100 marks. Prior to each exam there will be time
allocated for students to be informed of the exam instructions.
For more information on these changes and when they will be implemented, please visit the ACCA
website: www.accaglobal.com
9
INTRODUCTION
Key to icons
The following icons appear in this set of study notes
Question practice
This is a question from the Exam Question and Answer Bank in the Study Text
which we recommend you attempt to reinforce your learning on a key topic
Formula to learn
10
INTRODUCTION
1 Effective
5 Producing a reading and
tailored answer to the planning at the
scenario in the exam start of the exam
question
4 Tackling mini-case
style scenario 2 Quick and accurate
questions analysis of a question's
requirements
3 Disciplined
time management
to ensure that all
parts of the
question are
answered in the
time allowed
11
INTRODUCTION
We recommend that you spend time at the beginning of your exam to carefully read your exam,
specifically looking through the requirements of each question (especially in Section B). All of the
questions in this exam are compulsory so there is no choice to make in terms of which questions
you will attempt, but you should give some thought to the order in which you attempt them.
Once you feel familiar with your exam we recommend that you attempt Section A first but please
do not rush through Section A otherwise you will make unnecessary mistakes and lose valuable
marks.
When you are ready to begin the longer constructed response questions in Section B make sure
you focus on the requirements of each of the three questions first so you can decide the order in
which you will attempt them. Once you have decided this, highlight key verbs such as describe,
explain and state to ensure you know how many points you need in your answer. Where the
question includes a scenario you will need to use the information in the scenario. We therefore
recommend that you create a heading for each new area in the constructed response solution box,
and then briefly note down any key information from the scenario.
You need to be aware of the meaning of the verbs used by the examining team; these are
reproduced in full in the BPP Practice & Revision Kit.
You don't need to learn each term precisely but it is important that you appreciate the difference
between them, for example 'explain' means clarifying an issue or developing a point, whereas
'discuss' means critically examining an issue or considering the pros and cons.
Also the requirements of a question often contain a number of sub-requirements; you need to
make sure these are clearly identified on the exam by highlighting them and establishing headings
in the solution box so that your answer is comprehensive.
Section B (the constructed response questions) will undoubtedly be more time pressured than
Section A (mini-case scenario style questions). In the computer-based exam, you have 1.8
minutes for each mark so you should allocate 54 minutes to Section A as a whole, 54 minutes to
the 30 mark question in Section B and 36 minutes to each 20 mark question in Section B.
12
INTRODUCTION
When answering mini-case style scenario questions firstly read the requirements for each of the
five sub-questions relating to the scenario information, then read the scenario presented in the
question. Next re-read the requirement for each sub-question and have a think about what you
think the correct answer may be. Next try to locate the correct answer. Even if you see the
correct answer make sure that you still check the other answers just in case you have made a
common mistake. Read the requirement again to be sure that you are answering the correct
question and then choose your answer. Never leave a question unanswered – guess if you have
to!
You are expected to apply your theoretical knowledge to the specifics of the question set in the
exam. The best way to tailor your answer is to look for clues in the scenario and then to build them
in to your answer.
Also make sure you write your answer in a manner which reflects your role in the questions and
your intended addressee. For example if you are writing a report to the Board of Directors you
should write using professional language and avoid jargon.
13
INTRODUCTION
14
The concept of audit and
other assurance
engagements
15
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
Overview
Levels of assurance
16
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
1.2
Appoint
independent
Auditor
Adds credibility
Measure
performance Financial Prepare
Statements
Appoint
Shareholders Management
1.3 In a company the management act as agents for the body of shareholders (the principals).
They are accountable to the shareholders for their stewardship of the entity's assets which
are placed under their control.
They achieve this by preparing financial statements which are presented to the
shareholders.
1.4 Most incorporated entities are legally required to have their financial statements audited,
although many smaller entities are exempt from the requirement.
1.5 Auditors must be independent of the entity they are auditing, and seek to provide an opinion
to the shareholders as to whether the financial statements are 'presented fairly', or give a
true and fair view.
The phrase 'presented fairly' is interpreted as meaning:
Factual
Free from bias
17
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
1.6 The auditor's opinion enhances the credibility of the financial statements by providing
reasonable assurance that the financial statements are free from material misstatement.
Reasonable assurance is a high level of assurance.
1.7 The auditor can also be seen as an agent of the body of shareholders as they report to and
are appointed by them.
2.2 The opinion is expressed in the auditor's report. If the auditors are satisfied that the financial
statements are presented fairly, they will issue a report which gives an unmodified opinion.
18
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
19
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
20
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
Materiality
2.3 Materiality is covered in detail in Chapter 6; however, for now it should be noted that
'misstatements, including omissions, are material if they could reasonably influence the
economic decisions of users taken on the basis of the financial statements'. (ISA 320: para. 2)
Reasonable assurance
2.4 No auditor can give a 100% guarantee that the financial statements are free from material
misstatement but 'reasonable assurance' is the highest level of assurance that can be given.
2.5 Reasonable assurance is not absolute assurance because there are inherent limitations of
an audit which result in the auditor forming an opinion on evidence that is persuasive rather
than conclusive.
'
'
21
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
3 Assurance
3.1 The ACCA AA syllabus extends beyond audit to the wider context of assurance.
Definition
3.2 'An assurance engagement is an engagement in which a practitioner expresses a
conclusion designed to enhance the degree of confidence of the intended users other than
the responsible party about the outcome of the evaluation or measurement of a subject
matter against criteria.'
(International Framework for Assurance Engagements, 2005: para. 7)
3.3 There are five elements to an assurance engagement. These are illustrated by the diagram
below:
Practitioner
Criteria
Subject
matter
Users Responsible
party
3.4 One way to remember the key features of an assurance engagement is using the mnemonic
CREST:
Criteria
Report
Evidence
Subject matter
Three party relationship (responsible party, user, practitioner)
3.5 Assurance describes the process whereby one party is trying to provide a level of comfort to
another party about a subject matter.
3.6 Many assurance engagements are undertaken voluntarily; however, some, such as the
statutory audit, happen as a result of a requirement imposed on the entity by another party
(for example, legislation, a regulator or a bank). (IFAC, 2017)
22
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
Required
What other examples of assurance and assurance reports exist?
Consider the following scenarios:
Solution
(1) You are currently thinking of buying a house built in 1900. What assurance report could you
obtain and who might provide this?
(2) Your friend is considering meeting up with someone they have met on an online dating
website. What assurances do you think they should seek before meeting up?
(3) You work for a local council which is just about to issue a $10,000 grant to an organisation
which runs sports activity courses for children with special needs. What assurance report
could you obtain and who might provide this?
23
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
A review of the
effectiveness of an
entity's internal controls A review of cash flow
Statutory audit forecasts which will be
presented to a bank to
obtain funding
Examples
3.9 An assurance report provides the following benefits to the users of information:
It provides an independent opinion from an external source that enhances the
credibility of the information.
Management bias is reduced.
Any non-standard or modified opinion draws attention to risk.
The relevance of the information may be improved by the expertise and knowledge of
the assurance firm.
24
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
4 Levels of assurance
4.1 An assurance engagement will provide the user with either:
Reasonable assurance; or
Limited assurance.
Evidence–gathering
Type of engagement procedures The assurance report
4.2 The wording of the assurance report will vary according to the level of assurance provided
by the report:
Positive expression 'In our opinion internal control is effective, in all material
respects, based on XYZ criteria.'
Negative expression 'Based on our work described in this report, nothing has
come to our attention that causes us to believe that internal
control is not effective, in all material respects, based on
XYZ criteria.'
25
1: THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
5 Chapter summary
Section Topic Summary
1 The objective of an The objective of an external audit is to provide an
external audit independent opinion on the financial statements.
2 The auditor's report The objective of any audit or other assurance
engagement is to produce an opinion in the form of a
report.
3 Assurance Audit is only one type of assurance engagement.
4 Levels of assurance Reasonable assurance is usually reported in terms of
positive expression.
Limited assurance is usually reported in terms of
negative expression.
END OF CHAPTER
26
Statutory audit and
regulation
27
2: STATUTORY AUDIT AND REGULATION
Overview
Statutory audits
28
2: STATUTORY AUDIT AND REGULATION
The Companies Act 2006 makes it an offence for a company's officer knowingly or recklessly to
make a statement in any form to an auditor which is misleading, false or deceptive.
29
2: STATUTORY AUDIT AND REGULATION
Eligibility
1.4 Most legal frameworks require auditors to be members of an appropriate professional body
such as ACCA.
30
2: STATUTORY AUDIT AND REGULATION
31
2: STATUTORY AUDIT AND REGULATION
Mission
3.3 The mission of IFAC is 'to serve the public interest, strengthen the global accountancy
profession and contribute to the development of strong international economies by
establishing and promoting adherence to high-quality professional standards, furthering the
international convergence of such standards, and speaking out on public interest issues
where the profession's expertise is most relevant.' (IFAC, 2017)
Membership
3.4 Membership in IFAC is open to accountancy bodies recognised by law/general consensus
within their countries as substantial national organisations of good standing. Through IFAC,
members are automatically registered as members of the International Accounting
Standards Board (IASB).
Council
3.5 This consists of one representative from each member body of IFAC. It elects the members
of the Board and establishes the basis of financial contributions by members.
Board
3.6 The Board consists of the President and not more than 22 members elected by the Council
for 3-year terms. Elections to the Board are held annually so that one-third of the Board
retires each year.
The role of the Board is to supervise the general IFAC work programme.
The work programme itself is implemented by smaller working groups or the following
standing technical committees:
International Auditing and Assurance Standards Board
Compliance Committee
Education Committee
Ethics Committee
Financial and Management Accounting Committee
Public Sector Committee
Transnational Auditors Committee (executive arm of the Forum of Firms)
4.2 The 18 members of the IAASB are nominated by the IFAC Board based on names put
forward by the member bodies and Forum of Firms.
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2: STATUTORY AUDIT AND REGULATION
4.3 The objective of the IAASB, on behalf of the IFAC Board, is to serve the public interest by
setting high-quality auditing and assurance standards and by facilitating the convergence of
international and national standards, thereby enhancing the quality and uniformity of
practice throughout the world and strengthening public confidence in the global auditing and
assurance profession. The IAASB achieves this objective by:
(a) Establishing high-quality auditing standards and guidance for financial statement
audits that are generally accepted and recognised by investors, auditors,
governments, banking regulators, securities regulators and other key stakeholders
across the world
(b) Establishing high-quality standards and guidance for other types of assurance
services on both financial and non-financial matters
(c) Establishing high-quality standards and guidance for other related services
(d) Establishing high-quality standards for quality control covering the scope of services
addressed by the IAASB
(e) Publishing other pronouncements on auditing and assurance matters, thereby
advancing public understanding of the roles and responsibility of professional auditors
and assurance service providers
5.2 The IAASB's standards contain basic principles and essential procedures together with
related guidance in the form of explanatory and other material. The basic principles and
essential procedures are to be understood and applied in the context of the explanatory and
other material that provide guidance for their application. It is therefore necessary to
consider the whole text of a standard to understand and apply the basic principles and
essential procedures.
In exceptional circumstances, a professional accountant may judge it necessary to depart
from a requirement of a standard to achieve more effectively the objective of the
engagement. When such a situation arises, the professional accountant should be prepared
to justify the departure.
33
2: STATUTORY AUDIT AND REGULATION
Transparent debate
A proposed standard is discussed at a meeting, open to the public.
Consideration of comments
Any comments as a result of the exposure draft are considered at an open meeting of
the IAASB, and it is revised as necessary.
Affirmative approval
Approval is made by the affirmative vote of at least 2/3 of IAASB members.
34
2: STATUTORY AUDIT AND REGULATION
Status of ISAs
5.6 As statutory audit is governed by local legislation, the status of ISAs will vary between
countries:
National standards may continue to exist, but aligned with the principles of ISAs.
The ISAs could be adopted without any additional guidance relating to national
circumstances (eg South Africa).
The ISAs could be adopted but with additional specific guidance added (eg ISAs
(UK)).
35
2: STATUTORY AUDIT AND REGULATION
7 Chapter summary
Section Topic Summary
1 The regulatory Auditors' rights and duties are governed by
framework national legislation.
2 Appointment, removal Appointment and removal require shareholders'
and resignation of resolutions. Auditors may resign at any time by
auditors giving notice in writing.
3 International IFAC is an international organisation of accountancy
Federation of bodes. Its mission is to establish and promote
Accountants adherence to high-quality professional standards.
4 International Auditing The IAASB, an operating board of IFAC, produces
and Assurance international standards on auditing, assurance
Standards Board and related services.
5 The scope and IAASB pronouncements do not overrule local laws or
authority of IAASB regulations but where they form part of the regulatory
pronouncements framework (eg in the UK) they are mandatory.
6 Regulation by the Professional bodies, such as ACCA, establish
profession regulations relating to education and training and
ethics.
END OF CHAPTER
36
Corporate governance
37
3: CORPORATE GOVERNANCE
Overview
Corporate governance
Definition
38
3: CORPORATE GOVERNANCE
1 Corporate governance
Definition
1.1 Corporate governance relates to the internal systems or means by which companies are
directed and controlled.
1.2 It describes the framework of rules and practices by which a board of directors ensures
accountability, fairness, and transparency in a company's relationship with each of its
stakeholders.
1.3 In recent decades there have been several reviews performed in many different countries in
order to try to establish a set of principles for corporate governance.
1.7 The OECD document provides detailed recommendations expanding on each of the
principles.
1.8 In reality, each country can then develop its own corporate governance code for companies
to follow.
39
3: CORPORATE GOVERNANCE
41
3: CORPORATE GOVERNANCE
Our board
Gary Lewis (Chairman) Chairman of Nomination Committee
Mary Batter (CEO) Member of Nomination Committee
Katie Escombe (Chief Finance Officer) Executive Director
Bob Part (Non-executive Director) Chairman of the Audit Committee
Member of the Remuneration and Nomination
Committees
Adam Knight (Non-executive Director) Chairman of the Remuneration Committee
Member of the Audit and Nomination Committees
Jeremy Flage (Non-executive Director) Member of the Audit, Remuneration and Nomination
Committees
Solution
(1) Why should the role of the Chairman and the Chief Executive Officer ideally be carried out
by two different people?
(2) How does Dress You Like Co ensure that board members are properly equipped to do their
job?
42
3: CORPORATE GOVERNANCE
(3) Why do you think the directors are re-elected each year?
(4) How is the responsibility for risk management shared in Dress You Like Co?
(5) Why does the company have both executive and non-executive directors?
(6) Which sub-committees do the non-executive directors form and what are their roles?
43
3: CORPORATE GOVERNANCE
(e) Are the terms of reference for the audit committee available/
described in the annual report?
(f) Does the audit committee arrange methods for staff to report
impropriety in financial reporting?
(h) Does the audit committee have primary responsibility for the
appointment of the external auditors?
44
3: CORPORATE GOVERNANCE
3 Audit committees
Responsibilities of the audit committee
3.1
To monitor and
review
To implement policy effectiveness of
on supply of internal audit
non-audit services department
by external auditor
To monitor
To approve arrangements
remuneration and safeguarding the
engagement terms privacy of whistle
of external auditor blowers
To recommend
appointment,
reappointment and
removal of external
auditor
45
3: CORPORATE GOVERNANCE
46
Additional
Notes
47
3: CORPORATE GOVERNANCE
4.2 Detailed below are the main issues companies should address in their corporate
governance report.
48
3: CORPORATE GOVERNANCE
49
3: CORPORATE GOVERNANCE
50
3: CORPORATE GOVERNANCE
5 Chapter summary
Section Topic Summary
1 Corporate governance The OECD has developed Principles of Corporate
Governance as a reference point for national policy
makers.
2 The UK Corporate The UK Corporate Governance Code issued by the
Governance Code Financial Reporting Council in the UK requires listed
companies to include a corporate governance report
in the annual report detailing how the company has
been directed and controlled in terms of board
leadership and company purpose, division of
responsibilities, composition, succession and
evaluation, audit, risk and internal control and
remuneration.
3 Audit committees All listed companies should have an audit committee
which should be made up of at least three
non-executive directors. Some of the main roles of the
audit committee are to monitor the integrity of the
financial statements and the auditor's
independence and also to review the company's
internal controls and risk management systems.
4 The UK Corporate This section lists the main issues companies should
Governance Code address in their corporate governance report.
(revisited)
51
3: CORPORATE GOVERNANCE
END OF CHAPTER
52
Internal audit
53
4: INTERNAL AUDIT
Overview
IT Regulatory Customer
audits compliance experience
54
4: INTERNAL AUDIT
The board, the audit committee and the internal audit function
1.7 The corporate governance requirement to 'manage risk and oversee the internal control
framework' (FRC UK Corporate Governance Code: Principle O) is often met by a
partnership between the board, the audit committee and the internal audit function.
1.8 The board, which consists of all the directors (executive and non-executive), has the overall
responsibility for ensuring that the company meets corporate governance requirements.
1.9 The audit committee is a sub-committee of the board and comprises at least three
non-executive directors (two in the case of a smaller company).
The audit committee has many responsibilities (Chapter 3) including:
To review the internal control and risk management systems that the board has put in
place
To monitor and review the effectiveness of the internal audit function
1.10 The internal audit function is essentially an internal control available to management. The
tasks they carry out vary greatly but will include assessing the effectiveness of the board's
internal control and risk management systems.
55
4: INTERNAL AUDIT
BOARD
Monitor
management's
AUDIT COMMITTEE responsiveness to
IA findings and
recommendations
56
4: INTERNAL AUDIT
2.2 In order to provide such assurance, the internal auditor will examine and evaluate the quality
of risk management, governance and internal control processes across all parts of a
company and report this directly and independently to the most senior level of management.
2.3 Unlike external auditors, the internal audit function looks beyond the financial statements
and considers wider issues such as the company's reputation, compliance with laws and
regulations, growth, its impact on the environment and employee satisfaction levels.
This is because the key to a company's success is often managing such risks effectively.
Scope
2.4 There are many types of work that the internal auditor can perform. Those listed in the
syllabus are:
Value for money audits
Information technology (IT) audits
Financial audits
Audits to verify regulatory compliance
Fraud investigations
Customer experience audits
Operational audits
2.5 Value for money audits are covered in Section 2.6 whilst the other audits are addressed in
the additional notes section to this chapter.
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4: INTERNAL AUDIT
2.7 VFM audits tend to focus on three areas: economy, efficiency and effectiveness. These are
commonly known as 'the three Es':
Effectiveness Doing the right things and meeting the organisation's objectives
2.8 Management will need to set objectives for each of the three areas which will detail the
goals/aims they hope to achieve in terms of the company's economic purchase of
resources, efficient use of resources and the effectiveness of achieving the company's
objectives.
2.9 Once the objectives have been set, they will then need to put controls in place to ensure
each objective is met.
Dress You Like Co is a clothing manufacturer, based in the UK, which has been trading for over
ten years. It operates from two sites, a factory where the clothes are made and a head office
where the administration is carried out. Completed inventory orders are despatched from both the
factory and the head office.
In an effort to reduce costs, Dress You Like Co now imports its material from one sole supplier
based in China. Dress You Like Co's accounting system uses the US dollar as its currency;
however, most of its Chinese supplier's business contacts are based in Europe and so it both
invoices and requires payment in Euros.
Dress You Like Co sells its finished products to small independent retailers and also one major
supermarket chain. The supermarket chain often requires additional deliveries without much prior
notice and so Dress You Like Co has to maintain a high level of inventory should this occur. Credit
terms are normally 30 days, but the supermarket is given 60-day credit terms.
Required
Suggest TWO objectives Dress You Like Co may set in each of the areas of economy, efficiency
and effectiveness and describe the controls you would expect to be put in place to ensure they are
achieved.
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4: INTERNAL AUDIT
Solution
Objective Control
Economy
Efficiency
Effectiveness
2.10 Audits which are concerned solely with the 'economy' objective are often termed 'best
value' audits.
59
4: INTERNAL AUDIT
3.5 Independence
(a) Internal auditors should be independent of the activities they audit. For example,
internal auditors should not generally be involved in designing, installing and
operating systems. Rather their role is to review the effectiveness of them.
(b) Internal audit departments should be granted sufficient status to achieve
independence from the various company functions.
(c) Internal auditor's reports should be considered appropriately by directors and
recommendations acted upon.
(d) Internal auditors must have a reporting line that is independent of the function they
are auditing – highest level of management/audit committee.
3.6 Objectivity
Objectivity is all about maintaining an independent mental attitude – when they conduct their
work, the internal auditors should consider the facts in front of them without having any
pre-conceived ideas.
3.8 Note that internal auditors are not normally subject to any regulatory authority.
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4: INTERNAL AUDIT
There are both advantages and disadvantages of outsourcing a company's internal audit function.
Required
Explain FOUR advantages and disadvantages to a company of outsourcing the internal audit
function.
Solution
Advantages Disadvantages
4.2 Note that where the internal audit function is outsourced to the company's external auditor,
there may be a self-review threat to the auditor's independence (Chapter 5).
61
4: INTERNAL AUDIT
Abbie Jones has recently signed a training contract with Check & Co, a firm of Chartered Certified
Accountants, and is working in the firm's audit department. She has been reviewing some of the
firm's client audit files in an attempt to gain a better understanding of what an audit is. She has
noticed that some clients seem to have an internal audit function whilst others do not.
Abbie is a little confused as to the difference between her role as an external auditor and the role
of the internal audit function.
Required
You are an audit senior in Check & Co and have been asked to complete the following table for
Abbie which distinguishes between the key elements of the roles of the external and internal
auditor.
Solution
External auditor Internal auditor
Objectives
62
4: INTERNAL AUDIT
Status
Qualification
External Internal
auditors auditors
63
4: INTERNAL AUDIT
5.7 In these cases, it may be possible for the external auditor to rely on the work of the internal
auditor.
S cope of work
O rganisational status
I ndependence
T echnical competence
Direct assistance
5.9 It is also possible that the external auditors may use the internal auditors to provide direct
assistance to them. Direct assistance refers to the use of the internal auditors to perform
audit procedures under the direction, supervision and review of the external auditor.
5.10 When deciding whether the internal auditors should provide direct assistance the external
auditor should consider:
(a) The amount of judgement involved in planning and performing the relevant audit
procedures, and in evaluating the audit evidence gathered;
(b) The assessed risk of material misstatement; and
(c) The existence and significance of threats to the objectivity and the level of
competence of the internal auditors.
5.11 Where the external auditors have used direct assistance from the internal auditors they
should document:
(a) The evaluation of the existence and significance of threats to the objectivity of the
internal auditors, and the level of competence of the internal auditors used;
(b) The basis for the decision regarding the nature and extent of the work performed by
the internal auditors; and
(c) Who reviewed the work performed and the date and extent of the review.
5.12 The audit opinion remains the responsibility of the external auditor at all times.
64
Additional
Notes
65
4: INTERNAL AUDIT
IT audits
6.2 Computer, or IT, systems have become increasingly important to businesses and the way in
which they are run. It is fundamental therefore that a business knows it has appropriate IT
systems in place and that they are operating effectively.
6.3 An IT system could simply comprise a standalone computer on which a business maintains
its accounting records, produces invoices and sends and receives emails.
6.4 Alternatively, IT systems could comprise a database, an integrated inventory control system
or a company's e-commerce activities.
6.5 Whatever the extent of IT systems used by a business, it is essential that a company has
internal controls in place to make sure that the systems operate effectively.
6.6 An IT audit will involve these internal controls being tested to ensure that they are
operating effectively.
6.7 It is likely that an internal audit function will include a computer specialist who can carry out
specific tests of controls, especially where the controls are embedded into the computer
system.
Financial audits
6.8 The board of directors has a statutory responsibility to prepare financial statements and
maintain proper (accounting) books and records. They will also produce management
accounts on a monthly basis in order to assess the performance of the business.
6.9 Management will make decisions based on this information and therefore need to know that
it is reliable.
6.10 Financial audits involve the internal audit function reviewing the financial information
produced and gathering evidence to substantiate it.
66
4: INTERNAL AUDIT
6.11 For example, in order to be able to report about the accuracy of the figure for sales revenue,
the internal audit function may perform tests of controls to ensure that all orders processed
are despatched to customers and then invoiced.
6.12 Similarly, in order to be able to report on the accuracy of the figure for property, plant and
equipment, the internal audit function may carry out an inspection of assets to ensure that
the figure agrees to the list of assets in the non-current asset register and that these assets
exist and are being used by the business.
Regulatory compliance
6.13 Most businesses are subject to regulation such as health and safety requirements.
However, some businesses face additional regulation due to the nature of the products and
services they sell, for example banks and other financial institutions.
6.14 Where an entity is heavily regulated non-compliance could have a severe impact on their
business. For example an entity may incur fines or have its licence to trade revoked.
6.15 It is essential that management are up to date with the regulatory requirements applicable to
their business and put internal controls in place to ensure compliance and detect any
instances of non-compliance.
6.16 In such businesses it is likely that the internal audit function will include a member of staff
who has specific knowledge and training in these areas so that non-compliance can be
prevented and detected.
Fraud investigations
6.17 The board of directors is responsible for assessing the entity's risk from fraud and
maintaining a system of internal controls which prevent and detect fraud and error.
6.18 The internal audit function's general work on internal controls may identify instances of
fraud. The board may also instruct the internal audit function to perform a specific
investigation where fraud is suspected.
6.20 The internal audit function may be involved in conducting such reviews or in collating the
feedback obtained and making recommendations regarding changes which could improve
customer experience in the future.
67
4: INTERNAL AUDIT
Operational audits
6.21 Operational audits are also known as management or efficiency audits and they involve the
internal audit function monitoring management's performance to ensure company policy is
adhered to.
Two aspects
68
4: INTERNAL AUDIT
7 Chapter summary
Section Topic Summary
1 Corporate governance Having an internal audit function is one way in which
and internal audit the board of directors can demonstrate good
corporate governance. The internal audit function
should report regularly to the audit committee and the
audit committee should review and assess the internal
audit function's work plan.
2 Nature and purpose of The role of the internal audit function is extremely wide
internal audit and varied. Value for money audits assess whether
assignments the business has obtained the best goods/services for
the lowest level of resources. They focus on economy,
efficiency and effectiveness.
3 Scope and limitations For the work of the internal audit function to be
of internal audit effective, internal auditors must be independent and
objective and carry out their work with due skill and
care.
4 Outsourcing internal Some companies outsource internal audit to
audit accountancy or consultancy firms.
5 The role of external The role of the external auditor is clearly defined in
and internal audit statute; the role of the internal audit function is
decided by the management of a specific company.
6 Nature and purpose of As well as performing value for money audits, the
internal audit internal audit function may conduct IT audits, financial
assignments (cont.) audits, audits to verify regulatory compliance, fraud
investigations, customer experience audits and
operational audits.
69
4: INTERNAL AUDIT
END OF CHAPTER
70
Achievement Ladder Step 1
You have now covered the Topics that will be assessed in Step 1 of your Achievement Ladder.
It is vital in terms of your progress towards 'exam readiness' that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course Notes
Topic name Subtopic/Chapter name
chapter
The concept of audit and assurance 1
Audit and assurance
Regulation 2
Corporate governance 3
Governance
Internal audit 4
71
Achievement ladder
72
Professional ethics and
quality control
procedures
73
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
Overview
Engagement letters
74
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
75
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
76
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
You are an audit manager of Check and Co. The following situations have arisen with different
audit clients of your firm.
(1) In an initial meeting with the finance director of Weadon Co, an audit client, you learn that
the entire audit team will be invited to the company's annual summer social event, a
weekend at an exclusive spa hotel.
(2) Mr Walker has been the Engagement Partner for a client, Stewards Co, for nine years. He
has excellent knowledge of the client and knows all of the directors of Stewards Co very
well. Stewards Co is considered to be a public interest entity.
Required
(a) Explain the ethical threats which may affect the independence of Check and Co in respect of
each of the client audits.
(b) For each threat explain how it may be reduced.
Solution
Threat Safeguards
77
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
Risk (2)
Risk (3)
Risk (4)
78
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
Use one team to conduct the year-end audit and a separate team to perform any
non-audit work.
Discuss the situation with Emerald's audit committee and consider resigning from
some services.
The directors of Emerald must provide all source data and approve all journal entries.
Use one team to conduct the year-end audit and a separate team to provide
accountancy services.
Check and Co should decline the offer to prepare the financial statements.
FINANCIAL
MATTERS
79
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
Threats Safeguards
Threats Safeguards
Threats Safeguards
(i) Self-interest threat arises when total Discuss with audit committee
fees from a client represent a large Resign from some services
portion of the firm's total fees. The
External quality control review
firm may issue a favourable opinion
rather than risk losing such a Consult ACCA or another professional
significant income stream. accountant on any key audit areas
requiring judgement
80
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
Threats Safeguards
If the audit client is a public interest entity then there are additional ethical
requirements.
If the total fees from the client represent more than 15% of the total fees received
by the firm for 2 consecutive years then there is likely to be undue dependence
on the client and the firm should put safeguards in place.
Threat Safeguards
Acceptance of gifts from a client may Gifts and hospitality should not be
create a self-interest threat because the accepted unless the value is trivial
firm/individual may feel obliged to give a and inconsequential.
favourable opinion. Acceptance of gifts
may also be perceived as a bribe.
Hospitality from clients may give rise to a
familiarity threat.
81
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
RELATIONSHIPS
Threat Safeguards
Threat Safeguards
82
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
(c) Employment
Eg Member of an assurance team or partner becomes a director or employee of a
client in a position to exert influence on the financial statements or vice versa.
Threat Safeguards
Threat Safeguards
Rotate Do not
after return for
Key audit Seven Two years
partner* years
83
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
Threat Safeguards
NON-ASSURANCE
SERVICES
84
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
Threat Safeguards
Self-review threat arises if accounting If the client is not a public interest entity:
assistance includes making management Accounting services should not be
decisions eg approving transactions performed by audit team staff
because it is unlikely that the firm will
criticise its own work and decisions. Client must provide all source data
Client must approve all journal
entries
Discuss non-audit services with
audit committee
If the client is a public interest entity:
The provision of accounting or
bookkeeping services is no longer
permitted (even in the case of an
emergency)
Threats Safeguards
Threats Safeguards
Self-review threat arises if audit team Remind client (in engagement letter)
plan to rely on the work of the internal that it is their responsibility to
audit department. establish, maintain and monitor a
system of internal controls.
Internal audit services should not be
provided by audit team members.
Independent partner review to ensure
appropriate reliance is placed on
internal audit and that its work is
rigorously audited.
A managerial threat may arise if the firm Client is reminded that it must
makes decisions on behalf of the client evaluate and determine which
when providing internal audit services. recommendations of the firm should
be implemented.
85
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
86
Additional
Notes
87
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
4 Confidentiality
4.1
Members acquiring information in the course of their professional
work should not disclose any such information to third parties without
first obtaining permission from their clients. Likewise, students and affiliates
must treat any information given by members in the strictest confidence.
88
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
89
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
5.3 Advertisements and promotional material prepared or produced by members or firms should
not (either in content or presentation):
(a) Bring ACCA into disrepute or bring discredit to the member, firm or the accountancy
profession
(b) Discredit the services offered by others whether by claiming superiority for the
member's or firm's own services or otherwise
(c) Be misleading, either directly or by implication
(d) Fall short of the requirements of the UK Advertising Standards Authority's Code of
Advertising and Sales Promotion, notably as to legality, decency, clarity, honesty, and
truthfulness
5.5 Care should be taken to ensure that any reference to fees does not mislead the reader as to
the precise range of services and time commitment that the reference is intended to cover.
Any promotional activities should not amount to harassment of prospective clients.
Commissions, fees or rewards in return for the introduction of a client are permitted,
provided appropriate safeguards are put in place such as disclosure to the client.
6 Acceptance
6.1 New auditors should ensure that they have been appointed in a proper and legal manner.
(a) Before accepting nomination the auditor must:
Acceptance procedures
Ensure professionally Consider whether disqualified on legal or ethical
qualified to act grounds
Ensure existing resources Consider available time, staff and technical
adequate expertise
Obtain references Make independent enquiries if directors not
personally known
Communicate with present Enquire whether there are reasons/
auditors circumstances behind the change which the new
auditors ought to know, also courtesy
(b) The new auditors should communicate with the present auditors to determine whether
there are any professional reasons as to why they should not accept appointment as
auditors.
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5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
3
Present auditor New auditor
6
4
1
5 Audit client 2
If at any point in the above process the audit client refuses permission to correspond
then the new auditor should not accept appointment as auditor.
(c) After accepting nomination
(i) Ensure outgoing auditor's removal/resignation properly conducted in
accordance with national regulations
(ii) Ensure new appointment properly conducted – obtain a copy of the resolution
passed
(iii) Agree the terms of the engagement
91
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
92
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
7.7 Furthermore, for listed audits, the quality control reviewer should consider:
(a) The firm's independence in relation to the audit
(b) Whether appropriate consultation has taken place on difficult or contentious matters
(c) Whether audit documentation on such matters supports the conclusions reached
93
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
......................
Name and Title
Date
95
5: PROFESSIONAL ETHICS AND QUALITY CONTROL PROCEDURES
9 Chapter summary
Section Topic Summary
1 ACCA Code of Ethics The Code applies to members, affiliates and students
and Conduct of the ACCA and details the fundamental principles of
integrity, objectivity, professional competence
and due care, confidentiality and professional
behaviour.
2 Threats to the There are many circumstances which can lead to
fundamental principles threats to the fundamental principles. These
circumstances will fall into one or more of the five
categories of: self-interest, self-review, advocacy,
familiarity and intimidation.
Where threats exist, safeguards should be put in
place to eliminate or reduce the threat.
3 Application of the The ACCA Code adopts a principle- rather than
conceptual framework rule-based approach but gives many examples of
approach to specific situations where independence can be
independence threatened and the relevant safeguards that may
mitigate these.
4 Confidentiality The auditor must not disclose information obtained in
their professional work without prior consent unless
there is an obligation to do so.
5 Obtaining audit The ACCA Code imposes some restrictions on how
engagements firms market their services.
6 Acceptance Specific rules exist in the Code in relation to obtaining
and accepting new engagements.
An engagement letter is issued to confirm
acceptance and agree terms.
7 Quality control on an The audit engagement partner is ultimately
individual audit responsible for ensuring that an audit has been
carried out in accordance with the firm's quality
control procedures.
8 Specimen engagement You will not need to reproduce an engagement letter
letter but must be familiar with its contents.
END OF CHAPTER
96
Achievement Ladder Step 2
You have now covered the Topics that will be assessed in Step 2 of your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics.
It is vital in terms of your progress towards 'exam readiness' that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course Notes
Topic name Subtopic/Chapter name
chapter
The concept of audit and assurance 1
Audit and assurance
Regulation 2
Corporate governance 3
Governance
Internal audit 4
Professional ethics and quality control
Ethics 5
procedures
97
Achievement ladder
98
Risk assessment
99
6: RISK ASSESSMENT
Overview
Risk assessment
Professional scepticism
100
6: RISK ASSESSMENT
1 General principles
Professional scepticism
1.1 ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with International Standards on Auditing states that auditors must plan and
perform an audit with professional scepticism recognising that circumstances may exist
that cause the financial statements to be materially misstated.
This requires:
Critical assessment, with a questioning mind, of the validity of evidence obtained
Alertness to contradictory evidence
Neither the assumption that management is dishonest nor the assumption of
unquestioned honesty
Professional judgement
1.2 ISA 200 also requires the auditor to exercise professional judgement in planning and
performing an audit of financial statements. Professional judgement is required in the
following areas:
Analyse the risk in the client's business, transactions and systems that could lead to
material misstatement
Direct their testing to risky areas
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6: RISK ASSESSMENT
2 Audit risk
2.1 ISA 200 states that 'to obtain reasonable assurance, the auditor shall obtain sufficient
Section 1 appropriate audit evidence to reduce audit risk to an acceptably low level and thereby
enable the auditor to draw reasonable conclusions on which to base the auditor's opinion'
(ISA 200: para. 11).
2.2 Audit risk is the 'risk that the auditor expresses an inappropriate audit opinion when the
financial statements are materially misstated' (ISA 200: para. 13c).
It is made up of three component parts, inherent risk, control risk and detection risk:
Control risk
Audit risk
Inherent risk
Detection risk
Inherent risk and control risk together form the 'risk of material misstatement' or 'financial
statement risk'.
Inherent risk
2.3 This is the susceptibility of an assertion to a misstatement that could be material, either
individually or when aggregated with other misstatements, assuming that there were no
related internal controls.
2.4 The risk of such misstatement is greater for some assertions and related classes of
transactions, account balances, and disclosures than for others. For example:
Complex calculations are more likely to be misstated than simple calculations
Accounts consisting of amounts derived from accounting estimates pose greater risks
than accounts consisting of relatively routine, factual data
External circumstances giving rise to business risks may also influence inherent risk.
Control risk
2.5 This is the risk that a misstatement could occur in an assertion that could be material, either
individually or when aggregated with other misstatements, that will not be prevented, or
detected and corrected, on a timely basis by the entity's internal control.
2.6 Some control risk will always exist because of the inherent limitations of internal control.
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6: RISK ASSESSMENT
Detection risk
2.7 This is the risk that the auditor's procedures will not detect a misstatement that exists in an
assertion that could be material either individually or when aggregated with other
misstatements.
Detection risk is primarily the consequence of the fact that the auditor does not, and cannot,
examine all available evidence (sampling risk).
3.2 Information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements.
(a) The auditor must be concerned with identifying 'material' errors, omissions and
misstatements. Both the amount (quantity) and nature (quality) of misstatements need
to be considered, eg lack of disclosure regarding ongoing litigation is likely to be
considered material.
(b) To put this into practice the auditor therefore has to set their own materiality levels –
this will always be a matter of judgement and will depend on the level of audit risk.
The higher the anticipated risk, the lower the value of materiality will be.
(c) The level set has a critical impact on two key areas:
(i) The nature, timing and extent of audit procedures. The lower the materiality
level is set, the more work will need to be performed to ensure audit risk is kept
at an acceptably low level; and
(i) Evaluating the effect of misstatements:
Whether to seek adjustments; or
The degree of any auditor's report modification.
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6: RISK ASSESSMENT
Performance materiality
3.4 Performance materiality is less than materiality calculated during the planning stage of the
audit, to reduce the risk that the aggregate of uncorrected and undetected misstatements
exceed materiality for the financial statements as a whole.
Performance materiality also refers to the amount or amounts set by the auditor at less than
the materiality level or levels for particular classes of transactions, account balances or
disclosures.
Determining performance materiality involves the auditor's professional judgement. It is
affected by their understanding of the entity and the results of risk assessment procedures.
It can be qualitative and quantitative.
For example, if there are particular account balances that could reasonably be expected to
significantly influence the decisions of users (for example, turnover for the year) then the
auditors may decide to use performance materiality when performing their audit procedures.
3.6 In evaluating whether the financial statements give a true and fair view, the auditor should
assess the materiality of the aggregate of uncorrected misstatements. This is normally
documented on a schedule of unadjusted differences.
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6: RISK ASSESSMENT
Documentation of materiality
3.7 ISA 320 requires the following to be documented:
Materiality for the financial statements as a whole
Materiality level or levels for particular classes of transactions, account balances or
disclosures if applicable
Performance materiality
Any revision of the above as the audit progressed
Solution
106
Additional
Notes
107
6: RISK ASSESSMENT
108
6: RISK ASSESSMENT
Assessing risk
4.3 Risk assessment includes:
(a) Identifying risks by considering the entity and its environment, including its internal
control (audit risk, business risk and significant risks)
(b) Relating the identified risks to what can go wrong at the assertion level, ie the impact
the risks could have on figures in the financial statements
(c) Considering the significance and likelihood of the risks
(d) Establishing materiality and evaluating whether the original level set remains
appropriate as the audit progresses
(e) Developing expectations for use when performing analytical procedure
(f) Designing and performing further audit procedures to reduce audit risk to an
acceptably low level
(g) Evaluating the sufficiency and appropriateness of audit evidence
Business risk
4.5 Business risks 'result from significant conditions, events, circumstances, action or inactions
that could adversely affect the entity's ability to achieve its objectives and execute its
strategies, or from the setting of inappropriate objectives and strategies' (ISA 315 (Revised):
para. 4c).
It is usually split into financial risk, operational risk and compliance risk.
The auditor should obtain an understanding of the entity's process for:
Identifying business risks relating to financial reporting objectives
Deciding about actions to address those risks, and the results thereof
4.6 As part of the risk assessment, the auditor shall determine whether any of the risks are
significant risks.
Significant risks are those that require special audit consideration.
The following factors indicate that a risk might be significant:
Risk of fraud
Its relationship with recent economic, accounting or other developments
The degree of subjectivity in the financial information
It is an unusual transaction
It is a significant transaction with a related party
The complexity of the transaction
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6: RISK ASSESSMENT
5.3 Where the risk assessment suggests there may be material misstatements arising from
fraud the main effects on the audit strategy will relate to:
Assignment and supervision of personnel
Consideration of accounting policies
Unpredictability in nature, timing and extent of audit procedures
5.5 The auditor should apply analytical procedures as risk assessment procedures and in the
overall review at the end of the audit.
They can also be used as a source of substantive audit evidence when their use is more
effective or efficient than tests of details in reducing detection risk for specific financial
statement assertions.
110
6: RISK ASSESSMENT
111
6: RISK ASSESSMENT
Trade payables
(v) Payables payment period = 365 days
Credit purchases
(c) Gearing
Interest bearing debt
(i) Debt/equity =
Share capital and reserves
You have also been provided with the following draft accounts of Dress You Like Co for the year
ended 30 September 20X1:
EXTRACTS FROM THE DRAFT STATEMENT OF FINANCIAL POSITION
AS ON 30 SEPTEMBER 20X1
Draft Actual
20X1 20X0
$'000 $'000
Bank: 0 200
EXTRACTS FROM THE DRAFT STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED
30 SEPTEMBER 20X1
Draft Actual
20X1 20X0
$'000 $'000
Revenue (supermarket) 53,500 49,000
Revenue (other) 8,200 6,700
Cost of sales (supermarket) (51,895) (45,080)
Cost of sales (other) (7,380) (5,900)
Gross profit 2,425 4,720
Other expenses (1,400) (2,450)
Profit before taxation 1,025 2,270
Required
(a) Calculate THREE ratios, for BOTH years, which would assist the audit senior in planning the
audit.
(b) Using the ratios calculated, describe the MAIN audit risk and explain the auditor's response
to this risk in the planning of Dress You Like Co.
112
6: RISK ASSESSMENT
Solution
113
6: RISK ASSESSMENT
6 Chapter summary
Section Topic Summary
1 General principles Audits must be planned with an attitude of
professional scepticism.
2 Audit risk The auditor must plan to minimise audit risk.
Audit risk is a combination of inherent risk, control
risk and detection risk.
3 Materiality in Planning Materiality must be assessed during audit planning.
and Performing an It has both quantitative and qualitative aspects.
Audit (ISA 320)
4 Understanding the The auditor must obtain a knowledge of the business,
entity and its including an understanding of business risk, audit
environment risk, significant risks and assertions.
5 Risk assessment Analytical procedures should be used as part of risk
procedures assessment.
END OF CHAPTER
114
Audit planning and
documentation
115
7: AUDIT PLANNING AND DOCUMENTATION
Overview
116
7: AUDIT PLANNING AND DOCUMENTATION
Satisfactory
Restricted Full
substantive tests substantive tests
(Chapters 11 to 16) (Chapters 11 to 16)
Overall review of
financial statements
(Chapter 18)
Report to
management
(Chapter 10)
Auditor's
report
(Chapter 19)
117
7: AUDIT PLANNING AND DOCUMENTATION
2.2 Planning an audit involves establishing the overall audit strategy for the engagement and
developing an audit plan.
118
Additional
Notes
119
7: AUDIT PLANNING AND DOCUMENTATION
Guides the
development of
120
7: AUDIT PLANNING AND DOCUMENTATION
Section 1.3
4 Interim and final audit
4.1 The main audit procedures are likely to be carried out in two phases, the interim and final
audit.
A typical time frame for a client with a 31 December year end might be:
Planning
1 January visit 31 December
Interim Final
audit audit
121
7: AUDIT PLANNING AND DOCUMENTATION
5 Audit documentation
5.1 Audit documentation is the record of audit procedures performed, relevant evidence
obtained and conclusions reached. Also known as working papers.
ISA 230 Audit Documentation states that the auditor shall prepare audit documentation on a
timely basis.
Purpose of working papers:
Assist in the planning and performance of the audit
Assist in the supervision and review of audit work
Enable the audit team to be accountable for its work
Retain a record of matters of continuing significance to future audits (points carried
forward)
Enable quality control reviews to be performed
5.2 Contents
(a) Sufficiently complete and detailed to enable an experienced auditor with no previous
connection with the audit subsequently to ascertain from them what work was
performed and to support the conclusions reached
(b) Should record information on the auditor's planning of the audit, the nature, timing
and extent of the audit procedures performed, and the results thereof, and the
conclusions drawn from the audit evidence obtained
(c) Auditor's reasoning on all significant matters requiring exercise of judgement, with
auditor's conclusions thereon
Types of documentation
5.3
Engagement letters
Permanent file
(information of continuing Legal documents such as prospectuses, leases,
importance) sales agreement
Details of the history of the client's business
Previous years' signed accounts and management
letters
Accounting systems notes, previous years' control
questionnaires
122
7: AUDIT PLANNING AND DOCUMENTATION
Financial statements
Current file
(information of relevance to Accounts checklists
current year's audit)
A summary of unadjusted errors
Review notes
Audit strategy
Audit plan
Time budgets and summaries
Letter of representation
Management letter
Notes of board minutes
Communications with third parties
Lead schedule including details of the figures to be
included in the accounts
Problems encountered and conclusions drawn
Audit programmes
Details of substantive tests and tests of control
123
7: AUDIT PLANNING AND DOCUMENTATION
6 Chapter summary
Section Topic Summary
1 Overview of the An outline of the main stages of a statutory audit.
statutory audit
2 The need for planning Planning is carried out so that the audit is performed in
an effective manner.
3 The audit strategy and The overall approach to the audit is documented in the
the audit plan audit strategy.
The audit plan documents specific procedures for each
class of transactions, balance or disclosure.
4 Interim and final audit The audit is usually carried out in two phases, the
interim audit and the final audit.
5 Audit documentation All audit evidence that supports the auditor's opinion
must be documented.
END OF CHAPTER
124
Introduction to audit
evidence
125
8: INTRODUCTION TO AUDIT EVIDENCE
Overview
Analytical
procedures Inspection Recalculation
Enquiry and
confirmation Observation
126
8: INTRODUCTION TO AUDIT EVIDENCE
1 Introduction
1.1 When undertaking an audit, the auditor needs to find evidence through testing of processes,
transactions, account balances and data to support their opinion.
ISA 500 Audit Evidence outlines the requirements when conducting an external audit under
International Standards on Auditing.
2 Quality of evidence
2.1 The auditor should obtain sufficient, appropriate audit evidence to be able to draw
reasonable conclusions on which to base the audit opinion. (ISA 500: para. 4)
2.2
ISA 500 Audit Evidence
Sufficient Appropriate
Quantity – Sufficient to
support the audit opinion
Factors to consider are: Relevant Reliable
Risk assessment The evidence External better than
Nature of accounting and gathered must cover internal
internal control systems the financial Internal more reliable
Materiality of the item statement assertions. when controls effective
Experience gained during
Auditor generated better
previous audits than client generated
Results of audit
procedures Documentary better than
oral
Source and reliability of
information available Original documents more
reliable than copies/faxes
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2.3 Evidence must be relevant to the particular financial statement assertion the auditor is
trying to test. There are two categories:
Section 2 Assertions about Occurrence:
classes of Transactions and events that have been recorded or disclosed have occurred
transactions and and pertain to the entity.
events and Completeness:
related All transactions and events that should have been recorded have been
disclosures recorded and all related disclosures that should have been included in the
financial statements have been included.
O Cut-off:
C Transactions and events have been recorded in the correct accounting period.
C Classification:
C Transactions and events have been recorded in the proper accounts.
A Accuracy:
P Amounts and other data relating to recorded transactions and events have
been recorded appropriately, and related disclosures have been appropriately
measured and described.
Presentation:
Transactions and events are appropriately aggregated or disaggregated and
are clearly described, and related disclosures are relevant and
understandable in the context of the requirements of the applicable financial
reporting framework.
Assertions about Completeness:
account All assets, liabilities and equity interests that should have been recorded have
balances and been recorded and all related disclosures that should have been included in
related the financial statements have been included.
disclosures at Obligations and rights:
the period end The entity holds or controls the rights to assets, and liabilities are the
obligations of the entity.
C Valuation and allocation:
O Assets, liabilities, and equity interests are included in the financial statements
V at appropriate amounts and any resulting valuation or allocation adjustments
E are appropriately recorded and related disclosures have been appropriately
C measured and described.
P Existence:
Assets, liabilities, and equity interests exist.
Classification:
Assets, liabilities, and equity interests have been recorded in the proper
account.
Presentation:
Assets, liabilities and equity instruments are appropriately aggregated or
disaggregated and are clearly described, and related disclosures are relevant
and understandable in the context of the requirements of the applicable
financial reporting framework.
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2.4 Sometimes an entity will use an expert, for example a chartered surveyor, to assist them in
the preparation of the financial statements. A management's expert is an individual or
organisation possessing expertise in a field other than auditing or accounting, whose work is
used by the entity to assist in the preparation of the financial statements.
ISA 500 states that when wanting to rely on the work of the expert, the auditor must
evaluate the competence, capabilities and objectivity of the expert, obtain an understanding
of the work done, and evaluate the appropriateness of the work done as audit evidence.
2.5 If the auditor is unable to obtain sufficient, appropriate evidence, then they should consider
the implications for the auditor's report (Chapter 19).
These are procedures to test the effectiveness of the entity's internal controls in
preventing or detecting material misstatements.
(b) Substantive procedures
These are procedures to detect material misstatements. There are two types:
Tests of detail (for example vouching amounts back to invoices, physical
inspection of assets)
Analytical procedures (for example variance analysis and ratio analysis)
3.5 Enquiry, inspection, observation and recalculation can all be used as either a test of control
or as a substantive procedure.
Tests of detail
3.8 Tests of detail are a further type of substantive procedure and describe the process of
gathering audit evidence through detailed inspection of invoices, documents and assets.
3.10 There are further examples of tests of detail later on in the course.
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HMA Co (HMA) is a marketing company that designs advertisements which are then placed in
newspapers and magazines and on websites.
You are an audit senior of Check & Co and are currently conducting the audit of HMA for the year
ended 30 September 20X2. During the course of the audit a number of events and issues have
been brought to your attention.
Expenses
HMA rents an office in an upmarket location in order to promote itself as a fashionable and quality
marketing company. HMA currently has a Human Resource team, Accounts department and Sales
team and also employs a significant number of design staff.
On 1 January 20X2 HMA decided that it needed to occupy a second floor in its current office
premises in order to be able to create a specialist publishing department so that the designers'
adverts can be modified in-house which would then allow them to be used across different
publishing platforms (both published products and online). The directors decided to take out a loan
to help fund the cost of this in the short term.
1 The following information is available in relation to the loan:
$
Finance charge in the statement of profit or loss 81,000
Opening loan liability on 1 January 20X2 400,000
The loan carries a fixed rate of interest of 2% per month and interest is paid at the end of
each month. HMA repaid capital of $50,000 on 1 April 20X2. In order to verify the finance
charge for the year you have been asked to perform a proof in total.
What is the expected finance charge for the above loan for the year ended
30 September 20X2 and the resultant impact on profit for the period?
Finance charge should be $6,000, profit is overstated
Finance charge should be $72,000, profit is understated
Finance charge should be $67,000, profit is understated
Finance charge should be $66,000, profit is understated
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These focus on the auditor checking their These focus on the auditor performing detailed
understanding of the control being in place and checks on the numbers in the financial
testing that it has operated effectively statements.
throughout the period Source documentation → financial statements
Enquire from management the process used to Analytically review the amounts owed to major
reconcile supplier statements. suppliers at the year end compared to the prior
period.
For a sample of supplier statement
reconciliations, inspect the reconciliation to see Enquire from management the reasons for any
evidence that the reconciliation has been significant differences.
performed and any differences investigated and Circularise a sample of year-end payables and
resolved. Verify that any necessary changes to request them to confirm the balance owed at
the accounting system have been authorised the year end.
and processed.
Inspect the cash book payments in the post
Reperform the reconciliation to ensure it has year end period for any significant payments to
been completed accurately. suppliers to ensure the year-end liability is
Inspect the reconciliation to verify it has been accurately recorded.
reviewed by an appropriate level of Calculate the payables days' ratios and
management. compare to the prior period. Discuss any
Observe a supplier statement reconciliation significant differences with management.
being performed.
5 Chapter summary
Section Topic Summary
1 Introduction Auditors need to gain audit evidence in order to
support the audit opinion they give.
2 Quality of evidence ISA 500 requires the auditor to obtain sufficient
appropriate audit evidence. Evidence is appropriate
if it is both relevant (to the financial statement
assertion being tested) and reliable.
3 Procedures for There are two types of audit procedures: tests of
obtaining audit control and substantive procedures. Substantive
evidence procedures are broken down into two further
categories: analytical procedures and tests of detail.
The mnemonic AEIOU serves to remind you of the
ways in which you can generate audit procedures.
4 Tests of control vs Tests of control involve identifying and repeatedly
substantive procedures testing an entity's internal controls in order to gather
audit evidence. Substantive procedures are used by
the auditor to detect material misstatements.
END OF CHAPTER
134
Achievement Ladder Step 3
You have now covered the Topics that will be assessed in Step 3 of your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics.
It is vital in terms of your progress towards 'exam readiness' that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course Notes
Topic name Subtopic/Chapter name
chapter
The concept of audit and assurance 1
Audit and assurance
Regulation 2
Corporate governance 3
Governance
Internal audit 4
Professional ethics and quality control
Ethics 5
procedures
Audit risk Risk assessment 6
Planning and documentation 7
Audit planning
Introduction to audit evidence 8
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Achievement ladder
136
Internal control
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9: INTERNAL CONTROL
Overview
Internal control
Examples of internal
control
Limitations of internal
control
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9: INTERNAL CONTROL
The entity's risk assessment How management identifies risks and decides
process upon actions to manage them
Control activities The policies and procedures that help ensure that
management directives are carried out
The categories most relevant to an audit are:
Performance reviews
Information processing
Physical controls
Segregation of duties
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9: INTERNAL CONTROL
Required
Consider each of the following examples. What checks/internal controls would you expect to be
carried out in each situation?
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9: INTERNAL CONTROL
Solution
(1) The postman knocks at your front door and hands you a letter which has been sent by
recorded delivery.
(2) You submit a claim for expenses to your line manager.
(3) You need to work an extra day over and above your normal hours to clear a backlog of work
and will expect to be paid overtime for this.
(4) You are responsible for maintaining the cash book and have just been passed the latest
bank statement.
(5) You have just received a monthly statement from your main supplier.
(6) You are responsible for payroll processing and you have just received notification from
human resources that an employee wants to take advantage of a season ticket loan offered
by your company. Your password does not give you permission to amend employee
deductions.
(7) You have just returned from a three-month holiday and are trying to log on to your computer.
(8) You are preparing to pay an invoice received from a supplier.
(9) You have prepared a bank reconciliation for your supervisor.
(10) You are entering 75 sales invoices into the accounting records and want to check the
accuracy of your posting.
(11) You have been working on the computer but have now gone away to make a cup of tea,
leaving the computer inactive for a period of time.
(12) You have a Saturday job operating the till in a small corner shop which is closing for the
night.
(13) You work in a shop that sells diamond jewellery; the jeweller is very keen to keep their
inventory secure.
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2.3
Plan the audit
Report
Unsatisfactory to management
Satisfactory
Restricted Full
substantive tests substantive tests
(Chapters 11 to 16) (Chapters 11 to 16)
Overall review of
financial statements
(Chapter 18)
Report to
management
(Chapter 10)
Auditor's
report
(Chapter 19)
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2.9 ICQs identify where internal controls exist, are quick to prepare and can be completed by
junior staff.
2.10 They can, however, give a distorted view of the entity's internal controls as there is no
weighting of more important controls. They may not be relevant to unusual systems.
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2.12 The idea behind the above question is that the person responsible for this part of the
purchases cycle will answer:
'Yes, because a sequentially numbered, multi-part goods received note is generated upon
receipt of the goods and one copy passed to the accounts department. This is then filed
whilst we wait for the supplier's invoice. This file is then reviewed at the end of each month
and an accrual made for any goods received which have not yet been invoiced.'
2.13 The auditor would only ever test the internal controls to gain audit evidence if the initial
assessment indicates that the controls are relevant to the financial statement assertions and
appear to be operating effectively.
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146
Additional
Notes
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9: INTERNAL CONTROL
4 General controls
4.1 General controls are policies and procedures that relate to many applications and support
the proper operation of information systems. They commonly include the following:
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5 Application controls
5.1 Application controls ensure that all transactions are authorised and recorded, and are
processed completely, accurately and on a timely basis. Application controls include the
following:
Control Examples
Controls over input: Manual or programmed agreement of control totals
completeness Document counts
One-for-one checking of processed output to source documents
Programmed matching of input to an expected input control file
Procedures over resubmission of rejected controls
Controls over input: Programs to check data fields (for example value, reference number,
accuracy date) on input transactions for plausibility:
Digit verification (eg reference numbers are as expected)
Reasonableness test (eg sales tax to total value)
Existence checks (eg customer name)
Character checks (no unexpected characters used in reference)
Necessary information (no transaction passed with gaps)
Permitted range (no transaction processed over a certain value)
Manual scrutiny of output and reconciliation to source
Agreement of control totals (manual/programmed)
Controls over input: Manual checks to ensure information input was:
authorisation Authorised
Input by authorised personnel
Controls over Similar controls to input must be in place when input is completed, for
processing example batch reconciliations
Screen warnings can prevent people logging out before processing is
complete
Controls over master One-to-one checking
files and standing Cyclical reviews of all master files and standing data
data
Record counts (number of documents processed) and hash totals
(for example, the total of all the payroll numbers) used when master
files are used to ensure no deletions
Controls over the deletion of accounts that have no current balance
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6 Chapter summary
Section Topic Summary
1 Internal control A company's internal control system is the board of
systems directors' responsibility and comprises:
The control environment
The entity's risk assessment process
The information system
Control activities
Monitoring of controls
Examples of internal controls include approval/
authorisation, reconciliations, computer controls
(passwords, sequence checks), review and physical
controls.
There are inherent limitations in any system of
internal control.
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END OF CHAPTER
152
Tests of controls
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Overview
Tests of controls
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2 Tests of controls
2.1 Internal controls are implemented by management to prevent or detect fraud and error.
2.2 The auditor will only ever carry out tests of controls if their initial risk assessment suggests
that the entity's internal controls operate effectively.
2.3 If this is the case, then the auditor will perform tests of controls to gather audit evidence
about relevant audit assertions.
2.4 The auditor must test that the control:
Is properly designed;
Exists; and
Has operated throughout the period.
2.5 Failures of internal controls (or deviations) should be recorded and investigated regardless
of the amount involved.
The auditor must assess whether deviations are isolated departures or indicate existence of
errors in accounting records.
2.6 If the results of the tests of control are unsatisfactory, then the auditor's preliminary
assessment of control risk is not supported and the auditor must modify the nature, timing
and extent of their planned substantive procedures.
2.7 Tests of controls include enquiry in combination with other audit procedures, for example:
(a) Inspection of documents supporting controls or events to gain audit evidence that
controls have operated effectively, for example verifying that a transaction has been
authorised
(b) Observation of the entity's control procedures, for example observing an inventory
count to ensure it is being conducted in accordance with the inventory count
instructions
(c) Reperformance of the application of a control to ensure it was performed correctly,
for example reperforming a bank reconciliation to verify that it has been done properly
(d) Examination of evidence of management reviews, for example minutes of board
meetings
(e) Testing of the control activities performed by a computer, using for example
computer-assisted audit techniques (CAATs)
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3 Transaction cycles
3.1 There are six transaction cycles detailed in the syllabus:
(1) Sales
(2) Purchases
(3) Payroll
(4) Bank and cash
(5) Inventory
(6) Capital expenditure
3.2 The first three cycles are covered in Section 3 whilst the other cycles are addressed in the
additional notes section to this chapter.
Sales cycle
3.3 The sales cycle/sales system consists of four main stages. Each stage has its own key
documentation.
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Dress You Like Co is a clothing manufacturer, based in the UK, which has been trading for over
ten years. It operates from two sites: a factory where the clothes are made and a head office
where the administration is carried out. Completed inventory orders are despatched from both the
factory and the head office.
In an effort to reduce costs, Dress You Like Co now imports its material from one sole supplier
based in China. Dress You Like Co's accounting system uses the US dollar as its currency;
however, most of its Chinese supplier's business contacts are based in Europe and so it both
invoices and requires payment in Euros.
Dress You Like Co sells its finished products to small independent retailers and also one major
supermarket chain. The supermarket chain often requires additional deliveries without much prior
notice and so Dress You Like Co has to maintain a high level of inventory should this occur. Credit
terms are normally 30 days, but the supermarket is given 60-day credit terms.
You are an audit senior in Check and Co and you are carrying out the controls work on the sales
system for the year ended 30 September 20X1. You have access to the systems notes that Dress
You Like Co provided to its previous auditors for the year ended 30 September 20X0 and you have
spoken to several members of Dress You Like Co staff to obtain more information about the sales
system.
Extract from Dress You Like Co's sales systems notes for the year ended 30 September
20X0
Order Placed
Customers contact Dress You Like Co by phone or email and inform the sales team which
products they require. A member of the sales team completes a standard form with all of the
customer details and forwards this to the warehouse for despatch to the customer.
Despatch of Goods
The warehouse manager collates all of the orders from the previous day and passes them to the
picking team. This team then picks the items, packages them and produces a goods despatch note
detailing all of the products. The warehouse manager then organises delivery of the products for
the following day.
Goods Invoiced and Recorded
Each day the finance team receives copies of the GDNs completed by the warehouse staff and
uses these to generate invoices. Each invoice has the customer details, the products despatched
and the standard prices. The supermarket chain has its own price list, which is significantly
discounted on the other retailer prices.
Payment Received
Customers can pay by cash, cheque or BACS and should return a remittance advice with all
payments. There is no formal process for monitoring old debts. Bank reconciliations are performed
on a weekly basis by the accounts team and monthly by the internal audit department.
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Transcripts of conversations with Dress You Like Co staff (available as video clips)
Interview with Jenny Bristow, sales team
You: So Jenny, can you tell me a little more about the standard form that you complete
when you receive an order?
Jenny: Sure. The order form is three-part; we complete it by hand using the information the
customer has provided by phone or email. We refer back to the standard product list,
which all our customers have a copy of, to ensure that we have the correct product
codes for each item. Once the form is complete we send one copy to the customer
(either by post or scanned and emailed), one copy is sent to the warehouse and we
retain one copy here.
You: OK, is the process any different for the supermarket?
Jenny: No, not really. For the supermarket we send the order straight to the despatch team in
the warehouse so the order can be sent quickly, rather than sending it to the
warehouse manager.
You: Thanks. Oh, one more question. What happens with new customers?
Jenny: How do you mean?
You: Well, do you have any specific checks on new customers or any prescribed credit
limits?
Jenny: Umm, no not really. We just record their details on the form as normal and then pass
the order on to the warehouse.
You: Brilliant, thanks very much.
Jenny: You're welcome.
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You: OK, do you check this outstanding file back to any other information?
David: Yes, at the end of each month I sit down with Jenny from the sales team. We go
through the outstanding orders file and copies of all of the GDNs to make sure all
orders have been captured.
You: Lovely, thank you very much.
David: Great, I can get back to some proper work now.
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Solution
Deficiency Implication Recommendation
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Required
Continuing with the Dress You Like Co scenario, identify THREE controls within the sales system
and recommend a test of control that could be carried out for each control.
Solution
Control Test of control
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Purchases cycle
3.4 As with the sales system, the purchases cycle/purchases system also consists of four main
stages and has key documentation at each stage.
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You are now carrying out the work on the purchases system at Dress You Like Co. You again
have access to the systems notes that Dress You Like Co provided to its previous auditors for the
year ended 30 September 20X0 and you have spoken to several members of Dress You Like Co
staff to obtain more information about the purchases system.
Extract from Dress You Like Co's purchases systems notes for the year ended
30 September 20X0
Order Stage
Reorder levels exist for all items of inventory. When the level of inventory falls to the reorder level,
a standard order form is automatically generated by the inventory system to order a set quantity of
material. The order form details the name of the buyer responsible for that inventory line and a
copy of the order is forwarded to the warehouse where goods are received.
Goods Received
On receipt of the goods, the quality of the materials is checked and then the warehouse manager
generates a sequentially numbered, multi-part goods received note.
Goods Invoiced and Recorded
Each day the finance team receives copies of the GRNs completed by the warehouse staff. These
are filed in sequential number order to await receipt of the associated invoice.
Payment Made
All invoices in the file are automatically paid at the end of each month. The Chinese supplier sends
a monthly statement but this is not reconciled to the purchase ledger account. Bank reconciliations
are performed on a weekly basis by the accounts team and monthly by the internal audit
department.
Transcripts of conversations with Dress You Like Co staff (available as video clips)
Interview with Ivan Higster, purchasing department
You: So Ivan, can you give me some more information about the reorder levels that are
set?
Ivan: Yes, it's quite simple really; because we're involved in the fashion industry we need to
make sure our products meet current trends so every season the buyers monitor
which items sell well and then adjust the reorder levels for each product in the current
season based on our past experience.
You: Thanks. So what checks do the buyers perform when orders are generated for their
inventory lines?
Ivan: None really, we just get the order through and then place it with our supplier. We do
forward a copy of the order to the warehouse, though.
You: Great, thanks for your time.
Ivan: No worries!
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2 A second deficiency relates to the fact that the balance per the purchase ledger account is
not reconciled to supplier statements.
Which of the following recommendations would NOT be appropriate to address this
deficiency?
The accounts payable clerk should reconcile the balance per the purchase ledger to
the balance per the supplier statement each month
Invoices on the supplier statement which relate to goods received but not invoiced
should not be included in the purchase ledger to avoid the payables balance being
overstated at the year end
Any journals processed as a result of the reconciliation should be authorised by the
department supervisor
The reconciliation performed by the accounts payable clerk should be reviewed by the
department supervisor
3 The report to those charged with governance at Dress You Like Co will recommend that a
notification is added to the accounting system which identifies when an invoice is due for
payment.
Which of the deficiencies in Dress You Like Co's purchases system will this
recommendation BEST address?
That supplier invoices are not recorded accurately in the purchase ledger
That supplier invoices are incorrectly coded
That supplier invoices are paid too late
That supplier invoices are paid too early
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2 Your audit assistant is planning to inspect a sample of the bank payment authorisation
documents for evidence of the Finance Director's signature.
For which of the following internal control objectives would this provide sufficient,
appropriate audit evidence?
That payments to the supplier are made on a timely basis
That payments to the supplier are reviewed and authorised prior to payment
That payments to the supplier are accurately recorded in the ledger
That payments to the supplier are for valid business expenses only
Solution
3.10 The wages cycle/payroll system consists of three main stages with documentation at each
stage:
You are now carrying out the work on the wages system at Dress You Like Co. You have been given
the following information concerning the wages system for the year ended 30 September 20X1.
(i) The factory and warehousing staff record the number of hours worked using a clocking
in/out system which is observed by a supervisor. On arrival at work each morning and at the
end of each day's work, each worker enters their unique employee number on a keypad.
Any employee who does not clock out at the end of their shift is automatically clocked out by
the system.
(ii) In order to claim overtime, employees need to complete an 'overtime claim' form and submit
it to the wages clerk.
(iii) The Wages Clerk, Jake Newman, works in the finance team and is responsible for making
amendments to the computerised wages system in respect of employee holidays and
illness. He also sets up and maintains all employee records and processes the monthly
payroll.
(iv) The computerised wages system calculates deductions from gross pay, such as employee
taxes and net pay. Each month a list of net cash payments for each employee is produced
and this is reviewed and authorised by the acting finance director before the employees are
paid by BACS transfer. Deductions are checked by Jake Newman on a periodic basis.
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Required
Using the Dress You Like Co scenario, identify TWO deficiencies in the wages system of Dress
You Like Co. Explain the possible implications of these and suggest a recommendation (internal
control) to address each deficiency.
Solution
Deficiency Implication Recommendation
Required
Continuing with the Dress You Like Co scenario, identify TWO controls within the wages system
and recommend a test of control that could be carried out for each control.
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Solution
Control Test of control
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The susceptibility to
The likelihood of the loss or fraud of the The subjectivity and
deficiencies resulting in related asset or liability complexity of
material misstatements determining estimated
in the financial amounts
statements
Reports to management
4.5 Once the auditor has decided that there are significant deficiencies which need to be
communicated to those charged with governance, they should include this information in a
report to management.
4.6 In the exam you may be asked only to identify deficiencies in internal control, explain the
implications of the deficiencies and make a recommendation to address these.
4.7 Alternatively you may be asked to include the above information in a report to management.
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Yours faithfully
Check and Co
Appendix:
Deficiency Implication Recommendation
No credit checks are made The company may well A standard new customer
before new customers are accept an order and form should be created which
accepted and credit limits are despatch goods to a bad must be completed before
not prescribed. credit risk. This may mean orders are accepted from new
that goods are sold to a customers. This form should
customer who cannot pay require a credit check to be
for them, leading to a loss made in relation to the
of revenue and inventory. customer and a credit limit
allocated. Standard tiers of
credit limits could be applied
for different customers. All
completed new customer
forms should be authorised
by Edward Times or Katie
Escombe prior to goods being
despatched. The
authorisation should be
evidenced on the form.
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4.10 In Chapter 5 we saw that one of the roles of the internal audit function is often to review an
entity's internal controls and to report their findings (including any deficiencies) to
management.
4.11 It is very possible therefore that a report on deficiencies, implications and recommendations
might be prepared by the internal audit function. The format of such a report will be
determined by management and is much more flexible than the above report by the external
auditor.
4.12 An example internal auditor's report is included in the additional notes section of this
chapter.
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176
Additional
Notes
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7.2 Many of the objectives overlap with the initial stage of the purchases cycle where an entity
must ensure that only goods required are ordered and that all orders are authorised.
7.3 The principal internal controls in this cycle which have not already been detailed in the
purchases cycle are to ensure:
That capital expenditure is appropriately classified in the accounting records
That capital items are recorded in the non-current asset register
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Stage: That capital items are recorded in the non-current asset register
Risk Controls Tests of controls
That capital items Periodically review the non-current For a sample of non-current assets,
are not recorded assets held by the business and inspect the non-current asset register
in the non-current trace them through to verify that they to ensure that they have been
asset register. are recorded in the non-current asset included.
register.
On a monthly basis, reconcile the Review the reconciliation to see the
totals on the non-current asset level of adjustments required.
nominal ledger codes to the balance Discuss with management why errors
per the non-current asset register. have occurred and the action being
Investigate any differences. taken to reduce future errors.
Authorise all adjustments.
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REPORT
To: Board of Directors of Robinson Co
From: Internal audit department
Subject: Review of sales system
Period of fieldwork: March 20XX
Terms of Reference
The scope of the assignment was to carry out a thorough review of the sales system.
This involved performing tests of controls on the existing sales system to determine
whether the controls were operating effectively.
In addition, we considered the key risks surrounding the sales function and identified any
risks for which we found no related controls.
We have been able to make recommendations regarding existing controls as well as
suggest new controls where we believe they are needed.
Executive Summary
The main findings from our review are:
The sales system, on the whole, comprises adequate controls
Some specific control deficiencies were identified and recommendations are given
in the Appendix to the report
Follow-up
Responsibilities have been allocated for introducing/improving control procedures which
we found to be deficient.
We propose a follow-up review in six months' time.
Dated……………………… Signed………………………….
Head Internal Auditor
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10: TESTS OF CONTROLS
APPENDIX
Detailed identification of deficiencies, risks and recommendations
Customers are This could lead The proof of delivery To be June 20XX
not asked to to disputes as should be a multi-part implemented by
sign a proof of to whether document. All copies head of the sales
delivery. goods have must be signed by the department.
actually been customer. One copy
delivered, loss should be left with the
of customer customer and the other
goodwill and copy retained within
increased the sales department
irrecoverable along with the order
debts. and invoice.
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10: TESTS OF CONTROLS
Definition
12.2 ISA 260 defines those 'charged with governance' as the person(s) or organisation(s) with
responsibility for overseeing the strategic direction of the entity and obligations relating to
the accountability of the entity (ISA 260 (Revised): para. 10a).
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13 Chapter summary
Section Topic Summary
1 Audit evidence (recap) Audit evidence can be gained using tests of controls
and/or substantive procedures.
2 Tests of controls Tests of controls involve repeatedly testing specific
internal controls to ensure that they are properly
designed, exist and have operated throughout the
period.
Internal controls can be tested using enquiry,
inspection, observation and reperformance.
3 Transaction cycles There are six transaction cycles in the syllabus; each
of them could be tested but the most important ones
are sales, purchases and payroll.
Questions on this area will be scenario based and so
you need to be able to identify internal controls and/or
internal control deficiencies from a given scenario.
4 Communication of Significant deficiencies in internal control noted by the
deficiencies in internal auditor will be communicated via a report to
control management. You may need to produce this in the
exam and so will need to be familiar with its contents.
Reports on internal control deficiencies may also be
undertaken by the internal audit function (Section 11).
5 Other transaction Controls over bank and cash tend to focus on having
cycles: Bank and cash good segregation of duties, physical controls to
ensure the security of the assets and reconciliations.
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10: TESTS OF CONTROLS
END OF CHAPTER
192
Achievement Ladder Step 4
You have now covered the Topics that will be assessed in Step 4 of your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics. As a reminder, Step 4 must be completed and submitted in order to be able to qualify for Pass
Assurance. It is Step 4 and can also be found at the back of these Course Notes.
It is vital in terms of your progress towards 'exam readiness' that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course Notes
Topic name Subtopic/Chapter name
chapter
The concept of audit and assurance 1
Audit and assurance
Regulation 2
Corporate governance 3
Governance
Internal audit 4
Professional ethics and quality control
Ethics 5
procedures
Audit risk Risk assessment 6
Planning and documentation 7
Audit planning
Introduction to audit evidence 8
Internal controls 9
Internal control systems
Tests of controls 10
193
Achievement ladder
194
Audit procedures and
sampling
195
11: AUDIT PROCEDURES AND SAMPLING
Overview
Audit Test
software data
Audit data
analytics Audit of accounting Auditing smaller
estimates entities
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11: AUDIT PROCEDURES AND SAMPLING
1.4 Sometimes the auditor may want to ensure that they test certain items. For example, they
may decide they want to review the monies received post year end from the client's ten
largest receivables balances in order to gather evidence over the valuation of receivables.
1.5 This is not sampling but is often called stratification. This is because the receivables
population has been divided into two discrete sub-populations. One sub-population has the
ten largest balances in it and each of these will be tested. The second sub-population
contains all remaining receivables and the auditor may also test a sample of these balances.
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2 Sampling
Definition
2.1 Audit sampling means the application of audit procedures to less than 100% of the items
within a class of transactions or account balance such that all sampling units have an equal
chance of selection, in order to provide the auditor with a reasonable basis for forming a
conclusion on the entire population (ISA 530).
Types of sampling
2.2 There are two types of sampling: statistical sampling and non-statistical sampling.
2.3 Non-statistical sampling does not use any mathematical basis for selecting a sample.
2.4 An example of non-statistical sampling is haphazard selection. Here the auditor selects the
items to be included in the sample without following a structured technique but which avoids
any conscious bias or predictability (for example the auditor should not exclude items which
are difficult to locate from the sample purely because of the inconvenience).
2.5 Statistical sampling uses:
Mathematical number tables to choose a sample which is free from bias; and
Probability theory to evaluate the results of the testing.
2.6 Examples of statistical sampling methods include:
(a) Random selection – this process uses random number tables (or a computerised
random number generator) to select the items in the sample.
(b) Systematic selection – here the number of units in the population is divided by the
sample size to give a sampling interval. For example, if the auditor has a population
with 1,000 items and requires a sample containing 200 items then the sampling
interval is 5 (1,000 ÷ 200). A random starting point within the first 5 is then determined
(say 2) and the auditor will test every 5th item after item number 2 (ie 2 then 7 and so
on).
(c) Value weighted selection (or monetary unit sampling (MUS)) – here the
population is randomly ordered and items are selected for sampling by weighting the
items in proportion to their value.
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You are the auditor of XYZ Co and are intending to audit trade receivables by circularising a
sample of the year-end balances. The trade receivables listed below have been randomly
tabulated. At the year end trade receivables amount to $1 million and materiality is $100,000.
Required
State which receivable balances will be selected for sampling using value weighted selection (MUS).
Solution
Customer Balance Cumulative total Selected (Y/N)
$ $
1 60,000
2 70,000
3 90,000
4 105,000
5 28,000
6 100,000
7 46,000
8 1,000
9 84,000
10 94,000
11 108,000
12 34,000
13 160,000
14 20,000
1,000,000
Advantages Disadvantages
The auditor can design and evaluate the Selecting the sample can be time
sample quickly and in a cost-effective consuming if CAATs cannot be used to
way using CAATs (Section 3). select the sample.
All material items are automatically MUS does not cope where there are
selected ensuring all material items are negatively valued items in the
tested. population.
MUS will not be effective if the
population is not randomly ordered.
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11: AUDIT PROCEDURES AND SAMPLING
Sampling risk
2.8 Sampling risk is the risk that the auditor's conclusion, based on a sample, may be different
from the conclusion that would have been reached if the entire population were subjected to
the same audit procedure. Sampling risk must be reduced to an acceptably low level.
2.9 If the auditor judges that sampling risk is high then he will need to select a larger sample in
order to have reasonable assurance that the results are free from material misstatement.
2.10 There is therefore a direct relationship between sampling risk and sample size.
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11: AUDIT PROCEDURES AND SAMPLING
2.13 Where there are errors in the sample, the auditor should consider:
The nature and cause of the error
Whether the error is a 'one-off' (anomalous) error or a recurrent issue
Whether the error affects other areas of the audit
You are auditing trade receivables and have obtained the following results based on your sample:
Total value of the population $1,000,000
Number of items in the population 400
Number of items tested 20
Total value of the sample $200,000
Error in the sample $9,000
Required
(a) Assuming the errors are not anomalous ones, calculate the expected error in the population.
(b) Assuming that tolerable error/misstatement was set at $40,000, explain what action should
be taken.
Solution
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11: AUDIT PROCEDURES AND SAMPLING
You are auditing the internal controls relating to the authorisation of adjustments made to a client's
inventory system in order to determine the accuracy and validity of the adjustments. You have
obtained the following results based on your sample:
Total number of adjustments made to inventory records during the year 1,500
Number of adjustments tested in the sample 225
Number of occasions when adjustments tested were not authorised 18
Required
(a) Assuming the errors are not anomalous ones, calculate the error rate in the population.
(b) Assuming that tolerable error/misstatement was set at an error rate of 13%, explain what
action should be taken.
Solution
2.16 If the evaluation of sample results indicates that there may be significant issues, the auditor
may:
(a) Request management to investigate identified errors and the potential for further
errors and make any necessary adjustments;
(b) Modify the nature, timing and extent of further audit procedures; and/or
(c) Consider the effect on the auditor's report.
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11: AUDIT PROCEDURES AND SAMPLING
Audit software can be Read and extract data from a client's system and produce
used to: a report in a specified format, for example:
- The auditor could download the client's sales ledger
onto their own software, and use their own (trusted)
software to produce an aged receivables listing; this
can then be used as a basis for testing the valuation
of receivables
- Or an aged inventory report
Select information, for example:
- A sample of suppliers to circularise to test
completeness of the payables balance (perhaps
using MUS)
- Or to identify missing, large or unusual items or items
outside specified parameters
Perform calculations, for example:
- To calculate variances and ratios used in analytical
review
- Or to check the accuracy of the casting of the trial
balance or ledger listings
Print reports in specified formats, for example:
- Letters to be sent out in a receivables confirmation
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11: AUDIT PROCEDURES AND SAMPLING
3.10 In the context of the financial statement audit, data analytics is 'the science and art of
discovering and analysing patterns, deviations and inconsistencies, and extracting
other useful information in the data underlying or related to the subject matter of an
audit through analysis, modelling and visualisation for the purpose of planning or
performing the audit' (IAASB Data Analytics Working Group Request for Input, September
2016).
3.11 Current auditing techniques focus on a risk management approach to auditing and on
testing samples rather than entire populations.
3.12 The use of data analytics software will initially involve significant costs on the part of the
auditor and extensive training, however it could offer auditors the ability to examine all of
an entity's data and test entire populations. This is turn should improve both audit
efficiency and audit quality.
3.13 Examples of how auditors might use data analytics include:
Analyse patterns relating to revenue or costs per product or per customer
Trace the matching of orders to goods despatched/goods received documentation
and to the invoice, in order to determine whether revenue and costs should be
recognised
Interrogate journals to determine whether there are any patterns (regarding who has
processed certain journals) where fraud is suspected
3.14 The Audit and Assurance examining team requires you to have a broad understanding of
what data analytics is, how it may be used in an audit, and how it may improve audit
efficiency.
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206
Additional
Notes
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11: AUDIT PROCEDURES AND SAMPLING
4.2 Additionally, it is increasingly common for companies to outsource specific functions, for
example payroll, to service organisations that have more expertise than the entity.
4.3 As such, the auditor must consider the availability and reliability of the evidence provided by
such experts and by the work of service organisations.
4.4 Also, in some cases, external auditors may want to rely on work done by internal audit.
4.5 When the auditors plan to use the work of others, whether experts, service organisations or
internal audit, they must consider:
Scope of work – the work of others must be evaluated to determine if it is sufficient and
appropriate.
Organisational status – (relevant to internal audit only). The external auditor must evaluate
the status of the internal audit department within the entity. How seriously are its reports
taken? Are its recommendations for improvements implemented?
Due skill and care – the auditor must determine that the work of others is completed with
due skill and care, ie that it is planned, directed, supervised and adequately reviewed.
Independence – the auditor must determine that the expert, service organisation or internal
audit department is independent of the client to ensure no bias is reflected in their work.
Technical competence – the work of others must be of appropriate quality to be relied upon
by the auditor and hence the expert, service organisation or internal auditor must have the
technical ability and/or qualifications to provide such work.
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5.4 ISA 620 requires the auditor to evaluate whether the auditor's expert has the necessary
competence, capabilities and objectivity. Where the auditor's expert is external, the
evaluation of objectivity will include inquiry of interests and relationships that could create a
threat to objectivity.
5.5 Information on these areas may come from the following sources:
Personal experience with previous work done by the expert
Discussions with the expert
Discussions with other people who are familiar with the expert's work
Knowledge of the expert's qualifications, membership of a professional body or
industry association, licence to practise etc
Published papers or books by the expert
The auditor's firm's quality control policies and procedures
5.6 When using an auditor's expert, the auditor shall agree in writing the following matters:
The nature and objectives of that expert's work
The respective roles and responsibilities of the auditor and that expert
The nature, timing and any report to be provided by that expert
The need for the auditor's expert to observe confidentiality requirements
5.7 The auditor should evaluate the appropriateness of the expert's work as audit evidence.
This will involve evaluation of whether the substance of the expert's findings is properly
reflected in the financial statements or supports the assertions, and consideration of:
Source data
Assumptions and methods used and their consistency with prior periods
Results of the expert's work in the light of the auditor's overall knowledge of the
business and the results of other audit procedures
5.8 When issuing an unmodified audit report, the auditor should not refer to the work of an
expert.
5.9 Note. ISA 620 distinguishes between an 'auditor's expert' and 'management's expert'
(para. 6). Management's expert is an individual or organisation with expertise in a field
other than accounting or auditing which is used to assist the entity in preparing the financial
statements.
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11: AUDIT PROCEDURES AND SAMPLING
6.2 Where service organisations are relevant to the financial statements, the auditors (referred
to as 'user auditors' in ISA 402 (para. 8h)) are required to perform the following procedures:
(a) Understanding the services provided.
(b) The auditors must understand the nature of the services provided, the materiality of
transactions processed or the financial reporting processes affected.
(c) They need to determine the effect of the service organisation on internal control, to
enable them to assess the risk of material misstatement in the financial statements.
(d) They can either obtain this from the entity using the service organisation, or by
obtaining a report from the service auditor (an auditor who, at the request of the
service organisation, provides an assurance report on the controls of the service
organisation), if this is available.
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Direct assistance
7.3 It is also possible that the external auditors may use the internal auditors to provide direct
assistance to them. Direct assistance refers to the use of the internal auditors to perform
audit procedures under the direction, supervision and review of the external auditor.
7.4 When deciding whether the internal auditors should provide direct assistance the external
auditor should consider:
(a) The amount of judgement involved in planning and performing the relevant audit
procedures, and in evaluating the audit evidence gathered;
(b) The assessed risk of material misstatement; and
(c) The existence and significance of threats to the objectivity and the level of
competence of the internal auditors.
7.5 ISA 610 (Revised) prohibits the use of internal auditors to provide direct assistance to
perform procedures that:
(a) Involve making significant judgements in the audit;
(b) Relate to higher assessed risks of material misstatement where more than a limited
degree of judgement is required, for example internal auditors may verify the ageing
of receivables but may not assess the valuation of receivables;
(c) Relate to work with which the internal auditors have been involved; and
(d) Relate to decisions the external auditor makes regarding the internal audit function
and the use of its work or direct assistance.
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7.6 Where the external auditors have used direct assistance from the internal auditors they
should document:
(a) The evaluation of the existence and significance of threats to the objectivity of the
internal auditors, and the level of competence of the internal auditors used;
(b) The basis for the decision regarding the nature and extent of the work performed by
the internal auditors; and
(c) Who reviewed the work performed and the date and extent of the review.
Auditor's report
7.7 The external auditor cannot make reference to work done by the internal auditor in their
auditor's report.
8.2 The auditor is required to obtain sufficient appropriate evidence about whether the
accounting estimates and related disclosures are reasonable. To do this, they perform the
following procedures:
(a) Risk assessment procedures and related activities
(b) Understand how management identifies the need for accounting estimates and
determine how these accounting estimates are calculated, including the underlying
accounting assumptions
(c) Identifying and assessing the risks of material misstatement
(d) Evaluate the degree of uncertainty associated with an accounting estimate
8.3 Based on the assessed risk of material misstatement, the auditor can determine whether
the estimates are reasonable.
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11: AUDIT PROCEDURES AND SAMPLING
10 Chapter summary
Section Topic Summary
1 Selecting items for The auditor needs to decide which items they will
testing select for testing. It is most common for the auditor to
carry out sampling; however, there may be situations
where they test 100% of items or where they stratify
the population in order to test specific items.
2 Sampling Sampling relates to the application of audit
procedures to less than 100% of the population in
order to form a conclusion on the population as a
whole.
Statistical sampling methods provide more comfort
that the sample is free from bias and the sampling
results representative of the population as a whole.
Any errors identified in the sample must be
extrapolated and the impact on the population as a
whole considered.
3 CAATs CAATs describe any process where the auditor uses
a computer to help them carry out their audit
procedures. CAATs used to perform tests of detail
(substantive procedures) are known as audit
software whilst CAATs used to carry out tests of
controls are called test data. Data analytics is the
examination of data to try to identify patterns, trends
or correlations.
4 Using the work of
others
5 Using the work of an
Auditors may need to place reliance on the work of
auditor's expert
others, namely experts, service organisations or
6 Service organisations internal audit.
7 Use of internal
auditor's work for the
external audit
8 Auditing accounting Accounting estimates involve judgements and so can
estimates be high-risk items in the financial statements.
9 Auditing smaller Smaller entities tend to have more limited internal
entities controls than larger entities and so an auditor auditing
a smaller entity will tend to focus on substantive
procedures.
END OF CHAPTER
214
Non-current assets
215
12: NON-CURRENT ASSETS
Overview
Non-current assets
Evidence on statement of
profit or loss entries
Depreciation
Tangible non-current Intangible non-current Gains/losses on disposals
assets assets Impairments
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12: NON-CURRENT ASSETS
1.3 The auditor's role is to test that the carrying amount per the non-current asset register (in
this example $25,000) is reasonable. Sections 3 and 4 of this chapter discuss the
procedures used.
2 Key assertions
2.1 Completeness, obligations and rights, valuation and existence are key assertions
relating to the audit of non-current assets.
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12: NON-CURRENT ASSETS
218
12: NON-CURRENT ASSETS
219
12: NON-CURRENT ASSETS
Lecture example 1
When testing non-current assets in the financial statements, it is the IAS 16 disclosure note as
follows that is being tested:
At 31 December 20X1
Cost or valuation 2,900,000 600,000 3,500,000
Accumulated depreciation (360,000) (240,000) (600,000)
Carrying amount 2,540,000 360,000 2,900,000
At 31 December 20X0
Cost or valuation 2,000,000 600,000 2,600,000
Accumulated depreciation (400,000) (180,000) (580,000)
Carrying amount 1,600,000 420,000 2,020,000
Required
What tests would you perform on each area?
Solution
(1) Opening balances?
(2) Additions?
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12: NON-CURRENT ASSETS
(5) Disposals?
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12: NON-CURRENT ASSETS
4 Chapter summary
Section Topic Summary
END OF CHAPTER
222
Inventory
223
13: INVENTORY
Overview
Inventory
Auditor's attendance at
Third party confirmations
inventory count
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13: INVENTORY
1 Inventory counting
1.1 The audit approach must consider:
Quantity – normally arrived at by a year-end count
Valuation – must apply IAS 2 Inventories
Disclosure
A particular technique to verify quantity of inventories is for the auditor to attend the client's
inventory count.
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13: INVENTORY
Required
You have been provided with the following inventory count instructions by your client. Identify FIVE
matters that you believe will require action by management if the inventory count is to be effective.
Explain how the matters could be rectified.
(a) Mrs Ishbel Curbar, Assistant Chief Accountant, has overall responsibility for the inventory
count but she is to be assisted by Mr Jack Farditch, the warehouse manager, to whom the
inventory counting teams are to report, and who will be responsible for the detailed
organisation of the count.
(b) Five inventory count teams are to carry out the actual count, each team to be responsible for
a predetermined section of the warehouse. Each team comprises two persons, one from the
accounting department and the other from the warehouse.
(c) Each inventory count team is to meet Mr Farditch at 7:30am on 29 March 20X1 and will be
provided with pre-numbered and pre-printed inventory sheets for the section of the
warehouse for which they are responsible. These inventory sheets have been prepared by
the inventory control department and show the balance of each inventory item on hand as
shown on the inventory records held independently of the warehouse.
(d) During the count both members of the inventory count team are to count the inventories
independently of each other. In the event of differences arising between inventories counted
and the quantity shown on the inventory sheets, the quantity counted is to be entered
alongside the original quantity and must be initialled by the senior member of the count
team.
(e) Each inventory count sheet is to be signed by the senior member of the count team and the
bin or rack cards held in the warehouse are to be adjusted, if necessary, to actual quantities
counted. All cards are to be initialled to show that the count has been made.
(f) Any goods that appear to be in poor condition are to be deducted from the quantity
appearing on the inventory sheets, such action again to be supported by initials of the senior
member of the count team.
(g) Any queries during the count are to be referred to Mr Farditch to whom inventory sheets are
to be returned at the conclusion of the count. Mr Farditch is responsible for ensuring that all
inventory count sheets have been returned and for forwarding them to Mrs Curbar for
valuation.
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13: INVENTORY
Solution
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13: INVENTORY
3 Cut-off
3.1 Cut-off is a test used to ensure that all of the company's transactions have been included in
Section 5 the correct period.
3.4 Cut-off is usually tested by obtaining a sample of GRNs and GDNs either side of the year
end and then matching them to purchase/sales invoices to ensure they have been included
in the correct account balance(s).
After
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13: INVENTORY
4 Inventory valuation
Per IAS 2 inventory must be valued at the lower of cost and net realisable value (NRV).
Cost
4.1 (a) Record basis of valuation used
(b) Test material costs:
Agree to supplier invoices
Ensure first in, first out or appropriate basis is being used
Check quantities used WIP/Finished Goods
(c) Test labour costs:
Check calculations to supporting documentation
Review costing against actual labour and production
(d) Test application of overheads:
Ensure only production overheads included
Ensure based on normal levels of activity
NRV
4.2 Tests to determine whether NRV is lower than cost:
Compare the selling prices of goods sold after the year end per sales invoices with
their purchase price per supplier statements
Review order book to determine at what price the goods are ordered
Write down last year – are these items still in inventory?
Analytical review of gross profit margin post year end; if decreases may indicate that
some inventory is being sold for less than cost
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13: INVENTORY
5 Chapter summary
Section Topic Summary
1 Inventory counting Procedures to verify the quantity of inventory will
depend on whether the client uses a year-end
2 Continuous inventory
inventory count or a continuous inventory.
counting/perpetual
inventory The auditor will attend the inventory count to:
Perform tests of controls (observation)
Obtain substantive evidence of quantity (test
counts, cut-off details)
Obtain preliminary evidence of valuation (note
damaged or obsolete inventories)
3 Cut-off Cut-off tests are used to ensure that transactions have
been recorded in the correct accounting period.
4 Inventory valuation Procedures to audit the valuation of inventory must
cover both cost and net realisable value.
END OF CHAPTER
230
Receivables
231
14: RECEIVABLES
Overview
Receivables
232
14: RECEIVABLES
1 Direct confirmation
1.1 A specific technique used to test for the existence and obligation/rights of receivables is a
direct confirmation (alternatively called 'circularisation'). This is conducted as follows:
(a) Obtain listing of trade receivables as at the confirmation date
(b) Agree total to nominal ledger
(c) Review for any obvious omissions/misstatements by comparing this year's list with
last year's
(d) Select a sample of accounts for confirmation. An aged receivables report may be
used to make the selection. For example:
EXTRACT – RECEIVABLES LEDGER FOR S COMPANY
YEAR END 31 DECEMBER 20X9
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14: RECEIVABLES
You have obtained the following results from three receivables balances circularised during the
audit of ABC Co.
Solution
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14: RECEIVABLES
2 Other evidence
2.1
235
14: RECEIVABLES
236
14: RECEIVABLES
3 Your audit assistant has now calculated receivables days for each of Gem Threads's key
customers. One customer, JK Co, has receivables days of 62 days.
Which of the following audit procedures should the audit assistant perform next?
Request a written representation from the directors stating that the balance due from
JK Co is fairly stated in the financial statements
Review credit notes issued post year end in relation to the balance due from JK Co
Agree the balance due from JK Co to supporting invoices and goods despatched
notes
Vouch any changes in JK Co's credit limit to supporting documentation to determine
whether the change was properly authorised
Solution
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14: RECEIVABLES
3 Chapter summary
Section Topic Summary
1 Direct confirmation Direct circularisation of receivables is a key
procedure but does not give evidence on all the
relevant assertions.
2 Other evidence Other important procedures are:
Cut-off tests
Tests to determine recoverability
END OF CHAPTER
238
Bank and cash
239
15: BANK AND CASH
Overview
240
15: BANK AND CASH
Authority to disclose
1.3 Banks require the explicit written authority of their customers to disclose the information
requested. This often takes the form of an ongoing standing authority rather than a separate
authority each time information is requested.
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15: BANK AND CASH
242
Additional
Notes
243
15: BANK AND CASH
AB & Co
Accountants
29 High Street
London N10
The Manager
Clearing Bank Ltd City Branch
Dear Sir/Madam,
.........................................(Name of customer)
STANDARD REQUEST FOR BANK REPORT
FOR AUDIT PURPOSES FOR THE YEAR ENDED ....................
In accordance with your above-named customer's instruction given
}
(1) hereon
(2) in the attached authority Delete as appropriate
(3) in the authority date .................... already held by you
please send to us, as auditors of your customer for the purpose of our business, without
entering into any contractual relationship with us, the following information relating to their
affairs at your branch as at the close of business on ....................... and, in the case of
items 2, 4 and 10 during the period since .................... For each item, please state any
factors which may limit the completeness of your reply; if there is nothing to report, state
'none'.
We enclose an additional copy of this letter, and it would be particularly helpful if your
reply could be given on the copy letter in the space provided (supported by an additional
schedule stamped and signed by the bank where space is insufficient). If you find it
necessary to provide the information in another form, please return the copy letter with
your reply.
It is understood that any replies given are in strict confidence.
Information requested Reply
Bank accounts
(1) Please give full titles of all accounts whether in
sterling or in any other currency together with
the account numbers and balances thereon,
including nil balances:
(a) Where your customer's name is the sole
name in the title
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15: BANK AND CASH
245
15: BANK AND CASH
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15: BANK AND CASH
Other information
(10) A list of other banks, or branches of your bank,
or associated companies where you are aware
that a relationship has been established during
the period.
Yours faithfully,
........................................
(Official stamp of bank)
........................................
(Authorised signatory)
........................................
(Position)
3 Chapter summary
Section Topic Summary
1 Bank and cash Bank confirmation letters are a reliable source of
evidence in respect of the main financial statement
assertions relating to bank and cash.
The client's bank reconciliation must also be tested in
detail, in order to verify that reconciling items are
genuine.
2 Example bank Standard request for information from the client's bank.
confirmation letter
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END OF CHAPTER
248
Liabilities, capital and
directors' emoluments
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
Overview
Finance costs
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
2 Non-current liabilities
2.1 This will include bank loans, debentures, and other loans repayable more than one year
after the year-end date.
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
(b) Determine whether it is probable that an outflow of resources will be required to settle
the obligation by:
(i) Checking whether any payments have been made in the post year end period
in respect of the item.
(ii) Review of correspondence with solicitors, banks, customers, insurance
company and suppliers both pre and post year end.
(iii) Sending a letter to the solicitor to obtain their views (where relevant).
(iv) Discussing the position with similar past provisions with the directors. Were
these provisions eventually settled?
(c) Determine whether provisions represent the best estimate of liability by:
(i) Recalculating all provisions made.
(ii) Comparing the amount provided with any post year end payments and with any
amount paid in the past for similar items and considering opinions given by
independent experts.
(iii) In the event that it is not possible to estimate the amount of the provision,
check that this contingent liability is disclosed in the accounts.
3.3 Consider the nature of the client's business. Would you expect to see provisions eg
warranties?
3.4 For all material provisions and contingencies obtain a written representation.
3.5 Check that appropriate disclosures have been made in accordance with IAS 37.
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
4 Capital
4.1 This includes share capital, distributions and reserves.
5 Directors' emoluments
5.1 Directors' emoluments are a sensitive area and would therefore be deemed to be material
by its nature. It is important therefore that the disclosure of directors' emoluments is made
accurately.
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
Lecture example 1
You are responsible for auditing the directors' emoluments of ABC Co and have been provided
with the information below:
Termination Incentive
Salary Bonuses payments payments Total
$ $ $ $ $
Director A 120,000 90,000 – – 210,000
Director B 80,000 50,000 – – 130,000
Director C 50,000 5,000 15,000 – 70,000
Director D 20,000 5,000 – 10,000 35,000
270,000 150,000 15,000 10,000 445,000
Required
State what audit tests would you perform.
Solution
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
6 Chapter summary
Section Topic Summary
1 Payables and accruals Substantive tests on liabilities will cover all the
financial statement assertions but with an emphasis
on testing for understatement ie completeness.
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16: LIABILITIES, CAPITAL AND DIRECTORS' EMOLUMENTS
END OF CHAPTER
258
Not-for-profit
organisations
259
17: NOT-FOR-PROFIT ORGANISATIONS
Overview
Not-for-profit organisations
Types of not-for-profit
organisations
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17: NOT-FOR-PROFIT ORGANISATIONS
1 Introduction
1.1 Examples of not-for-profit organisations are charities, clubs and societies. Their primary
objective is to provide a service and not to generate profits. Such entities are keen to keep
their costs to a minimum.
1.2 Such organisations may fall within the scope of statutory audit if the entities concerned are
limited liability companies.
1.3 Organisations not incorporated may require an assurance engagement due to the
requirements of regulatory or governing bodies, eg the Charity Commission.
2.2 However, the auditor should have specific regard to any laws, regulations or guidelines
imposed on the entity by any regulatory body.
2.3 The scope of the auditor's work will be detailed in the engagement letter.
3 Risk assessment
3.1 The auditor should, during the planning stage, fully assess the risks associated with the
not-for-profit organisation.
4 Audit evidence
4.1 When designing substantive procedures for not-for-profit organisations, the auditor should
Section 3 give special attention to the possibility of:
Understatement (ie completeness) of income, including gifts in kind, cash donations
and legacies
Incorrect accounting treatment of lifetime subscriptions
Q28 'Tap!'
Overstatement (ie existence) of cash grants or expenses
Misanalysis or misuse of funds
Misstatement or omission of assets including donated properties
Misallocation of expenses to disguise excessive administration expenditure
5 Reporting
5.1 For incorporated not-for-profit organisations, the reporting requirements of ISA 700 Forming
an Opinion and Reporting on Financial Statements apply.
5.2 Additionally, the reporting requirements of the governing body will need to be encompassed
in the auditor's report.
5.3 For organisations not incorporated under statute, the nature of the report will be determined
in accordance with the terms of appointment detailed in the letter of engagement.
Solution
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17: NOT-FOR-PROFIT ORGANISATIONS
6 Chapter summary
Section Topic Summary
1 Introduction Not-for profit organisations include charities, clubs
and societies.
2 Planning the audit All relevant regulations must be understood.
3 Risk assessment Particular risk areas for the auditor of not-for-profit
entities are:
Complexity of regulation
High level of cash receipts
Competence of staff and volunteers
Segregation of duties
4 Audit evidence The audit approach is likely to be mainly substantive.
5 Reporting The auditor must consider the requirements of
ISA 700 as well as any specific regulations.
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17: NOT-FOR-PROFIT ORGANISATIONS
END OF CHAPTER
264
Audit review and
finalisation
265
18: AUDIT REVIEW AND FINALISATION
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18: AUDIT REVIEW AND FINALISATION
Overview
Uncorrected misstatements
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18: AUDIT REVIEW AND FINALISATION
(a) Those that provide evidence of conditions that existed at the date of the financial
statements; and
(b) Those that provide evidence of conditions that arose after that date of financial
statements.
1.2 The auditor should consider the effect of subsequent events on the financial statements and
on the auditor's report.
Active duty Passive duty
Auditor's
Year F/S
report AGM
end issued
signed
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18: AUDIT REVIEW AND FINALISATION
2.2 Under the going concern assumption, an entity is ordinarily viewed as continuing in business
for the foreseeable future with neither the intention nor the necessity of liquidation, ceasing
trading or seeking protection from creditors pursuant to laws or regulations.
2.3 Management's assessment of the entity's ability to continue as a going concern should
cover a period of at least 12 months after the period end.
2.4 In obtaining an understanding of the entity, the auditor should consider whether there are
events or conditions and related business risks which may cast significant doubt on the
entity's ability to continue as a going concern.
2.5 Based on the audit evidence obtained, the auditor should determine if, in their judgement, a
material uncertainty exists related to events or conditions that, alone or in aggregate, may
cast significant doubt on the entity's ability to continue as a going concern.
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18: AUDIT REVIEW AND FINALISATION
2.6 Examples of events or conditions, which may cast significant doubt on the going concern
assumption, include:
Financial
Net liability or net current liability position
Fixed-term borrowings approaching maturity without realistic prospects of renewal or
repayment; or excessive reliance on short-term borrowings to finance non-current
assets
Indications of withdrawal of financial support by creditors
Negative operating cash flows
Adverse key financial ratios, eg high gearing, low current ratio, poor profit margins
Substantial operating losses or significant deterioration in the value of assets used to
generate cash flows
Arrears or discontinuance of dividends
Inability to pay creditors on due dates
Inability to comply with the terms of loan agreements
Change from credit to cash-on-delivery terms with suppliers
Inability to obtain new financing
Operational
Management intention to liquidate the entity or to cease operations
Loss of key management without replacement
Loss of a major market, key customer, licence, or principal supplier
Labour difficulties or stock outs
Emergence of a highly successful competitor
Other
Non-compliance with capital or other statutory requirements
Pending legal or regulatory proceedings against the entity that may, if successful,
result in claims that are unlikely to be satisfied
Changes in legislation or government policy expected to adversely affect the entity
Uninsured or underinsured catastrophes when they occur
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18: AUDIT REVIEW AND FINALISATION
2.8 When analysis of cash flow is a significant factor in considering the future outcome of events
or conditions the auditor considers:
The reliability of the entity's information system for generating such information; and
Whether there is adequate support for the assumptions underlying the forecast.
In addition, the auditor compares:
The prospective financial information for recent prior periods with historical results;
and
The prospective financial information for the current period with results achieved to
date.
2.9 The auditor will form their opinion on the going concern status of the company based on the
outcome of the above.
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18: AUDIT REVIEW AND FINALISATION
You are planning the audit of Truckers Co whose principal activities are road transport and
warehousing services, and the repair of commercial vehicles. You have been provided with the
draft accounts for the year ended 31 October 20X2.
Draft 20X2 Actual 20X1
$'000 $'000
SUMMARY STATEMENT OF PROFIT OR LOSS
Revenue 10,971 11,560
Cost of sales (10,203) (10,474)
Gross profit 768 1,086
Administrative expenses (782) (779)
Finance costs (235) (185)
Profit/(loss) for the period (249) 122
SUMMARY STATEMENT OF FINANCIAL POSITION
8,248 7,100
You have been informed by the managing director that the fall in revenue is due to:
The loss, in July, of a long-standing customer to a competitor; and
A decline in trade in the repair of commercial vehicles.
Due to the reduction in the repairs business, the company has decided to close the workshop and
sell the equipment and spares inventories. No entries resulting from this decision are reflected in
the draft accounts.
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18: AUDIT REVIEW AND FINALISATION
During the year, the company replaced a number of vehicles, funding them by a combination of
leasing and an increased overdraft facility. The facility is to be reviewed in January 20X3 after the
audited accounts are available.
The draft accounts show a loss for 20X2 but the forecasts indicate a return to profitability in 20X3
as the managing director is optimistic about generating additional revenue from new contracts.
Required
From the scenario above identify features which might cause you to have doubts about Truckers'
going concern status.
Solution
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18: AUDIT REVIEW AND FINALISATION
3.2 The auditor should obtain written representations from management on matters material to
the financial statements when other sufficient appropriate audit evidence cannot reasonably
be expected to exist.
Audit evidence
3.3 The representations should relate to matters where they are critical to obtaining sufficient
appropriate audit evidence. Representations cannot be a substitute for other audit evidence
that auditors expect to be available.
3.4 They should be restricted to matters where the auditor is unable to obtain independent
corroborative evidence and could not reasonably expect it to be available. For example:
Where knowledge of facts is confined to management, eg management's intentions
Where the matter is principally one of judgement, eg whether a receivable is a
doubtful debt or not
Procedures
3.5 (a) Agree procedures at early stage (eg letter of engagement)
(b) Discuss letter with client first
(c) Usually signed by senior executive officer and senior financial officer on behalf of
board
(d) Should be minuted
(e) Dated – after all other audit work completed but before signing of the auditor's report
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4.3 When considering whether the accounting policies are appropriate, auditors should
consider:
Policies commonly adopted in particular industries
Policies for which there is substantial authoritative support
Whether any departures from applicable accounting standards are necessary for the
financial statements to give a true and fair view
Whether the financial statements reflect the substance of the underlying transactions
and not merely their form
Uncorrected misstatements
Section 4.4 4.4 During the audit, a schedule will have been maintained of errors identified that have not
been corrected by the client.
Some of these may have been individually immaterial but the schedule must be reviewed at
this stage before the audit opinion is finalised. The effect of the uncorrected misstatements
must be considered in aggregate as their combined effect may be material and thus could
affect the audit opinion.
The auditor shall request a written representation from management and those charged with
governance whether they believe the effects of uncorrected misstatements are immaterial
(individually and in aggregate) to the financial statements as a whole. A summary of these
items shall be included in or attached to the representation.
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18: AUDIT REVIEW AND FINALISATION
Documentation
4.6 ISA 450 requires the auditor to document the following information:
The amount below which misstatements would be regarded as clearly trivial
All misstatements accumulated during the audit and whether they have been
corrected
The auditor's conclusion as to whether uncorrected misstatements are material and
the basis for that conclusion
(ISA 450: para. 15)
276
Additional
Notes
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18: AUDIT REVIEW AND FINALISATION
– Unrestricted access to persons within the entity from whom you determined it
necessary to obtain audit evidence.
All transactions have been recorded in the accounting records and are reflected in the
financial statements.
We have disclosed to you the results of our assessment of the risk that the financial
statements may be materially misstated as a result of fraud. (ISA 240)
We have disclosed to you all information in relation to fraud or suspected fraud that
we are aware of and that affects the entity and involves:
– Management;
– Employees who have significant roles in internal control; or
– Others where the fraud could have a material effect on the financial
statements. (ISA 240)
We have disclosed to you all information in relation to allegations of fraud, or
suspected fraud, affecting the entity's financial statements communicated by
employees, former employees, analysts, regulators or others. (ISA 240)
We have disclosed to you all known instances of non-compliance or suspected
non-compliance with laws and regulations whose effects should be considered when
preparing financial statements. (ISA 250)
We have disclosed to you the identity of the entity's related parties and all the related
party relationships and transactions of which we are aware. (ISA 550)
Any other matters that the auditor may consider necessary.
Management
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18: AUDIT REVIEW AND FINALISATION
6 Chapter summary
Section Topic Summary
1 Subsequent events The auditor has a duty to perform procedures to identify
subsequent events up to the date of the auditor's
report.
If further events are discovered after the date of the
report the auditor should discuss with client
management and take appropriate action.
4 Overall review of Before issuing the audit opinion, the auditor should
financial statements carry out an overall review of the financial statements.
END OF CHAPTER
280
Reports
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19: REPORTS
Overview
Reports
Auditor's reports
Emphasis of Other
matter paragraph matter
'Our opinion is paragraph Insufficient or inappropriate Material misstatement
not modified in (eg 8) audit evidence
respect of this
matter'
(eg 7)
Material Material and Material Material and
but not pervasive but not pervasive
pervasive Disclaimer pervasive Adverse
Qualified 'do not Qualified 'do not give
'except for' express an 'except for' a true and fair
(eg 5) opinion' (eg 3) view'
(eg 6) (eg 4)
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19: REPORTS
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19: REPORTS
1.5 Example 1: Unmodified auditor's report with unmodified opinion (listed entity)
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19: REPORTS
285
19: REPORTS
From the matters communicated with those charged with governance, we determine those matters
that were of most significance in the audit of the financial statements of the current period and are
therefore the key audit matters. We describe these matters in our auditor's report unless law or
regulation precludes public disclosure about the matter or when, in extremely rare circumstances,
we determine that a matter should not be communicated in our report because the adverse
consequences of doing so would reasonably be expected to outweigh the public interest benefits
of such communication.
Report on Other Legal and Regulatory Requirements
[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. The reporting of other reporting responsibilities that address the same topics as those
required by the ISAs may be combined (ie, included in the Report on the Audit of the Financial
Statements section under the appropriate subheadings) provided that the wording in the auditor's
report clearly differentiates the other reporting responsibilities from the reporting that is required by
the ISAs where such a difference exists.]
The engagement partner on the audit resulting in this independent auditor's report is [name].
[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]
Definition
2.2 A KAM is a matter which, in the auditor's professional judgement, is significant in the audit of
the financial statements for the current period. It is an issue which has required significant
auditor attention during the course of the audit and would also have been communicated in
writing to those charged with governance in accordance with ISA 260 (Revised)
Communication with Those Charged with Governance.
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19: REPORTS
2.4 KAMs relate to matters which are already included in the financial statements.
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19: REPORTS
2.8 Where the auditor's opinion is modified (Section 3) in relation to a KAM, the issue would not
be disclosed in the KAM, paragraph but in the 'Basis for modified opinion' paragraph.
2.9 Any concerns relating to an entity's ability to continue as a going concern would not be
disclosed in the KAM, paragraph but in the 'Material uncertainty relating to going concern'
paragraph.
Material but not Material and pervasive Material but not Material and pervasive
pervasive pervasive
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19: REPORTS
Qualified Opinion
We have audited the financial statements of ABC Company (the Company), which comprise
the statement of financial position as at 31 December 20X1, and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for the
year then ended, and notes to the financial statements, including a summary of significant
accounting policies.
In our opinion, except for the effects of the matter described in the Basis for Qualified
Opinion section of our report, the accompanying financial statements present fairly, in all
material respects, (or give a true and fair view of) the financial position of the Company as at
31 December 20X1, and (of) its financial performance and its cash flows for the year then
ended in accordance with International Financial Reporting Standards (IFRSs).
Basis for Qualified Opinion
The company's inventories are carried in the statement of financial position at xxx.
Management has not stated inventories at the lower of cost and net realisable value but has
stated them solely at cost, which constitutes a departure from IFRSs. The company's
records indicate that had management stated the inventories at the lower of cost and net
realisable value, an amount of xxx would have been required to write the inventories down
to their net realisable value. Accordingly, cost of sales would have been increased by xxx,
and income tax, net income and shareholders' equity would have been reduced by xxx, xxx
and xxx, respectively.
Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of most
significance in our audit of the financial statements of the current period. These matters
were addressed in the context of our audit of the financial statements as a whole, and in
forming our opinion thereon, and we do not provide a separate opinion on these matters. In
addition to the matter described in the Basis for Qualified Opinion section we have
determined the matters described below to be the key audit matters to be communicated in
our report.
[Description of each key audit matter in accordance with ISA 701.]
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19: REPORTS
3.5 Example 4: Adverse opinion due to material misstatement with a pervasive effect
Adverse Opinion
We have audited the financial statements of ABC Company (the Company), which comprise
the statement of financial position as at 31 December 20X1, and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for the
year then ended, and notes to the financial statements, including a summary of significant
accounting policies.
In our opinion, because of the significance of the matter discussed in the Basis for Adverse
Opinion section of our report, the accompanying financial statements do not present fairly
(or do not give a true and fair view of) the financial position of ABC Company as at
31 December 20X1, and (of) its financial performance and its cash flows for the year then
ended in accordance with IFRSs.
Basis for Adverse Opinion
As explained in Note X, the company has included houses built for re-sale (including related
land) at a cost of $X as non-current assets and depreciated them at a rate of X%, resulting
in depreciation of $X. Under International Financial Reporting Standards, these should have
been included as inventory in the financial statements and no depreciation should have
been provided in respect of these. The carrying value of the houses represent 90% of the
company's total assets and the company's records indicate that … [explanation of the effect
on amounts presented in the financial statements].
Key Audit Matters
Except for the matter described in the Basis for Adverse Opinion section, we have
determined that there are no other key audit matters to communicate in our report.
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19: REPORTS
3.6 Example 5: Qualified opinion due to inability to obtain sufficient appropriate audit
evidence about the carrying amount of inventory (material but not pervasive)
Qualified Opinion
We have audited the financial statements of ABC Company (the Company), which comprise
the statement of financial position as at 31 December 20X1, and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for the
year then ended, and notes to the financial statements, including a summary of significant
accounting policies.
In our opinion, except for the possible effects of the matter described in the Basis for
Qualified Opinion section of our report, the accompanying financial statements present
fairly, in all material respects, (or give a true and fair view of) the financial position of ABC
Company as at 31 December 20X1, and (of) its financial performance and its cash flows for
the year then ended in accordance with IFRSs.
Basis for Qualified Opinion
With respect to inventory having a carrying amount of $X the audit evidence available to us
was limited because we did not observe the counting of the physical inventory as at
31 December 20X1, since that date was prior to our appointment as auditor of the company.
Owing to the nature of the company's records, we were unable to obtain sufficient
appropriate audit evidence regarding the inventories quantities by using other audit
procedures.
Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of most
significance in our audit of the financial statements of the current period. These matters
were addressed in the context of our audit of the financial statements as a whole, and in
forming our opinion thereon, and we do not provide a separate opinion on these matters. In
addition to the matter described in the Basis for Qualified Opinion section we have
determined the matters described below to be the key audit matters to be communicated in
our report.
[Description of each key audit matter in accordance with ISA 701.]
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3.7 Example 6: Disclaimer of opinion due to inability to obtain sufficient appropriate audit
evidence about multiple elements of the financial statements (inventories and
accounts receivable – material and pervasive)
Disclaimer of Opinion
We were engaged to audit the financial statements of ABC Company (the Company), which
comprise the statement of financial position as at 31 December 20X1, and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for the
year then ended, and notes to the financial statements, including a summary of significant
accounting policies.
We do not express an opinion on the accompanying financial statements. Because of the
significance of the matters described in the Basis for Disclaimer of Opinion section of our
report, we have not been able to obtain sufficient appropriate audit evidence to provide a
basis for an audit opinion on these financial statements.
Basis for Disclaimer of Opinion
We were not appointed as auditors of the company until after 31 December 20X1 and thus
did not observe the counting of physical inventories at the beginning and end of the year.
We were unable to satisfy ourselves by alternative means concerning the inventory
quantities held at 31 December 20X0 and 20X1 which are stated in the statement of
financial position at xxx and xxx, respectively. In addition, the introduction of a new
computerised accounts receivable system in September 20X1 resulted in numerous errors
in accounts receivable. As of the date of our auditor's report, management was still in the
process of rectifying the system deficiencies and correcting the errors. We were unable to
confirm or verify by alternative means accounts receivable included in the statement of
financial position at a total amount of xxx as at 31 December 20X1. As a result of these
matters, we were unable to determine whether any adjustments might have been found
necessary in respect of recorded or unrecorded inventories and accounts receivable, and
the elements making up the income statement, statement of changes in equity and
statement of cash flows.
Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of most
significance in our audit of the financial statements of the current period. These matters
were addressed in the context of our audit of the financial statements as a whole, and in
forming our opinion thereon, and we do not provide a separate opinion on these matters. In
addition to the matter described in the Basis for Disclaimer of Opinion section we have
determined the matters described below to be the key audit matters to be communicated in
our report.
[Description of each key audit matter in accordance with ISA 701.]
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4.2 Examples of circumstances where the auditor may include an emphasis of matter paragraph
are:
An uncertainty relating to the future outcome of exceptional litigation or regulatory
action;
A significant subsequent event that occurs between the date of the financial
statements and the date of the auditor's report, for example a fire at the entity's
production facilities;
Early application (where permitted) of a new accounting standard that has a material
effect on the financial statements; and
A major catastrophe that has had, or continues to have, a significant effect on the
entity's financial position.
4.3 An emphasis of matter paragraph is not used to highlight any going concern issues. Such
issues would be disclosed in a 'material uncertainty related to going concern' paragraph
(Section 5).
4.4 For listed entity audits, the same issue would not be included within the emphasis of matter
paragraph and the KAM paragraph.
(a) If the issue is fundamental to users' understanding and has required significant audit
attention then it should be disclosed as a key audit matter.
(b) However, if the issue is fundamental to users' understanding but has not required
significant audit attention, for example a subsequent event, then it should be
disclosed within the emphasis of matter paragraph.
Emphasis of Matter
We draw attention to Note X of the financial statements, which describes the effects of a fire
in the company's production facilities. Our opinion is not modified in respect of this
matter.
Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of most
significance in our audit of the financial statements of the current period. These matters
were addressed in the context of our audit of the financial statements as a whole, and in
forming our opinion thereon, and we do not provide a separate opinion on these matters.
[Description of each key audit matter in accordance with ISA 701.]
4.8 Examples of circumstances where the auditor may include an other matter paragraph are
where the prior year financial statements:
Have not been audited; or
Have been audited by another auditor.
4.9 For listed entity audits, the same issue would not be included within the other matter
paragraph and the KAM paragraph.
Other Matter
The financial statements of ABC Company for the year ended 31 December 20X0 were
audited by another auditor who expressed an unmodified opinion on those statements on
31 March 20X1.
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5 Going concern
Responsibilities of directors and auditors
5.1 It is the directors' responsibility to determine whether or not an entity is a going concern.
5.4 If there is concern about any of the items above, then the auditor should consider the
implications for their report.
5.6 Scenario 1
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19: REPORTS
5.8 Scenario 2
The going concern basis is believed to be inappropriate
The auditor should express an adverse opinion due to material and pervasive
misstatement
5.9 Scenario 3
The directors are unwilling/unable to make an assessment as to whether or not the
going concern basis is appropriate
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19: REPORTS
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19: REPORTS
3 One of Maker's construction workers, Edward Shift, was dismissed in August 20X2 after
turning up for work under the influence of alcohol. In September 20X2, Mr Shift began a
case against Maker for unfair dismissal.
Which TWO of the following audit procedures should be performed in order to form a
conclusion as to the appropriate accounting treatment of the above claim in the year
end financial statements?
Recalculate Mr Shift's wages and salaries for the year to verify that he was only paid
up to the date of dismissal
Review the construction work performed by Mr Shift in August 20X2 to determine
whether there are any concerns over the quality of his work and whether Maker's
health and safety procedures were followed
Review legal correspondence relating to the claim in order to determine Maker's
lawyers' opinion as to the likely outcome of the claim
Review the post year end cash book in order to determine whether any payments
were made to Mr Shift
4 Mr Shift has sent such a huge amount of paperwork to Maker detailing the extent of his claim
along with supporting medical documentation and character references that the audit team
has had to devote a significant amount of audit attention to this area of the audit. The directors
have not made any reference to the claim in the financial statements and you agree with
Maker's lawyers' indication that it is highly unlikely that Mr Shift will be successful in his claim.
Based on the above information indicate whether the audit opinion should be modified or
unmodified and the appropriate disclosure which should be made in the auditor's report:
Modified Unmodified
The final audit client is TH Co (TH). The audit fieldwork is complete; however, your audit senior
has raised an outstanding issue.
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19: REPORTS
5 The directors of TH have made appropriate disclosures relating to worries over going
concern in the financial statements. Your audit senior has a significant level of concern
regarding the going concern basis but feels the disclosure is appropriate and agrees with
the use of the going concern basis. You concur with the audit senior's conclusions.
Based on the above information indicate whether the audit opinion should be
qualified 'except for' or unmodified and the appropriate disclosure which should be
made in the auditor's report:
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6 Chapter summary
Section Topic Summary
1 ISA 700 (Revised) The elements of the auditor's report are specified by
Forming an Opinion ISA 700 (Revised).
and Reporting on Auditor's report may be unmodified or modified.
Financial Statements
2 ISA 701 For listed entity audits the auditor should report areas of
Communicating Key the audit which have required significant audit attention
Audit Matters in the as key audit matters. These should also be reported to
Independent Auditor's those charged with governance.
Report
3 ISA 705 (Revised) Auditors will modify their opinions when the financial
Modifications to the statements are not free from material misstatement or
Opinion in the when they have been unable to obtain sufficient
Independent Auditor's appropriate evidence. There are two levels of modified
Report opinions auditors can give – material but not pervasive
and material and pervasive.
4 ISA 706 (Revised) A report may be modified by an emphasis of matter or
Emphasis of Matter other matter paragraph. These do not affect the
Paragraphs and Other opinion.
Matter Paragraphs
5 Going Concern It is the directors' responsibility to determine whether an
entity is a going concern and the auditor's responsibility
to assess whether this is appropriate. Uncertainty over
going concern will lead to the inclusion of a 'Material
uncertainty related to going concern' paragraph being
included in the auditor's report (provided that the issue
is adequately disclosed). Material misstatement in
relation to going concern is likely to be one of the rare
circumstances where an adverse opinion is issued.
END OF CHAPTER
300
Achievement Ladder Step 5
You have now covered the Topics that will be assessed in Step 5 in your Achievement Ladder. This
mainly focuses on the shaded topics below but will also include some recap questions on earlier
topics.
It is vital in terms of your progress towards 'exam readiness' that you attempt this Step in the near future.
You will receive feedback on your performance, and you can use the wide range of online resources and
ongoing BPP support to help address any improvement areas. This will help you to tailor your learning
exactly to your own individual requirements.
Course Notes
Topic name Subtopic/Chapter name
chapter
The concept of assurance 1
Audit and assurance
Regulation 2
Corporate governance 3
Governance
Internal audit 4
Professional ethics and quality control
Ethics 5
procedures
Audit risk Risk assessment 6
Planning and documentation 7
Audit planning
Introduction to audit evidence 8
Internal controls 9
Internal control systems
Tests of controls 10
Audit procedures and sampling 11
Audit evidence I
Non-current assets 12
Inventory 13
Audit evidence II Receivables 14
Bank and cash 15
301
Achievement ladder
Course Notes
Topic name Subtopic/Chapter name
chapter
Liabilities and equity 16
Audit evidence III
Not-for-profit organisations 17
Audit finalisation 18
Audit completion
Audit reports 19
302
Achievement Ladder Step 6
In the final run up to your exam, you should attempt Step 6 as the final check that you are fully prepared
to move onto the revision phase of your studies. As a reminder, Step 6 must be completed and submitted
in order to be able to qualify for Pass Assurance. It is Step 6 and can also be found at the back of these
Course Notes.
It covers all the Topics in your course. As ever, you will receive feedback on your performance, and you
can use the wide range of online resources to help address any final areas where you need to fine tune
your knowledge or technique.
Course Notes
Topic name Subtopic/Chapter name
chapter
The concept of assurance 1
Audit and assurance
Regulation 2
Corporate governance 3
Governance
Internal audit 4
Professional ethics and quality control
Ethics 5
procedures
Audit risk Risk assessment 6
Planning and documentation 7
Audit planning
Introduction to audit evidence 8
Internal controls 9
Internal control systems
Tests of controls 10
Audit procedures and sampling 11
Audit evidence I
Non-current assets 12
Inventory 13
Audit evidence II Receivables 14
Bank and cash 15
Liabilities and equity 16
Audit evidence III
Not-for-profit organisations 17
Audit finalisation 18
Audit completion
Audit reports 19
303
Achievement ladder
304
Answers to
Lecture Examples
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20: ANSWERS TO LECTURE EXAMPLES
Chapter 1
Answer to Lecture Example 1
1 Here you would want some comfort as to whether or not the house you plan to buy is
structurally sound, whether the roof is in a good condition, whether there is any damp and
so on. Most house buyers would have a survey carried out by a building surveyor prior to
completing a purchase. This survey is carried out by an independent party who is
professionally qualified and would give you confidence/comfort that there are no major
issues with the property you plan to purchase.
2 One of the primary risks of meeting someone you have met online must be the risk that they
are not who they say they are and that instead of being a funny, loveable, friendly
companion they are actually someone who is out to harm you. Your friend should therefore
consider the checks that the website make on each of their members and they could also
sound out any mutual friends or acquaintances you have as to the type of person they are
about to meet. They could also consider checking any public registers such as the sex
offenders register.
3 Here the council body will be concerned that the money they have given is used for the
designated purpose. They will need assurance that the money has been spent on sports
equipment, sports hall premises, staff and so forth rather than on items which are not related
to this cause. The council could require the organisation to provide them with a report
stating that the money was spent in accordance with the stipulations of the grant. This report
would need to be produced by an independent body, perhaps an accountant.
Chapter 2
No Lecture Examples
Chapter 3
Answer to Lecture Example 1
1 The Chairman's role is to run/direct the board of directors so that its members can undertake
their roles effectively. These duties include ensuring that the board is appropriately balanced
(in terms of the numbers of executive and non-executive directors) and that each director is
aware of their responsibilities and equipped to fulfil them.
The Chief Executive Officer's role is to decide on the company's strategy and put
procedures in place to achieve these.
These are very different roles and so should ideally be undertaken by two separate people.
Also separating the roles will not allow one person to have too much power (as in the case
of Robert Maxwell).
2 Dress You Like Co undertakes a board evaluation each year which allows directors to voice
their concerns as to how the board is being run.
It also makes training available to its directors and offers a full induction to new directors.
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20: ANSWERS TO LECTURE EXAMPLES
3 Directors should only remain in position if they are performing in their role. Having the
annual re-election of directors allows companies to remove directors who are not performing
and also encourages directors to work effectively for the company/shareholders.
4 Board of directors:
The responsibility for risk management lies with the board of directors. It is the directors'
responsibility to assess the risks that the business is exposed to. All businesses are
exposed to general risks; however, there are additional, specific risks relevant to each
business. Dress You Like Co is a clothing manufacturer and so there are lots of risks
inherent in the business – two of these are mentioned in the scenario: changing fashion
trends and the security of inventory.
Once the board has identified the key risks to which the business is exposed, it must then
implement a system of internal controls (or procedures) to prevent and/or detect these risks
occurring.
Internal controls could range from performing continual market research into consumer
fashion tastes to installing security cameras in the factory to deter theft of inventory.
The existence of an internal audit function is often cited as a positive form of risk
management and internal control.
Audit committee:
As well as giving the board of directors the responsibility for risk management, corporate
governance principles require a company to establish an audit committee. This should
comprise at least three non-executive directors (two non-executive directors for a small
company).
The audit committee has a responsibility to review the company's risk management and
internal control systems and should include at least one non-executive director with financial
knowledge.
The audit committee must also review the effectiveness of the internal audit department
where one exists. If there is no internal audit department, then the audit committee should
consider annually whether or not there is a need for one.
5 Executive directors are responsible for the day to day running of the company and perform
operational and strategic business functions such as entering into contracts, safeguarding
company assets and managing people.
Non-executive directors are not involved in the day to day running of the business. Instead
they should use their experience and expertise to provide independent advice and
objectivity to the board as a whole. They also perform a supervisory role and will review and
monitor the executive directors to ensure that they are fulfilling their duties and running the
company in the best interests of the shareholders.
In order to improve their independence, non-executive directors should not be reliant on the
company for their main source of income. They often work part time for the company and
can have a specialist role within the organisation.
All directors, executive and non-executive, are required to attend as many board meetings
as they reasonably can.
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20: ANSWERS TO LECTURE EXAMPLES
Also there is no legal distinction between executive and non-executive directors – each has
the same responsibilities and rights under law.
Dress You Like Co has three executive and three non-executive directors which makes the
board very well balanced.
6 As well as forming part of the board of directors as a whole, the non-executive directors also
sit on the audit committee, remuneration committee and nomination committee. These are
sub-committees of the board of directors.
The audit committee is responsible, amongst other things, for reviewing the effectiveness of
the board's risk management processes.
The remuneration committee is responsible for making sure that the company offers a
performance-related remuneration package which is sufficient to attract and retain quality
directors (but not excessive).
The nomination committee is responsible for identifying and approving the appointment of
new directors to the board, for example Mary Batter, the new Chief Executive Officer.
Non-executive directors have a very important role to play in each of these sub-committees
and their independence and objectivity can improve the quality and relevance of the
decisions taken.
Chapter 4
Answer to Lecture Example 1
Objective Control
Economy
To ensure that material is purchased at The prices from the Chinese supplier should be
the best possible price for the quality checked regularly against those offered by other
required. suppliers. Where alternative suppliers offer better value
for money, these suppliers should be used or prices
renegotiated with the Chinese supplier.
A list of preferred suppliers, who have been vetted for
price and quality, should be established and orders only
placed with these suppliers.
Establish a tender process whereby suppliers are
invited to quote for the supply of materials. This may
take place on a season by season or six-monthly basis.
To ensure that transportation and Identify a list of companies which import goods from
delivery costs are minimised whilst China and invite them to tender for the delivery
ensuring goods are received on a timely contract.
basis. Regularly review the price paid under the tender to
ensure it is competitive against other companies.
308
20: ANSWERS TO LECTURE EXAMPLES
Objective Control
To ensure that the accommodation costs If premises are rented, review the rental charged in
of the factory and head office are relation to similar properties in the same location.
minimised. Attempt to renegotiate the rent favourably whenever the
lease comes up for renewal.
If premises are owned establish an ongoing schedule of
maintenance for the property to avoid unexpected
repair costs.
Establish a capital expenditure budget to ensure
monies are not wasted continually repairing machines
which should be replaced.
Efficiency
To ensure that the clothes manufacturing The factory machines should be serviced according to a
process is as efficient as possible and rolling schedule of maintenance in order for them to
minimises waste. work efficiently.
To ensure that machine down time due Orders for different clothing items should be collated
to changing the machine set up for and scheduled into a weekly plan of work in order to
different clothing items is minimised. minimise the requirement to set up machines to
manufacture different clothing items.
Effectiveness
To ensure that all additional deliveries A record should be maintained of the principal inventory
ordered by the supermarket are lines ordered by the supermarket and a buffer of
completed within the required inventory for these items maintained. The level of this
timescales. buffer should be reviewed on a fortnightly/monthly basis.
To minimise the level of inventory which A fortnightly/monthly count of inventory held should be
becomes obsolete/un-saleable due to conducted and compared to the schedule of work
changing seasons/fashions. planned for the next fortnight/month to ensure that only
sufficient quantities of inventory are manufactured to
supply orders and maintain the required buffer.
To monitor the company's cash flow to Monthly cash flow forecasts should be produced by
ensure that the company does not suffer management to monitor when cash is due to be
from short-term cash flow problems received from all customers and when cash needs to be
given the 60-day terms given to the paid out to suppliers and employees.
supermarket. Establish an overdraft facility with the company's bank
to cover short-term deficits in cash flow.
Implement strong credit control procedures whereby
customers are contacted as soon as their account
becomes overdue. Send regular customer statements
to all customers and letters to those with overdue
accounts.
Note. Only two points were required under each heading.
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20: ANSWERS TO LECTURE EXAMPLES
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20: ANSWERS TO LECTURE EXAMPLES
Chapter 5
Answer to Lecture Example 1
Threat Safeguards
Weadon Co
This involves a self-interest threat because Gifts and hospitality should not be accepted
the auditors may wish to continue enjoying unless the value is trivial and
lavish hospitality so may be reluctant to raise inconsequential.
any problems in their auditor's report.
There is also a familiarity threat because In this case it would be appropriate to decline
involvement in social events with the client is the weekend away so as not to impair the
likely to increase the audit staff's familiarity firm's independence.
with the client staff and make them more likely
to accept explanations without adequate
questioning.
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20: ANSWERS TO LECTURE EXAMPLES
Threat Safeguards
Stewards Co
This involves a familiarity threat because Mr Mr Walker should be rotated off the audit and
Walker has been the engagement partner for another partner assigned to the client. Given
nine years and his long association with the that Stewards Co is a public interest entity,
client could mean that he does not question key audit partners (such as the engagement
judgements made by the client and does not partner) should serve for no more than seven
exercise sufficient professional scepticism. years before being rotated off. They should
not return to having involvement in the client
for a period of two years.
Risk (2)
Risk (3)
Risk (4)
Chapter 6
Answer to Lecture Example 1
Audit risk Auditor's response
The audit is a new audit for the firm; the firm The auditors should spend time ensuring they
may not have as good an understanding of fully understand the nature of the business, its
the client as it would have for an established products or services, its locations, revenue
client and so there is likely to be an increased sources, key customers and suppliers, internal
level of detection risk. controls and any external pressures or laws
and regulations it is subject to in order to best
assess the risk of material misstatement in the
financial statements.
This information must be communicated to all
members of the audit team.
312
20: ANSWERS TO LECTURE EXAMPLES
313
20: ANSWERS TO LECTURE EXAMPLES
314
20: ANSWERS TO LECTURE EXAMPLES
315
20: ANSWERS TO LECTURE EXAMPLES
(b)
Audit risk Auditor's response
The draft financial statement extracts Discuss the going concern status of Dress
indicate that there may be cash flow You Like Co with management.
problems leading to concern over going Obtain a copy of the cash flow forecasts
concern. produced by management and consider
Dress You Like Co has seen falling gross whether the assumptions on which they are
profit margins during the year. For the based are reasonable, particularly in terms
supermarket customer these are from 8% in of the timings of cash received from
20X0 to 3% in 20X1 and for other customers customers.
12% (20X0) to 10% (20X1). Discuss with management whether Dress
The receivables days for the supermarket You Like Co has any alternative funding
customer are 81 days in 20X1 compared to available in the event that it struggles with
62 days in 20X0. For other customers cash flow.
receivables days are largely stable at 31 and Discuss with management whether any
33 days. disclosures relating to going concern have
Inventory days have risen from 35 days in been made in the financial statements.
20X0 to 85 days in 20X1 largely due to
stockpiling for last minute orders.
Overall the fall in margins, lack of credit
control and increased inventory holdings
mean that the company has gone from a
cash position of $200,000 in 20X0 to an
overdraft of $750,000 in 20X1.
This further compounds cash flow and going
concern worries and worries that inventory
may be overstated.
Chapter 7
No Lecture Examples
Chapter 8
Answer to Lecture Example 1
1 The correct answer is: Finance charge should be $66,000, profit is understated
$
1.1.X2–31.3.X2
$400,000 × 2% = $8,000 × 3 months 24,000
1.4.X2–30.9.X2
($400,000 – $50,000) × 2% = $7,000 × 6 months 42,000
Total 66,000
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20: ANSWERS TO LECTURE EXAMPLES
2 The correct answer is: Obtain a copy of the latest rental agreement and recalculate the
expected rent expense for the year
The latest rental agreement is documented evidence from a third party and should stipulate
the rental charge for both floors which are now occupied by HMA.
3 The correct answer is: Calculate the gross profit margin for the years ended 30 September
20X2 and 20X1 and investigate any significant differences in the ratio with management
Generally speaking an entity's gross profit margin tends to remain relatively stable and so
any unexpected changes should be investigated as they could indicate that material
misstatements exist. For example, an unexpected increase in gross profit margin could
indicate a cut-off error where sales after the year end have been included in the year-end
figures.
Chapter 9
Answer to Lecture Example 1
1 The postman knocks at your front door You should be required to sign for the letter on
and hands you a letter which has been the postman's handset.
sent by recorded delivery.
2 You submit a claim for expenses to your You should need to evidence the claim by
line manager. presenting the receipt; the line manager should
sign the claim form to authorise payment.
3 You need to work an extra day over and You should submit a request that the overtime
above your normal hours to clear a be authorised prior to it being completed and this
backlog of work and will expect to be authorisation request should be signed by your
paid overtime for this. line manager.
4 You are responsible for maintaining the You should perform a bank reconciliation to
cash book and have just been passed verify the completeness and accuracy of the
the latest bank statement. cash book.
5 You have just received a monthly You should reconcile the balance per the
statement from your main supplier. supplier statement to the purchase ledger
balance.
6 You are responsible for payroll You should be provided with a copy of the letter
processing and you have just received signed by the employee which authorises the
notification from human resources that deductions and a hierarchical password should
an employee wants to take advantage of be required to amend the standing data.
a season ticket loan offered by your
company. Your password does not give
you permission to amend employee
deductions.
7 You have just returned from a Your password should have expired and the
three-month holiday and are trying to log computer should automatically require you to
on to your computer. change your password.
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20: ANSWERS TO LECTURE EXAMPLES
8 You are preparing to pay an invoice You should verify that the goods have been
received from a supplier. received by checking to a goods received note,
vouch the prices to the supplier's price list and
recalculate the sales tax and addition of the
invoice. The invoice should then be authorised
for payment and this evidenced by a signature.
9 You have prepared a bank reconciliation Your supervisor should review the bank
for your supervisor. reconciliation to verify it has been done properly
and sign to evidence that the review has taken
place.
10 You are entering 75 sales invoices into You should perform a batch reconciliation
the accounting records and want to whereby you manually count the number of
check the accuracy of your posting. invoices posted and verify to the system or
manually total the value of the invoices and
verify that the revenue, sales tax and
receivables accounts have increased by the
corresponding amounts.
Provided that the invoices are sequentially
numbered, you should also perform a sequence
check to determine whether any invoice
numbers have been omitted.
11 You have been working on the computer You should log out/lock your computer prior to
but have now gone away to make a cup leaving your work station.
of tea, leaving the computer inactive for a If you do not lock your computer then the
period of time. computer should 'time out' after a certain period
of time and require you to re-enter your log on/
password details before you can resume work.
12 You have a Saturday job operating the till The cash in the till should be counted at the end
in a small corner shop which is closing of the day and reconciled to the till receipt.
for the night. Money should be kept in a safe overnight.
13 You work in a shop that sells diamond The shop should have CCTV in operation, the
jewellery; the jeweller is very keen to front door should be locked with a door bell
keep their inventory secure. which must be rung to gain entry, jewellery
should be kept in locked cabinets and stored
overnight in a safe/secure vault and grilles pulled
down over the shop windows.
318
20: ANSWERS TO LECTURE EXAMPLES
Chapter 10
Answer to Lecture Example 1
Deficiency Implication Recommendation
Many parts of the sales system Completing items by hand The computer system should
process are completed by could lead to an increased risk generate a blank standard
hand/manually. of manual error in filling out the order form for the sales team
For example, the order form is form or errors in processing if to complete electronically.
completed by hand and is then handwriting cannot easily be Once completed, this should
read.
passed (by hand) to the be emailed to the customer
warehouse. Additional time is also taken and sent electronically to the
photocopying/scanning orders warehouse.
which are then posted/emailed
to customers.
There could also be delays in
passing the order to the
warehouse.
The goods despatched note If errors are made in the The GDN should be generated
(GDN) is not generated from packing process, then the as an electronic copy of the
the order form but is simply customer could be despatched order form and detail the
written up from what is packed items that they did not order or product code and quantity
in the boxes. may not receive items they did ordered. Where an item is not
order, even if they are not out in stock this should be
There is also no double check
of stock. recorded on the GDN.
that the items on the GDN are
those items packed in the Spot checks should be carried
boxes. out to verify that the contents
packed agree to the order
form.
Monies received from The company does not have Monies received with
customers are not always an accurate record of remittance advices should be
accompanied by a remittance outstanding invoices and so allocated against the specific
advice and so cannot always cannot chase overdue invoices which are being paid.
be allocated to specific amounts efficiently. Where a remittance advice is
outstanding invoices. This will also mean that not received, the accounts
Sometimes monies are simply disputed invoices are not receivables clerk should
allocated to the oldest necessarily identified. contact the customer by
invoices. telephone to determine the
This could lead to a loss of
breakdown of invoices being
cash flow and/or irrecoverable
paid.
debts.
Note. Only THREE deficiencies were required for this lecture example.
However, there were many other deficiencies in the lecture example and these are detailed below
for completeness.
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20: ANSWERS TO LECTURE EXAMPLES
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20: ANSWERS TO LECTURE EXAMPLES
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20: ANSWERS TO LECTURE EXAMPLES
Goods received should be vouched to the order form in order to ensure that the business
receives exactly what it ordered; however, this process will not stop orders being processed
unnecessarily. Furthermore, a separate quality check should be performed on the goods
received.
2 The correct answer is: Invoices on the supplier statement which relate to goods received but
not invoiced should not be included in the purchase ledger to avoid the payables balance
being overstated at the year end.
Where goods have been received before the month end/year end a corresponding liability
should be recognised even if the invoice has not been received.
3 The correct answer is: That supplier invoices are paid too early
At Dress You Like Co supplier invoices are currently being paid in the month in which they
are received rather than when they fall due. Therefore having some sort of
prompt/notification in the accounting system which identifies when each invoice needs to be
paid according to the supplier's credit terms will reduce the risk that invoices are paid too
early.
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20: ANSWERS TO LECTURE EXAMPLES
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20: ANSWERS TO LECTURE EXAMPLES
Chapter 11
Answer to Lecture Example 1
Customer Balance Cumulative total Selected (Y/N)
1 60,000 60,000 N
2 70,000 130,000 Y
3 90,000 220,000 Y
4 105,000 325,000 Y
5 28,000 353,000 N
6 100,000 453,000 Y
7 46,000 499,000 N
8 1,000 500,000 Y
9 84,000 584,000 N
10 94,000 678,000 Y
11 108,000 786,000 Y
12 34,000 820,000 Y
13 160,000 980,000 Y
14 20,000 1,000,000 Y
1,000,000
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20: ANSWERS TO LECTURE EXAMPLES
Chapter 12
Answer to Lecture Example 1
Tests on:
1 Opening balances
These should be agreed to the previous year's audit file and signed financial
statements.
2 Additions
A list of additions should be obtained and the total agreed to the financial statements.
A sample of assets should be selected and their value should be traced to invoices.
The amount capitalised should be checked to verify that it excludes recoverable sales
tax.
Legal costs capitalised should be agreed to invoices from the company solicitor.
3 Revaluations
Trace the revalued amount to the valuer's report and confirm that the surplus is
$1,000,000.
Agree that the $1,000,000 has been transferred to a revaluation reserve through
scrutiny of the nominal ledger.
Agree the basis of valuation to the valuer's report. Verify the disclosure of this to the
notes to the financial statements.
Recalculate depreciation to confirm that it is based on revalued amount.
Review the notes to the financial statements to confirm that the revaluation has been
disclosed.
326
20: ANSWERS TO LECTURE EXAMPLES
Chapter 13
Answer to Lecture Example 1
Five matters which will require action by management if the inventory count is to be effective
together with corrective action are:
1 By allowing Mr Farditch to take responsibility for the detailed organisation of the count, the
present instructions permit the person with day to day responsibility for the inventory area to
supervise one of the most important control checks on that area. This represents a
deficiency in the company's system of internal check, since the opportunity is afforded to
Mr Farditch to cover up any inadequacies there may be in the operational efficiency of
controls in the area of inventories.
Mrs Curbar should take more direct responsibility for the detailed organisation of the count.
2 By giving to those members of staff responsible for the physical count of the inventories an
indication of the quantity which is expected to be in inventory, there is a risk that this may
prejudice their opinion in the event of there being a discrepancy. More importantly, it will
tend to reduce the benefits which it is intended to derive from having an independent check
on the inventory records by having to reconcile them with the quantities determined by a
physical count.
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20: ANSWERS TO LECTURE EXAMPLES
The pre-printed inventory sheets should not show the balance of each inventory item on
hand as shown on the inventory records held independently of the warehouse.
3 At the moment clear instructions do not appear to have been given of the action required in
the event of there being a discrepancy in the counts arrived at by the two members of the
counting team. Unless precise instructions are given, there would be a tendency to accept
the quantity determined by the senior member of the count team, which is not necessarily
going to be the correct one.
The teams of counters should be instructed that in the event of their independent counts of
the inventory quantities not agreeing a further count should take place. If they are still
unable to agree then a note of this fact should be made on the inventory count tag so that a
further check may be made by the inspection team.
4 A number of teams of checkers (two or three) should be appointed to go around after the
counters. The task of these checkers would be to:
Carry out sample tests on the accuracy of the original counters
Ensure that inventory count completion tags have been left by the counters at each
inventory location
The appointment of checkers will improve the efficiency of the overall count by acting as a
check on both the accuracy and completeness of the count.
5 Allowing the members of staff involved in the count to deduct any goods in poor condition
from the quantities appearing on the inventory sheets increases the risk that:
(a) Errors of judgement are made; or
(b) This procedure could be used deliberately to cover up past or future
misappropriations of inventory.
The staff involved in the count should be instructed to identify any goods that appear to be in
poor condition on the inventory sheets and these can then be reviewed by a more senior
employee.
Goods should only be written off on the authorisation of that more senior employee.
Chapter 14
Answer to Lecture Example 1
Customer 1
The cash in transit should be traced to the cash receipts book post year end. I would expect
it to be received within a few days of the year end.
I would also trace the cash to the bank paying in slip. Again, this should be stamped by the
bank post year end.
Customer 2
The goods in transit should be traced to a GDN dated prior to the year end.
If inventory records exist the despatch could be traced to the records to confirm that it was
sent prior to the year end.
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20: ANSWERS TO LECTURE EXAMPLES
Customer 3
The reason for the dispute and my client's views on it should be obtained from the
correspondence file between Customer 3 and my client.
Credit notes post year end should be scrutinised to determine whether a credit was given for
the disputed goods.
Cash receipts should be reviewed post year end to determine whether Customer 3 paid the
full balance.
If the amount is outstanding at the audit date, discuss recoverability with the credit
controller.
Chapter 15
No Lecture Examples
Chapter 16
Answer to Lecture Example 1
Salary:
Vouch salary amounts to monthly payroll records and bank statements to ensure the
amounts are accurate.
For Directors C and D, obtain their leaving/start dates from the HR department and vouch
this to board meeting minutes. Recalculate their salaries on a pro-rata basis to ensure they
are accurately recorded.
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20: ANSWERS TO LECTURE EXAMPLES
Bonuses:
Vouch the level of bonuses awarded to board meeting minutes, payroll records and bank
statements to ensure they have been authorised and are accurately recorded.
Discuss with management the reasons why Director C was awarded a bonus despite
leaving the company during the year. Support any explanations with written documentation
where possible (for example Director C's contract).
Termination payments/incentive payments:
Review the employment contracts for Directors C and D to verify that there is a clause
outlining that these payments are applicable.
Vouch the level of these payments to board meeting minutes, payroll records and bank
statements.
General:
Recast the schedule to ensure the note is accurate.
Review the disclosure to ensure that it is in accordance with applicable law and accounting
standards.
Chapter 17
Answer to Lecture Example 1
Cash collections
Discuss procedures for cash collection with management and assess risk of fraud, loss,
robbery or error
Discuss selection criteria for collectors and collection procedures with management
Observe the cash collection, recording and banking process
Trace a sample of cash received control lists to cash records and bank statements
Reperform a reconciliation of total cash received to income
Perform an analytical review of cash donations per month vs previous year taking into
account factors such as number of collectors and weather
Regular donations by the 'Big 4' and wealthy individuals
Obtain and compare analysis of major/regular contributions with previous year
Send circularisation letters to confirm material amounts donated by Big 4 and wealthy
individuals
Circularise tax authorities to confirm contributions made where tax deductions have been
claimed
330
20: ANSWERS TO LECTURE EXAMPLES
Chapter 18
Answer to Lecture Example 1
The following factors might cause me to have doubts about Trucker's going concern status:
Fall in gross profit margin (20X2: 7%; 20X1: 9.4%). This will make a return to profitability
difficult.
Truckers is making losses. This will make negotiations with the bank difficult.
Debtors are taking longer to pay (20X2: 99 days; 20X1: 75 days). This will squeeze cash
flow coming into the business. Irrecoverable debts will increase the existing loss.
Worsening liquidity ratio (0.88 in 20X2; 1.05 in 20X1). Loan and lease commitments may not
be met.
Increasing reliance on short-term finance. The overdraft can be recalled by the bank at any
time. It should not be used to finance long-term investment.
Increased gearing (20X2: 63% [750 + 250 + 1,245/3,544]; 20X1: 50% [1,000 + 913/3,793]).
Interest on debt must be paid from a decreasing cash position.
Loss of major customer. Other customers may follow, worsening the company's prospects.
Loss of commercial customers. This represents loss of regular income. Damage to
company's reputation.
Overdraft facility to be reviewed three months after the year end. This short period is
probably not long enough to see any improvement in the company's future prospects and
therefore may not be renewed.
Despite the managing director's optimism, there is no evidence to support the forecasts of
additional revenue from new contracts.
Chapter 19
Answer to Lecture Example 1
1 The correct answer is: Qualified 'except for'.
LB has not valued inventory at the lower of cost and net realisable value on a line by line
basis, which is contrary to the accounting standard IAS 2 Inventories.
If it had, then the inventory line would have been written down by $14,000 ($17,000 cost
less $3,000 NRV).
The error is material as it represents 8% of profit before tax ($14,000/$175,000), so
management should correct this error in the financial statements.
As the Finance Director has refused to amend this error then the auditor's opinion will need
to be modified. As management has not complied with IAS 2 and the error is material but
not pervasive, a qualified opinion 'except for' would be necessary.
The auditor's report would include a qualified opinion section, together with a basis for
qualified opinion section explaining both the material misstatement in relation to the
inappropriate valuation of inventory, and quantifying its effect on the financial statements.
331
20: ANSWERS TO LECTURE EXAMPLES
333
21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
1 Introduction
1.1 The accounting knowledge that is assumed for Audit and Assurance is the same as the
accounting standards examined in Financial Accounting.
1.2 The purpose of this appendix is to provide you with a recap of the accounting standards
covered in the Financial Accounting syllabus which could feature in Audit and Assurance
questions.
2.2 Much of the prescribed format is determined by IAS 1 Presentation of Financial Statements.
This accounting standard states what should be included in a set of financial statements and
how they should be presented.
A complete set of financial statements in accordance with IAS 1 comprises:
(a) A statement of financial position as at the end of the period
(b) A statement of profit or loss and other comprehensive income for the period
(c) A statement of changes in equity for the period
(d) A statement of cash flows for the period
(e) Notes, comprising a summary of significant accounting policies and other explanatory
notes
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335
21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
Realised Unrealised
gains and losses gains and losses
336
21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
20X7 20X6
$'000 $'000
Profit for the year X X
Other comprehensive income:
Gains on property revaluation X X
Total comprehensive income for the year X X
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
2.6 STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 MARCH 20X7
$'000 $'000
Cash flows from operating activities
Profit before taxation X
Adjustment for:
Depreciation X
Investment income (X)
Interest expense X
XX
Increase in trade and other receivables (X)
Decrease in inventories X
Decrease in trade payables (X)
Cash generated from operations XX
Interest paid (X)
Income taxes paid (X)
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
At 31 March 20X7
Cost or valuation X X X X
Accumulated depreciation (X) (X) (X) (X)
Carrying amount X X X X
At 31 March 20X6
Cost or valuation X X X X
Accumulated depreciation (X) (X) (X) (X)
Carrying amount X X X X
At 31 March 20X7
Cost X
Accumulated amortisation (X)
Carrying amount X
At 31 March 20X6
Cost X
Accumulated amortisation (X)
Carrying amount X
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
3.3 Provisions
$
At 1 April 20X6 X
Increase in period X
Released in period (X)
At 31 March 20X7 X
4 Inventory (IAS 2)
4.1 The inventories figure in the financial statements comprises two elements:
QUANTITY VALUATION
Quantity
4.2 The quantity of inventories a business has at the year end is normally ascertained by
completing an inventory count at the end of the accounting period or by continuous
inventory records.
Valuation
4.3 The valuation of inventories is much more subjective and so guidance is provided in IAS 2
Inventories.
4.4 The basic rule per IAS 2 is:
'Inventories should be measured at the lower of cost and net realisable value.' (IAS 2:
para. 9)
4.5 This is another example of prudence in presenting financial information.
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
Cost
4.5 The cost of an item of inventory includes:
For example:
Purchase price
Import duties
Cost of purchase
But not:
Sales tax
Relating to productions:
Direct labour
Costs of conversion Direct/variable overheads
An allocation of fixed
overheads (based on
normal level of activity)
Other costs incurred in bringing
the inventories to their present For example:
location and condition Carriage inwards
No netting off
4.8 The IAS 2 rule 'lower of cost and net realisable value' (IAS 2: para. 9) should be applied
as far as possible on an item by item (or line by line) basis.
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
Cost
5.2 Property, plant and equipment should initially be recorded at cost.
Cost includes:
Purchase price, excluding sales tax and trade discounts but including import duties
Directly attributable costs to bring the asset to its intended location and ready to
use. These include:
– Initial delivery and handling costs
– Installation and assembly costs
– Costs of testing whether the asset is working properly
– Professional fees
The following costs may not be included:
– The cost of maintenance contracts
– Administration and general overhead costs
– Staff training costs
5.3 The asset can then be kept at cost and depreciated or the entity may choose to revalue its
tangible non-current assets.
Depreciation
5.4 Assets will eventually be worn out (used up) and so there is a cost of generating income.
This cost should be shown in the income statement to 'match' against the income.
This is called depreciation.
5.5 Depreciation results in the property, plant and equipment being systematically charged to
the income statement over several accounting periods in recognition of the fact that the
asset will contribute to the income-generating activities of each of these periods.
A formal definition is given by the accounting standard, IAS 16 Property, Plant and
Equipment:
'…the systematic allocation of the depreciable amount of an asset over its useful life.'
(IAS 16: para. 6)
5.6 Land normally has an unlimited useful life and is therefore not depreciated. Buildings have
a limited life and, therefore, are depreciable assets.
5.7 There are two main methods for calculating depreciation, the straight line method and the
reducing balance method.
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
5.9 This method is suitable for assets which are used up evenly over their useful life.
Revaluations
5.12 If an entity owns a property it may notice that its value increases over time.
5.13 IAS 16 requires property, plant and equipment to initially be recorded at cost. The entity can
then either keep the asset at cost (and depreciate it) or choose to revalue it (depreciation is
still required).
This is a choice of accounting policy.
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
5.14 If an entity chooses a policy of revaluation then all items in the same class of assets must be
revalued.
Examples of classes of assets are:
Land and buildings
Plant and machinery
Motor vehicles
5.15 Revaluations must be carried out sufficiently often so that the asset's carrying value is not
materially different from its market value.
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
Accounting treatment
6.2
Research Development
6.4 In the same way development expenditure which is incurred now will generate future
economic benefit.
The cost of the development expenditure should be matched against the future economic
benefit it produces. This is called amortisation.
6.5 The 'depreciable amount' (cost less residual value) should be amortised over the useful life
of the intangible asset and shall reflect the pattern in which the asset's future economic
benefits are expected to be consumed by the entity.
6.6 Amortisation should begin when the asset is ready for use.
6.7 It is an expense in the statement of profit or loss and is accounted for using the following
entry:
Dr Amortisation expense (SPL)
Cr Accumulated amortisation (SOFP)
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
7.2 Recognition
A provision should only be recognised (ie included in the financial statements) when:
(a) An entity has a present obligation (legal or constructive) as a result of a past event;
(b) It is probable that an outflow of economic resources will be required to settle the
obligation; and
(c) A reliable estimate can be made of the amount of the obligation.
Unless all three conditions are met, no provision can be recognised.
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
Illustrative example
7.7 Company A has entered into an agreement to act as guarantor on a bank loan taken out by
Mr Smith. Mr Smith is a financially secure individual, and the directors are of the opinion that
the chances of him defaulting on the loan are slim.
How should Company A account for this guarantee?
Solution
7.8 Company A has a present obligation (it is legally obliged to honour the guarantee).
However, as the likelihood of Company A having to pay out under the guarantee is not
probable then no provision for the liability should be made. Instead, the guarantee should be
disclosed in the notes as a contingent liability (unless considered remote, in which case it
should be ignored altogether).
Contingent assets
7.9 A possible asset that arises from past events and whose existence will be confirmed only by
the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity.
Contingent assets should be disclosed in the notes where an inflow of economic benefits is
probable, otherwise they should be ignored.
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21: APPENDIX A: ASSUMED KNOWLEDGE FROM FINANCIAL ACCOUNTING
If the probability of an inflow of economic benefits is virtually certain then the asset is not a
contingent asset and should be recognised in the financial statements.
8.2 There are two types of event after the reporting period.
Events which provide evidence of conditions Events that relate to conditions which
which existed at the end of the reporting arose after the end of the reporting period
period
Examples: Examples:
(1) Resolution of a court case (1) Destruction of major asset, eg by
(2) Bankruptcy of a major customer flood or fire
(3) Evidence of NRV of inventories (2) Major share transactions
(4) Discovery of fraud or errors that show (3) Announcement of a plan to close part
the financial statements were incorrect of a business
8.4 (a) Dividends proposed or declared after the end of the reporting period but before the
financial statements are approved should be disclosed in a note to the financial
statements.
(b) A non-adjusting event that affects going concern becomes an adjusting event.
END OF APPENDIX A
348
ACCA Audit and Assurance (AA)
Achievement Ladder
Step 4 Questions
Questions
Effective planning
This exam is half the real exam.
Read the requirements carefully: focus on mark allocation, question words (see below) and
potential overlap between requirements.
Identify and make sure you pick up the easy marks available in each question.
Effective layout
Present your numerical solutions using the standard layouts you have seen. Show and
reference your workings clearly.
With written elements try to make a number of distinct points using headings and short
paragraphs. You should aim to make a separate point for each mark.
Ensure that you explain the points you are making ie why is the point a strength, criticism or
opportunity?
Give yourself plenty of space to add extra lines as necessary; it will also make it easier for the
examining team to mark.
Common terminology
Advise To counsel, inform or notify
Analyse Examine in detail the structure of
Calculate/compute To ascertain or reckon mathematically
Compare and contrast Show the similarities and/or differences
Define Give the exact meaning of
Describe Communicate the key features of
Discuss To examine in detail by argument
Distinguish Highlight the differences between
Evaluate To appraise or assess the value of
Explain Make clear or intelligible/state the meaning of
Identify Recognise, establish or select after consideration
Interpret Process information to explain its meaning
Justify To produce reasons in support of
List State short pieces of information on separate lines
Prepare To make or get ready for use
Recommend To advise on a course of action
Summarise To express the most important facts of
350 Sept19/Dec19/March20/June20 EDITION
Section B
BOTH questions are compulsory and MUST be attempted.
Question 1 SeaPass
(a) List and explain the elements of an assurance engagement. (5 marks)
SeaPass is a ferry company which operates daily ferry crossings from the UK to France. The
company's year end is 30 June 20X9. You are the audit senior and you have started planning the
audit. Your audit manager has asked you to have a planning meeting with the client and to identify
any relevant audit risks so that the audit plan can be completed.
You obtained the following information at the meeting:
SeaPass has had a challenging year. The current economic crisis and worries about the future of
the Euro currency have meant that many passengers who might previously have booked ferry
crossings to France are now choosing to spend their holiday within the UK. SeaPass is under
continual pressure from its shareholders to show consistent performance.
In an attempt to win new passengers and generate additional income, SeaPass spent $800,000 on
an advertising campaign which featured both in the national press and on national television. The
campaign took place in May 20X9 and the company is convinced that this will vastly improve
customer numbers during Summer 20X9. Consequently the finance director is proposing to match
most of the advertising cost against summer revenues and has shown $600,000 of the $800,000
spent as a prepayment at the year end.
When customers book their ferry crossing they are required to pay an upfront deposit of 20% of the
total cost. In previous years this has been recognised as revenue in the month that the ferry
crossing is made. However, this year SeaPass has recognised the revenue when the deposit is
received. The finance director has explained that this is because the company has spent the
money as it was received in order to finance the advertising campaign. The balance of 80% is
taken by the company on the day of departure.
SeaPass wants its customers to have an excellent experience when they travel with them. With
this in mind it offers a 'money back guarantee'. If customers are excessively delayed or they are
not happy with the service provided by SeaPass, then they can claim compensation under the
company's money-back guarantee. Despite the company's very best efforts to improve customer
satisfaction, compensation payments are made on a regular basis.
SeaPass has also found that the price of fuel has risen sharply during the course of the year and it
has not been able to pass this price rise on to its customers in the form of higher ticket prices. This
has meant that its operating costs have increased considerably, leading to falling profit margins.
The company does hold some cash reserves in the form of bank deposits. However, these cannot
be accessed for six months and so the company has had to take out a short-term overdraft. The
finance director is pleased that the financial statements will show a net positive cash position as
the bank deposits will be greater than the overdraft at the year end.
Required
(b) Using the information provided, describe FIVE audit risks and explain the auditor's response to
each risk in the planning of the audit of SeaPass.
Note. Prepare your answer using two columns headed Audit risk and Auditor's response
respectively. (10 marks)
During a telephone conversation the finance director informed you that the company had had a
good year, mainly due to securing a new contract to supply a number of major new customers in
the UK.
He also stated that there has been no revaluation of non-current assets but there has been
extensive refurbishment and improvement of the company's manufacturing facility and its plant and
machinery.
You have also learned that the company introduced a new accounting system three months before
the year end. All balances were transferred from the old system to the new one which will form the
basis of the numbers in the financial statements. Training for accounts staff on this new system is
ongoing.
Required
(b) Using the information provided, describe SIX audit risks and explain the auditor's response to each
risk in the planning of the audit of Jaffa Co.
Note. Prepare your answer using two columns headed Audit risk and Auditor's response
respectively. (12 marks)
Questions
Effective planning
This exam is 80% of the real exam.
Read the requirements carefully: focus on mark allocation, question words (see below) and
potential overlap between requirements.
Identify and make sure you pick up the easy marks available in each question.
Effective layout
Present your numerical solutions using the standard layouts you have seen. Show and
reference your workings clearly.
With written elements try and make a number of distinct points using headings and short
paragraphs. You should aim to make a separate point for each mark.
Ensure that you explain the points you are making ie why is the point a strength, criticism or
opportunity?
Give yourself plenty of space to add extra lines as necessary; it will also make it easier for the
examining team to mark.
Common terminology
Advise To counsel, inform or notify
Analyse Examine in detail the structure of
Calculate/compute To ascertain or reckon mathematically
Compare and contrast Show the similarities and/or differences
Define Give the exact meaning of
Describe Communicate the key features of
Discuss To examine in detail by argument
Distinguish Highlight the differences between
Evaluate To appraise or assess the value of
Explain Make clear or intelligible/state the meaning of
Identify Recognise, establish or select after consideration
Interpret Process information to explain its meaning
Justify To produce reasons in support of
List State short pieces of information on separate lines
Prepare To make or get ready for use
Recommend To advise on a course of action
Summarise To express the most important facts of
356 Sept19/Dec19/March20/June20 EDITION
Section A
ALL 10 questions are compulsory and MUST be attempted.
Each question is worth 2 marks.
The following scenario relates to questions 1–5.
You are an audit manager of Adams & Co which has just won a contract for the tender of a new audit
client, Zen Co (Zen). Zen has been in business for five years and provides spa facilities for a national
hotel group.
One key factor in awarding the audit contract to Adams & Co was the fact that one of Adams & Co's
audit managers, Anthony Davidson, is married to the financial controller at Zen, Liz Davidson. The audit
engagement partner assigned to Zen is Carol Lamb.
In an initial meeting with the finance director of Zen, you learn that the employees of Adams & Co will
be entitled to a staff membership rate for the spa which is 50% of the standard membership rate and
that this will then entitle the member to 75% off spa treatments. This is the same benefit afforded to
Zen's employees.
Furthermore, the finance director has asked Carol if she will sit on the board of directors at Zen Co as a
non-executive director. He has also indicated that he will need Adams & Co to confirm the figures on an
insurance claim to be submitted in respect of a fire in the treatment centre just prior to the year end.
Zen has one major competitor, Revitalise, a large members-only spa, which started business two years
ago. Adams & Co has just been invited to tender for the audit of the company which owns Revitalise.
1 In relation to Adams & Co accepting appointment as auditors of Zen:
Which TWO of the following statements are correct?
Adams & Co will have a right to attend all directors' meetings and receive all notices and
communications relating to such meetings.
Adams & Co should obtain management's acknowledgement that they are responsible for
establishing internal control to ensure that the financial statements are free from material
misstatement.
Adams & Co must deposit a statement of circumstances within 14 days of accepting
appointment as auditor.
Adams & Co must agree the objective and scope of the audit in an engagement letter.
3 In relation to the employees of Adams & Co being offered a reduced cost spa membership:
Which of the following safeguards should be implemented in order to comply with ACCA's
Code of Ethics and Conduct?
The value of the gift should be assessed and only accepted if its value is not material to the
financial statements.
The gift can be accepted as it is no more beneficial than the rate offered to Zen's employees.
The gift should only be accepted for those employees of Adams & Co that form part of the
audit team.
The gift should only be accepted if its value is trivial and inconsequential.
4 In relation to the request that Carol Lamb serve as a non-executive director on the board of Zen:
Which of the following safeguards should be implemented in order to comply with ACCA's
Code of Ethics and Conduct?
Carol may perform the role and continue as the audit engagement partner but an independent
review partner should also be appointed to the audit.
Carol may perform the role but should not act as the audit engagement partner, although she
may serve as the independent review partner.
Carol may perform the role but should be removed from the audit team.
Carol should not accept the offer to serve as a non-executive director.
6 In July 20X3, the company's flagship restaurant in the South West of the UK was badly flooded
following unprecedented levels of rainfall. All kitchen equipment and much of the restaurant's
furniture and fittings had to be disposed of. WGH's insurance is expected to cover the repairs to
the property and replacement furniture and fittings. However, it will be some time before the
restaurant is ready to re-open and some revenue will be lost. The directors do not propose to
disclose details of the event in the financial statements on the basis it occurred after the year end.
Which TWO of the following audit procedures should be performed in order to form a
conclusion as to whether the financial statements require amendment?
Discuss with directors the measures they intend to take to reduce the risk of the restaurant
flooding in the future
Obtain a written representation to confirm that WGH's going concern status is not impacted by
the forced closure and lost revenue
Agree the original cost of the kitchen equipment to purchase invoices
Review any correspondence from the insurers, confirming that the cost of the restaurant
repairs and replacement furniture and fittings can be recovered
A second audit client, PTL Co (PTL), is a small listed company which designs mountain bikes and track
bikes to a high specification. PTL's year end is 31 August 20X3 and this year PTL's design team have
developed a new lightweight track bike which uses an alternative to carbon fibre as its main
construction material. Initial prototypes did not perform well during testing and consequently the audit
team had to undertake significant audit testing on the area of research and development in order to
ensure that PTL's intangible assets were not overstated.
8 Sales of the new bike went really well during the year and consequently the Design and Production
directors have each been paid a bonus on top of their annual salaries. The bonus was not paid
until the September 20X3 payroll but was accrued as part of the total wages and salaries expense
for the year ended 31 August 20X3. However, PTL's Finance Director does not want to disclose
the bonus separately in the financial statements as part of the directors' emoluments note for two
reasons. Firstly he does not want to draw the bonus to the attention of the other directors who did
not receive a bonus and secondly he does not want to risk any negative publicity for paying a
bonus during difficult economic conditions.
Which TWO of the following audit procedures are MOST relevant to form a conclusion as to
whether the financial statements require amendment?
Vouch the payment of the bonus to the bank statement for September/October 20X3
Review local company legislation to determine whether separate disclosure of the bonus is
required
Agree the bonus to the wages and salaries expense for the year
Consider whether the bonus is material to the current year financial statements