Audit and Assurance

Suggested Answers
Certificate in Accounting and Finance – Spring 2020

A.1 (a) Business Risk (b) Financial Statement Assertions

DPL has to comply with very strict Liabilities may be understated relating to
regulations and any non-compliance undisclosed penalties.
would result in heavy fines.
A contingent liability may not be disclosed in the
financial relating to any legal action taken by the
regulator against DPL.
DPL’s competitor has introduced a new Since DPL is selling Drug-A at lower margin, its
product which has caused DPL to inventory might need to be recorded at lower of cost
reduce it selling price. or net realizable value.

Since DPL is a listed entity and the revenues are

decreasing, DPL may overstate its revenue or
understate its expenses.

If the revenues keep on decreasing DPL’s property,

plant and equipment may need to be tested for
impairment.
DPL has to continuously carry on If the criteria for development cost (or intangible
research projects. asset) has not been met research cost might be
in-appropriately recorded as development cost.
Due to significant imports of raw There is a risk that trade payables may not be
material DPL is exposed to foreign translated using the correct exchange rate.
currency risk because of the
fluctuation in exchange rates. Exchange gains and losses may not be calculated
correctly.

A.2 Aggressive targets for departmental heads

CEO aggressively follows up with the departmental heads for achieving the targets set by those
charged with governance. It seems that there is an excessive pressure on management to meet
financial targets established by the directors therefore they may be under undue pressure to
misstate the financial statements.

Performance measurement of senior management

Since the performance of the senior management is measured in terms of year-on-year profit
growth they would have an incentive to fraudulently misstate the financial statements to obtain
bonuses or increments.

Internal audit department reports to CEO

Reporting of internal audit department to the CEO will impair their independence. Therefore this
deficiency in internal control structure would give an opportunity for fraudulent financial
reporting.

Significant subjective judgements

Determination of the provision required for onerous contract may require significant subjective
judgements on part of the management. There is an opportunity for the management to misstate
the recognition of expenses and liabilities.

Furthermore, since the performance is measured in terms of year-on-year profit growth,

management would have an opportunity to achieve those targets by not recording the required
provision.

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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Spring 2020

Not recording provision

Justification of the CFO does not seem correct as information regarding rise in the cost of raw
material can easily be obtained from the market. The fraud risk factor further increases with the
fact that the audit team also suspects that the provision has not been recorded to maintain the
profitability.

Maintaining the profitability

Excessive interest by management in maintaining the profitability and earning trend represents
the management’s attitude which would increase the fraud risk.

A.3 (a) Information is considered material if its omission could influence the economic decision of
the users taken on the basis of the financial statements. Only considering the board of
director as the only users of financial statements for determining materiality is not correct.

Furthermore, since TL is a newly established entity, use of ‘profit before tax’ will not be a
good benchmark as current year profit is low because of first year of operation. Further,
considering a benchmark on the basis of future profitability is also not correct.

If materiality is still to be determined based on ‘profit before tax’, it will result in a low
materiality level, which will require performing detailed testing. By setting a lower
materiality the auditteam would also increase their sensitivity to a potential misstatement.

Alternatively assets or revenue may be considered to be an appropriate benchmark, in the

determination of materiality. The audit team however, based on their audit strategy and
approach, may consider other appropriate benchmarks (e.g. total expenses, net assets etc.).

(b) The total development cost incurred to date is Rs. 78 million which is 52% of profit before
tax and is therefore material.

Your team should first discuss with the management and those charged with governance to
evaluate the contradicting views obtained from the board minutes and the management’s
explanation.

If the view of the board of directors is valid then perform the following audit procedures:
 Consider whether CL would be able to arrange the additional funding requirements for
completion of the project.
 Ask management to provide the revised marketing plans to assess that whether a
market at such an increased price actually exists.
 Review revised projections, feasibility and forecasts for using resources and generating
future economic benefits.
 Obtain written representation from management as to their commitment to complete
the project.
 Assess whether CL would be able to produce the solar roof at an increased cost.

If the view of the board of directors is not valid then perform the following audit procedures:
 Obtain and read the documentation of research team’s notes and conclusions related to
completion of the project and the funding requirements.

Reporting implications:
If the matter is resolved the auditor may consider including it in the key audit matter
section of the audit report.
However, if it is established that conditions required for recognition of development cost
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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Spring 2020

are not met then auditor should request the management and those charge with
governance to expense out the development cost. If they disagree, as the matter is not
pervasive as it only affects specific items in the financial statements and therefore a
qualified opinion should be issued. The audit report should include an explanation of the
issue in the basis for qualified opinion paragraph.
A.4 (i) Tracing of payable amounts recorded in supplier ledgers may not be relevant as it is
directed towards evidence about overstatement of recorded payables.
Suggestion:
 Obtain the list of goods received near to year end and check whether payable has been
recorded or not.
 Trace supplier statement received from the creditor to the supplier’s ledger.
(ii) Sending direct confirmation to suppliers which are already recorded in books of account
may not be a relevant audit procedure for understatement in payables.
Suggestion:
Select accounts for direct confirmation, showing nil balances and debit balances.
(iii) Tracing material subsequent disbursement from bank ledger is not a reliable audit
procedure as amounts are being traced through bank ledgers which is an internally
generated document.
Suggestion
Trace material subsequent disbursement from third party provided bank statements.
(iv) Obtaining and reviewing unpaid invoices is a relevant audit procedure for understatement
and may be a reliable audit evidence.

Further procedures to be performed

 Review the list of account balances for any supplier who are not in the listing of trade
payable, but who would be expected to be in the listing, such as suppliers of frequently
purchased items.
 Compare the list of trade payables balances with the listing that was prepared for the
previous year’s audit. Look for explanations as to why any major balances do not appear.
 Compare the ratio of trade payables days with the previous year and investigate the
variance.

A.5 (a) Auditor remains fully responsible for the report produced, even if evidence on which it is
based was produced by others. The auditor has sole responsibility for the audit opinion
issued and this is not reduced in any way by his use of an expert.

Therefore, he should not refer in his report to the use of an expert, unless that is required
by law or regulation. Even then, or if the auditor refers to the expert’s work in his report
because it is relevant to an understanding of a modified opinion, then he must make it clear
that such a reference does not reduce his responsibility for that opinion in any way.

The auditor therefore cannot simply accept work performed by experts. That work must be
evaluated in the same way as any other audit evidence is evaluated.
 reasonableness of the expert’s conclusions.
 consistency of those conclusions with other audit evidence.
 reasonableness of significant assumptions and methods used.
 relevance, completeness and accuracy of source data.

(b) Reporting lines: Hina works in close coordination with CFO and CEO and also discusses all
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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Spring 2020

of the findings with them. Therefore it seems that the internal audit department is also
reporting to CFO and CEO which would impair its independence. Hina should be directly
reporting to the audit committee rather than going through CEO and CFO.

Deciding the scope of internal audit work: The scope of work carried out by the internal
auditors is solely decided by Hina without the consultation of the audit committee. The
scope of internal audit work should be decided by the audit committee or the chief internal
auditor herself with the approval of the audit committee.

Rotation of internal audit staff: Internal auditor staff has been auditing the same processes
for the last three years. They would have become too familiar with the operations that they
audit or the management responsible for them. To reduce the familiarity threat, internal
auditors should be rotated regularly.

Designing internal controls: The internal audit department is also involved in designing the
internal controls. However, they should not be responsible for the design of internal
controls within the entity. If they did, they would be required to audit their own work,
which creates self-review threat. Senior management in accounting and finance or line
management should have responsibility for the design and implementation of internal
controls, taking advice where appropriate from the external auditors when control
weaknesses are identified during the external audit.

A.6 Debtor A
Evaluation
Even though the balance confirmed is the same, it raises doubt for the reliability of the response
because the confirmation was not received directly from the confirming party.

Steps to perform
 Auditor should modify or add procedures to resolve doubts over the reliability of
information to be used as audit evidence.
 Auditor should contact the confirming party and request them to respond directly to the
auditor.

Debtor B
Evaluation
It appears that the confirmation did not come from the originally intended confirming party. It
carries risk of interception, alteration or fraud.

Steps to perform
 Auditor should resend the confirmation again to the debtor.
 Auditor should revise the risk of material misstatement at the assertion level and modify
planned audit procedures accordingly.
 If it is ascertained that fraud exist, it is important that the matter is brought to the
appropriate level of management and those charged with governance.
 If the auditor has doubts about the integrity of the management or those charged with
governance, than the auditor should consider to obtain legal advice for appropriate course
of action.

Debtor C

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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Spring 2020

Evaluation
Sales return subsequent to the year-end can be an adjusting event which needs to be adjusted in
the financial statements.

Steps to perform
 Check the return of goods with the relevant goods receipt document.
 Inquire from the management the reasons for the return of good and assess whether it is
an adjusting event.
 If it is established that it is an adjusting event than ask the client to reduce the sales and
receivables and incorporate corresponding effects in cost of sales and inventory.
 Consider the fraud risk that whether the sales were made for overstating the sales for the
year end.

Additional steps (overall)

Since there are doubts over the reliability of the confirmation response, the auditor should also
perform the following alternate audit procedures to gather audit evidence:
 Subsequent receipt of the amount should be checked.
 If no payment has been received, the outstanding sales invoices should be checked with
purchase order issued by the customer and delivery note duly acknowledged by the
customer.

A.7 (i)  Firewalls to prevent intrusion into the programs that send and receive data.
 Restricting access to source data that is transmitted.
 Using check sums and check digits to ensure that data received is intact.

(ii)  SL should also store its backup data at some other location.
 SL should develop disaster recovery plans, such as an agreement with another entity to
make use of its computer center in the event of a disaster such as a fire or flood.
 The company should make suitable maintenance and service agreements with
software companies, to provide ‘technical support’ in the event of operating difficulties
with the system.

A.8 Rao Arif & Co.

Under the provision of Companies Act, 2017, a person who is, or at any time during the preceding
three years was a director, other officer or employee of the company is not eligible for
appointment as auditor.

Furthermore, a person will not be qualified for appointment as auditor of a company if he is

disqualified for appointment as auditor of any other company which is that company’s subsidiary
or holding company.

Therefore, being the former CFO of WBL’s subsidiary will make Rao Arif & Co. ineligible for
appointment as external auditor.

Hatim Tughlaq & Co.

Under the provision of Companies Act, 2017, a person who is indebted to the company other than
in the ordinary course of business of such entities cannot be appointed as the auditor.

Since it is in the ordinary course of WBL to grant loan therefore HatimTughlaq & Co. can be
appointed as external auditor WBL.
Rashid Kareem & Co.
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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Spring 2020

A person or a firm who, whether directly or indirectly, cannot be appointed as auditor if it has
business relationship with the company other than in the ordinary course of business of such
entities.

If properties are rented out in the ordinary course of business than Rashid Kareem & Co. can be
appointed as the external auditor of WBL.

A.9 (a)  Whether the interests of all parties, including third/related parties whose interests
may be affected, could be harmed if the client consents to the disclosure of
information.
 Whether all the relevant information related to the related parties is known and
substantiated, to the extent it is practicable.
 Since the requirement of the committee involves reporting on the arm’s length price of
the transaction which generally involves unsubstantiated facts or unsubstantiated
conclusions, professional judgment shall be used in determining the type of disclosure
to be made, if any.

(b) Threat
Close friendship of the audit manager with the managing director would cause a familiarity
threat, because the audit manager would be biased towards the managing director and
would sympathetic to his interest or too accepting of his work.

Safeguard
 Structure the audit manager’s responsibilities to reduce any potential influence over
the assurance engagement; or
 Review the assurance work from a chartered accountant; or
 Remove the audit manager from the engagement.

Threats
 Offering of membership at reduced rate could cause a self-interest threat to the audit,
because the recipients may not want to lose their benefit, and therefore be biased in
their audit work or not seek adjustments where there are material issues in the
financial statements.
 An intimidation threat may also arise because the audit client may threaten to make
such offers public to degrade the firm’s reputation.

Safeguards
Auditors are not allowed to accept such benefits unless their value is trivial and
inconsequential. In this case, the value of a reduced membership of a high end gym is
unlikely to be trivial and inconsequential to audit staff members and therefore the firm
should reject this discounted offer of MD.

A.10 (a) In response to assessed risk of material misstatement due to fraud, the auditor shall:
 emphasize to the audit team the need to maintain an attitude of professional
skepticism.
 assign more experienced staff or increased supervision of staff.
 to the extent not already done, the auditor shall obtain an understanding of the
entity’s related controls, relevant to such risks.
 evaluate whether the selection and application of accounting policies by the entity,
particularly those related to subjective measurements and complex transactions, may
be indicative of fraudulent financial reporting resulting from management’s effort to
manage earnings.
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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Spring 2020

(b) Logical access controls are tools and protocols used for identification, authentication,
authorization and accountability in computer information systems. It enables the
organization to identify users, restrict access to specific resources and produce audit trail
of systems and user activity.
 The login account must uniquely identify the person, but it must be part of a standard
similar to all other logins.
 The password has to be sophisticated and must be of a certain prescribed length.
 The access to the system must be limited in accordance with roles and
responsibilities of the users.
 User must be logged out after a certain period of in-activity.

(c) Many of the control activities that are typically found in a large company such as
segregation of duties, internal audit etc. may be inappropriate for a small entity because
they are too costly or impractical for such smaller organizations. Often, control systems in
small entities are based on a high level of involvement by the directors or owners.

Following audit risks may arise when control systems rely excessively on the involvement
of senior management:
 There may be a lack of evidence as to how systems are operating.
 There may be lack of evidence of controls.
 Management may override controls that are in place.
 Management may lack the expertise necessary to control the entity effectively.

(THE END)

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