AUDIT AND ASSURANCE (AAA)

SOLUTION PACK

S. No Question ACCA Paper Syllabus Area

1 Forsythia Group Sep/Dec 2022 Completion, review and reporting
2 Geller Co Sep/Dec 2022 Planning and conducting an audit
3 Winberry Co Sep/Dec 2022 Planning and conducting an audit
4 Infinity Co Mar/Jun 2022 Planning and conducting an audit
5 Morrissey Mar/Jun 2022 Professional and ethical considerations
6 Byres Mar/Jun 2022 Completion, review and reporting
7 McClane & Co Sep/Dec 2021 Planning and conducting an audit
8 Flynn Co Sep/Dec 2021 Professional and ethical considerations
9 Sol & Co Sep/Dec 2021 Completion, review and reporting
10 Crux Group Sep/Dec 2020 Planning and conducting an audit
11 Welford & Co Sep/Dec 2020 Professional and ethical considerations
12 Myron Co Sep/Dec 2020 Completion, review and reporting
13 Rick Group Mar/Jun 2020 Audit Planning
14 Moritz & Co Mar/Jun 2020 Other Assignments
15 Saul and Co Mar/Jun 2020 Audit Completion
16 Squire & Co Sep/Dec 2019 Planning and conducting an audit
17 Lifeson Co Sep/Dec 2019 Completion, review and reporting
18 Kaffe & Co Sep/Dec 2019 Completion, review and reporting
19 Snow & Co Mar/Jun 2019 Planning and conducting an audit
20 Kilmister Co Mar/Jun 2019 Completion, review and reporting
21 Awdry Co Mar/Jun 2019 Planning and conducting an audit
22 Huntsman & Co Dec 2018 Planning and conducting an audit
23 Daley Co Dec 2018 Planning and conducting an audit
24 Thomasson & Co Dec 2018 Professional and ethical considerations
25 Bison & Co Sep 2018 Planning and conducting an audit
26 Coram & Co Sep 2018 Completion, review and reporting
27 Jansen & Co Sep 2018 Professional and ethical considerations
28 Cathy & Co - Planning and conducting an audit
29 Red & Co - Planning and conducting an audit
30 Morgan & Co - Other assignments
31 Yes Co - Professional and ethical considerations
32 Circus & Co - Professional and ethical considerations
33 Friday & Co - Planning and conducting an audit
34 Mike Group - Professional and ethical considerations
35 Hook Co - Completion, review and reporting
36 Mint & Co - Professional and ethical considerations
37 Hello & Co - Completion, review and reporting
38 Orange Co - Planning and conducting an audit
39 Faster Jets Co - Other assignments
40 Paul Co - Professional and ethical considerations
41 Brick Co - Planning and conducting an audit
42 Tame & Co - Completion, review and reporting
43 Rockwell & Co - Completion, review and reporting
44 Nidge & Co - Completion, review and reporting
45 Cold & Co - Completion, review and reporting
46 Raphael & Co - Other assignments
47 James Ltd - Other assignments

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 Forsythia Group

General
• As the Forsythia Group is a listed entity, it is appropriate that an engagement quality review (EQR) is
taking place.
Robin Co
• The acquisition of a subsidiary after the financial year end should not be ignored by the audit team.
This is an example of a subsequent event which may need to be recognised or disclosed in the Group
financial statements.
• In this case, the acquisition of a subsidiary after the year end is a significant non-adjusting event in
respect of which no adjustment is needed to the financial statements, but disclosure should be made
in the notes.
• The audit engagement partner is therefore incorrect to agree with the chief finance officer's (CFO)
assertion that the matter will only be recognised in next year's financial statements.
• Given that the subsidiary is forecast to increase Group revenue by 20%, it appears that the acquisition
is material to the financial statements and audit procedures should be performed to determine and
conclude on the disclosures necessary.
• If the Group CFC is planning not to disclose information about the acquisition in this year's financial
statements, this could indicate a lack of competence, or a deliberate intention to omit the necessary
disclosures which would indicate a lack of integrity. In either case, this increases the level of audit risk.
• If the necessary disclosures are not made in the Group financial statements, a material misstatement
would exist, with implications for the auditor's opinion on the Group financial statements.
Camelia Associates
• It is not prohibited for audit work to be delegated to other audit firms. However, the evidence obtained
should not just be accepted without proper review and the audit work of Camelia Associates cannot
simply be relied upon.
• Without review, the audit engagement partner cannot consider whether the evidence obtained has
been performed in accordance with the audit plan or whether it is sufficient and appropriate to support
the audit opinion.
• Delegating the audit of revenue is particularly problematical given that the Group's revenue has
increased significantly, by 14.2% this year. Camelia Associates has performed audit work on the
revenue of significant subsidiaries, and they may not have appropriate knowledge and understanding
of the Group to perform good quality audit work.
• Auditor is needs to work on the presumption that there are risks of fraud in revenue recognition.
Therefore, revenue is usually approached as a high-risk area of the audit, so the delegation of audit
work in respect of revenue is likely to be inappropriate.
• The work which has been performed by Camelia Associates should be fully reviewed in order to
determine whether sufficient and appropriate audit evidence has been obtained in relation to revenue.
Further audit procedures, such as analytical procedures on the revenue figures of the subsidiaries,
may need to be performed by the audit team if the work of Camelia Associates cannot be relied upon
or is insufficient.
Development Expenditure
• The accounting treatment of the capitalised development costs is also significant as this could indicate
deliberate misapplication of the relevant financial reporting standards in order to boost the profit (as
profit before tax has decreased by nearly 20% on the prior year).
• Insufficient audit evidence has been obtained relating to the capitalised development expenditure.
Confirming that a set of management assumptions agrees to the assumptions from another source
does not provide evidence on the validity of the assumptions.

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 • Further audit procedures need to be performed in order for the auditor to conclude on the
appropriateness of the accounting treatment applied, for example, checking that the criteria for
classification as development costs.
• Assigning the audit of development expenditure to a junior member of the audit team is not appropriate.
This issue should have been dealt with by a more senior member of the audit team.
Yew Co
• Based on the draft financial statements, Yew Co represents 13% of Group assets and 5% of Group
revenue and based on the prior year financial statements, Yew Co represented 18% of Group assets
and 5.7% of Group revenue in the previous year.
• When considering the individual financial significance of a component of a group, benchmarks such
as group assets and revenue can be used and 15% may be considered a reasonable benchmark.
However, this is not a rigid rule, and a higher or lower percentage may be considered appropriate in
the circumstances. For Yew Co, despite its percentage contribution to the Group this year being less
than 15%, it may still be considered to be significant, for several reasons. The reduction in the value
of its assets of 27.1% is unusual and significant, which could justify classification of Yew Co as a
significant component.
• It is concerning that Yew Co was not identified as a significant component in the previous year, when
based on monetary values alone its assets made it significant to the Group. The rationale behind this
needs to be investigated and additional audit work may need to be performed
• It is also concerning that the consultant was not engaged due to cost pressure. Audit engagement
partner shall take responsibility for consultation on difficult and contentious matters and deciding not
to follow the audit strategy for the reason of saving costs is not appropriate.
• Any significant changes to the audit strategy or audit plan, including reasons for the changes, should
be fully documented, and it appears that this has not happened. Sections of the audit strategy and
audit plan should not be deleted, even if there are valid reasons for changes to them.
• Further work should be performed as necessary, and these issues resolved prior to the issuance of
the auditor's report.

Marking scheme
Part Details Max
N/A One mark per each well-explained point 20
Professional marks 5

TOTAL 25

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 Geller Co
Part (a)
Cash receipts from customers
• Management has assumed growth of 2% in each six-month period, which appears optimistic given
that this year revenue has decreased by 20%.
• Assumption that a full range of digital book and magazine titles will be available in August 20X5 seems
extremely optimistic. The digital publishing acquisition is a recent event, and there is no indication from
the information provided by management as to how a full digital offering will be created in one month.
• The cash flow forecast contains no specific expenditure relating to the creation of this digital portfolio,
so it is unclear how this business development is supported given the apparent lack of resources being
devoted to it.
• There are also no specific cash flows included in the forecast relating to forging closer connections
with online retailers, so it is difficult to see how this assumption is supported.
Cash receipt from sale of Happy Travels range
• The decision to sell this range of books has only recently been made, and it may be optimistic to
assume that the sale will actually go ahead.
• The estimated cash receipt on sale should be challenged. Just because other ranges of books have
successfully sold in the past, it does not mean that the same model can be used for this particular
range of books.
Operating expenses
• It is overly simplistic to assume an increase in operating expenses of 1% per six-month period based
on inflation. This may be an attempt to understate operating expenses and improve the appearance
of the cash flow forecast.
• Operating expenses are likely to include advances paid to authors and royalty payments relating to
the volume of sales of their books. If sales are expected to increase by 2% per six-month period, then
royalty payments should also increase.
• There are no specific cash outflows in relation to the recently acquired digital publishing division, yet it
is likely that significant costs and cash outflows are likely to be incurred in merging this into the existing
business.
Other assumptions
• Interest payments appear static at $125,000 until the point at which the forecast assumes that the loan
will be repaid. This should be challenged, as an overdraft would result in variable figures.
• It is not certain that the bank will agree to renegotiate the loan repayment date to 30 September 20X6,
which is the date assumed in the cash flow forecast. This assumption may be over-optimistic and an
attempt to move the timing of the significant cash outflow
• There does not appear to be any cash flows relating to tax payments included in the forecast. This
assertion needs to be approached with professional skepticism.

Part (b)
• Notes of a discussion with appropriate personnel, e.g. sales director and commissioning editors, to
obtain understanding of how management justify a 2% growth rate per six-month period given the
company's recent declining revenues, including specific evidence relating to the company's plans to
develop closer relations with online retailers.
• A copy of the signed contract between Geller Co and Chandler Muriel to confirm the expected
publication dates of the books and the amounts of any advances and royalty payments due.
• Confirmation, from a review of board minutes, that the sale of the Happy Travels range has been
discussed and approved by management.

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 • Confirmation that the assumptions in relation to cash receipts underpinning the cash flow forecast are
consistent with the audit team's knowledge of the business and the environment in which Geller Co is
operating.
• Written representations from management confirming the reasonableness of their assumptions
relating to cash receipts and that all relevant information has been provided to Bing & Co.

Part (c)
• The audit assistant is correct to identify that there is a significant going concern issue facing Geller Co
due to the uncertainty over the sale of the Happy Travels publishing range, and as a consequence,
the company may be unable to repay its borrowings.
• If sufficient evidence were available to support the use of the going concern basis of accounting in the
financial statements and to confirm the adequacy of relevant notes to the financial statements, an
unmodified opinion could be issued, and the auditor's report would include a Material Uncertainty
Related to Going Concern section to highlight the issue for users of the auditor's report.
• However, the lack of evidence over the assumptions used in the cash flow forecast and in particular in
relation to the sale of the Happy Travels range means that the auditor should consider modifying the
audit opinion to disclaim an opinion (when the auditor is unable to obtain sufficient).
• The seriousness of the going concern problems facing Geller Co, particularly whether the company
will be able to use the sales proceeds from the sale of the Happy Travels range to repay its borrowings,
should be considered both material and pervasive as it impacts on the survival of the company.
• A basis of disclaimer of opinion section should be included to explain the reasons for the inability to
obtain sufficient and appropriate audit evidence.

Marking scheme
Part Details Max
a One mark per relevant point 10
b One mark per relevant point 5
c One mark per relevant point 5
Professional marks 5

TOTAL 25

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 Winberry Co
Part (a)
Briefing notes

To: Olivia Fig, audit engagement partner

From: Audit manager
Subject: Audit planning in relation to Winberry Co
Date: XX-XXX-XXXX

Introduction
These briefing notes have been prepared to assist in the planning of Winberry Co, and more specifically,
cover the following area:
(a) Evaluation of significant business risks
(b) Evaluation of risk of material misstatements
(c) Principle audit procedures in respect of the classification of the investment in LPS Co
(d) Auditor’s responsibilities in relation to an audit client’s compliance with laws and regulations

(a) Evaluation of significant business risks

Damage to operations caused by warehouse fire
• The fire has caused the destruction of the warehouse servicing Winberry Co's northern customer base.
• If there is disruption to services due to an interruption of grocery service, then this will cause a
detrimental effect to Winberry Co's reputation which is likely to result in a fall in sales and profit
International expansion
• The expansion into Farland introduces a business risk in that the company will be managing operations
in a foreign country for the first time.
• Farland may have different laws and regulations compared to the company's home jurisdiction, so
there is a heightened risk of non-compliance.
Loan finance
• The $125 million expansion into Farland is to be funded by loan finance. The additional debt financing
will increase Winberry Co's gearing and result in a higher business risk.
• Winberry Co's existing bank loans have the covenant that interest cover must remain above 3. The
expansion and additional proposed loan will therefore make it more difficult to maintain the required
interest cover.
• This increases the company’s insolvency and default risk as well.
Cyber attack
• The internet search, if accurate, states that the company had not fulfilled the requirements of the data
protection legislation and corporate governance principles.
• This may result in reputational damage to the firm as well as the possible requirement to pay fines or
penalties which both could result in cash outflows from Winberry Co, whether it is by cash payments
or reduced sales.
(b) Evaluation of risk of material misstatements
Materiality
• This is an existing client and we have cumulative knowledge and experience of Winberry Co, however,
the changes to the company's operations in the year increase the level of risk in the current year.
• Benchmark used for materiality is usually 5 to 10% of the profit after tax. Considering the risk involved
in the assignment, the materiality has been set at 7.5% of the profit before tax at $3.975 million,
rounded to $4 million.
Financial and trend analysis

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 • Revenue is projected to increase by ((597 – 358) / 358 =) 66.8%, operating profit by ((172 – 110) / 110
=) 56.4% and profit before tax by ((53 – 31) / 31 =) 71%, all of which are broadly consistent with each
other.
• Total assets are forecast to increase by ((957 – 884) / 884 =) 8.3% which may seem overly optimistic
given that a large warehouse has been destroyed by fire during the year without being written down.
There is a risk that assets are overstated.
Warehouse fire
• The most significant identified risk would be the assessment of the carrying amount of the fire damaged
warehouse which is clearly above the materiality threshold of $4 million.
• The damage to the warehouse should have triggered an impairment review. However, the finance
director has wrongly assumed that the insurance cover relieves the company to properly assess for
impairment. Impairment is measured by comparing the carrying amount of an asset with its recoverable
amount.
• The significance of the warehouse fire is not simply a quantitative one, but also an indicator of potential
management bias and the impact of their judgement on the financial statements. The risks of material
misstatement regarding this issue are, therefore, of high significance to the audit team.
Investment in LPS Co
• LPS Co’s revenue is projected to reach $10 million this year. The investment is expected to occur in
August 20X5, so based on these projections the $10 million revenue is for a maximum of two months,
which is above the determined materiality threshold.
• The finance director has stated that he intends to consolidate the results of LPS Co. This treatment is
not in the accordance with the relevant standards, where the control is considered to be joint if the
investors in the venture have equal shareholdings. There is no evidence that Winberry Co holds a right
to veto decisions.
• The impact of the full consolidation of LPS Co by Winberry Co as a subsidiary would be that the gross
totals of all areas in Winberry Co's statement of financial position and profit or loss would be inflated
by LPS Co being incorrectly consolidated as a subsidiary undertaking.
Revenue recognition — premium delivery pass
• There is a risk arising from Winberry Co recognising revenue for customers in advance of the
satisfaction of the performance obligation for the annual premium delivery pass, with revenue being
recognised when the invoice is sent to the customer.
• As the premium delivery pass covers 12 months and the company is providing the service over time,
it can be difficult to determine how much service has been provided at partial point in time, as such,
revenue should be recorgnised over time.
• It does not appear that the requirements of IFRS 15 are being adhered to and there is a risk that
revenue is being overstated and deferred income is understated.

Corporate governance
• The recent cyber-security attack could highlight that internal control framework of the company is weak
or inefficient.
• Even though this problem has now been rectified, there remains the possibility that there could be
other areas which are deficient, leading to higher control risk.
• The issue also indicates that the audit committee is not appropriately fulfilling its responsibilities with
regards to internal audit which could indicate wider weaknesses in the company's corporate
governance.
Legal provision
• The internet search results show that a legal case was brought against Winberry Co in January 20X5.
From the information provided, it is not possible to determine if the amount involved is material.
• A provision should be recognised as a liability if there is a present obligation as a result of past events
which gives rise to a probable outflow of economic benefit which can be reliably measured.

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 • The warehouse fire is a known event, so if there has been harm brought about to people in the local
area as result of this then it is feasible that there is a liability as a result of a past event. There is a risk
that liabilities and expenses will be understated, if necessary provision is not recorded.
Conclusion
• In conclusion, Winberry Co has a significant number of audit and business risks which could result in
material misstatement in the financial statements. Quince & Co should reassess their assessed level
of planning materiality to ensure that the risk profile of the company is adequately reflected in the level
of testing planned.
(c) Principle audit procedures in respect of the classification of the investment in LPS Co
• Obtain the legal documentation supporting the investment and agree the details of the investment
including:
o The rights and obligations of the investing parties to understand the implications for the reporting
by Winberry Co in the financial statements
o The date of the investment
o The nature of the profit-sharing arrangement between Winberry Co and Durian Co
o Contact and communication with the auditors of the joint venture if not Quince & Co
• Review board minutes to understand the business rationale for the investment and to assess the
amount of control over the venture.
• Review minutes of relevant meetings between the company and Durian Co to confirm that control is
shared between the two investors and to understand the nature of the relationship and the decision-
making process, particularly if any party holds the right to veto decisions.
• Obtain documentation such as LPS Co's organisational structure to confirm that the company has
successfully appointed members to the board of the company and that those members have equal
power to the members appointed by Durian Co.
(d) Auditor’s responsibilities in relation to an audit client’s compliance with laws and regulations
• Winberry Co appears to be in breach of relevant law and regulations regarding the protection of
customer data.
• While it is management's responsibility to ensure the entity's operations are conducted in accordance
with the provisions of laws and regulations, the auditor is responsible for obtaining sufficient and
appropriate audit evidence regarding compliance with laws and regulations.
• Auditors need to assess the evidence especially where non-compliance has an impact on the financial
statements or where any non-compliance will affect the entity's ability to continue its operations.
• Auditor should ensure they have a full knowledge and understanding of the data protection regulations
in order to evaluate the implications of non-compliance by Winberry Co.
• Procedures must be performed to obtain evidence about the instances of non-compliance in relation
to the data protection breach, for example, discussions with management to understand how the data
breach occurred.
• In addition, the audit team should perform further procedures, for example, discussion with Winberry
Co's legal advisers to understand the legal and operational consequences of the breach.
• Auditor should also determine whether they have a responsibility to report the identified or suspected
non-compliance to parties outside the entity, in the event that management of Win berry Co fails to
make the necessary disclosures.
• Auditors should also comply with the fundamental principle of confidentiality, and if disclosure were to
be made by the auditor, it would be advisable to seek legal advice on the matter.

Marking scheme
Part Details Max
a Business risk evaluation
Up to 2 marks for each business risk 7

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 0.5 marks per trend and calculations 3
b Risk of material misstatement evaluation
Up to 3 marks each risk of material misstatement 13
Materiality calculations 3
c Principle audit procedures
One mark per valid procedure 7
d Auditor’s responsibility
One mark per valid point 7

Professional marks 10

TOTAL 50

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 Infinity Co
Briefing notes

To: Brian Fox, Audit engagement partner

From: Audit manager
Subject: Audit planning in relation to Infinite Co and assessment of client acceptance performed on
Meadow Co

Introduction
These briefing notes have been prepared to assist in planning the audit of The Infinite Co. in the first
section, the risk of material misstatement is evaluated. The second section includes the recommended
principal audit procedures designed for the valuation of the theme park rides. Third section covers a
discussion on risk factors relating to money laundering arising from The Infinite Co’s operations. The fourth
and final section evaluates the weaknesses in Pascal & Co’s client acceptance of the client Meadow Co.

(a) Evaluation of risks of material misstatement

Going concern (Licence)
The company is dependent on licences for its ability to operate. There is a risk that these licences are
revoked if breaches in regulations occur.
The company will then not be allowed to offer the products and services covered by the licence, affecting
the company’s ability to operate as a going concern.
the potential loss of the operating licence may require disclosures to be made in the notes to the accounts
describing the uncertainty arising. Such disclosures are material.

Valuation of land
The company holds land representing (6,000 / 9,500 x 100 =) 63% of the company’s total assets. This is
highly material.
The company is correct not to depreciate the land held. The use of a revaluation model is permitted by
IAS 16, however, where this is used, the valuation must be kept up to date. The most recent valuation was
done seven years ago. Therefore, the current values might be outdated.
There is a risk of inaccurate valuation of land if the valuation is not up to date or if the valuer is not
appropriately independent and qualified. This is likely to result in either an over or understatement of the
land and equity.

Valuation of rides
The rides represent (1,431 / 9,500 x 100 =) 15.1% of total assets and are material to the financial
statements.
According to IAS 36, an entity should assess at the end of each reporting period whether there is any
indication that an asset may be impaired. If there are indicators of impairment, recoverable amount needs
to be computed for the assets.
The findings of the government inspector suggesting that the assets are ageing, lack modern safety
features and are not properly maintained are all indicators of impairment. IAS 36 states that an asset is
impaired when the carrying amount exceeds the recoverable amount.
There is a risk that management does not conduct an impairment review or that the review does not take
into account the inspector's findings.

Revenue
The Infinite Co operates a business where a large amount of revenue is received in cash. In a company
where a substantial proportion of revenue is generated through cash sales, there is a high risk of
unrecorded sales or theft.
There is also a risk of revenue overstatement within the park. As The Infinite Co’s business is cash-based,
it provides an ideal environment for cash acquired through illegal activities to be legitimised

Inventory
Inventories represent (0.35m / 9.5m x 100 =) 3.7% of assets and are material.

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 IAS 2 requires inventory to be held at the lower of cost and net realisable value.
It is possible that defective items or goods past their sell-by date have not been written off appropriately.
If this is the case, then inventories are overstated, and cost of sales is understated.

Sale and leaseback

The value of the buildings in the projected statement of financial position, relating to sale and leaseback,
is $854,000. This represents (0.854m / 9.5m x 100 =) 9% of total assets and is material.
Under IFRS 16 Leases, where a sale has occurred, The Infinite Co should recognise a right of use asset
for the buildings replacing the previously held building asset, measured at the proportion of the previous
carrying amount which is retained for use by The Infinite Co.
The treatment that finance director has highlighted is incorrect, gain and loss needs to be computed based
on the rights retained and taken to the P/L.
If the approach stated in the standard is not followed, this might lead to overstatement or understatement
of the gain/loss recognised in the P/L.

Legal cases (food poisoning)

There is currently outstanding litigation against the company. The amounts of the claims are not yet known,
so materiality based on amount cannot be computed.
IAS 37 requires that contingent liabilities are disclosed in the notes to the financial statements.
Management is not planning on making disclosures, hence there is a risk of insufficient disclosure which
could be material by nature.

General provisions
The projected statement of financial position shows a general provision of $250,000, representing (0.25m
/ 9.5m x 100 =) 2.6% of assets which is material to the statement of financial position.
IAS 37 states that an entity must recognise a provision if it is a present obligation, payment is probable
and amount can be estimated reliably.
The general provision does not appear to relate to a present obligation and, as such, is not permitted. This
means that the expense and liabilities might be overstated.

Related party disclosures

The managing director appears to move funds from the company with the description ‘drawings’. It is
unclear if this represents salary, dividends or a loan.
IAS 24 defines a related party transaction as a transfer of resources, services, or obligations between
related parties, regardless of whether a price is charged.
These disclosures are material by nature and there is a risk that appropriate disclosures are not made for
all related party transactions.

(b) Audit procedures in relation to the impairment of rides

• Obtain the report from the safety inspector and review the outcome of the inspection to identify specific
rides of concern and to understand maintenance failings which could be an indicator of impairment.

• Obtain and review the regulations regarding the maintenance and upgrades of rides to understand the
company’s obligations in this respect in order to assist in assessment of value in use.

• Obtain management's impairment review of the rides and assess whether the assumptions are in line
with the auditor's understanding.

• Assess the competence, scope and independence of the auditor’s expert.

• Physically inspect the rides on the park to ensure they are operational and that there is customer
demand for the rides to support value in use calculations.

• Obtain any ride usage and closure statistics held by management to ensure the rides are operational
and hence a value in use valuation would be appropriate.

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 (c) Money laundering
Regarding money laundering, the auditors are required to:
• Perform customer due diligence, i.e. procedures designed to acquire knowledge about the firm’s
clients and prospective clients and to verify their identity as well as monitor business relationships and
transactions.
• Create channels for internal reporting within the audit firm including appointment of a money laundering
reporting officer (MLRO) to receive the money laundering reports to which personnel report suspicions
or knowledge of money laundering activities.
• Keep records (e.g. customer due diligence) that need to be kept for five years after the end of a
relationship and records of transactions, which also need to be kept for five years.
• Take measures to make relevant employees aware of the law relating to money laundering and
terrorist finance.
• Put in place ongoing monitoring procedures to ensure that policies are up to date and being followed.
The Infinite Co's business is cash-based, making it an ideal environment for cash acquired through illegal
activities to be legitimised by adding it to the cash paid genuinely by customers.
There are a lot of cash transactions and it would be possible to incorporate funds to be laundered with the
funds from customers. The ticket sales for rides would be an ideal place for this to occur as there is no
monitoring of the number of people actually taking part in the ride, so actual sales would be hard to prove.
The use of family members for areas of high cash transactions and the managing director making transfers
to his international account outside of the normal accounting for the business further increases the risk
that money laundering may be occurring.

(d) Acceptance procedures

Auditors are required, prior to establishing a client relationship or accepting an engagement, to have
controls in place to address the risks arising from it.

Criticisms of the content of the client acceptance documentation

Overall, the acceptance document appears too brief and there is a lack of information to support the
conclusions within the document.
There is no section evidencing and justifying the type of customer due diligence required. Depending on
the nature of the client and the risks, either standard, simplified or enhanced due diligence will be required.
ISQC 1 requires the firm to consider whether it has sufficient capabilities and resources to conduct the
assignment. This does not appear to be done.
The money laundering risk assessment is too brief. This should identify whether there are any potential
areas of high risk for money laundering.

Specific criticisms of the information gathered for Meadow Co

No references have been received prior to acceptance of the client which means that the firm’s client due
diligence procedures have not been properly adhered to. The professional clearance from the predecessor
auditor should be received in writing prior to acceptance.
Client risk assessment states that the company has no high/unusual risk. A cash-based business is likely
to give rise to risks and the fact that Meadow Co is being investigated with respect to money laundering
suggests that risks existed which were not considered on the acceptance form.
For confirming the company identity, a certificate of incorporation alone is not sufficient to confirm the
principal trading address, current directors and major shareholders.
The checklist does not state whether it has been confirmed that the person the firm is dealing with is
properly authorised to do so by the client. It should document the appropriate steps taken to be satisfied
that the person the firm dealing with is properly authorised by the client.

Marking guide
Part Description Marks
(a) Risk of material misstatement evaluated (max 3 marks per risk) 18
Trend and ratio analysis 3

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 Relevant materiality calculations 3
Max 24
(b) 1 mark per procedure 6
(c) 1 mark per relevant point 8
(d) 1 mark per relevant point 8
Professional Heading 1
Introduction 1
Headings within the briefing notes 1
Clarity 1
TOTAL 50

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 Morrissey
Part (a) (i) Specific enquiries

In relation to the import licence:

• Enquire with management to ascertain the acquisition date of the import licence and confirm that the
licence lasts for three years. This indicates to Morrissey Co when the next licence will need to be
acquired.

• To obtain understanding of the nature and scope of the licence, discuss and confirm the terms with
management, including the specific goods covered by the licence and whether the licence applies to
goods imported only from certain countries.

• Enquire with management whether there have been any breaches of the import licence, such as fines,
which could affect the likelihood of Brodie Co obtaining a new import licence once the three years are
complete.

• Discuss with management whether there are any plans to source the dye from an alternative supplier,
perhaps a supplier for which an import licence would not be necessary, saving on the cost of
reacquiring a licence.

In relation to the patent:

• Obtain evidence (original invoice, contract, details of the terms and conditions regarding the patent)
regarding the initial cost and expected period which the patent will be valid for to assess whether the
current amount in the financial statements (cost and amortisation) is accurate.

• Ask management to provide information showing the value of sales made under the ‘PureFab’ label,
to confirm that there is economic benefit being generated from the patented manufacturing process.

• Assess whether there is any impairment of the patent, caused by a new process superceding the one
attached to the patent.

• Discuss with management whether there are any factors which may affect the carrying amount of the
patent in the financial statements.

Part (a) (ii) Additional information relating to financing arrangements

• In relation to the equity shares, the number of equity shares in issue, the value per share, and the
voting rights attached to each share. This is essential information for Morrissey Co to consider how
many shares to acquire in order to gain control of Brodie Co.

• The company’s authorised share capital, to ascertain the capacity of Brodie Co to issue further shares.
This will help form an understanding as to whether Morrissey Co’s shareholding will result from a fresh
share issue or whether existing shareholders will need to be bought out of their shareholding.

• The rate of interest payable on the bank loan and venture capitalist funds, whether interest is fixed or
variable rate for forecasting the relevant cash flows.

• The redemption dates of the bank loan and venture capitalist funds, and whether a premium is payable
on the redemption of any debt, for forecasting the relevant cash flows.

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 • Whether any loan covenants exist, in particular in relation to the bank loan, and the terms of such
covenants. The acquisition itself could trigger a breach of covenant or lead to changes in payment
terms.

• Management should also be asked to confirm whether any covenants have been breached in the past,
this indicates their capability of managing the company’s finances.

• Details of any other sources of finance used by the company (e.g. lease arrangements, debt factoring,
etc.). This is to ensure that all sources of finance have been identified and that Morrissey Co has
complete understanding of Brodie Co's financing arrangements.

• Enquire if management has any plans for alternative arrangements should current facilities not be
extended, this will give an idea of how the company will overcome any difficulties encountered as a
result of not being able to renegotiate current facilities.

(b) Ethical and professional issues

Ethical issues
On the acceptance of client relationships and audit engagements, ISA 220 requires the audit firm to
determine whether the firm and the engagement team can comply with relevant ethical requirements.

Self-review threat
In this case, a significant self-review threat arises should Marr & Co accept the appointment as auditor.
The threat arises because Marr & Co, having performed the due diligence assignment on Brodie Co.
Marr & Co will need to evaluate the significance of this threat, based on matters such as the materiality of
the balances and transactions involved.
The significance of the self-review threat and risk of assuming a management responsibility depends on
the nature and extent of the accounting services provided to the audit client and the level of public interest
in the entity.

Management responsibility
A related self-review threat relates to the finance director’s request for Marr & Co to produce the Group
financial statements.
The risk of assuming a management responsibility arises where the auditor is taking on the decisions and
responsibilities belonging to management, in this case, the preparation of the Group financial statements.
The significance of the self-review threat and risk of assuming a management responsibility depends on
the nature and extent of the accounting services provided to the audit client and the level of public interest
in the entity.

Self-interest threat
There is also a possible self-interest threat arising from the range of services provided to Morrissey Co.
This could give rise to fee dependency.
Marr & Co's total practice income, to see if fee dependency could be an issue.

Other professional issues

• Competence and resources – Marr & Co should consider whether audit staff have experience in the
textile industry and whether there will be enough staff available at the time when the audit needs to be
performed.

• Internal control and quality of financial reporting – There is evidence that the internal control
environment may not be strong due to the errors found by Butler Associates in payroll processing. In
addition, the request by the finance director also raises an issue relating to the competence of the
client. While these issues do not mean that the audit should be declined, they indicate that Marr & Co
would need to approach the audit as high risk.

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 Marking guide
Part Description Marks
(a) (i) Specific enquiries in relation to the import licence (1 mark per point) 4
Specific enquiries in relation to the import patent (1 mark per point) 4
(a) (ii) Additional information (1 mark per point) 8
(b) Ethical and other professional matters 6
Safeguards 3
TOTAL 25

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 Byres
Part (a) (i) Matters and evidence in relation to the new product

Matter
The carrying amount of the capitalised development costs in relation to the new product are immaterial as
they amount to (0.25m / 31.6m x 100 =) 0.8% of assets and immaterial to profit before tax at (0.25m / 6.3m
x 100 =) 4.0%.
There is a significant risk that the requirements of IAS 38 have not been followed. Research costs must
be expensed and strict criteria must be applied to development expenditure to determine whether it should
be capitalised and recognised as an intangible asset.
There is a risk that research costs have been inappropriately classified as development costs and then
capitalised, overstating assets and understating expenses.

Evidence
• Review of board minutes for discussions relating to the commercial feasibility of the smart vacuum
cleaners.
• Notes of a discussion with management regarding the accounting treatment of the research costs and
confirmation that they were written off.
• A schedule itemising the individual costs capitalised to date in the production of the smart vacuum
cleaner prototype to ensure there are no research elements.
• Review of the results of tests performed on the products to demonstrate that the prototype is fully
operational.

Part (a) (ii) Matters and evidence in relation to the warranty provision

Matter
The warranty provision is material as it amounts to (2.1m / 31.6m x 100 =) 6.6% of total assets and (2.1m
/ 6.2m x 100 =) 33.3% of profit before tax respectively.
The provision has shown a significant decrease (from $4.3m to $2.1m), whereas, the revenue shows a
significant increase (from $50m to $55.5m).
Based on the information provided, in 20X4, the warranty provision was 8.6% of revenue (4.3m / 50m x
100). In 20X5, the warranty provision is only 3.8% (2.1m / 55.5m x 100) of revenue.
According to ISA 540, the audit team should have tested how management made the accounting estimate,
and the data on which it is based.
The value of the warranty provision should have increased in line with the revenue. In previous years, the
finance director and finance department had dealt with the judgement when estimating the warranty
provision, however, this year the CEO has had significant input. There is therefore an increased risk of
management bias.

Evidence
• A copy of management's calculation of the $2.1 million warranty provision, with all components agreed
to underlying documentation, and arithmetically checked.
• Notes of a meeting with management, at which the reasons for the reduction in the warranty provision
were discussed, including the key assumptions used by management.
• Analysis of total sales in terms of product mix against prior years with investigation into differences
and a quantification of the effect this might have on the warranty provision.
• A copy of any quality control reports, disaggregated by product, reviewed for any indications that
certain product lines have fewer warranty claims than in previous years.
Part (b) Implications for the auditor's report
The work carried out by the audit team suggests that the value of the warranty provision has been
suppressed. Assuming that the provision should have increased consistently with the increase in revenue

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 of (5.5m / 50m x 100 =) 11%, it would be expected that the year-end warranty provision should be around
($4.3m x 1.11 =) $4.8 million.
The actual provision recorded is $2.1 million, therefore, the liability appears to be understated by ($4.8m
– $2.1m =) $2.7 million. At ($2.7m / $31.6m x 100 =) 8.5% of total assets, therefore, the matter is material
to the statement of financial position.
The misstatement of the warranty provision is confined to specific accounts in the financial statements and
does not represent a substantial proportion of the financial statements, therefore, the matter is not
pervasive.
The auditor’s opinion should be modified due to the material, but not pervasive, misstatement. A qualified
opinion should therefore be given. The auditor's report should include a qualified opinion paragraph at the
start of the report.
This paragraph should be followed immediately by a basis for qualified opinion paragraph which should
explain the reasons for the qualified opinion and quantify the impact of the matters.

Part (c) Proposed sale implications for the auditor’s work

The failure to disclose important information regarding the proposed sale would therefore indicate that the
CEO lacks management integrity.
When there is a potential sale of a company, the audit risk is increased as the results of the company
could be manipulated to make it look more favourable to any potential purchaser.
It is likely that materiality should be decreased in order to ensure that more testing is carried out and
smaller errors are considered for adjustment to the financial statements than would otherwise be the case.
Judgements, such as the development capitalisation and the warranty provision, should be under further
scrutiny as the company owner has a vested interest in selling the company for as high a price as possible.
Wheeler & Co would have to plan additional procedures over any judgemental areas of the financial
statements, particularly those with direct input from William Byres.
The auditor would have to review the audit work already performed with an increased level of professional
scepticism, particularly with any representations made by the owner or any senior management who were
party to the proposed sale.

Marking guide
Part Description Marks
(a) (i) Matters and evidence in relation to the new product
Matters 3
Evidence 4
Total 7
(a) (ii) Matters and evidence in relation to the warranty provision
Matters 3-4
Evidence 4-5
Max 8
(b) Auditor’s report
Material misstatement due to inappropriate accounting estimates 1
Calculation of possible misstatement 1
Matter is not pervasive 1
Qualified audit opinion 1
Basis of qualified audit opinion 1
Total 5
(c) Proposed sale implications for the completion of the audit
Effect on audit risk 1
Management integrity 1
Materiality 1
Management representations (1-2 marks) 1-2
Professional scepticism 1
Venture capitalist due diligence 1
Max 5

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 McClane & Co
Briefing notes

To: Audit engagement partner

From: Audit manager
Subject: Audit planning of Gruber Co

Introduction
These briefing notes are prepared to assist with planning the audit of Gruber Co for the financial year
ending 30 September 20X5. The notes are divided into four sections that cover the following areas:
(a) Discussing the implications of an initial audit engagement
(b) Evaluating the audit risks which should be considered in planning the audit
(c) Recommend the audit procedures to be performed in relation to investment property
(d) Addressing the ethical issues arising from the meeting with the Gruber Co’s management team

(a) Initial audit engagement

As this is an initial audit engagement, we need to consider following factors when planning the audit of
financial statements of Gruber Co:
• The predecessor auditor, Ellis Associates, should be contacted and requested access to review
their working papers for the audit of previous financial year. This will help us develop preliminary
understanding of the last year’s audit, the risk areas and appropriate responses by the last year’s
auditor.
• We need to refer to the last year’s auditor’s report, to confirm the type of opinion issued, and the
basis of that opinion. If a modified report was issued by last year’s auditors, we need to understand
the reason for the modification, and give specific attention to that area, if relevant in current year’s
audit.
• We also need to consider any ethical issues that were raised during client acceptance, that can
have impact on the audit. We need to pay special attention to the request for the non-audit service
made by Gruber Co.
• We should also consider our quality control procedures in case of initial engagements. This can
include involvement of another partner to review the overall audit strategy.
• As this in an initial audit engagement, we will have to develop our understanding of client’s internal
and external environment, and client’s operations from scratch. We need to review the legal and
regulatory framework and the governance structure of the client. We also need to obtain knowledge
and understanding of the operations and significant policies of the company in thorough detail.
• Considering that this is a new client for us, to reduce the detection risk, when developing the audit
strategy and allocating resources, we should select experienced audit team members for the audit
engagement.

(b) Audit risk

Based on the information provided regarding this initial audit engagement, following main audit risks have
been identified:
1. Initial audit engagement
As discussed in section (a) of these notes, this is an initial audit engagement for us. This increases our
detection risk, which means it will be more difficult to detect material misstatements.
This risk can be managed by thorough audit planning, risk management and allocation of resources.
There is a risk that the opening balances and the comparative information might be incorrect. Therefore,
we will have to apply detailed procedures to verify the opening balances.
As already explained in section (a), Ellis Associates should be contracted and requested to provide access
to their working papers. We also need to ascertain the reason why they resigned to act as the auditors,
and ensure that this is not due to any ethical matter or disagreement, however, if it is due to such matters,
there should be further investigations made.

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 2. Potential sale of the shares of major shareholder
We are told that Martin Gruber (Gruber Co’s major shareholder) is planning to sell his shares in the
company, and negotiations have already started.
This increases the inherent risk of the client, as this gives the management an incentive to elevate the
performance of the company, so that a good picture of the company’s position and performance is shown
to the potential buyers.
Gruber Co is a family owned entity, which increases the risk of management override of the controls, to
show a better picture of the company’s affairs and results.
3. Analytical procedures
Applying analytical procedures on the extracts of the management accounts provided show the following
results:
Measure (Projected) 20X5 (Actual) 20X4 Increase or (decrease)
Operating profit margin 18/75 = 24% 10/65 = 15% 24%-15% = 9%
Revenue 75 65 (75-65)/65 = 15%
Profit before tax 14 9 (14-9)/9 = 56%
Operating profit 18 10 (18-10)/10 = 80%

The projected figures of operating profit and profit after tax are showing significant increase from the last
year, there is a risk that these profit figures have been manipulated to show better performance of the
company, to aid with the potential sale of Martin Gruber’s shares. Apart from that, the operating profit
margin has also significantly increased to 24%, which indicates improved margins and efficient operations,
this can be due to unrealistic projections and assumptions by the management. These figures need to be
thoroughly investigated and tested as part of the audit.
4. Intangible asset
The increase in the intangible assets appearing in the financial extracts represents purchase of design
from Martin Gruber, the majority shareholder and the CEO of Gruber Co.
Intangible assets have increased by (19-10 =) $9 million during the current year. This increase represents
(9/120 =) 7.5% of the total assets, which makes it material. However, as this transaction relates to Martin
Gruber, this makes it material by nature (related party transaction).
We have requested Martin Gruber to provide us with information to support the value that was determined
by Martin Gruber himself, however, we have not yet received any response for this request.
There is a risk of management bias relating to this transaction, such that the amount of the designs being
sold might be substantially overstated, to improve the financial position of the company. The lack of
corroboratory evidence regarding the sale price agreed between the related parties increases the risk of
this transaction being either fake or substantially overstated.
We also need to evaluate other audit risks that relate to intangible assets, which include, ensuring that the
intangibles meet the capitalisation criteria according to IAS 38 and these intangibles are being properly
amortised over their useful life, the total value of intangible assets is also material (i.e. represents 19/120
= 16% of the total assets).
5. Revenue recognition
Around 25% of the contracts of Gruber Co include three-year service support, however, all the contracts
are established as having only one performance obligation.
Such contracts are 25% of the total revenue, therefore, this is material figure.
IFRS 15 provides guidance over this area, and provides specific instructions on how to account for multiple
performance obligations in a single contract. This has a direct impact on the revenue recognised in the
financial statements from such contracts.
There is an audit risk that Gruber Co is not properly recording the revenue from different performance
obligations under a single contract.
6. Onerous contract
We are told regarding Johnson contract, that it is an onerous contract, meaning that the unavoidable costs
to meet the obligations exceed the economic benefit expected from the contract.
The total loss is estimated to be $840,000, which represents (840,000/14,000,000 =) 6% of profit before
tax, and therefore, is a material figure.
The management has adjusted this loss on pro-rata basis.
There is an audit risk that the guidance provided by the standard IAS 37 is not properly followed, which
states that we need to record the provision for the loss expected from onerous contracts. This means that

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 the entire expected loss should be charged against the profit. This will make our profit overstated and our
expenses understated in the projected results of 20X5.
7. Investment property
Gruber Co’s total assets include an investment property of $15 million. A gain of $2 million, due to the
increase in the fair value of this investment property, is appearing in the projected profit before tax.
The investment property represents (15/120 =) 12.5% of the total assets, and the gain recorded represents
(2/14 =) 14% of the profit after tax. Therefore, both these figures are material.
IAS 40 allows the use of fair value model for investment property, the gain or loss arising on the fair value
are recorded in the statement of profit or loss. However, the valuation has not yet been finalised by the
management’s expert, but Gruber Co has still included an estimate of $2 million. Any gain or loss arising
on the fair value should be properly supported by evidence, like valuation conducted by an expert valuer.
Auditor might also decide that they do not wish rely on the management’s expert, but rather consult
auditor’s expert for the valuation instead.
There is a risk that the management has deliberately included the gain on revaluation, before the
management expert’s valuation, to show improved financial results of the company.
8. Related party transaction
As we have already established, the sale of the designs by Martin Gruber to Gruber Co is a related party
transaction, therefore, this transaction is material by nature.
IAS 24 lists down the detail disclosure notes that are needed for related party transactions.
Such transactions are inherently risky, as the party that is transacting with the company has influence on
the company and can impact its results and performance. Therefore, auditors need to apply robust audit
procedures on such transactions.
There is also the risk of inadequate disclosure notes made for such transactions. We need to assess the
sufficiency of the disclosure notes, and ascertain that they are complete and accurate.

(c) Audit procedures in respect of the Nakatomi building

We can apply the following audit procedures in respect of the investment property:
1. Inspect the bank statement of the company to confirm the payment of $15 million in respect of the
investment property, to confirm valuation and accuracy.
2. Physically verify the existence of the investment property by visiting the building and inspecting
the occupancy status to ensure appropriate classification of investment property.
3. Inspect the legal documents, like title deed and transfer documents, to confirm rights and
obligations of the company relating to the investment property.
4. Inspect the non-current asset register of the company, to confirm the carrying value of the
investment property agrees with the asset register, and verify both opening and closing values of
the investment property, to confirm valuation and accuracy.
Following additional procedures can be applied with regards to the use of the management’s expert for
valuation purpose of the investment property:
1. Obtain and inspect the documents relating to the qualification and experience of the expert, to
evaluate whether reliance can be placed on the work of the expert or not.
2. Inquire from the management about the independence of the expert, ensuring that the expert is
objective and independent.
3. Inquire from the management regarding the policy of valuation to ensure that the valuation has
been conducted in accordance with policy.
4. Obtain expert’s final report and inquire regarding the assumptions taken and estimates used in the
report, to ascertain their reasonableness.

(d) Ethical issues

Gruber Co has requested us to perform a vendor due diligence. As Willis Co is our existing audit client,
this creates a conflict of interest between these two clients. This is because Willis Co will want to purchase
the shares from Gruber Co at lowest possible price, whereas, Martin Gruber will want to sell them at the
highest possible price. These conflicting interests of the two clients can impair our objectivity as their
auditors, as we might be inclined to act in the interest of one party at an expense of the other.
As such we need to consider following major ethical treats, possible safeguards for these threats are also
identified below:

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 (i) Breach of confidentiality
One of the major threats that this request exposes us is the breach of confidentiality. ACCA’s Ethical Code
states that we need to ensure confidentiality of our clients. However, considering the fact that we are
auditors of both these companies, which provides us access to sensitive and confidential information, that
might be very valuable for the other company under these circumstances, special care must be taken to
ensure confidentiality.
Possible safeguards
We need to make full disclosure regarding the current situation and our position to both the parties, and
ask them to give permission in writing for the service to be provided. If either of the party refuses to this
arrangement, we should decline the request.
However, if both parties provide us their consent, we must ensure that we have sufficient resources to
keep both engagement teams separate. We need to ensure a ‘Chinese wall’ between the engagement
teams, and arrange for an independent reviewer to ensure appropriate conclusions are drawn from this
engagement.
(ii) Advocacy threat
Providing a valuation service to our audit client also exposes us to advocacy threat, where the auditor
appears to be promoting the interest of the client. This can impair our objectivity, and thus we need to
ensure appropriate safeguards are in place to mitigate and manage the exposure.
Possible safeguards
A possible safeguard to help reduce this threat is to ensure two separate teams conducing these
engagements, as discussed for breach of confidentiality.
Similarly, having a second partner review and additional quality control checks will ensure our
independence and objectivity.
In summary, considering the ethical threats involved with accepting the valuation engagement, if accepting
the engagement impairs our independence significantly, then we should refuse the non-audit service
offered by the client.

Conclusion
These briefing notes evaluate the major audit risks relating to this initial audit engagement, and additional
matters that we need to consider for this client. These notes also recommend audit procedures in relation
to investment property, and provide guidance regarding the acceptability of the valuation engagement,
concluding that due to significant conflict of interest, it is unlikely that the audit firm should accept the
vendor due diligence service.

Marking guide
Part Detail Marks
(a) Generally, up to 1 mark for each relevant point discussed 6
(b) Up to 2-3 marks for each audit risk evaluated 17
In addition, ½ mark for relevant trends or calculations which form part of 3
the evaluation of audit risk
Materiality calculations should be awarded 1 mark each 4
(c) Up to 1 mark for each relevant audit procedure. 4
With regard to the expert appointed by management to provide the 4
valuation for the building
(d) Up to 1 mark for each relevant, explained answer point for ethical risks 4
Relevant safeguards (2 marks per ethical threat) 4
Professional Heading 1
marks
Introduction 1
Headings within the briefing notes 1
Clarity of comments 1

Page 22 of 146
 Flynn Co
Part (a) Matters to be considered before accepting Flynn Co as a client
Following matters should be considered before accepting Flynn Co as a client:
1. Ethical issues
There are two major ethical issues that need to be considered before accepting Flynn Co as a client:
• The managing director is offering audit engagement as a reward, provided a favourable report is
submitted to the bank.

This offer creates two ethical treats for Kelly & Co:

First, it exposes the audit form to self-interest threat, as the firm will have a financial incentive in
accepting the engagement.

Secondly, this also leads to an advocacy threat, as Kelly & Co will be promoting the interest of its
potential future audit client.

Kelly & Co needs to consider appropriate safeguards to reduce these ethical threats to acceptable
level. Kelly & Co can assign a second independent partner for review. However, if Kelly & Co
concludes that the safeguards do not reduce the threats to an acceptable level, then the review
engagement should not be performed, or Kelly & Co should decline to become the auditors.

• The new audit manager of Kelly & Co, Mary Sunshine, is recently been recruited from Flynn Co.
The new manager is from the internal audit department. The managing director wants Kelly & Co
to make Mary part of the team.

This exposes Kelly & Co to a range of ethical threats like self-interest threat, self-review threat and
familiarity threat. It is possible that Mary lacks necessary professional scepticism due to her
familiarity with the client.

However, this threat can be reduced by not including Mary in the review team.
2. Client integrity
• The offer made by the managing director to make Kelly & Co the auditor of the company,
contingent on the successful loan application, casts doubts over the client’s integrity.

• In addition, as confirmed by Mary, the existence of the Material Uncertainty Related to Going
Concern paragraph in the audit report suggests that the client is facing liquidity issues.

• This also suggests that the existing auditors are not in support of the client’s application, thus,
increasing the concerns over the client’s integrity.

• Kelly & Co needs to consider the reputational risk and other possible legal risks the firm can be
exposed to, if Flynn Co is not able to repay the loan after a positive report is issued by Kelly & Co.
Considering this, a thorough reflection of the going concern issue is needed before accepting the
review engagement.
3. Competence and resources
• Kelly & Co also needs to consider whether they have the required resources and competencies to
carry out the review engagement successfully.

• Although, it is highly likely that the firm has required competencies and resources, it is possible
that they are engaged in other assignments, the firm needs to ensure that those resources will be
available for the engagement before accepting it.

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 • The engagement team assigned to the Flynn Co should have the required skills and experience
and should be led by appropriate senior staff member, considering the higher risk involved in the
assignment.

(b) (i) Evaluation of the assumptions used by management in preparing the cash flow forecast
1. The new processing plant is expected to open on 31 March 20X6, however, the six months to 30
June 20X6, show a growth of 17%. Thus, the sales revenue appearing in the forecast appears to
be overly optimistic. Considering that this is the launch of a new product, it makes the growth
assumption more doubtful. Therefore, there is a risk that these figures are intentionally
manipulated to show better performance than expected.

2. The management is assuming reduction in the operating costs over the life of the project, arguing
that this is due to the benefit of economies of scale. However, this assumption is contingent open
many factors, and is closely linked to the assumption of growth in the demand, which already
appears too optimistic. Thus, the assumption of improved efficiency in the operations might also
be unjustified. Considering that this is a launch of the new product, and management is assuming
a reduction in the operating costs of ([(920/200) – (940/234)] / (920/200)) = 13% in the second six
months of operations, which appears unrealistic.

3. The annual interest cost appearing in the forecast is $60,000, which represents only (60/15,000 =)
0.4% of the principal amount. The interest rate that is being demonstrated in the estimates is
extremely low. It is highly unlikely that the banks will be willing to provide loan to Flynn Co at such
low rates, considering the fact that the company’s audit report states there are liquidity issues with
the company (i.e. significant doubt over the going concern). The company should revise the
forecasts with more realistic interest rates to ensure that the projections are more accurate.

4. The forecast is not showing any tax expense on the taxable net inflows. It appears that the
management has missed including the tax outflows. This omission can be an error, or can be a
deliberate attempt to show better projections for the investment. The management should be
asked to elaborate on the reason of this omission.

5. The forecast shows an unrealistic pattern of dividend payment, for example, the first dividend
payment of $100,000 is shown in first six months. The revenue generated over this period is
already doubtful, therefore, paying dividend also seems quite unrealistic. This dividend policy
should be challenged, requesting the management to support their assumptions and estimates.

6. The management has assumed that after the completion of the new processing facility, the
production will automatically increase, however, this is contingent upon the fact that the current
production has spare capacity. If not, then further capital expenditure would be required to support
the increased growth of 17% assumed in the 6 months to 30 June 20X6. Specific inquiries should
be made from the management, to ensure that the growth assumed in the forecasts is achievable
in reality without incurring further capital expense to increase total capacity.

(b) (ii) Examination procedures on the cash flow forecast

• Re-calculate the forecast, applying the assumptions of the management, to ensure arithmetical
accuracy.

• Inspect the bank statement to confirm the opening balance of $50,000 in the management
accounts.

• Obtain and inspect the detailed schedule and breakup of the marketing expense of $100,000 to
ensure it is accurate and realistic.

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 • Obtain and review the breakdown of the operating expenses, and evaluate each component in
detail, for example, salary, rent, rates, utilities, etc. and compare these estimates with the audited
financial statements to confirm their reasonableness.

• Inquire from management regarding any missing cash flows from the forecasts, like tax expense
and payment of loan installments (repayment of principal amount of the loan in installments).

• Obtain and inspect the current loan agreements of the company and compare the interest charged
in these existing loan agreements with the interest rate of 0.4% assumed in the forecasts. Inquire
from the management the reason for the lower rate to ascertain its reasonableness.

• Inquire and compare the existing customer payment pattern for credit sales with the assumed
pattern in the forecast, and discuss any discrepancy identified.

• Obtain a written representation from management, confirming the reasonableness of the

assumptions and that all relevant information has been provided to Kelly & Co.

• Obtain a confirmation directly from the bank, confirming the repayment terms and the interest rate
being negotiated for the potential loan, to confirm the accuracy of the forecast.

Marking guide
Part Detail Marks
(a) Up to 1 mark for each matter explained 10
(b) (i) Generally, up to 1 mark for each relevant point of evaluation 6
(b) (ii) Up to 1 mark for each procedure explained. 7
½ mark for relevant calculations, e.g. trend analysis, up to a maximum of 2
2 marks.

Page 25 of 146
 Sol & Co
Part (a) Arjan Co
Inventory
(i) Comments on evidence gathered
The write off for obsolete inventory as a percentage of inventory held has increased. This result is very
alarming, as the JIT system should reduce this expense.
This demands for further investigation, specifically considering that this could be deliberate attempt of the
management to reduce the profits reported by the entity.
As inventory should be assessed on a line by line basis rather than as a general adjustment, the auditor
would need to determine whether this would result in a material misstatement.
The comment that the current allowance for obsolete inventory is immaterial and therefore no further work
has been performed is inappropriate. A misstatement in this allowance could be material in conjunction
with other misstatements and at present there is no evidence as to whether this value is under or
overstated.
(ii) Further actions and audit procedures
The auditor should obtain the details of how the current allowance has been calculated and assess the
appropriateness of the assumptions and methods used by Arjan Co.
The auditor should review slow moving items and ascertain the reason for the increase in the allowance,
despite the JIT system being implemented.
The auditor should perform further tests to ensure the net realisable value of any slow-moving inventory
is in accordance with the write off of obsolete inventory appearing in the records.
Trade receivables
(i) Comments on evidence gathered
The increase in the receivables collection period compared with the prior year appears to suggest trade
receivables may be overstated due to an understatement of the allowance for irrecoverable trade
receivables.
The audit team has relied on direct confirmations from trade receivables as evidence of recoverability and
this is inappropriate. While this can reliably confirm the balances of the receivables, this cannot be used
as an evidence to support their intention to pay.
The comments of the controller in regards to the allowance for doubtful debt contradicts with the increase
in the receivables correction period. It is unlikely that the allowance for doubtful debts should decrease if
the receivables collection period is increasing.
Additionally, it is inappropriate to conclude that no further work is required on this area, because the
reduction in the allowance is not material. It is possible that the allowance could be materially understated
and further procedures should have been performed to confirm this is not the case.
(ii) Further actions and audit procedures
The auditor should have performed after year end (subsequent) testing for the receivable balances, to
ensure that year-end balances have in fact been settled.
The auditor should inquire the basis of the controller’s comments regarding Cami Co, and any update on
the matter, if the receivable balance is still outstanding after the year end.
The auditor should reassess the assumptions and past trend of allowance of receivables to see if the
reduction is justified by the past trend.
The auditor should compare the actual bad debt expense with the annual increase in allowance in the
past, to ascertain the reliability of the management’s estimates in the past.

(b) Barnaby Co
(i) Grand
Matters to be discussed
IAS 20 states that the government grants relating to assets should be recorded in one of two ways: (i)
either as deferred income; or (ii) by deducting the grant from the asset’s carrying amount. The grant is
released to the statement of profit or loss in line with the use of the asset accordingly, either as deferred
income or through the lower depreciation charge.
Recording the entire grant in profit or loss contradicts the guidance provided by the standard, and thus, is
incorrect.

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 The profit is overstated by $5 million due to this misstatement, and current liabilities are understated (as
the asset is not yet purchased, the grant should be recorded as deferred income).
The grant represents (5/43 =) 12% of the profit before tax and (5/105 =) 5% of the total assets, and as
such is material. Therefore, this is a material misstatement.
Impact on the auditor’s opinion
If the management does not rectify the misstatement, the auditor will issue a qualified opinion, because
this is a material misstatement on its own.
As the misstatement relates to two areas, and does not represent a substantial portion of the financial
statements on its own, this will not be considered pervasive.
A basis of qualified opinion will follow the opinion paragraph, where auditor will explain the reason for
qualification and also provide the financial impact of the misstatement.
(ii) Machine sale
Matters to be discussed
IFRS 9 states that receivables should be initially recorded at fair value and held at amortized cost basis.
As such, the fair value needs to be discounted for one year when recording the receivables in the financial
statements.
Thus, the receivables are overstated if the management has recorded the future value of the receivables
in one year’s time in the current financial statements.
The amount is overstated by $1 million which is (1/105 =) 1% of the total assets and (1/43 =) 2% of the
profit before tax, and therefore, unlikely to be treated as material.
Impact on the auditor’s opinion
If the misstatement is not material, it will not have any impact on the auditor’s opinion, thus, an unqualified
opinion will be issued, considering this misstatement in isolation.
However, even if the misstatement is immaterial, the management should be requested to adjust the
misstatement.

Marking guide
Part Detail Marks
(a) Generally, up to 1 mark for each valid comment of evaluation and 1 mark 15
for each relevant further action or procedure
(b) Government grant 6
(b) Machine sale 4

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 Crux Group

Briefing notes

To: Audit engagement partner

From: Audit manager

Subject: Crux Group – Audit Planning

Introduction

These briefing notes are prepared to assist with planning the audit of the Crux Group (the Group) for the
financial year ending 30 September 20X5. The notes contain an evaluation of the audit risks which
should be considered in planning the Group audit. The notes also recommend the audit procedures to be
performed on the Group’s segmental disclosure of revenue. Following on, there is a discussion of the
matters to be considered by Pegasus & Co in relation to a proposed additional engagement to advise
management on the Group’s social and environmental information. Finally, there is a discussion of how
data analytics could be used to enhance audit efficiency, effectiveness and quality.

(a) Evaluation of audit risk

New audit client

The Group is a new client, our firm having been appointed six months ago. This gives rise to detection
risk, as our firm does not have experience with the client, making it more difficult for us to detect material
misstatements. However, this risk can be mitigated through rigorous audit planning, including obtaining a
thorough understanding of the business of the Group.

In addition, there is a risk that opening balances and comparative information may not be correct. We
have no information to indicate that this is a particularly high risk. However, because the prior year
figures were not audited by Pegasus & Co, we should plan to audit the opening balances carefully, in
accordance with ISA 510 Initial Audit Engagements – Opening Balances, to ensure that opening
balances and comparative information are both free from material misstatement.

Upgrade and maintenance costs

The Group incurs high costs in relation to upgrade and maintenance of its fleet of ships. For the
Sunseeker ships, $75 million is being spent this year. This amounts to 4·2% of total assets and 92·6% of
profit before tax and is therefore material to the financial statements. There is an audit risk that costs are
not appropriately distinguished between capital expenditure and operating expenditure. Upgrade costs,
including costs relating to new facilities such as gyms, should be capitalised, but maintenance costs
should be expensed. There is a risk that assets are overstated, and expenses understated, if operating
expenses have been inappropriately capitalised. A further risk relates to depreciation expenses, which
will be overstated if capital expenditure is overstated.

Component depreciation

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 IAS 16 Property, Plant and Equipment requires that each part of an item of property, plant, and
equipment with a cost that is significant in relation to the total cost of the item must be depreciated
separately. There is a risk that ships in use are not broken down into component parts for the purpose of
determining the individual cost, useful life, and residual value of each part. For example, if significant, the
gym equipment should be depreciated over three years and therefore requires separate consideration
from other assets such as ship exterior, engine, etc. There is an audit risk that depreciation is not
correctly determined on this component basis, meaning that the assets and their associated depreciation
expense could be over or understated in value.

Tutorial note: Credit will also be awarded for discussion of the movement in accumulated
depreciation, which has increased by only $49 million in the year. Information is not given on the
Group’s depreciation policy, however compared to the total cost of PPE at the financial year end
of $2,304 million, this equates to only 2·1%, which appears quite low suggesting understatement.

Related party transaction

It appears that Vela Shipbuilders Co, which is building new Explorer Cruise ships for the Group, is a
related party of the Group. This is because Max Draco is the chairman of both the Group and Vela
Shipbuilders Co. According to IAS 24 Related Party Disclosures, a related party relationship exists
where a person has control or joint control, significant influence, or is a member of the key management
personnel of two reporting entities. The fact that Max Draco’s son is the chief executive officer of Vela
Shipbuilders Co also indicates a related party relationship between the Group and the company.

IAS 24 requires that where there have been transactions between related parties, there should be
disclosure of the nature of the related party relationship as well as information about the transactions and
outstanding balances necessary for an understanding of the potential effect of the relationship on the
financial statements. There is an audit risk that the necessary disclosures regarding the Group’s
purchases of ships from Vela Shipbuilders Co are not made in the Group financial statements.

The related party transactions are material by their nature, but they are also likely to be material by
monetary value. The information provided does not specify how much has been paid in cash from the
Group to Vela Shipbuilders Co during the year, but the amount could be significant given that the Group
has presumably paid any final instalments on the ships which have come into use during the year, as
well as initial instalments on the new ships starting construction this year.

Borrowing costs

The ships being constructed fall under the definition of a qualifying asset under IAS 23 Borrowing Costs,
which defines a qualifying asset as an asset that takes a substantial period of time to get ready for its
intended use or sale. This includes property, plant, and equipment during the relevant construction
period, which for the ships is three years. IAS 23 requires that borrowing costs which are directly
attributable to the acquisition, construction or production of a qualifying asset should be capitalised. The
audit risk is that interest costs have not been appropriately capitalised and instead have been treated as
finance costs, which would understate assets and understate profit for the year.

The amounts involved appear to be material. The information does not state precisely when the loans
were taken out and when construction of the ships commenced or when they come into use by the
Group on completion, so it is not possible to determine exactly when capitalisation of finance costs
should commence and cease. However, looking at the loan of $180 million taken out for the ships
currently under construction, the interest for the year would be $11·7 million, which is 14·4% of profit
before tax and therefore material to profit.

Operating licences

The Group’s operating licences are material to the financial statements, representing 3·1% of Group total
assets. It is appropriate that the licences are recognised as intangible assets and that they are amortised

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 according to their specific useful life. However, an audit risk arises due to the possible impairment of
some or all of these licences, which arises from the governments having withdrawn the licenses in some
countries where the Group operates their Pioneer cruises. While the licence withdrawal is apparently
temporary in nature, the withdrawal is an indicator of impairment and it is possible that the operating
licences are worth nothing, so should be written off in full. Management should conduct an impairment
review in accordance with IAS 36 Impairment of Assets to determine the recoverable amount of the
licences and if this is less than the carrying amount, recognise an impairment loss accordingly. If this
does not take place, the intangible assets are likely to be overstated, and profit overstated.

Tutorial note: Credit will also be awarded for discussion regarding de-recognition of the
operating licences as well as their reduction in value, and for considering whether the Pioneer
Cruise ships also need to be reviewed for impairment.

Revenue and profit trends

Group revenue is projected to increase by 14% in the year. The segmental information shows that this
overall increase can be analysed as:

– Revenue from Sunseeker Cruises increasing by 11·1%

– Revenue from Explorer Cruises decreasing by 5·3%

– Revenue from Pioneer Cruises increasing by 37·5%.

The different trends for each segment could be explained by business reasons, however there is a
potential risk that revenue has been misclassified between the segments, e.g. revenue from Explorer
Cruises could be understated while revenue from Pioneer Cruises is overstated.

In particular, the projected revenue for Pioneer Cruises could be impacted by the recent withdrawal of
operating licenses which affects the operation of these cruise itineraries. Management may not have
factored this into their projections, and there is a risk that this segment’s revenue is overstated.

Operating profit is projected to increase by 43·6% in the year, and profit before tax is projected to
increase by 24·6% in the year. However, as discussed previously, revenue is projected to increase
overall by 14%. While the increased margins could be due to economies of scale, the increase in profit
appears out of line with the increase in revenue and could indicate that expenses are understated or
misclassified.

On-board sales

On-board sales of food, drink and entertainment account for approximately 15% of revenue. There is a
risk that this is a reportable operating segment, but the projected operating segment information does
not disclose this revenue separately. According to IFRS 8 Operating Segments, an operating segment is
a component of an entity that engages in business activities from which it may earn revenues and incur
expenses, whose operating results are reviewed regularly by the entity’s chief operating decision maker
and for which discrete financial information is available which seems to be the case in this instance.

A reportable segment exists where the segment’s revenue is 10% or more of the combined revenue of
all operating segments. There is a risk of incomplete disclosure of revenue by reportable segments if on-
board sales meet the definition of an operating segment and it is not disclosed in the notes to the
financial statements as such.

Revenue recognition

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 An audit risk arises in relation to the timing of revenue recognition. It is appropriate that customer
deposits are recognised as deferred revenue when they are received. This is in line with IFRS 15
Revenue from Contracts with Customers which requires that revenue is recognised when a performance
obligation is satisfied, and therefore any amounts paid to the Group by customers before a cruise begins
are not revenue and should be deferred. However, the policy of recognising all the revenue from a ticket
sale when the cruise starts may not be in line with the principles of IFRS 15 because the Group is
performing its obligations over time, which may be as long as a six-week period for some cruises. This is
a problem of cut-off, meaning that recognition of all revenue at the start of a cruise could result in
overstated revenue and understated liabilities.

Cyber-security attack

The recent cyber-security attack could highlight that internal controls are deficient within the Group. Even
though this particular problem has now been rectified, if the Group internal audit team had not properly
identified or responded to these cyber-security risks, there could be other areas, including controls over
financial reporting, which are deficient, leading to control risk. The situation could also indicate wider
weaknesses in the Group’s corporate governance arrangements, for example, if the audit committee is
not appropriately discharging its responsibilities with regards to internal audit.

Tutorial note: Based on best practice the audit committee should review and approve the annual
internal audit plan and monitor and review the effectiveness of internal audit work. The audit
committee should ensure that the internal audit plan is aligned to the key risks of the business.
Credit will be awarded for discussion of these issues in the context of the cybersecurity attack.

In addition, the cyber-security attack could have resulted in corrupted data or loss of data relating to the
sales system, if the customer details were integrated with the accounting system. There is an audit risk
that reported revenue figures are inaccurate, incomplete or invalid. Though the issue could be confined
to the sales system, it is possible that other figures could also be affected.

Finally, the cyber-security incident is likely to result in some fines or penalties being levied against the
Group as it seems the risk was not properly dealt with, leaving customer information vulnerable to attack.
It may be necessary for the Group to recognise a provision or disclose a contingent liability depending on
the likelihood of a cash payment being made, and the materiality of any such payment, in accordance
with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The related audit risk is
understated liabilities and understated expenses or incomplete disclosures if any necessary liability is
not recognised or disclosure not made in the notes to the financial statements.

(b) Principal audit procedures to be performed on the segmental information

– Review the financial reports sent to the highest level of management to confirm the basis of segmental
information which is reported internally and confirm that this basis is used in the notes to the published
financial statements.

– Review the Group’s organisational structure to confirm the identity of the chief operating decision
maker.

– Discuss with management the means by which segmental information is reviewed by the chief
operating decision maker, e.g. through monthly financial reports and discussion at board meetings.

– Review board minutes to confirm that the segments as disclosed are used as the basis for monitoring
financial performance.

– Discuss with management whether the on-board sales should be reported separately given that it
appears to constitute a reportable segment contributing more than 10% of total Group sales and is
actively monitored.

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 – Obtain a breakdown of the revenue, e.g. by cruise line or individual ship, to confirm that revenue has
been appropriately allocated between the reportable segments.

– Perform analytical procedures to determine trends for each segment and discuss unusual patterns with
management.

– Recalculate the revenue totals from the breakdown provided to confirm that they are reportable
segments i.e. that they each contribute more than 10% of revenues

(c) Additional service to advise management on measurement of social and environmental

information

The Group’s request for Pegasus & Co to advise management on its social and environmental reporting
creates an ethical threat to objectivity. Providing additional, non-audit services to an audit client can
create several threats to the objectivity and independence of the auditor.

The IESBA International Code of Ethics for Professional Accountants does not specifically discuss this
type of additional engagement, so the audit firm should apply the general framework to consider whether
it is appropriate to provide the service. This means that the firm should evaluate the significance of the
threats to independence, and consider whether safeguards can reduce the threats to an acceptable
level.

A self-review threat could arise if Pegasus & Co provides the service to the Group. Some of the social
and environmental information could be related to transactions or balances within the financial
statements which will be subject to audit, for example the value of charitable donations. The self-review
threat means that less scrutiny may be used in performing procedures due to over-reliance on work
previously performed by the audit firm. This potentially impacts on the level of professional scepticism
applied during the audit and the quality of work carried out.

There could be a further self-review threat depending on whether the social and environmental
information will form part of the Group’s annual report. If this is the case, the audit team is required by
ISA 720 The Auditor’s Responsibilities Relating to Other Information, to read the other information
included in the annual report and to consider whether there is a material inconsistency between the other
information and the financial statements and to also consider whether there is a material inconsistency
between the other information and the auditor’s knowledge obtained in the audit. This requirement
creates a selfreview threat if members of the audit team have been involved with the additional service to
provide advice on measurement of the social and environmental information.

A self-interest threat can be created by the provision of non-audit services where the fee is significant
enough to create actual or perceived economic dependence on the audit client. The Group is willing to
pay an ‘enhanced fee’ for this service due to its urgent nature, and while this does not necessarily create
fee-dependency there could be a perception that the audit firm has secured a lucrative fee income in
addition to the income from providing the audit.

The Group needs the work to be carried out to a tight deadline, which could impact on the scope and
extent of the procedures which the firm can carry out, also impacting on the quality of work and the risk
of the engagement. This pressure to perform work quickly within the next month could be viewed as
intimidation by the client.

A further ethical issue, and perhaps the most significant, is that providing advice to management, which
would involve determining how social and environmental information is measured and published could
be perceived as taking on management responsibilities, which is prohibited by the Code. To avoid taking
on management responsibilities, the audit firm must be satisfied that client management makes all
judgements and decisions that are the proper responsibility of management. Measures to achieve this
could include:

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 – Ensuring that a member of the Group’s management with appropriate skill, knowledge and experience
is designated to be responsible for the client’s decisions and to oversee the service,

– Management oversees the work performed and evaluates the results, and

– Management accepts responsibility for any actions arising as a result of the service provided.

All of these threats are heightened by the fact that the Group is a listed entity, therefore a public interest
entity in the terminology of the Code.

Other safeguards could possibly be used to reduce the threats identified to an acceptable level. These
may include having a team separate from the audit team, including a separate partner, perform the work
on the social and environmental information; and conducting a review of both the audit and additional
service by the engagement quality control reviewer.

The audit firm should discuss the request with the Group audit committee, who ultimately will need to
approve that the firm can perform the service. The corporate governance code under which the Group
operates may restrict or prohibit the provision of non-audit services by the audit firm in the case of listed
entities, so the audit committee should consider if any such restrictions exist.

Discussions should also be held regarding the new regulatory requirements. The audit firm should be
clear on the reliance which will be placed on the report by the regulatory authorities and matters such as
whether an assurance report is required, and if so, who will be performing this work. In addition there
may be specific requirements which impact on the scope of the work, for example whether any specific
KPIs are required to be published.

Finally, even if the ethical issues can be overcome, the firm should consider whether it has the skills and
competencies to provide the advice to management. This can be quite specialised work and it is not
necessarily the case that the firm will have staff with the appropriate skills available to carry out the work,
especially if the work is to be carried out to a tight deadline.

(d) Use of audit data analytics

Data analytics is the process of inspecting, extracting, filtering and selecting information, and usually
involves presenting the results in a dashboard using charts, diagrams and other data visualisation
techniques to communicate the results in an effective manner. It can be used to discover and analyse
patterns, trends, inconsistencies and anomalies.

Data analytics is increasingly used by audit firms and can assist in the performance of a range of audit
procedures, for example, to perform preliminary analytical procedures, to select items from a population
to include in a sample for substantive audit procedures, and to identify unusual transactions or balances.

Many analyses performed using data analytics techniques are not fundamentally different to those
performed by auditors already, but they have the following advantages:

– For an audit of a new client such as the Group, audit data analytics could assist Pegasus & Co in
obtaining an understanding of the Group, especially in relation to systems and controls over financial
reporting and should help improve the overall quality of the audit performed.

– By analysing the trends and anomalies in the Group’s data, the audit team can obtain a deep insight
into the Group’s performance as well as how it is performing against competitors and industry trends.

– The two points above can lead to enhanced client service. Communication with clients can be
enhanced as issues identified are raised earlier in the audit process and from the client’s perspective,

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 seeing data analysed in new ways provides them with the opportunity to understand their own
information from a different perspective.

– Much larger populations can be analysed very quickly, making audit procedures much more efficient.
For a large client like the Crux Group this could be very important due to the volume of transactions
which fall under the scope of audit testing. In this way, audit data analytics can increase efficiency and
productivity by removing the task of extracting, sorting and reconciling data. The audit team will have
more time to use their professional expertise and judgement in higher risk areas, or in dealing with
anomalies which will improve audit quality.

– Larger samples can be tested, sometimes 100% testing is possible using data analytics, improving the
coverage of audit procedures and reducing or eliminating sampling risk. In the Group audit for example,
this could be used in auditing the classification of individual items of capital expenditure increasing the
efficiency and effectiveness of testing in this area.

– Data can be easily manipulated to assess, for example, the impact of different assumptions. In the
Group audit, for example, this could be applied in the audit of the impairment review which is needed on
operating licences.

– Using dashboards and other innovative visual presentation of results can make it easier for the auditor
to identify unusual trends or other anomalies, therefore assisting in evaluating the risk of material
misstatement. This could be particularly useful in auditing the segmental information, for example in
performing analytical procedures and reviewing the results.

– Data analytics could be used to determine the extent of the cyber-attack, for example by identifying the
customer accounts which were affected, and to confirm that the problem has now been resolved by
performing tests of controls.

Other benefits of using audit data analytics include improving consistency of audit procedures, assuming
that standard data analytics tools are used on all audit clients, and being able to enhance discussions
with management and audit committees regarding the audit.

Conclusion

These briefing notes highlight a number of significant audit risks, including those relating to property,
plant and equipment, revenue recognition and disclosure requirements. A number of audit procedures
have been recommended in relation to the audit of segmental information provided in relation to
revenue. In terms of providing advice to management on social and environmental information, this will
be difficult to do without breaching ethical principles and should be further discussed with the Group
audit committee. Finally, some benefits of using audit data analytics in the Group audit have been
described.

Marking scheme Marks

Part (a)
Up to 3 marks for each audit risk, (unless indicated otherwise). Marks may be awarded for other, 3
relevant audit risks not included in the marking guide.
In addition, ½ mark for relevant trends or calculations which form part of the evaluation of audit 3
risk
Materiality calculations should be awarded 1 mark each (max 4 marks) 20
Part (b)
Up to 1 mark for each relevant audit procedure. 5
Part (c)
Up to 1 mark for each relevant answer point explained. 10
Part (d)

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 Up to 1 mark for each relevant and explained answer point. Note that as a discussion question 5
there are a range of valid answer points.
Professional marks
Headings 1
Introduction 1
Use of headings within briefing notes 1
Clarity 1
TOTAL 50

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 Welford & Co
Part (a)

Rivers Co

A review of the information relating to the audit of Rivers Co indicates many problems with how the audit
has been planned and performed which imply that the audit has not been conducted in accordance with
ISA 220 Quality Control for an Audit of Financial Statements, ISQC 1 Quality Control for Firms that Perform
Audits and Reviews of Financial Statements, and other Assurance and Related Services Engagements,
and the IESBA International Code of Ethics for Professional Accountants (the Code)

Audit partner rotation

Bob Newbold has been acting as audit engagement partner for eight years. As Rivers Co is a listed
company this goes against the requirements of the Code which requires that an individual shall not act as
the engagement partner for more than seven years. The problem is that long association of the
engagement partner with the client leads to a self-interest threat to auditor objectivity, whereby the audit
firm’s judgement is affected by concern over losing the long-standing client. There may also be a familiarity
threat due to close relationships between the audit engagement partner and management of Rivers Co,
meaning that the partner ceases to exercise sufficient professional scepticism, impacting on audit quality.
This is especially the case given that Bob Newbold is performing additional non-audit services for the
client, which will be discussed further below. Bob Newbold should be replaced as soon as possible by
another audit engagement partner.

The fact that Bob has been allowed to continue as audit partner for longer than the period allowed by the
Code indicates that Welford & Co does not have appropriate policies and procedures designed to provide
it with reasonable assurance that the firm and its personnel comply with relevant ethical requirements, as
required by ISQC 1. The firm should review whether its monitoring of the length of time that audit
engagement partners act for clients is operating effectively and make any necessary improvements to
internal controls to ensure compliance with ISQC 1.

Tutorial note: The Code does allow a key audit partner to serve an additional year in situations where
continuity is especially important to audit quality, as long as the threat to independence can be eliminated
or reduced to an acceptable level. Credit will be awarded for appropriate discussion on this issue

Supervision and review

Bob Newbold has booked only two hours for audit work performed on Rivers Co. This is not sufficient time
for the audit partner to perform their duties adequately. The audit partner is required to take overall
responsibility for the supervision and performance of the audit. He should have spent an appropriate
amount of time performing a review of the audit working papers in order to be satisfied that sufficient
appropriate audit evidence had been obtained; this is a requirement of ISA 220. Instead it appears that
most of the final review was performed by a newly promoted audit manager who would not have the
necessary experience to perform this review. It is possible that there is insufficient evidence to support the
audit opinion which has been issued, or that inappropriate evidence has been obtained.

There is also a related issue regarding the delegation of work. Possibly some of the detailed review of the
working papers could have been delegated to someone other than the audit partner, in which case the
senior audit manager Pat Canley would be the appropriate person to perform this work. However, Pat only
recorded six hours of work on the audit. Thus, confirming that too much of the review has been delegated
to the junior audit manager, especially given that going concern was identified as a significant audit risk,
meaning that the audit partner has even more reason for involvement in the final review of audit work.

There is also an issue around the overall amount of time which has been recorded for the audit work
performed on this client. A total of 173 hours does not seem sufficient for the audit of a listed company,

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 suggesting that audit quality could have been impacted by inadequate time spent in planning and
performing the audit work.

Special investigation

Bob Newbold’s focus appears to have been on the special investigation performed for Rivers Co, to which
he booked 40 hours of time.

There is insufficient documentation as to the nature of this non-audit work, and it could relate to the
provision of a non-audit service which is not allowed for a public interest entity. Rivers Co is a listed
company, and the Code prohibits the audit firm from providing certain non-audit services, for example
certain internal audit services, valuation services and tax services. The lack of documentation means that
Welford & Co could have provided a prohibited service and therefore be in breach of the Code.

The fact that $890,000 was charged for this special investigation indicates that it was a substantial
engagement and just the matter of inadequate documentation is a cause for concern. There is also a
possibility that in fact no work has been performed, and the firm has accepted this money from the client
but provided no service. This would be a very serious issue, could be perceived as a bribe, and it should
be investigated with urgency.

However, there are also possible threats to auditor objectivity including a self-interest threat due to the
monetary value of the service provided meaning that Bob Newbold’s attention seems to have been
focussed on the special investigation rather than the audit, leading to the problems of inappropriate
delegation of this work as discussed above. His additional involvement with Rivers Co by providing this
work compounds the familiarity threat also discussed previously. Depending on the nature of the work
performed for the client there may also be other threats to objectivity including self-review and advocacy.

A self-interest threat is created as the value of the services provided is substantial compared to the audit
fee. The fact the non-audit fees are so high would create a proportionately bigger intimidation threat
because they would form a larger part of the firm’s income and the audit firm may not be objective for fear
of losing the client.

Welford & Co should ensure that its policies and documentation on engagement acceptance, especially in
relation to additional services for existing audit clients, are reviewed and made more robust if necessary.

Engagement Quality Control Review

As this is a listed audit client, an Engagement Quality Control Review should have been performed. It is
not clear whether this took place or not, but no time has been recorded for this review. If a pre-issuance
review was carried out then it should have picked up these problems prior to the audit opinion being issued.

Audit of going concern

The audit work on going concern has been inappropriately delegated to an audit assistant who would not
have the necessary skill or experience. This is especially concerning given that going concern was
identified as a significant audit risk, and that the work involves using judgement to evaluate information
relating to contract performance. The work should have been performed by a more senior member of the
team, probably one of the audit managers, who is more able to exercise professional scepticism and to
challenge management where necessary on the assumptions underpinning the forecasts.

It is concerning that the audit work appears to have been based on a review of contracts which were
selected by management. First, only five contracts were reviewed but the company is typically working on
20 contracts at one time. So it is likely that the coverage of the audit work was insufficient, and more
contracts should have been subject to review. Given the risk attached to going concern perhaps all the
contracts currently being carried out should have been reviewed, or the sample selected based on the
auditor’s evaluation of the risk associated with each contract and their materiality.

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 Second, management may have selected the better performing contracts for Mary to review. This would
create a false impression of the performance of the company as a whole, leading to an inappropriate
conclusion on going concern being reached.

Finally, the work performed by Mary on this small selection of contracts appears insufficient and
inappropriate. Assumptions should not just be agreed as consistent with the previous year, especially in a
situation of increasing economic uncertainty as applies in this case. Assumptions should be challenged
and other work performed as required by ISA 570 Going Concern. The lack of further audit procedures
means that the audit evidence is not likely to be sufficiently robust in this significant area.

Audit Committee

It is concerning that the audit committee of Rivers Co does not appear to have raised concerns about the
issues discussed, especially the provision of the non-audit service and the length of time which Bob
Newbold has served as audit engagement partner. One of the roles of the audit committee is to oversee
ethical issues relating to the external auditor and to be involved with the engagement of external providers.
Welford & Co should ensure that these matters are discussed with the audit committee so that further
ethical issues do not arise in the future.

Conclusion

From the discussion above it can be seen that there are many problems with the audit of Rivers Co. Bob
Newbold appears to have ignored his responsibilities as audit engagement partner, and the audit firm
needs to discuss this with him, consider further training or possibly taking disciplinary action against him.
Welford & Co need to implement procedures to ensure all work is carried out at the appropriate level of
personnel with the appropriate experience and that training is given to staff to ensure they understand the
client does not pick or specify the audit work to be carried out in any area, it is to be selected by the audit
team in accordance with the audit firms methodology and sampling tools.

Part (b)

Client acceptance decision – the Broadway Group

In deciding whether to accept the Broadway Group (the Group) as a client, Welford & Co should consider
several matters in accordance with ISCQ 1, including their competence to perform the audit, ethical matters
and client integrity.

Competence, capabilities and resources

Welford & Co should only accept the Group as a client if the firm is competent to perform the engagement
and has the capabilities, including time and resources, to do so. There are two issues to consider here.
First, the Group is a large, multinational organisation with listed status and with many subsidiaries.
Although the majority of the subsidiaries would be audited by other firms, this is still a sizeable audit
spanning many countries and requiring extensive liaison with component auditors, all of which will be
demanding on the audit firm’s resources. Welford & Co should only accept the audit appointment if it has
enough suitably skilled staff available to resource the audit without disrupting the service provided to
existing clients. It is worth mentioning at this point that the Group audit committee wants the audit fee ‘as
low as possible’ indicating that there may be pressure on the audit firm to use a smaller audit team than
they would prefer, this point will be discussed further below in relation to ethics.

Second, the activities of the Group are quite specialised, with its operations including the production of
various agricultural goods and their processing. Audit staff will need to be familiar with this industry, or
Welford & Co can consider bringing in staff with the necessary experience, though this will have
implications for the profitability of the audit engagement. The Group is also listed, so audit staff would need
to be familiar with the reporting requirements of the listing rules in the Group’s home jurisdiction.

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 Welford & Co could bring in experts to perform this work, if necessary, but this would have cost implications
and there already appears to be fee pressure on the assignment.

The financial reporting standards applied by the foreign subsidiaries many also be a problem for the Group
audit team if Welford & Co have no experience in reconciling subsidiaries financial statements prepared
under local accounting rules to that under which the Group reports. This lack of competence could be a
significant barrier to accepting the audit.

Client integrity

ISQC 1 requires consideration of client integrity when assessing whether to take on a new audit client.
The environmental damage allegedly caused by Palm Co could cause Welford & Co to question the
business ethics of the Group, though it is not certain that the accusations are based in fact. Even so, the
audit firm may not wish to be associated with a client with a poor reputation.

The ‘incentive payment’ also brings the Group’s integrity into question, as it could be a bribe paid to ensure
that the land acquisition could go ahead. As this situation has been reported in the media it is another
reason why the audit firm may conclude that the Group’s business ethics are in doubt.

Ethical requirements

The only ethical issue apparent which may impact on whether the firm can comply with ethical
requirements relates to the request from the Group audit committee to keep the audit fee as a low as
possible. This could be seen as an intimidation threat to auditor objectivity. The Code defines the
intimidation threat as where the auditor is deterred from acting objectively because of actual or perceived
pressures, and pressure to maintain a low audit fee is evidence of this. A low audit fee puts pressure on
the audit firm to keep costs as low as possible, for example by using less experienced auditors, or
performing fewer audit procedures, both of which impact on audit quality.

Tutorial note: The Group’s requirement for a low audit fee could equally be discussed as a matter
relating to client integrity. ISQC 1 states that considering whether the client is aggressively
concerned with maintaining the firm’s fees as low as possible is a matter relating to the evaluation
of client integrity.

In addition to the matters discussed above, because this engagement relates to a Group audit, some
specific issues should be assessed in accordance with ISA 600 Special Considerations – Audits of Group
Financial Statements (Including the Work of Component Auditors)

One of the issues which ISA 600 requires an audit firm to evaluate before accepting a new engagement
relates to component auditors. Specifically, where component auditors will perform work on components
of the Group, the audit firm should evaluate whether the group engagement team will be able to be involved
in the work of those component auditors to the extent necessary to obtain sufficient appropriate audit
evidence. Therefore, before making their acceptance decision, Welford & Co should find out more about
the component auditors and whether there may be any restriction on obtaining evidence from them, or any
potential difficulty in dealing with them.

In addition, ISA 600 suggests that the Group auditor should understand group management’s rationale for
appointing more than one auditor. This is a significant issue for this audit, as the Group audit committee
has requested that component auditors are used for all foreign subsidiaries, which account for 60% of the
Group’s assets. In particular, Welford & Co should discuss with group management their reason for
appointing a new Group auditor but keeping the incumbent component auditors for the audits of the
subsidiaries.

In addition, given the specialised nature of the Group’s activities, Welford & Co should evaluate the
competence of the component auditors as this will have a significant impact on the quality of the audit
work, on which the Group auditors will be placing some reliance.

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 Welford & Co should also obtain an understanding of the group structure, components’ business activities
that are significant to the group, including the industry and regulatory, economic and political environments
in which those activities take place and the complexity of the consolidation process. This will help the audit
firm to assess the potential audit risk of the engagement and the skills and competencies that will be
needed in the audit team.

One specific risk attaches to the new business in Farland which seems very unusual in that it is not
incorporated as a company and is not required to prepare accounts or have a local audit. This means that
the Group audit team would have to audit this business, creating logistical issues due to its remote location
and having cost implications.

Finally, Welford & Co should consider whether the group engagement team will have unrestricted access
to those charged with governance of the group, group management, those charged with governance of
the components, component management, component information, and the component auditors (including
relevant audit documentation sought by the group engagement team); and will be able to perform
necessary work on the financial information of the components. Given the multinational spread of the
Group and the fact that there may be many component auditors involved, it might be difficult to manage
the communications required with management of the various subsidiaries and their audit providers.

Logistical issues

The global positioning of this potential client makes it logistically difficult. Members of the Group audit team
must be willing to travel to conduct at least some of their work, as it would be difficult to perform the
engagement without visiting the component auditors to review their work.

There are also cost implications of the travel, which will need to be built into the proposed fee for the
engagement.

Language may also present a barrier to accepting the engagement, depending on the language used in
other locations.

Marking guide Marks

(a) Generally, up to 1 mark for each well explained point 15
(b) Generally, up to 1 mark for each well explained point 10
TOTAL 25

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 Myron Co

Part (a)

Matters, further actions and auditor’s report implications

Matters

The company is at an advanced stage of negotiations with a competitor to sell its scientific publishing
division. Currently the finance director has not included any reference to the sale in the financial statements
for the year ended 31 March 20X5.

Materiality

The revenue of the scientific publishing division of $13 million represents 12% of total revenue and the
profit of the division of $1·4 million represents 15·1% of profit before tax. The division is therefore material
to the statement of profit or loss. The assets of the division are also material, as they represent 27·3% of
the company’s total assets, based on their value in use which is recognised in the financial statements.

Discontinued operation and classification of assets held for sale

IFRS® 5 Non-Current Assets Held for Sale and Discontinued Operations defines a discontinued operation
as a component of an entity which either has been disposed of or is classified as held for sale, and:

– represents either a separate major line of business or a geographical area of operations;

– is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area
of operation.

IFRS 5 requires specific disclosures in relation to assets held for sale and discontinued operations,
including that the assets are recognised as current assets and the results of the discontinued operation
are presented separately in the statement of profit or loss and the statement of cash flows.

According to IFRS 5, a disposal group of assets should be classified as held for sale where management
plans to sell the assets, and the sale is highly probable. Conditions which indicate that a sale is highly
probable are:

– management is committed to a plan to sell

– the asset is available for immediate sale

– an active programme to locate a buyer is initiated

– the sale is highly probable, within 12 months of classification as held for sale (subject to limited
exceptions)

– the asset is being actively marketed for sale at a sales price reasonable in relation to its fair value

– actions required to complete the plan indicate that it is unlikely that plan will be significantly changed or
withdrawn.

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 In respect of the scientific publishing division, management has decided to sell the division and a buyer
has been found. The advanced stage of negotiations would suggest the sale is highly probable.

As a result, important disclosures are currently missing from the financial statements which could mislead
users with respect to the future revenue, profits, assets and cash flows of the company. Failing to provide
information about the sale of the division could be seen as a significant omission from the financial
statements, especially given the materiality of the assets of the division to the company’s assets as a
whole.

There is therefore a material misstatement as the scientific publishing division has not been classified as
held for sale and its profit presented as a discontinued operation and the necessary disclosures have not
been made in the financial statements.

Held for sale – valuation

IFRS 5 provides further guidance regarding the valuation of the assets held for sale. Prior to classification
as held for sale, the disposal group should be reviewed for impairment in accordance with IAS 36
Impairment of Assets. This impairment review would require the asset to be held at the lower of carrying
amount and recoverable amount where the recoverable amount is the higher of value in use or fair value
less costs of disposal.

In this case the recoverable amount would be $42 million representing the fair value less costs of disposal.
Management has valued the disposal group based on its value in use at $41 million which means that
assets and profit are currently understated by $1 million. This represents 10·7% of profit before tax and is
material to the profit for the year.

After classification as held for sale, non-current assets or disposal groups are measured at the lower of
carrying amount and fair value less costs which would continue to be $42 million. Depreciation ceases to
be charged when an asset is classified as held for sale.

Adoption of IFRS 16 and change in accounting policy

IAS® 8 Accounting Policies, Changes in Accounting Estimates and Errors permits a change in accounting
policy where the change:

– is required by a standard or interpretation; or

– results in the financial statements providing reliable and more relevant information about the effects of
transactions, other events or conditions on the entity’s financial position, financial performance, or cash
flows.

Where the change in policy is due to the requirements of a new standard then the method of applying the
change set out in the new standard should be followed. In this case, IFRS 16 permits a lessee to either
apply IFRS 16 with full retrospective effect or alternatively not restate comparative information but
recognise the cumulative effect of initially applying IFRS 16 as an adjustment to opening equity at the date
of initial application. Therefore, the accounting treatment by Myron Co is acceptable.

However, the lack of disclosure of the change in accounting policy is not in accordance with IAS 8 which
requires the following disclosures in these circumstances:

– the title of the standard or interpretation causing the change

– the nature of the change in accounting policy

– a description of the transitional provisions, including those that might have an effect on future periods

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 – for the current period and each prior period presented, to the extent practicable, the amount of the
adjustment:

1. for each financial statement line item affected, and

2. for basic and diluted earnings per share (only if the entity is applying IAS 33)

– the amount of the adjustment relating to periods before those presented, to the extent practicable

– if retrospective application is impracticable, an explanation and description of how the change in

accounting policy was applied.

As these disclosures have not been made, there is an omission of disclosure which is key to understanding
the changes in deriving the lease balances in the financial statements which is likely to be a material
omission given that leased assets are material to the financial statements.

Further actions

– The auditor should request that management adjusts the financial statements to recognise the
discontinued operation and to separately disclose the assets held for sale in accordance with IFRS 5 and
to disclose the change in accounting policy for leases as required by IAS 8.

In addition, the client should be requested to amend the carrying amount of the assets to the recoverable
amount of $42 million in line with IFRS 5 requirements.

If management refuses to adjust the financial statements, the auditor should communicate the
misstatements to those charged with governance. They should repeat the request and inform them of the
modifications that would be made to the auditor’s report if the adjustments are not made.

– If management still refuses to amend the financial statements, the auditor should request a written
representation from management confirming their intent to proceed without amending the financial
statements and that they are aware of the potential repercussions.

Auditor’s report implications

If the adjustments are not made then there is a material misstatement in the financial statements. The
matters above have resulted in an understatement of assets and profits by $1 million which in isolation is
unlikely to be pervasive as limited components of the financial statements are affected. This would result
in a qualified audit opinion in which the report would state that ‘except for’ the material misstatement in
relation to the valuation of the assets held for sale the financial statements are fairly stated.

However, there are also several important disclosures omitted which would be required for users to
understand both the current financial position of the company and its ability to generate future revenue
and profits. As such, it would be a matter of judgement as to whether the lack of disclosures in conjunction
with the material misstatement mentioned above have a pervasive impact on the financial statements.
Depending on the auditor’s judgement on this issue, this may give rise to an adverse opinion if the auditor
considered the impact of these issues to result in the financial statements being wholly misleading.

Depending on the opinion provided, a basis for qualified or adverse opinion paragraph would be added
underneath the opinion paragraph to describe and quantify the effects of the misstatements.

Part (b)

(i) Auditor’s responsibility for other information presented with the financial statements

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 ISA 720 (Revised) The Auditor’s Responsibilities Relating to Other Information requires the auditor to read
other information, defined as financial or non-financial information (other than financial statements and the
auditor’s report thereon), included in an entity’s annual report.

The purpose of reading the other information is to consider whether there is a material inconsistency
between the other information and the financial statements or between the other information and the
auditor’s knowledge obtained in the audit. If the auditor identifies that a material inconsistency appears to
exist, or becomes aware that the other information appears to be materially misstated, the auditor should
discuss the matter with management and, if necessary, perform other procedures to conclude whether:

(i) A material misstatement of the other information exists;

(ii) A material misstatement of the financial statements exists; or

(iii) The auditor’s understanding of the entity and its environment needs to be updated.

The auditor does not audit the other information and does not express an opinion covering the other
information.

Matters identified from the chairman’s statement

In this case, the chairman’s statement refers to strong growth in the year, in particular the scientific
publishing division and suggests that the growth will continue. In the current year, the scientific publishing
division represented 12% of revenue and 15% of profit before tax and is a material component of the
company. As the scientific publishing division will be disposed of early in the next financial period, it will
not continue to form part of the basis for revenue or growth, and the chairman’s statement could be
considered misleading. Further, as a result of the disposal, on a like for like basis it is more likely that the
financial statements for the year ended 31 March 20X6 will include a reduction in revenue rather than
growth.

In addition, the remainder of the business has experienced a lower level of growth in revenue and profits
in the period than the scientific publishing division. Revenue growth of continuing business is 2% compared
to 44% in the scientific publishing division. Profit growth of the ongoing business is 5% compared to 100%
for the scientific publishing division.

ISA 720 states that a misstatement of the other information exists when the other information is incorrectly
stated or otherwise misleading, including because it omits or obscures information necessary for a proper
understanding of a matter disclosed in the other information. In the case of the chairman’s statement
regarding growth of the company, it could be argued that the way the information is presented obscures
the understanding of the growth and profitability of the ongoing business. As mentioned above, this would
be considered very misleading.

The chairman has also made inappropriate reference to the view of the auditor, implying that the auditor’s
report validates this assertion. The statement also appears to inappropriately pre-empt that the auditor’s
report will provide an unmodified opinion which based on the assessment above may not be the case
given the material misstatement and lack of disclosures. This is inappropriate and all reference to the
auditor’s report should be removed.

In addition, there is also an issue arising with respect to the use of recycled paper. The chairman’s
statement in this case is inconsistent with the knowledge obtained during the audit. Whether the auditor
considers this to be material would be a matter of judgement, depending on how many publications there
are in total and the proportion using non-recycled paper and whether the issue may be material by nature
rather than by size. This could be the case if it is perceived that there is a deliberate misrepresentation of
facts which may be misleading to the users of the financial statements.

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 (ii) Implications for completion of the audit

The auditor should discuss with management and the chairman the information in the statement which
appears inaccurate or inconsistent. In particular, this should focus on a discussion of the misleading growth
analysis given that the scientific publishing division will not be contributing to company performance once
it is sold.

In the case of the incorrect disclosure relating to the use of recycled paper, the auditor should seek further
information to support the file note regarding publications not using recycled paper. The names of those
publications should be obtained, and a discussion held with the production manager to confirm the
auditor’s understanding.

Following these investigations and discussions, the auditor should then request that any information which
is inaccurate, inappropriate or inconsistent is removed or amended in the chairman’s report.

If management refuse to make the changes then the auditor’s request should be escalated to those
charged with governance. If the issue remains unresolved then the auditor should take appropriate action,
including:

– Considering the implications for the auditor’s report and communicating with those charged with
governance about how the auditor plans to address the issues in the auditor’s report; or
– Withdrawing from the engagement, where withdrawal is possible under applicable law or regulation.

Implications for the auditor’s report

If the other information remains uncorrected the auditor would use the Other Information section of the
auditor’s report to draw the users’ attention to the misstatements in the chairman’s statement. This
paragraph would include:

• A statement that management is responsible for the other information;

• A statement that the auditor’s opinion does not cover the other information and, accordingly, that the
auditor does not express (or will not express) an audit opinion or any form of assurance conclusion
thereon;
• A description of the auditor’s responsibilities relating to reading, considering and reporting on other
information as required by this ISA; and
• A statement that describes the uncorrected material misstatement of the other information.

As the inconsistency is in the chairman’s statement rather than the audited financial statement the audit
opinion is not modified as a result.

Marking scheme Marks

Part (a) - Up to 1 mark for each point unless otherwise stated
Matters 8
Further actions 4
Auditor's report implications 3
Part (b)
(i) Assessment of ISA requirement 2
Matters arising from chairman’s statement - 1 mark per point 3
(ii) Implications for the completion of the audit - 1 mark per point 3
Implications for the auditor’s report arising from the draft chairman’s statement 2
TOTAL 25

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 Rick Group

Briefing notes

To: Audit engagement partner

From: Audit manager

Subject: Rick Group – Audit planning

Introduction

These briefing notes are prepared to assist with planning the audit of the Rick Group (the Group) for the
financial year ending 30 September 20X5.

a) Audit Risk evaluation

Annual Incentive Scheme

Based on prior year’s figures, the total bonus payable would have been $8·2 million, representing 14% of
prior year’s profit before tax, and therefore material to the financial statements.

Employees whose bonus payment is linked to profitability have an incentive to maximise profit, and given
that senior executives are involved with the scheme, there is a risk of management bias in the financial
statements.

There is also an audit risk relating to the obligation for the Group to pay the bonus, which should be
recognised as an accrual at the year end. There is a risk that the liability recognised is over or understated
in value given the potential complexity involved in calculating the bonus payment, the calculation of which
is based on a range of selected targets for different employees.

Legal Case

In January 20X5, a legal case was brought against the Group. There should be appropriate consideration
as to whether the court case gives rise to an obligation at the reporting date.

According to IAS 37, a provision should be recognised as a liability if there is a present obligation as a
result of past events which gives rise to a probable outflow of economic benefit which can be reliably
measured. There is therefore an audit risk that if any necessary provision is not recognised, liabilities and
expenses will be understated.

If there is a possible obligation at the reporting date, then disclosure of the contingent liability should be
made in the notes to the financial statements. There is a risk of inadequate disclosure if the Group finance
director refuses to make appropriate disclosure in the notes – this is an audit risk whether the situation
gives rise to a provision or a contingent liability, as provisions also have disclosure requirements which
may not be complied with.

Daryl Co

Daryl Co is a significant component of the Group, with its assets equating to 17·9% of the Group’s total
projected assets. There is an audit risk that the Group’s policies are not applied correctly, meaning that
the amounts consolidated in respect of Daryl Co are not recognised, measured or disclosed appropriately.

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 The goodwill in relation to Daryl Co is material to the Group financial statements, at 4·9% of total assets.
Goodwill should be tested for impairment annually, which is the Group’s accounting policy. The audit
strategy prepared by Neegan Associates indicates that Daryl Co is loss making this year, which is an
indication of impairment. Therefore management will need to factor this into their impairment review

There is also an incentive for impairment losses not to be recognised, due to the annual incentive scheme
which is based on profit. There is an audit risk that goodwill could be overstated, and expenses
understated, if any necessary impairment loss is not correctly determined and recognised.

Reliance on Component Auditor

Given the materiality of Daryl Co, the Group audit team needs to consider the extent of reliance which can
be placed on the audit of the company conducted by Neegan Associates.

The independence and competence of Neegan Associates will need to be evaluated by the Group audit
team. Independence is threatened by the fact that Neegan Associates has been engaged in providing a
non-audit service to Daryl Co since 1 October 20X4. This matter is discussed further in the section of the
briefing notes dealing with the component auditor’s strategy. Any material misstatements which may
remain uncorrected in Daryl Co will impact on the consolidated financial statements, leading to audit risk
at the Group level.

Post year-end acquisition of Michonne Co

The acquisition of Michonne Co is planned to take place within a month of the reporting date. It is therefore
a significant event which is taking place after the year end and as such, it falls under the scope of IAS 10.

According to IAS 10, a non-adjusting event is an event which is indicative of a condition which arose after
the end of the reporting period, and which should be disclosed if they are of such importance that non-
disclosure would affect the ability of users to make proper evaluations and decisions. The required
disclosure includes the nature of the event and an estimate of its financial effect or a statement that a
reasonable estimate of the effect cannot be made. There is therefore an audit risk that the disclosure in
relation to the acquisition of Michonne Co is not complete or accurate.

b) (i) Evaluation of component auditors strategy

Materiality

Materiality involves the exercise of professional judgement and often benchmarks such as 1% of total
assets are used as a basis. However, this would normally be appropriate for a capital-intensive business,
not for a company like Daryl Co, which is service based.

A percentage of profit is deemed an appropriate method of calculating materiality in a profit-making

business. However, this can be distorting in a year of significant losses. The fact that the company has
made a loss this year does not mean that materiality should be based on assets alone. Neegan Associates
should revisit how materiality has been determined and might conclude that materiality is more
appropriately determined using a normalised profit before tax from continuing operations figure based on
past results.

Also the fact that materiality has been set at a higher level this year is not likely to be appropriate given
that the company is loss making and facing unusual trading conditions with the loss of many customers.
This indicates that the audit is likely to be higher risk, so a lower level of materiality should be applied
which would show appropriate professional judgement.

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 There must be full documentation of how materiality has been determined on the audit file. This should
cover the rationale for determining different materiality levels which have been decided upon for different
classes of transaction and balances.

Payroll

The audit work planned on payroll appears to be limited due to Neegan Associates having performed a
payroll service for Daryl Co since 1 October 20X4. This is not appropriate and will not provide sufficient
and appropriate audit evidence regarding the $6 million payroll expense.

Given that payroll is material to the company’s financial statements, based on Neegan Associates’ own
materiality threshold of $1·4 million, further testing will be required. An ethical threat to auditor’s
independence is raised by the provision of the payroll service to the client. There is a significant self-review
threat which means that Neegan Associates is over-relying on the work they have performed on payroll
as a non-audit engagement and are not planning to audit the $6 million at all.

ISA 600 states when performing work on the financial information of a component for a group audit, the
component auditor is subject to ethical requirements which are relevant to the group audit. Therefore, as
Daryl Co is listed, the service should not have been provided and discussion need to be had to find an
alternative provider for the payroll accounting services.

Sale of Property

From the Group perspective, this meets the definition of a related party transaction under IAS 24 Related
Party Disclosures, and will need to be disclosed in the consolidated financial statements. As the transaction
would also be considered to be material by nature, the Group audit team must therefore provide
instructions to Neegan Associates on the additional audit work to be performed which will enable sufficient
and appropriate evidence to be obtained in respect of the transaction and disclosure. These procedures
will be outlined in the next section of these briefing notes.

The procedures stated do not consider how the profit or loss being made on the disposal is determined or
whether the asset has been properly removed from the accounting records. The carrying amount of the
asset itself may be material to the financial statements of the company. There may be an incentive to
recognise a higher profit than is appropriate on this transaction due to trading difficulties encountered by
the company during the year, so the transaction may be at risk of material misstatement with the objective
of maximising the profit recognised. There is no evidence that the transaction is bona fide – the CEO has
not yet paid for the property and the whole transaction could be an attempt to window dress the financial
statements.

(ii) Audit Procedures on sale of property

- Review board minutes to see if the property sale has been discussed and formally approved by the
company’s board

- Agree the $50,000 sale price to the legal documentation relating to the sale of the property to the Group
CEO

- Confirm the book value of the property at the date of disposal to underlying accounting records and non-
current asset register and confirm that the asset has been removed from the company accounts at the
date of disposal

- Obtain management’s determination of profit or loss on disposal, re-perform the calculation based on
supporting evidence, and agree the profit or loss is recognised appropriately in the company statement of
profit or loss

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 - Obtain an estimate of the fair value of the property, for example, by comparison to the current market
price of similar properties

- Review cash receipts after the reporting date to confirm whether or not the $50,000 has been received
from the Group CEO

c) Joint Audit

Discussion and justification for a joint audit of Michonne Co

The main advantage of a joint audit of Michonne Co is that the local audit firm’s understanding and
experience will be retained, and that will be a valuable input to the audit. At the same time, Atlanta & Co
can provide additional skills and resources if necessary.

Farland may have different regulations to the rest of the Group, for example, there may be a different
financial reporting framework. It therefore makes sense for Lucille Associates, the local auditors, to retain
some input to the audit as they will have detailed knowledge of such regulations.

Given the distant location it will be more cost effective for this to be carried out by local auditors. Two audit
firms can also stand together against aggressive accounting treatments. In this way, a joint audit can
enhance the quality of the audit.

Disadvantages of a joint audit of Michonne Co

The main disadvantage is that for the Group, having a joint audit is likely to be more expensive than
appointing just one audit firm. However, the costs are likely to be less than if Atlanta & Co took sole
responsibility, as having the current auditors retain an involvement will at least cut down on travel
expenses. Due to the size of the respective firms, Lucille Associates will probably offer a cheaper audit
service than Atlanta & Co.

For the audit firms, there may be problems in deciding on responsibilities, allocating work, and they will
need to work very closely together to ensure that no duties go underperformed, and that the quality of the
audit is maintained. There is a risk that the two firms will not agree on a range of matters, for example,
audit methodology, resources needed and review procedures, which would make the working relationship
difficult to manage.

Problems could arise in terms of liability because both firms have provided the audit opinion; in the event
of litigation, both firms would be jointly liable. While both of the firms would be insured, they could blame
each other for any negligence which was discovered, making the litigation process more complex than if
a single audit firm had provided the audit opinion.

Recommendation

On balance, the merits of performing a joint audit outweigh the possible disadvantages, especially if the
two audit firms can agree on the division of work and pool their expertise and resources to provide a high-
quality audit.

Conclusion

The briefing notes indicate that there are several significant audit risks to be addressed, and in respect of
the component audit firm, there are some concerns over the adequacy of their audit planning, which will
need further consideration in developing the Group audit strategy. Finally, performing a joint audit on
Michonne Co appears to be a good way to perform a high-quality audit on this new subsidiary.

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 Moritz & Co

(a) Lavenza Co

(i) Matters to consider before accepting the review engagement

Before accepting the review engagement ISAE 3400 identifies a number of matters which need to
be considered:

The intended use of the information

Moritz & Co must consider whether the cash flow forecast and assurance report will be used solely for the
purpose of the increase in Lavenza Co’s overdraft facility. If Lavenza Co is planning to use the assurance
report for purposes other than an extension to its current overdraft, this must be made clear to Moritz &
Co. Whether the information will be for general or limited distribution Moritz & Co needs to consider who
will receive the report and potentially rely upon it, as this will impact on the firm’s assessment of the risk
associated with the engagement. If the information will be used solely in support of the application to the
bank and will not be made available to other parties, this should be confirmed before accepting the
engagement and will reduce the risk of the assignment.

The period covered by the cash flow forecast and the key assumptions used

A prospective financial information (PFI) engagement should not be accepted when the assumptions used
in its preparation are clearly unrealistic or when the practitioner believes that the PFI will be inappropriate
for its intended use. In the case of Lavenza Co, although the forecast is only for 12 months, assumptions
may be judged unrealistic. For example, the operating cash receipts growth rate may be innappropriate
given recent trends in its business and the requested overdraft facility of $17 million for the next six months
may prove to be insufficient.

The scope of the work

Moritz & Co will need to consider the specific terms of the engagement, the level of assurance being sought
by Lavenza Co and the form of the report required by the bank. Moritz & Co will need to identify is it being
asked to report on the cash flow forecast only or is the firm also being asked to report on accompanying
narrative. Due to the uncertainty of forecasts and the inevitable subjectivity involved in their preparation,
Moritz & Co will need to confirm that it is only being asked to provide negative assurance as to whether
management’s assumptions provide a reasonable basis for the cash flow forecast and to give an opinion
as to whether it is properly prepared on the basis of these assumptions.

Resources and skills

The firm needs to consider whether it has sufficient staff available with the appropriate skills
and experience needed to perform the PFI engagement. Moritz & Co should also consider whether it
can meet the deadline for completing the work and whether it will have access to all relevant
information and client staff. Given the company’s predicted need for cash in the next six months,
presumably the extended overdraft facility will need to be provided very soon and this may lead to Moritz
& Co being under pressure to meet a tight reporting deadline.

Client integrity and ethical matters

Before accepting the engagement, the firm should consider management’s reasons for appointing
a different firm from its auditors and the potential for management bias in the preparation of a cash
flow forecast in support of its required overdraft facility. Additionally, it is important to ensure that there

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 are no threats to the firm’s objectivity which might prevent it from accepting the appointment. Finally
when asked to perform work for a non-audit client, Moritz & Co should be given permission by the client
to contact its auditors in order to obtain relevant information. If this permission is not given, the appointment
should be declined.

(ii) Examination procedures on cash flow forecast

– Cast the cash flow forecast to confirm its mathematical accuracy.

– Confirm the consistency of the accounting policies used in the preparation of the forecast
financial statements with those used in the last audited financial statements.

– Agree the opening cash position of $9,193,000 to the cash book and the bank statement.

– Discuss the key assumptions underlying the preparation of the forecast with management, such as
the predicted growth rates in operating cash receipts of 13·4% over the year compared to an
equivalent growth rate of only 7·3% in operating cash payments, and confirm that the assumptions
appear reasonable and are consistent with the firm’s knowledge and understanding of the client.

– Analytically review the forecast trends in cash flows comparing with them with historical cash
flow statements and other forecast data which is available for the sector and local economy and
investigate any significant differences.

– Agree the settlement discount of 8% and the late payment penalty of 5% penalty terms with suppliers to
supporting contractual documentation; agree to purchase ledger payments in order to confirm
that discounts are taken and penalties are paid.

– Perform sensitivity analyses on the cash flow forecast by varying the key assumptions (in particular,
in relation to growth rates and payment periods) and assessing the impact of these variations on
the company’s forecast cash position.

– Agree the salary payments to the latest payroll records and cash book payments analyses to
confirm accuracy and completeness.

– Assess the competence and experience of the preparer of the forecast.

(b) Long association of senior audit personnel

Frances Stein’s eight-year tenure as audit engagement partner creates a familiarity threat for Moritz & Co.
The threat arises because using the same senior audit personnel on an audit assignment over a
long period of time may cause the auditor to become too familiar and too trusting with the client resulting
in less professional scepticism being exercised and the possibility of material misstatements
going undetected. With listed audit clients the IESBA International Code of Ethics for Professional
Accountants (the Code) states key audit partners must be rotated after seven years unless exceptional
circumstances arise. The Code also clarifies that if an existing audit client becomes listed, the length of
time which the partner has already served on the client is included in the period to be considered. In the
case of Beaufort Co, therefore, Frances Stein has already served as a key audit partner for the maximum
possible period of eight years and following the listing of the client next year, it would be appropriate for
her to be replaced by another audit partner.

Fee dependence

Over dependence on an audit client for fee income leads to a self-interest threat for the auditor. The
firm will have a financial interest in the client due to its dependency on the client and its concern about

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 the impact on its business if it were to lose the client. In the case of a listed client, the Code states that
an audit firm’s independence is threatened and should be reviewed if the total fees from a single
client exceed 15% of its total fee income for two consecutive years. In this case, the 15% limit has been
exceeded in both 20X4 and 20X5 and following the listing of the company’s shares in September 20X5,
Moritz & Co is required to review its dependence on the client. If retained as a client, the level of fees
should be disclosed to those charged with governance and it should be discussed whether prior to the
audit opinion being issued, having an independent pre-issuance or post-issuance review performed on the
engagement by an external party or by the firm’s professional regulatory body is enough to mitigate the
threat.

Provision of bookkeeping and accounting services

The provision of bookkeeping and accounting services for Beaufort Co creates a self-review threat
for Moritz & Co. The self-review threat arises because the auditor is generating figures for inclusion in
the financial statements on which they will then give an opinion. As a result, the auditor may be less likely
to highlight errors if they are aware that another member of the firm has calculated the figures. For a
listed client, the Code states that a firm is not permitted to provide accounting and bookkeeping services.
The Code does, however, make an exception for divisions of a company if the services are of a routine
and mechanical nature, a separate team is used and the service which the firm provides relates to
matters which are immaterial to the division and the company. Following Beaufort Co’s listing in September
20X5, therefore, Moritz & Co will no longer be able to provide the payroll services for Beaufort Co although
it may still be able to maintain the financial records for the small division if the conditions stated in the Code
are satisfied.

Share prospectus

Performance of these services for Beaufort Co would create an advocacy threat for the auditor.
The advocacy threat arises because the auditor is effectively being asked to promote and represent
their client’s position to the point where the auditor’s objectivity is compromised. The Code prohibits
an auditor from acting in this way for an audit client and Moritz & Co should politely decline to assist in
the preparation of the document and to endorse the recommendation to investors to purchase the shares.
It may be possible, however, for the auditor to provide an accountant’s report on some elements of
the prospectus. Moritz & Co may be able to provide an opinion on the financial information if, for example,
it limits the form of opinion to stating that it has been properly compiled on the basis stated within
the document and that this basis is consistent with the accounting policies of the company.

Review of audit appointment

Margaret Shelley’s comment that Beaufort Co is currently reviewing the audit appointment and that it
is looking for an audit firm which is capable of taking it through the listing process and providing a full
range of services in the future represents an intimidation threat to the auditor’s objectivity. The
intimidation threat arises because Margaret Shelley is applying pressure on Moritz & Co to offer a range
of services which will result in breaches of the Code for the audit firm, effectively threatening to appoint
another audit firm if Moritz & Co does not comply. Moritz & Co should explain its ethical duties to those
charged with governance and identify clearly the services which it will not be able to provide if it continues
as the company’s auditor after the stock market listing in September 20X5.

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 Saul and Co
Part (a)

(i) Fraud

The fraud would be immaterial to the financial statements if the full extent amounts to $40,000, however,
the current evidence is not sufficiently reliable. Without performing further procedures and gaining
independent auditor evidence it is not possible to determine that is the extent of the stolen funds, and
whether the financial statements are materially misstated.

We must maintain professional scepticism throughout the audit and during conversations with the Group
finance director, as they could be involved with the fraud, and attempting to minimise the suspected scale
in order to deter further procedures being carried out, or investigation or actions being taken. Their
comments made and unwillingness to make financial statement adjustments should raise further
suspicion.

Furthermore ISA 240 requires that when fraud has taken place, auditors shall communicate these matters
on a timely basis to management and those charged with governance, who have the primary responsibility
for the prevention and detection of fraud. The auditor should consider whether a formal, written
communication is needed if there is no evidence of the finance director having done this.

In addition, ISA 240 requires that the auditor shall determine whether there is a responsibility to report the
occurrence or suspicion to a party outside the entity. The auditor’s duty to maintain the confidentiality of
client information makes such reporting potentially difficult, and the auditor may wish to take legal advice
before reporting externally.

(ii) & (iii) Audit Evidence

Development costs

Given that the development costs are material to the Group financial statements, more audit work should
have been carried out to determine whether the capitalization of the $600,000 is appropriate. There is a
risk that research costs, which must be expensed, have not been distinguished from development costs,
which can only be capitalised when certain criteria have been met. Currently, there is not sufficient,
appropriate audit evidence to conclude that the accounting treatment is appropriate, and intangible assets
could be materially misstated, and profits overstated.

Agreement of amounts to invoice provides evidence of the value of expenditure, but does not provide
evidence as to the nature of the expenditure, and whether it should be classed as revenue or capital.

Performing an arithmetic check on a spreadsheet does provide some evidence over the accuracy of the
calculations but it does not provide evidence on the validity of the projections and the underlying
assumptions.

The Group finance director has not allowed the audit team access to information supporting the
spreadsheet and has refused to answer questions, so the audit of the projection should be approached
with a high degree of professional scepticism. Furthermore, the attitude and actions of the Group finance
director indicate a lack of integrity, and should be discussed with the audit committee to ensure all
necessary information is made available to the audit team.

Finally, there appears to be over-reliance on a written representation from management, which should be
used to support other audit evidence and are not sufficient evidence on their own.

Further evidence should be obtained, including:

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 – A discussion with the project manager to obtain their view on the likely launch date for the new product,
anticipated level of demand, any problems foreseen with completion of the project.

– A further review of a sample of the costs included in the $600,000, including evaluation of whether the
costs are capital or revenue in nature.

– Assuming supporting documentation is obtained, the assumptions should be reviewed for

reasonableness, with the auditor considering whether they are in line with the business understanding and
other audit evidence.

Trade receivables

The Hamlyn Co balance is material and currently there is not sufficient, appropriate audit evidence to
determine whether the amount should remain recognised within current assets. The Trade Receivables
balance could be materially misstated and profit overstated if any necessary reduction in value is not
recognised.

Agreeing the balance to invoices and order forms, and including it in the direct confirmations, may provide
evidence of existence but it does not provide evidence on the recoverability of the balance so additional
procedures are required. Furthermore, discussing the situation with the credit controller will provide some
relevant background information, but on its own is not sufficiently robust evidence to support the
recognition of the balance.

Further evidence should be obtained including:

– Any written correspondence between the Group and Hamlyn Co indicating the measures which the
Group has taken to attempt to recover the debt, and the response from Hamlyn Co.

– Review of post year-end cash receipts for any amounts received from Hamlyn Co.

– Search public registers for evidence of whether Hamlyn Co has been placed in administration or
receivership (e.g. Companies House or equivalent), this will indicate the need for an impairment review if
it is listed.

Part (b)

Critique of Auditor’s Report

Headings and structure

The report should not have the opinion and basis for opinion combined in one paragraph. The report should
start with the opinion paragraph, which is then followed by the basis for opinion. In addition, these
paragraphs should be separated using appropriate headings with the modification which is being made to
the opinion in the title (i.e. ‘Qualified opinion’ and ‘Basis for qualified opinion’).

Qualified opinion

The draft opinion paragraph uses ambiguous wording – in particular, using the phrase ‘the financial
statements are likely to be materially misstated’. This does not indicate that a firm conclusion has been
reached, and could give users of the report some doubt as to the credibility of the auditor’s opinion.

Basis for qualified opinion

This paragraph should contain further information on the reasons for the modification including a
description and quantification of the financial effects of the material misstatement. In this case, the

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 paragraph should refer to the overstatement of trade receivables and profit of $450,000 based on audit
evidence (not $500,000).

Emphasis of matter paragraph

An emphasis of matter (EOM) paragraph is used when the auditor considers it necessary to draw users’
attention to a matter which is of such importance that it is fundamental to users’ understanding of the
financial statements.

Neither matter discussed in the current EOM are appropriate to be included. The fraud is immaterial in
monetary terms and therefore is not likely to be considered fundamental to users’ understanding of the
financial statements. In addition, it is not professional to highlight illegal activity in this way, and the breach
of confidentiality could risk litigation from the Group.

The EOM also refers to the difficulties encountered in the audit of trade receivables due to the Group
finance director refusing to allow full access to necessary sources of evidence. This matter should not be
reported to shareholders in the auditor’s report, but instead to those charged with governance. Additionally,
it is inappropriate to mention this was caused by the Group finance director, and this could be seen as
defamation resulting in further litigation.

Finally, referring to the potential resignation of the audit firm anywhere in the auditor’s report is not
appropriate. This matter should be discussed with those charged with governance who will then take the
matter up with the Group’s shareholders.

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 Squire & Co

Briefing notes

To: Mo Iqbal, audit engagement partner

From: Audit manager
Subject: Audit planning in relation to the Ryder Group

Introduction

These briefing notes have been prepared to assist in planning the audit of the Ryder Group. The notes
begin with an evaluation of the audit risks. Additional information required to plan the audit of a significant
disposal which is expected to take place shortly after the financial year end is identified. The notes also
include principal audit procedures for joint arrangement investment and a government grant. Lastly, the
notes discuss several ethical matters arising from audit committee requests.

Part (a)

Evaluation of significant audit risks

Planned disposal and acquisition – events after the reporting date

The disposal of Primal Burgers Co will have a material impact on the Group financial statements given
that Primal Burgers Co accounts for 23·2% of projected Group total assets and 30·9% of projected Group
revenue.

The acquisition of Valentine Co will be material to the Group, with the anticipated cost of investment and
the fair value of identifiable net assets of Valentine Co representing 21·1% and 17·9% of projected Group
assets respectively.

These are non-adjusting events as per IAS 10, and should be disclosed. The required disclosure is the
nature of the event and an estimate of its financial effect or a statement that a reasonable estimate of the
effect cannot be made. There is a risk of incomplete or inaccurate disclosure.

Disposal of Primal Burgers Co – assets held for sale and discontinued operations

As per IFRS 5, a disposal group of assets should be classified as held for sale if certain conditions are
met. Given that the board approved the sale in March 20X5 and potential purchasers have already
expressed an interest, the conditions appear to have been met.

The assets should be reclassified as assets held for sale and measured at the lower of carrying amount
and fair value less costs to sell. Before reclassification, impairment is measured and recognised in
accordance IAS 16 and IAS 36.

There is a risk that the assets are not treated as a disposal group for the purpose of IFRS 5 and have
continued to be depreciated.

Assets are possibly overvalued if an impairment review has not been performed or assets not measured
at the lower of carrying amount and fair value less costs to sell.

There is also a risk relating to disclosure, as assets and liabilities held for sale should be recognised
separately from other assets and liabilities in the statement of financial position, and if they have not been
appropriately reclassified, then non-current assets and liabilities will be overstated.

There is also an audit risk that Primal Burgers Co is not treated as a discontinued operation in accordance
with IFRS 5.

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 Disposal of Primal Burgers Co – potential for manipulation

Another audit risk relating to the disposal of Primal Burgers Co is that the results of the subsidiary could
be manipulated to make it look more favourable to any potential purchaser. The subsidiary’s revenue has
declined, and therefore it could be that management attempts to manipulate the financial statements to
present a healthier financial performance to potential buyers.

Investment in Peppers Co

Planned investment of $48 million in Peppers Co represents 10·1% of projected group assets and
therefore is material. As per IFRS 11, the joint venture should be equity accounted.

There is a risk that group may fail to apply equity accounting to the investment, which may lead to an under
or overstated value of investment and incorrect presentation of income and expenses relating to the joint
venture.

Mondays Coffee drive-through – capital expenditure

There has been significant capital expenditure ($43 million) relating to 50 new drive-through coffee shops.
$15 million relates to acquiring operating licences.

The audit risk relates to the classification of the licences within property, plant and equipment, they should
instead be recognised as intangible assets. This error is material, with the $15 million cost of the licences
representing 3·2% of projected Group assets. If the error is uncorrected, property, plant and equipment is
overstated and intangible assets are understated.

Mondays Coffee drive-through – reportable operating segment

According to the Group finance director, revenue from the new drive-through coffee shops accounts for
almost all of the increase in revenue from Mondays Coffee Co. The financial information shows that
Mondays Coffee Co revenue is projected to increase by $45 million this year. Total Group revenue is
projected to be $320 million; $45 million is 14·1% of this total.

The revenue from the drive-through coffee shops could be a reportable operating segment under IFRS 8
Operating Segments.

IFRS 8 requires an entity to report financial and descriptive information about its reportable segments.
Reportable segments are operating segments or aggregations of operating segments which meet
specified criteria, including that its reported revenue is 10% or more of the combined revenue of all
operating segments.

It seems that the drive-through coffee shops should be treated as a reportable segment as it generates
more than 10% of Group revenue. The audit risk is that disclosure is not provided at all in relation to this
reportable segment, or that disclosure is incomplete in the final version of the financial statements.

Government grant

The group received a government grant of $20 million, representing 4·2% of projected group assets and
therefore material to the group statement of financial position. In addition, if the $20 million grant receipt
had not been recognised in full as income this financial year, the projected Group profit before tax would
be $0. The recognition as income is therefore extremely significant to the Group financial statements.

As per IAS 20, government grants should be recognised in profit or loss on a systematic basis over the
periods in which the entity recognises as expenses the related costs for which the grants are intended to
compensate.

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 The two parts of the grant should be accounted for separately. The amount relating to capital expenditure
should be deferred on the statement of financial position, and the grant should then be recognised in profit
or loss over the periods in which depreciation expense on the assets to which it relates is recognised. The
part of the grant relating to promotional activity should be recognised in profit or loss in the same period
as the relevant expenses.

If funds are not used in the manner intended by the government, the grant would be repayable. This would
mean that a provision or contingent liability should be recognised, and there is an audit risk that liabilities
are understated if any amount probable to be repaid is not accounted for as a provision, or that insufficient
disclosure is made in the note to the financial statements.

Therefore, the audit risk is that group profit is overstated by a maximum amount of $20 million, and
liabilities understated by the same amount. The accounting treatment could be a deliberate attempt to
enhance the appearance of the Group profit for the year, and this issue should be approached with a high
degree of professional scepticism during the audit.

Audit committee lack of financial reporting expert

Since January 20X5, the Group audit committee does not have a financial reporting expert. It is a
requirement of best practice corporate governance principles that the board should satisfy itself that at
least one member of the audit committee has recent and relevant financial experience and that the
committee as a whole shall have competence relevant to the sector in which the Group operates.

Without a financial reporting expert on the audit committee to provide this oversight, there is a risk that
inappropriate judgements are made and a higher risk that errors or deliberate manipulation of the financial
statements are not addressed.

Part (b)

Additional information required to plan the audit of the disposal of Primal Burgers Co

• The standalone financial statements of Primal Burgers Co: This will assist the audit team in planning
to audit the compliance with measurement and disclosure requirements of IFRS 5 and to confirm
materiality of the balances involved.

• A copy of the vendor’s due diligence report produced by Usami & Co: This will help in planning to
audit the measurement of the disposal group and whether any impairment should be recognised.

• Information regarding the potential acquirers of Primal Burgers Co and the stage of negotiations:
This will help the audit team develop an expectation as to whether the disposal is likely to take place
after the year end and the potential sales price.

• Obtain a copy of management’s assessment/workings of the impact on the Group’s financial position
on the sale of Primal Burgers Co and the overall impact of the restructure of the Group.

Part (c)(i)

Principal audit procedures in respect of the classification of the investment in Peppers Co

• Inspect the legal documentation supporting the investment and agree all the details of the
investment.

• Review board minutes to confirm the approval of the investment and to understand the investment
rationale.

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 • Review minutes of relevant meetings between the Group and Smiths Co to confirm that control is
shared between the two investors and to understand the nature of the relationship.

• Obtain Peppers Co’s organisational structure to confirm that the Group has successfully appointed
members to the board of the company and that those members have equal power to the members
appointed by Smiths Co.

Part (c)(ii)

Principal audit procedures in respect of the government grant received

• Obtain and review the Group’s capital expenditure forecast to confirm the amount planned to be
spent on capital expenditure relating to environmental matters.

• Review any plans to use the funds for promotional purposes to confirm that recycling features are
included in the campaign, as intended by the government.

• Confirm, through agreement to marketing plans, whether any funds will be spent during this financial
year.

• Obtain a written representation from management that the grant received will be used for the specific
purposes required by the government.

Part (d)

Ethical issues

Partner to serve on audit committee

The audit committee has requested the senior partner to assume a role on the group audit committee.

Should a partner from Squire & Co take this appointment, a self-review threat to objectivity arises because
an audit committee member is in a position to exert influence over the financial statements, and the audit
team would be less likely to challenge issues during the audit, thereby losing their professional scepticism.

Therefore, Squire & Co cannot provide a senior partner, or any other member of staff, to serve on the
Group’s audit committee.

Referral fee

The audit committee understands that Squire & Co cannot provide a corporate finance service, but could
recommend another firm, Ranger Associates, for this work, for which the firm would earn a referral fee.

The Code states that this creates a self-interest threat to objectivity and to professional competence and
due care.

The self-interest threat arises from the income generated from the referral, and this may result in the audit
firm recommending another firm for the work without proper consideration of their competence to perform
the engagement.

Internal audit

A further threat arises from the audit committee’s request for Squire & Co to work with the Group internal
audit team to design and evaluate internal controls relating to revenue.

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 The Code suggests that providing an audit client with an internal audit service might create a self-review
threat to objectivity. This is because in subsequent audits the audit team may use the internal audit work
performed in their audit of revenue. They may over-rely on the internal controls designed and evaluated
by the audit firm or will not apply an appropriate level of scepticism when assessing the work.

In addition, a threat of management responsibility arises, whereby the audit firm is making decisions and
using judgement which is properly the responsibility of management.

The Code states that taking responsibility for designing, implementing, monitoring and maintaining internal
control is assuming management responsibility.

According to the Code, an audit firm must not assume management responsibility for an audit client
because the threat to independence created is so significant that no safeguards could reduce it to an
acceptable level.

Specifically in relation to public interest entities, the Code further states that an audit firm shall not provide
internal audit services which relate to a significant part of controls over financial reporting, financial
accounting systems which are significant to the financial statements or amounts or disclosures which are
material to the financial statements.

Therefore, Squire & Co should politely decline the request made by the audit committee and ensure that
the committee is fully aware of the ethical issues raised by their requests.

Conclusion

There are a range of audit risks to be considered in planning the forthcoming Group audit. The
recommended audit procedures are included, and finally three ethical issues have been identified and
evaluated. Our firm should not provide internal audit assistance to the Group, nor allow a partner to serve
on the Group audit committee.

Lifeson Co

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 Part (a)(i)

Sale and leaseback transaction

Matters

Transfer of control

As per IFRS 16, an assessment should be performed based on the criteria specified in IFRS 15 as to
whether control of the asset has been retained by the seller or whether it has passed to the buyer.

Control of an asset is defined by IFRS 15 as the ability to direct the use of and obtain substantially all of
the remaining benefits from the asset. This includes the ability to prevent others from directing the use of
and obtaining the benefits from the asset. The benefits related to the asset are the potential cash flows
which may be obtained directly or indirectly.

Right-of-use asset

In this case, the lease term of ten years appears short compared to the asset’s remaining life which is
expected to exceed 50 years. It seems likely that Clive Co will direct the use of and obtain substantially all
of the remaining benefits from the asset.

Therefore, the proposed derecognition of the property in Lifeson Co’s financial statements and the
recording of the transaction as a sale in accordance with IFRS 15 appears to be correct.

Lifeson Co should therefore derecognise the property and recognise a right-of-use asset based on the
proportion of the previous carrying amount of the asset effectively retained under the terms of the lease.

In addition, it should recognise a financial liability based on the present value of the lease payments and
any gain or loss arising on the transaction should be recognised in profit or loss for the year.

Evidence expected to be on file:

• Agreement of the sale proceeds as per the sale agreement to the cash book and/or bank statement
to confirm the correct calculation of the gain or loss on disposal.

• Notes of discussions with management in relation to the transfer of control to confirm whether the
correct treatment of the sale and leaseback arrangement has been determined.

• A review of the board minutes for evidence of management’s discussion of the sale and leaseback
transaction and any evidence in relation to the transfer of control.

• A review of surveyor reports on the property to confirm the expected remaining life of the property.

• A copy of the client’s working papers for the calculation of the present value of the lease payments
and a recalculation of the present value of the lease payments by the auditor in order to form a basis
for confirming the detailed accounting treatment of the lease.

Part (a)(ii)

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 Investment property

Matters

The carrying amount of the investment property represents 2·6% ($353,000/$13·8 million) of Lifeson Co’s
total assets, and is material to the financial statements.

The auditor should consider whether the requirements of IAS 40 have been satisfied and confirm if the
warehouse held by Lifeson Co is actually an investment property. Lifeson Co’s warehouse has been held
to earn rentals and for capital appreciation from 1 April 20X4 and therefore qualifies as an investment
property from this date. The fact that the property has not yet been let by the reporting date does not
impact on this classification. The end of owner-occupation of the warehouse is evidence of the change in
use to an investment property

The warehouse is recognised at fair value of $353,000 and according to IAS 40, the fair value model is
acceptable provided the treatment of any other investment property held by Lifeson Co is consistent. On
transfer to investment property carried at fair value, IAS 40 requires that any resulting increase in the
carrying amount should be recognised in other comprehensive income as a revaluation surplus within
equity. Thereafter, any further increase in fair value is recognised in profit or loss for the year.

In this case, Lifeson Co should recognise the initial increase of $25,000 ($348,000 – $323,000) in other
comprehensive income rather than in its profit for the year and the additional increase of $5,000 ($353,000
– $348,000) which arises during the current year should be recognised in this year’s profit or loss. Lifeson
Co’s recognition of the full $30,000 gain in its profit before tax for the current year is incorrect and therefore
results in an overstatement of profit by $25,000.

Evidence expected to be on file:

• Notes of discussions with management to confirm its intention to hold the property to earn rentals
and for capital appreciation.

• Inspection of title deeds held by Lifeson Co to confirm its ownership of the investment property.

• Record of the physical inspection of the building by the auditor in order to confirm its general
condition and that it is no longer occupied by Lifeson Co.

• Review the disclosures made in the financial statements, such as details of the external valuation,
to ensure they comply with the requirements of IAS 40.

Part (a)(iii)

Matters

Asset impairment

The carrying amount of the shopping mall represents 64·1% ($8·85 million/$13·8 million) of Lifeson Co’s
total assets at the reporting date and is therefore highly material to the company’s financial statements.

The auditor should consider whether the client’s calculation of the shopping mall’s recoverable amount
based on value in use is in line with the requirements of IAS 36 Impairment of Assets. This should include
an assessment of whether the client has used an appropriate discount factor for calculating value in use
based on the rate which reflects current market assessments of the time value of money and the risks
specific to the asset.

Reversal of impairment loss

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 IAS 36 requires that the increased carrying amount of an asset, such as property, attributable to a reversal
of an impairment loss should not exceed the carrying amount which would have been determined, net of
depreciation, had no impairment loss been recognised for the asset in prior years. In this case, therefore,
recognition of the reversal of the impairment loss should be calculated as follows:

$million $million

Carrying amount at 31 Mar 20X5 before reversal ($8·25m x 18/19) 7·816

Recoverable amount based on impairment review as at 31 March 20X5 8·850
Capped to $9·5m x 18/20 = 8·550 8·550
Impairment reversal to be recognised 0·734

As a result of Lifeson Co’s failure to limit the impairment reversal to $0·734 million, profit and assets are
overstated by $300,000 (1·034m – 0·734m)

Evidence expected to be on file:

• Agreement of the opening balances for the property to the non-current asset register as at 1 April
20X4 to confirm the correct amount has been brought forward in the client’s working papers.

• Physical inspection of the shopping mall property to confirm its condition, occupancy level and to
assess the reasonableness of the depreciation policy and forecast cash flows for the value in use
calculation.

• Copy of the client working papers for impairment review giving evidence of the client’s basis for
assessing the fair value less selling costs of the mall and detailed calculations of its value in use.

• Copy of the client’s cash flow forecasts and budgets supporting the value in use calculations.

• External confirmation of the shopping mall’s net realisable value by an appropriately qualified,
independent expert in order to ensure the recoverable amount has been correctly determined.

Part (b)

Implications for the auditor’s report

Investment property

Lifeson Co has recorded the increase in the carrying amount of $30,000 on the warehouse in the statement
of profit or loss for the year. The increase in fair value of $25,000 on transfer of the property to investment
property should have been recorded in other comprehensive income and profit is therefore overstated by
$25,000 in the year. This overstatement represents 1·2% of profit before tax and therefore is immaterial in
isolation. As this misstatement is immaterial, the auditor’s report would not need to be modified. If
management intends to leave this as an uncorrected misstatement, written confirmation of its immaterial
nature should be obtained via a written representation.

Shopping mall

Lifeson Co has incorrectly recognised the full impairment reversal of $1·034 million in profit for the year.
As per IAS 36, the reversal of an impairment loss should not exceed the carrying amount which would
have been determined had no impairment loss been recognised. Based on depreciation over a 20-year
useful life, the carrying amount of the asset should be capped at $8·550 million and the reversal of the
impairment to be recognised at $0·734 million ($8·550 million – $7·816 million). Assets and profit are
currently overstated by $300,000 representing 2·2% of total assets and 14% of profit before tax which is
material to both the statement of financial position and statement of profit or loss.

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 Overall impact on the auditor’s report

The shopping mall misstatement is individually material and if management fails to amend the financial
statements, the auditor’s opinion should be modified due to the material, but not pervasive, misstatement
of the shopping mall. A qualified ‘except for’ opinion should therefore be given.

Kaffe & Co

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 Part (a)

Scope of the investigation

Kaffe & Co should establish the specific work which Beyer Co expects them to perform. It is likely that the
quantification of the loss represents an agreed upon procedures engagement and these would need to be
confirmed with Beyer Co in advance. The assignment may require specific competencies, such as the use
of specialists in the use of computer-assisted audit techniques.

Kaffe & Co would also need to establish the time period Beyer Co would like them to investigate. This will
all have an impact on the total fee charged.

Establishing how Kaffe & Co’s investigation relates to the criminal investigation

If the quantification of the loss were to become a criminal investigation, then the relevant authorities would
take the lead. It is not clear whether the authorities would require additional, professional support in their
investigation and, if so, what sort of assistance they would require.

Kaffe & Co should speak to the authorities to ascertain whether there will be any criminal investigation
and, if so, what their role might be in the investigation, and how they might interact with any other experts
appointed by the authority to assist in the investigation.

Confidentiality

Firms providing professional services must always ensure that information relating to clients is not given
to third parties without the permission of the client. In preparing the report for the insurance company,
Kaffe & Co will need permission from Beyer Co to disclose the information to the insurance company.

The types of reports and prospective users

The firm must confirm with Beyer Co what types of report they would expect as a result of the engagement
and whom the reports would be distributed to. In forensic engagements, the procedures to be performed
would normally be agreed and then the results of those procedures would be reported. It may be that the
insurance company expects an opinion to be given on the results of the investigation and if this is the case,
then the assurance issued would be limited to negative assurance. Kaffe & Co would usually expressly
state that the report is not intended for use by third parties

Professional competence

Before they can accept the role, Kaffe & Co must be certain that they have staff with the requisite
competencies to be able to conduct the investigation effectively. If this were conducted as a criminal
investigation, it is also vital that the staff used have sufficient experience in relation to the gathering and
safeguarding of evidence. Any failure to follow the relevant protocol may render the evidence useless to
the legal case.

Part (b)(i)

Procedures to be performed to quantify the inventory loss

• Discuss with the company’s legal team what is known about the fraud at present and the source of
the information.

• Obtain the prior year report to management from the auditor and inspect auditor’s reports to identify
any deficiencies or discrepancies in inventories identified by the auditors.

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 • Obtain/prepare a reconciliation of all orders placed including cancelled orders to all invoices raised
to identify the total of all orders placed but not invoiced to establish the maximum potential value of
the theft.

• Arrange to conduct a full inventory count to identify discrepancies between the inventory records and
physical inventory.

• Investigate records of inventory written off to identify possible attempts to disguise the missing items.

• Interview sales, warehouse and accounting staff to identify the system in place for creating a sales
order and for setting up customers within the sales and inventory systems.

Part (b)(ii)

Control deficiencies and recommendations

Lack of segregation of duties and monitoring of order cancellations

There is a lack of internal control over the warehouse team, particularly in relation to authorisation and
approval of transactions. The warehouse manager having the ability to create new customers on the
system without authorisation has allowed fictitious customers to be created. Additionally, the lack of
reconciliation of the sales orders to the amounts invoiced allowed the cancellation of deliveries to avoid
detection from any invoicing process. A proper monitoring system would have flagged that one sales
representative in particular had higher than usual cancellation levels which could have been investigated
and monitored by management.

Lack of segregation of duties in the warehouse counts

The lack of segregation of duties between warehouse staff and inventory count staff allowed the fictitious
sales orders to pass unnoticed as the inventory discrepancy which would have flagged the issue was
ineffective.

Additional implications of the fraud

In addition to the value of the inventory stolen by the warehouse manager and sales representative, the
business is not holding accurate records of its inventory, meaning that it may be in breach of the
requirement to keep proper records of assets and liabilities and its assets are overstated. This may or may
not be a material amount.

Recommendations

• Integration of the sales order and invoicing systems into the management information system.

• New customers should be created by the accounts department not the sales/dispatch teams.

• Regular inventory counts to be performed by staff independent of the warehouse and sales staff.

Part (c)

Difficulty identifying fraud

According to ISA 240, the management of the company and those charged with governance are
responsible for the prevention and detection of fraud and error within the company through the provision
of a sound system of internal controls and a strong control environment. However, even when controls are

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 in place, fraud can be difficult to detect. By its nature, fraud is hidden, and controls intended to reduce the
risk of fraud may be insufficient to prevent or detect fraud.

In many cases, the detection of fraud is made difficult because the perpetrator will deliberately conceal
their activity. In the case of Beyer Co, the missing inventory was concealed by the falsifying of inventory
count records.

Owing to the inherent limitations of an audit, the auditor’s responsibility for detection of fraud is therefore
a secondary one to that of management and auditors face the same issues as management when it comes
to detecting fraud through the concealment, controls override and often immaterial nature of fraud.

Auditors should, however, consider the risks of fraud when planning their audit and the control weaknesses
which would increase the risk of fraud occurring. Auditors should conduct their audit with professional
scepticism having awareness that override of controls may exist and that representations made to them
may be false

Overall, for both management and for auditors, fraud is hard to detect especially when collusion exists to
enable override of controls and concealment of the fraud.

Snow & Co

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 Briefing notes
To: Ben Duval, Audit engagement partner
From: Audit manager
Subject: Audit planning for Margot Co

Introduction

These briefing notes relate to audit planning for Margot Co, with a financial year ending 30 June 20X9.

a) Significant risks of material misstatement

The following risks should be considered when planning the audit for Margot Co.

• Preliminary analytical procedures indicate several potential risks of misstatement:

o Current ratio has increased from 1.4 in 20X8 to projected 2.9 in 20X9. Current assets
are projected to increase by 53% and current liabilities are projected to fall by 17.6%.
These are significant amounts.
The cash balance has remained static, so this may indicate that inventory and receivables
may be overstated. The increase in current assets is partly explained by the prepayment
in respect of restoring the damaged factory which should not be included. This is
discussed below.
Current liabilities may also be understated. Part of this is due to the inappropriate
inclusion of a provision. Also discussed below.
o Gearing is projected to fall slightly from 32% to 28%. This is inconsistent with the loan of
$375,000 that was taken out during the year which should have caused gearing to
increase
o Operating margin and ROCE have both increased. This is inconsistent with offering
discounts to customers which should have negatively affected margins. This indicates
operating profit may be overstated.
o Projected increase in sales. Significant increase of 90.5% in online sales and increase
of 5.3% in other sales are projected as a result of the advertising campaign. This needs
to be further investigated to ensure that revenue is not overstated
• Pressure from family members. The majority of shares are owned by the Margot family. A
significant dividend is paid annually which the family members will expect to continue. The
CEO is also family member and is in a position to influence the financial statements. The
treatment applied to impairment (discussed later) suggests the financial statements may be
being deliberately manipulated. There is therefore a risk that the profit will be overstated.
• Online sales represent 7% of total revenue and this revenue stream is increasing. Margot Co
offers discounts on online sales, the level of which changes frequently, which increases the
complexity of accounting for the sales. It will be necessary to ensure there are suitable controls
over the accounting system so that it is updated to reflect any changes in discounts.
Incorrectly recording or applying discounts may lead to over or understated revenue
• New online sales portal has been launched which is likely to mean the system used to record
sales revenue received online has also changed. This creates risks in relation to the
completeness of the revenue recorded by the system during the transition period. Risk of
error is also likely to be increased while staff adapt to the new system, particularly if insufficient
training has been provided.
• Research and development costs of $220,000 for the new packaging have been capitalised
as intangible assets. This represents 1.8% of total assets and 10.5% of profit before tax so is
material. IAS 38 states that only development costs can be capitalised, and research costs
must be expensed. However, Margot has capitalised the full amount. If this figure contains
research costs, intangible assets will be overstated and operating expenses will be
understated.

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 In addition, the packaging is only at the prototype testing stage, and the development work
has been outsourced. It is therefore unlikely that sufficient evidence regarding feasibility of the
product, and demonstrating Margot’s control over its development exists. Without such
evidence, the development costs do not meet the criteria for capitalisation and should have
been expensed. Again, intangible assets will be overstated and operating expenses will be
understated.
• The impaired factory represents 7% of total assets and is material, however the recoverable
amount has not been calculated correctly as per IAS 36.

Recoverable amount = lower of value in use and fair value less costs to sell asset.

The value in use should relate to the current condition of the asset, however the finance
director’s estimate of value in use assumes that the building will be repaired and new
machinery purchased.

The fair value calculated could be over-optimistic if the factory is damaged and the machinery
needs to be completely replaced.

Both the value in use and fair value used by the finance director are too high, therefore the
impairment is understated and the carrying value of the asset overstated.

• Provision for restoring the factory and buying new machinery should only be recognised
if there is a present obligation as a result of a past event. The company is not contractually
obliged to repair the damage, so there is no present obligation and this should not have been
recognised. The related prepayment is also inappropriate as it relates to an expense that has
not yet been incurred. The current assets and current liabilities are both overstated. While
this does not impact on the profit, the amount of the misstatement is 3.6% of total assets and
is material.

• Advertising costs of $225,000 have been capitalised as intangible assets. This is not
appropriate as IAS 38 states advertising and promotional costs must be expensed, not
capitalised. The amount represents 1.8% of total assets and 10.7% of profit, therefore
intangible assets are materially overstated, and operating expenses are materially
understated.

• Software development costs have also been capitalised. The development costs are not
material, and do not in isolation present a risk of material misstatement, however as the same
rational has been used to capitalise advertising costs there is a risk that all costs relating to
intangible assets have not been treated appropriately. The aggregate impact of which may be
material.

• Identification and possible misstatement of assets may have occurred due to difficulties
distinguishing between bearer plants, which should be measured at cost and depreciated in
line with IAS 16 Property, plant and equipment, and fruit growing on trees, which should be
measured at fair value in accordance with IAS 41 Agriculture

b) Audit procedures
i) Impaired factory
• Obtain detailed calculations and assess methodology and assumptions used
• Discuss methodology and assumptions with management
• Confirm the carrying amount of the cash generating unit prior to impairment to the non-
current asset register, and confirm the carrying amount of each component of the cash
generating unit

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 • Review the terms and conditions of insurance policy to confirm buildings and machinery
are covered
• Estimate the value in use and fair value less costs to sell and compare this to the estimate
prepared by management

ii) Research and development costs

• Discuss the project with management; rationale, intended use of new packaging, stage
of development, any additional funding required etc to develop understanding
• Review progress reports and correspondence to assess progress to date
• Review ProPack contract to establish if Margot will own and control the asset and ensure
ProPack has no continuing interest once complete
• Ask for permission to discuss with ProPack matters such as technical feasibility and
results of prototype testing
• Review project budgets to confirm amount of expenditure approved, and ensure costs
are clearly distinguishable
• Ensure Margot has sufficient funds to complete the development by reviewing cash
position and available finance
• Obtain samples of prototype to confirm existence
• Agree amount spent to date to ProPack’s invoices and Margot’s cash records

c) Prior to placing reliance on the work of the auditor’s expert the following requirements of IAS 620 Using
the Work of an Auditor’s Expert should be considered:
Objectivity. The auditor should evaluate the objectivity of the expert, including any interests and
relationships that may threaten this. The auditor needs to be satisfied that the expert has no
connection to Margot or individual within Margot who is in a position to influence the financial
statements. No reliance can be placed on their work if the objectivity is in any way threatened.

Competence. The auditor must assess the competence of the expert. The auditor will need to be
satisfied that the expert has sufficient experience in valuing the fruit and can measure fair value in
accordance with IAS 41 Agriculture and IFRS 13 Fair Value Measurement. Reliance will be
reduced if doubts over competence arise.

Scope of work must be agreed with the expert. In assessing the expert’s work, the auditor must
ensure this is in line with the scope agreed at the start of the engagement. Any deviations from
this will reduce the reliance that can be placed on the work

Relevance of the expert’s findings or conclusions must be evaluated by the auditor. The
conclusion should be consistent with other relevant audit findings and the auditor’s general
understanding of the business. Any inconsistencies may indicate the work is unreliable and should
be further investigated.

d) The email from Len Larch raises a number of audit implication that must be considered:
Non-compliance with law/regulations. It is the responsibility of management to ensure
compliance with law and regulations, however the auditor does have some responsibility in
ensuring this, particularly if the non-compliance has an impact on the financial statements

Auditor understanding. The auditor is required to gain an understanding of the legal and
regulatory frameworks in which the client operates. This increases the likelihood of detecting any
non-compliance and allows for a better assessment of its impact.

Bribery. It appears a production manager has been bribed by a company director, indicating a
lack of integrity, as well as supporting the claims that the company is using banned chemicals.
The auditor will now be required to carry out further work, including
• Evidence about the suspected non-compliance should be obtained to establish the facts

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 • Further audit procedures such as reviewing invoices to determine if the chemicals are
being purchased, and who has authorised these purchases
• The matter should be discussed urgently (due to the severity and health risks involved)
with management and those charged with governance
• Determine if any member of management authorised the use of these chemicals. The
matter should be communicated to the next level of higher authority, eg audit committee.
Such a higher authority may not exist given that Margo is a family business. If this is the
case, and the auditors consider that the entity may not communicate the matter, legal
advice should be sought
• The impact on the financial statements will need to be considered. For example to
determine the likelihood of incurring fines and penalties and the probability of these arising
so that it can be determined if these need to be provided for in the financial statements.
• Going concern will need to be assessed. Media coverage may lead to reputational
damage, and customers may fear for their health and stop purchasing from Margot
• If management, or those charged with governance, do not disclose to the relevant
authorities, the auditor should consider whether they should make the disclosure
• Legal advice will be required prior to auditors making any disclosures given the impact on
confidentiality

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 Kilmister Co
a) Kilmister Co – critical appraisal of draft auditor’s report
Presentation and structure
• The report should be addressed only to the shareholders, not the directors
• The first two paragraphs are in the wrong order, the Opinion should precede the Basis for
Opinion
Ethical code
• The report does not reference the ethical code that has been applied. This is a breach of
ISA 700
Material uncertainty regarding going concern
• The use of a ‘material uncertainty regarding going concern’ should only be used if adequate
disclosure of a material uncertainty has been made in the financial statements. This has
not been disclosed so this paragraph should not be included
• Where adequate disclosure about the material uncertainty is not made then under IAS 570
Going Concern the auditor should issue a qualified opinion or adverse opinion as
appropriate. Therefore, there are grounds in this case to issue a modified report.
• Details of the uncertainty regarding going concern should be given in the basis for qualified
or adverse opinion.
Long term contracts
• The ‘other information’ paragraph should be used to detail the auditor’s responsibilities for
‘other information’ ie the rest of the annual report. The paragraph has been wrongly used
here
• Long-term contracts should instead have been disclosed in a Key Audit Matters (KAM)
paragraph. KAM paragraphs are used for areas in which significant professional judgment
of the auditor was relevant
• Significant professional judgement has been applied in assessing the percentage of
completeness of material long term contracts, and this percentage is used to calculate the
revenue for the year. Therefore there is a greater risk in this area of material misstatement
of the revenue.
• A KAM paragraph should be included which
o Explains what a KAM is,
o Why long-term contracts are considered to be a KAM referring to the significant
professional judgment involved; and
o How the KAM was addressed by the audit process

b) Taylor Co – report to those charged with governance

The purpose of a report to those charged with governance is to communicate matters relating to
the external audit to the individuals who are ultimately responsible for the financial statements. The
matters to be communicated in this report for Taylor Co include:
Revaluation of property portfolio
Significant audit findings relating to the change in accounting policy in relation to the property
revaluation and related material misstatements, as well as significant difficulties encountered
during the audit should be communicated:
• Under IAS 16 revaluation policies should be consistent across a class of assets. However,
four properties of material value have not been revalued and are therefore materially
misstated
• The independent external valuation reports requested by the auditor at the planning stage
were not available. The delay, its impact, and any implications for the audit fee should be
communicated
Renovation of car parking facilities

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 • The renovation expenditure of $13.2 million has been expenses when it should have been
capitalised. This is an incorrect application of IAS 16 and results in a material misstatement
which will need to be communicated as a significant finding from the audit which will impact
on the form and content of the audit report.
• Deficiencies in internal controls identified during the audit should also be communicated.
Therefore, the report should detail the findings in relation to the expenditure for the
renovation not having been authorised. This is a serious control deficiency which creates
the potential for fraud. It is also an example of management override which brings the
integrity of management into question. The report should contain full details of the internal
control deficiency along with recommendations to reduce the associated business risk.
Long association of audit partner
Matters relating to auditor independence should be communicated in the report. The long
association of the audit partner with the client creates familiarity and self-interest threats to auditor
independence. Audit partners should be rotated every 7 years to address this risk. A further year
is allowed if rotation is not possible due to unforeseen circumstances, as has happened here. In
this situation, safeguards should be put in place, such as the independent review of the
engagement which is being performed. Details of this should be communicated in the report.

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 Awdry Co
a) ED-540 Auditing Accounting Estimates and Related Disclosures
Accounting estimates are imprecise and subjective, therefore increasing inherent risk. They are
often complex and require judgments on factors such as market conditions, timing of cash flows
and future intention of the entity and the building of complex models based on these assumptions.
Often, the value is significant and material. Two problems arise
• Management may not have the required knowledge and experience to make these
judgments, increasing the risk of error
• The subjective nature of estimates means they are easier to manipulate in order to present
better results in the financial statements.
The need for auditors to apply professional scepticism is therefore crucial when auditing
accounting estimates.
ED-520 aims to help the auditor to apply this scepticism and to consider the potential for
management bias. It also aims to be scalable by recognising that all accounting estimates, not
just complex and material estimates, are covered by the standard. This is because, while simpler
estimates may not give rise to significant audit risk, many measures based on estimates in the
financial statements will create high inherent risk.
The reasons for the development of ED-520 was based on the following findings and concerns:
• Perceived lack of consistency in the extent to which auditors obtained an understanding of
accounting estimates
• Evidence of insufficient or inappropriate work carried out by auditors in relation to estimates
• Perceived lack of professional scepticism exercised by auditors
• A need for more specific risk assessment requirements and requirements relating to
obtaining audit evidence
It emphasises that the risk of material misstatement in relation to the audit of accounting estimates
is influenced by three factors:
• Complexity
• Application of management judgement
• Estimation uncertainty
The increased focus on fair value measurement in IFRS standards has increased the complexity
of the business environment, and thus the complexity of estimates. This was a key factor driving
the need to update ISA 540.

b) Difficulties in auditing estimates and procedures

i) Cash-settled share-based payment scheme
The expense recognised of $825,000 represents 11.1% of profit so is material.
The related liability of $825,000 represents 1.4% of assets so has borderline materiality.
Under IFRS 2 Share-Based Payment the services acquired and liability incurred should be
measured at the fair value of the liability. The fair value of the liability should be re-measured
at the end of each reporting period and at the date of settlement, and any changes in fair value
should be recognised in the profit or loss for the period.
The expense and associated liability at Awdry has been calculated based on the fair value of
the rights as at the reporting date and so complies with IFRS 2.
Also under IFRS 2, the amount recognised as an expense for cash-settled share-based
payments should be based on the best estimate of the number of awards which are expected
to vest. At Awdry, management’s estimate that all 55 staff will qualify is based on historic
good staff relations, which may not be accurate, and assumes no staff will leave over the three
year period, which may be unrealistic. It will be difficult for the auditor to obtain reliable
evidence due to the predictive nature of the estimate.
The fair value estimate of $4.50 is based on options pricing models which incorporates
significant estimates and assumptions so again is challenging to audit.
Procedures:

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 • Obtain the contractual documentation for the share-based payment scheme and
principle terms and confirm:
o Grant date and vesting date
o Number of executives and senior employees awarded share appreciation
rights
o Number of share appreciation rights awarded to each member of staff
o Conditions attached to the share appreciation rights
• Assess the appropriateness of the model used to value the share appreciation rights
and confirm in line with IFRS 2
• Assess the experience, reputation, professional certification and objectivity of external
expert
• Obtain details of historic staff turnover rates and consider alongside management
assumptions
• Assess reasonableness of assumptions in forecast staffing levels during vesting period
and their consistency with other budgets and forecasts
• Discuss with management the basis of staff retention assumptions and challenge
appropriateness
• Carry out sensitivity analysis on the valuation model and staffing forecasts
ii) Regulatory penalties
The expense of $1.3m is material to profits (17.6%0 and assets (2.2%)
Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets the fine should be
measured at its present value at the reporting date. Therefore the cashflows for the repayment
of the fine over the ten years should be discounted at an appropriate rate to present value as
at 28 February 20X9.
Procedures:
• Obtain copy of the regulator’s notice. Check the date of issue and review for indication
of the amount of the penalty to be paid
• Obtain copy of any draft instalment agreement detailing the timing and amount of each
repayment
• Review correspondence with regulator for details of amount payable and repayment
schedule
• Review post year-end cash book and bank statements for any payments made after the
year end
• Assess ability to pay instalments by reviewing cash flow statements and forecasts
• Review board minutes for discussions relating to the penalty and any planned remedial
action to address the safety issues
• Discuss with management the need to establish a present value for the provision

iii) Property development

The proposed property valuation of $4.9m represents 8.4% of assets and so is material.
Under IFRS 13 Fair value measurement, the fair value should take into account the ‘highest
and best use’ of the asset.
This means the auditor will need to consider the fair value of the property in its current use
and in other potential uses. There is also a risk that some other potential uses may exist that
have not been considered.
The valuation also should be adjusted for all of its associated costs. Therefore the valuation
of $4,9m is not correct, and should be adjusted to $3,527,000 (ie. 4.9m – 1.2m – 173,000).
The property is therefore overstated by £1.373m.

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 Procedures:
• Physically inspect building to assess condition and suitability for conversion into
residential apartments
• Agree carrying amount of property to non-current asset register
• Obtain valuation of completed development from independent external expert, ensure
this is in line with IFRS 13
• Assess expertise and objectivity of external expert
• Confirm expected cost of $1.2m to quotation or contract
• Inspect planning permission documentation from local authority to ensure alternative
use of building has been approved
• Discuss alternative uses of the building with management
• Review board minutes to evidence discussion of the development
• Review cashflow statements and forecasts to ensure project is financially feasible
• Obtain written representations from management confirming all details and costs
relating to the development have been disclosed to auditor

Huntsman & Co

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 To Stella Cross
From Audit manager
Subject Audit /assurance planning issues

Introduction
This is in response to your e mail that requested various audit and assurance planning tasks to be carried
out in relation to Redback sports and Emu Gyms.

a) Redback – Business Risks

Weak governance
The company does not have an audit committee or an internal audit function at present. The re are also
only two non-executive directors. All of this suggests that there are insufficient resources to run the
company effectively.

This results in a weak control environment and potential inefficiencies that could cost Redback in terms of
expense and lost opportunities. This situation will become even more critical if a listing is obtained because
compliance with corporate governance guidelines will effectively become compulsory for a Plc.

Liquidity
The fall in cash by 75% ($5.6m to $1.4m) is cause for concern in both the short and the long term. Soon,
Redback may not have sufficient cash to meet its short term obligations. It may also struggle to adopt its
stated policy of expansion if there is no cash available in order to expand.

Overtrading
This significant fall in cash should be linked to the 50% increase in profit and the 18% increase in revenue.
Redback is expanding in size but could lack the liquid resources that are required in order to maintain this.
This is a classic sign of overtrading.

Compliance
Operating in the leisure industry means that Redback will have to comply with a large amount of health
and safety regulations in order to keep its operating licence.

Failure to comply could result in a loss of licence, which can result in adverse publicity and loss of
customers. Once lost, it would be difficult to get these customers to return.

Training costs / staff

There would be a considerable amount of training costs associated with the activities that are provided by
Redback, especially with the new scuba diving opportunities that is now being offered.

There is a risk that Redback will not be able to find the required quality of staff and that they will not be
able to afford to train them properly due to the decrease in cash that has occurred during the year. This
could result in the inability to provide all the advertised services.

Competition
This is a highly competitive industry. There is constant pressure to provide a high quality service and make
pricing as affordable as possible for customers. Marketing expenses are high which puts further strain on
liquidity.

If margins are not regularly reviewed and cash is not spent on advertising, it is easy for customers to switch
which means lost revenue and profit for Redback.

New scheme
The encouragement to unemployed people to use the facilities will increase usage and may upset existing
customers who now find that a lot of the facilities are too busy for them to use when they are wanting to
use them.

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 There is also the possibility that Redback will fail to comply with the terms of the grant by not recording all
the information relating to hours usage. This could result in the grant having to be repaid, either in part or
in full, thus further impacting adversely upon liquidity.

b) Redback -Risks of Material Misstatement

Management bias
The company is looking to expand and obtain a stock exchange listing, so there is pressure on the
management of Redback to achieve good results. They may be tempted to manipulate the financial
statements in order to make the performance look better than it really is.

The increase in both profit and revenue supports this concern. In general, it is likely that revenue is
overstated and expenses are understated in order to achieve this.

Revenue recognition
A large percentage of the revenue comes form membership fees. IFRS 15 would require these fees to be
spread over the year to reflect the fact that the obligation to provide the service is met OVER a period of
time.

There is a risk that revenue has been recognised too early ,thus overstating it in the financial statements.
No revenue would have been deferred so deferred income would be understated.

Capital /Maintenance Expenses

Maintenance costs have only increased by 3.8% which seems quite low given that there are two new
centres that have opened this year. It is possible that maintenance costs have been understated.

It is also possible that maintenance expenses have been misclassified as capital items during the year.
Capital expenditure has increased from $20m to $32m and could include some items that should have
written off to the statement of profit and loss.

This supports the suspicion that maintenance costs are understated and could also mean that non-current
assets are overstated.

Staff Costs
Staff costs are projected to increase by 7%. It is likely that staff costs are currently overstated.

Marketing costs
Marketing costs are included at exactly the same amount as in the previous period. This is very unlikely to
be accurate because the company has to spend more and more each year in order to fight off competitors
and maintain its market share.

It is, therefore, likely that marketing costs are understated at present.

Loan
The new bank loan is material because it represents 23% of total assets.

The discount on the loan should be recognised as an additional finance cost and spread over the loan
period. This should gradually increase the loan liability and be an expense in the statement of profit and
loss.

If this is not done, then liabilities and finance costs are both understated.

Director Loan
The loan from the director is not material in value because it represents only .8% of total assets, but it is
material in nature because it is a related party transaction.

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 It should be separately disclosed in a note to the financial statements and there is a risk that this has not
been done.

The loan was made on July 1 so should have accrued 8 months worth of interest that should also be
recognised. If this has not been done, then the loan liability and the finance cost are both understated.

New System
The introduction of the new data management system increases the risk of misstatement occurring. The
changeover form the old to the new system may not have been carried out properly so some data may
have got lost or corrupted during the process.

The company staff may not have sufficient training on how to operate the new system so more errors may
be made, again leading to loss and disruption. This will increase control risk.

Grant
The government grant is material because it represents 29% of the projected profit figure. IAS 20 states
that the grant income should be spread over the period to which the grant relates- in this case this is three
years. Some revenue that is received now should be deferred.

Redback is not applying this because all of the income is being recognised all of the income this year. This
will result in the overstatement of revenue and the understatement of the deferred income liability.

Athlete fee
The athlete fee is material because it represents 14% of the projected profit for the year. The fee paid to
the athlete should be spread over the two year period to which it relates.

If it is all recognised this year, then the profit is understated and deferred expenses (which should be a
prepayment) will also be understated.

c) Redback -Principle Audit Procedures for the Grant

Agree the amount of cash received form the government by matching it from the grant document to the
cashbook and bank statements.

Obtain a copy of the grant document and confirm the date of receipt, the amount received and the period
covered by the agreement.

Inspect the agreement for any conditions attached to the grant that may result in potential repayment of
some, or all, of the money if the conditions are not met.

Recalculate the amount that should have been included in the financial statements assuming that the
grant is spread over three years .

Discuss with company management the rationale behind including all of the grant in the current accounting
period.

Carry out some tests of control on the system that records the amount of hours usage that is used as a
basis for the application for the grant in the first place.

d) Emu Gym – Assurance Review Acceptance

Competence
This should not be a problem. Our firm already provides services to another company in the same business
sector that is much bigger, so we should already have the knowledge as to how this industry operates.

Resources
This will depend upon the scope of the work. An audit would probably require more resources because
there will be the need to carry out a greater volume of detailed work.

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 We also need to confirm if the assurance report will require specific tests to be performed at the request
of the bank manager, as this may also be time consuming and require more resources.

Deadline
The deadline for completion of the work appears to be quite short. This is a problem because it increases
the risk of misstatement ( corners being cut due to time pressure ) and makes it even more important that
we ensure that adequate resources are available in order to avoid this.

Payroll Preparation- Self Review

The face that we already provide a payroll service is a self-review threat. The payroll information produced
by our firm will then form part of the information covered by the assurance review or the audit. There is a
risk that not enough work is done on these figures because we assume that they are correct.

This can be safeguarded against by using separate teams for the assurance review/ audit to that which
carried out the original payroll work.

Meeting
By attending the meeting with the bank after carrying out the assurance review/ audit could be perceived
as a management/ advocacy threat as it would appear that we are representing the client in the negotiation
with the bank.

If we do attend the meeting, then it should be a member of staff that has not previously had any dealings
with this client.

We should also clarify ours, and Emu managements, responsibilities in a letter of engagement.

Conflict
Redback and Emu are direct competitors so there could be a possible conflict of interest if are acting for
both clients. This is not prohibited but consent should be obtained from both clients before acceptance of
the new assignment, as well as the use of separate teams of staff and review of work by an independent
partner.

e) Emu – Suspected Fraud

There is no legal duty for either an audit or a n assurance review to identify if a fraud has taken place. It is
the responsibility of the management of Emu to prevent and detect frauds by running their company
properly.

However, either of the two engagements COULD have identified that a fraud was occurring.

The scope of an external audit is very wide and would involve details substantive procedures as well as
tests of control. This means that the chances of identifying a material fraud would be quite high.

The chances are that detailed work would have been carried out on the shop revenue because of the
significance of the value of the total revenue and the fact that it is not consistent with the previous year
amounts. This work is likely to have uncovered the fraud.

However, the fraud may not have been uncovered even with a full audit if the perpetrators had gone to
great lengths to cover up what they were doing, which would normally be the case.

An assurance review would have less chance of spotting the fraud because the scope of the work is
narrower and less detailed testing would normally been carried out.

However, analytical review is normally used so the change in margin should have been identified and
investigated. It is, therefore, possible that a fraud could still have been spotted, although the chance of this
happening would be less than it would be if a full audit had been carried out.

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Page 81 of 146
 Daley Co
a)

Going Concern Indicators

Legal Claim
The £3.5m legal claim will put a considerable strain on the cash position of Daley Co. It is a large amount
that will have to be paid in one go and it is likely that this kind of amount will not be available when it is
needed.

There may also be further claims by other customers which would make the problem even worse.
The adverse publicity that arises form a court case is also likely to mean that some customers will take
their business elsewhere, thus reducing the future revenue of Daley Co.

Forecast Figures
Some of the forecast figures produced by Daley Co appear to be over optimistic. The revenue is predicted
to increase by 28% which, given the above point concerning the legal claims and potential loss of
customers, is very unlikely.

Operating expenses have been projected to increase by more than 4 times, presumably partly as a result
of the expansion plans. This may be accurate, but is not sustainable given the level of cash and losses.

Loss Making
The company is now predicted to be loss making which means no profits available to re-invest in the future
and no profits available to distribute to the owners in the form of dividends.

Cash management
The decline in both the current and the acid ratio suggest that Daley Co is not good at managing its liquidity.
Cash appears to be leaking out of the business at an alarming rate.

Inventory
The inventory holding period has increased which means that more cash is being tied up in inventory that
is not being sold quickly enough. It also increases then chance of obsolete inventory that will have to be
written off.

Receivables
Receivables days has also increased which will mean more bad debts to be written off which will have an
adverse impact on profitability.

Payables
The payables payment period has also increased which shows a lack of sufficient cash to continue to pay
within an agreed period. Suppliers are likely to get upset, stop supplying and maybe even take Daley Co
to court over unpaid debts.

Reliance on Finance
Daley Co will need the further finance from the bank that is currently being negotiated. The current level
of finance will not be sufficient in order to continue.

Even with the additional finance, prospects are uncertain. The new loan will mean greater finance costs
and more pressure on company profitability.

It will also have an adverse impact on gearing, which is already poor- the debt equity ratio has increased
and the interest cover has fallen even without taking into account the effect of any potential new bank
finance.

b) Cashflow audit procedures

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 Re perform the calculations carried out by the client on the numbers in the actual cashflow forecast to
confirm mathematical accuracy.

We should agree the opening cash balances, as included in the forecast, to the cashbook and bank
statement.

We should inspect any customer orders that have already been received to help confirm the volume and
value for projected sales revenue.

We should inspect any correspondence from lawyers to confirm the value of the legal claims and ensure
that this figure is included in the forecast.

We should inspect the existing loan agreement to confirm the existence of any ongoing sources of finance.

We should inspect any recent correspondence with the bank to try to confirm the likelihood that the new
loan will be authorised.

We should use this, and the existing loan confirmation, to recompute the finance cost to ensure the correct
amount is included in the forecast.

We can compare any previously produced forecasts with previous actual company performance in order
to confirm the accuracy of any previous estimate that have been made by management.

This can be done for the first couple of months of the current year, as well as for previous accounting
periods.

We should inspect a copy of any market research that has been carried out by Daley Co to ensure that
any estimates have accounted for the impact of increased competition from the new market entrants.

We should carry out a review of the company board minutes to confirm the stage of the ongoing
negotiations with the bank and that the management believe the assumptions used in the preparation of
the forecast information are reasonable.

c) Reasons for non-disclosure

The directors may not want to own up to the going concern problems because they feel that it may put any
future sources of finance at risk. If the bank knows that the company is in financial difficulty, then they
would be less likely to provide further finance because they may think it will not be repaid.

Customers may stop paying their debts as they believe that the company will fail and then the debts may
not need to be paid at all. This would make the current liquidity problem even worse and would be a reason
why the directors are reluctant to disclose the full extent of the cash problem.

Impact on the audit report

Failure to disclose the problem would mean that the financial statements of Daley Co are misstated. The
fact that the disclosure is missing creates the misstatement.

This would result in a modified audit opinion. We would need a qualified opinion ( often referred to as an
“except for” opinion ) on the grounds of material misstatement.

It is very unlikely that this would result in an adverse opinion because the misstatement is isolated to the
disclosure only and we are NOT disagreeing with the basis of preparation.

The full reason for the modified opinion would be explained a paragraph that would be included after the
opinion in the audit report and would be entitled “ basis for qualified opinion.”

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 Seeing as there is no disclosure of the going concern problem, it is NOT appropriate to include a “Material
Uncertainty Relating to Going Concern” paragraph- this can only be used if the disclosure has been
missed out completely, which it has not.

Page 84 of 146
 Thomasson & Co
ai) Anti-money laundering policies

Money Laundering Reporting Officer (MLRO)

Thomasson should appoint an MLRO who will be responsible for evaluating the significance of any threats
that are communicated to them by the staff. Staff should feel able to talk to this person in confidence and
the MLRO should be experienced enough to be able to deal with a range of confidential issues.

Training
All staff should receive regular training on how to spot potential money laundering activities. They should
be aware of the typical scenarios and transactions that are more susceptible and be very clear as to who
they should report any concerns.

Due diligence/ Know your Client Procedures (KYC)

All client relationships must be clarified and authorised before acceptance of any engagements. Client
identities should be confirmed by inspection of passports or driving licences and a background check
should be carried out to try to establish that the client is ethical and reputable.

Tipping Off
This is when a member of your staff either deliberately or accidentally alerts the client that they are under
suspicion of money laundering. This would allow the client to falsify records to conceal their crime or even
to flee before prosecution.

Tipping off is illegal and can lead to you or your staff being prosecuted and all staff should be made aware
of the seriousness of this.

aii) Possible Indicators

Cash based business

A business that has a large number of cash transactions makes it easier for someone to introduce funds
into that business from an illegal source without detection. This is called placement.

Clean Co is 75% cash based with lots of individual sales reports that would placement relatively easy.

Overseas Transfer
Where money laundering is taking place, funds are often transferred between a number of different bank
accounts in order to hide the origin of the transaction. This often includes the use of overseas bank
accounts. This is called layering.

Clean uses overseas bank accounts as a possible means layering funds – another potential money
laundering indicator.

Property Acquisition
This layered cash can then be used to purchase what appear to be legitimate business items that will then
be used in the normal course of business to generate income and profit, just like any other business. This
is called integration.

Clean is doing this by purchasing a number of properties. These properties can either by used by the
business to generate income or sold on for immediate profit. The origin of the funds would now be very
difficult to trace and it may be assumed that the funds are legitimate.

b) Ethical and Professional Issues

Company Tax Computation

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 There is a self-review threat here. We would be preparing the company tax computation and then auditing
the tax figure because it is part of the financial statements. It is likely that we would fail to spot any errors
in the original tax work because it is subject to less scrutiny.

There is also a possible advocacy threat because it may appear that we are representing our client to the
tax authorities.

Safeguards
Clean is not a listed company so we are allowed to provide other services as long as sufficient safeguards
are implemented.

I would suggest segregation of duties (one team does the tax work and another does the audit work) and
a review of all of the work by an independent partner.

Personal Tax Computation

This is not prohibited so could is acceptable additional work. It is wrong, however, to bill it as accompany
expense because it is a transaction that relates to the individual director and not the company as a whole.

Website and Sales System

There is a self-review threat here too. Part of an external audit is a control risk assessment. This will involve
testing the client systems. If this system is part designed by us, it could appear that we will over rely on its
effectiveness and not audit it properly.

There is also a management threat. The design and implementation of new systems should be
management responsibility. By taking on that role, we are acting as company management.

The sales system will definitely be a significant part of the audit so we cannot justify this role by saying
that it applies to an insignificant component of the company control system.

Safeguards
There are safeguards available. We should ensure that the management acknowledge ultimate
responsibility for the design and implementation of the new system, perhaps by clarifying it in the letter of
engagement.

Once again, separate teams of staff should be used for the audit and the systems work.

It is still likely that the ethical threat would be too great, so we should consider not accepting the systems
work.

Party
This could create a familiarity threat because the staff attending the party would be considered to have too
close a personal relationship with the client. The work done may suffer as a result because the audit staff
do not want to threaten this relationship, so they do not act upon errors found.

The vouchers could be considered a self-interest threat. It could be a bribe on the part of the client to
attempt to silence any criticism of then client operations.

Safeguards
It is too late to reject these offers this year because the party has gone and the vouchers have been
accepted.

It should be noted on the audit file for next year that both benefits should not be accepted again. They are
unlikely to be deemed trivial simply because we are already suspicious of the client and the possible
money laundering.

All staff should be reminded that any offers of this nature should be declared and pre-authorised by the
audit firm’s own internal policy for assessment of these matters.

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 The ethics partner should be involved in the assessment process.

Bison & Co

Page 87 of 146
 To : Audit manager
From : Maya Crag
Subject : Planning document for the Eagle Group

Introduction
This is the audit planning document, as requested in your e mail.

a) Audit risks

Revenue v profit

The stated fall in revenue of 3.7% is inconsistent with both the change in operating margin and return on
capital employed.

The operating margin has risen from 4.5% to 6.1% and the return on capital employed has also risen from
10% to 12.1%.

This could be due to an overstatement of revenue or an understatement of operating expenses. In view of

the fact that operating expenses has reduced by 4.5% (bigger than the fall in revenue), then this is likely
to be the reason for the inconsistency.

Operating income has increased by 50% due to a $60m provision reversal, which could also explain the
more than proportionate fall in operating profit.

Staff costs

Staff costs have increased by 1.1% which is not consistent with the company activities. There is an
increase in automation and a number of redundancies have occurred as a result.

We would expect staff costs to have fallen for the current year. Staff costs are likely, therefore, to be
overstated.

Taxation

The effective tax rate has fallen from 25% to 20% which is not consistent with the fact that profit before tax
has increased.

We would really expect the tax expense to be higher this year so , currently, the tax liability and the tax
expense are likely to be understated.

Loans and interest

There has been an increase in borrowings of $50m, yet finance charges are lower this year.

This, in combination with a higher operating profit, has resulted in interest cover improving from 9 to 12.5.

We would expect the increase in borrowing to mean higher finance costs, so it is possible that finance
costs are understated.

Management Manipulation

Seeing as this is a listed company the management of Eagle may feel under pressure to engage in
earnings management in order to portray the company in as positive a way as possible in order to keep
the shareholders happy and to try and boost the share price.

The current financial performance, with low operating expense and finance cost and high operating
income, suggests that this may be being done.

Page 88 of 146
 Acquisition of new subsidiary

The net assets of the new subsidiary acquired are $300m which is material to the group because it is 8.6%
of total group assets.

The acquisition has also resulted in in increase to goodwill of 13.4%. These values mean that the new
subsidiary, Lynx, is a significant component of the group.

There could be misstatements for a number of reasons.

Valuation of net assets

The assets and liabilities may not have been recognised using a reliable measurement for fair value.

Some assets and liabilities may have been missed, resulting in understatement for both.

Impairment

Goodwill should be tested annually for impairment. It is likely that Lynx has been impaired during the year
because it is loss making. If this is not done, then goodwill will be overstated.

Contingent consideration

This could well never end up actually getting paid because the new subsidiary is loss making. If this is the
case, then goodwill is currently overstated and the contingent consideration should be removed.

Even if it does get recognised as part of the goodwill calculation, the current discount rate being used is
likely to be too high. Using 18% instead of the weighted average cost of capital of 10% would be difficult
to justify and would result in understatement of goodwill.

Non-controlling interest

The NCI acquired is $49m but the NCI on the group statement of financial position has only increased by
$2m. There is an inconsistency here and it is possible that the total NCI is understated.

Time apportionment

The new subsidiary was acquired during the year so the results for the year will need to be time apportioned
during the consolidation process. If a full year has been included, then group profits will be understated as
Lynx is loss making.

Foreign Subsidiary

Lynx is located overseas so may not have been translated properly.

The closing rate method states that assets and liabilities must be translated at closing rate and all profit
and loss items must be translated at average rate. This may not have been done using the correct rates.

Exchange movements

Any exchange gains or losses that arise when translating the results of an overseas subsidiary should be
recognised in Other Comprehensive income. The gains have been included in operating income by Eagle
so this means profit will be overstated.

Intangibles

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 Intangibles are material to the group because they are 5.7% of total assets.
Intangibles have increased by $60m which is material as it is 1.7% of total group assets.

It is possible that some of the new intangibles that have been capitalised do not fulfil the recognition criteria.
It needs to be likely that future benefit will be obtained from the research into new technology.

If this is not the case, then some of this amount should have been recognised as an expense in the
statement of profit and loss. Assets will be overstated and expenses understated if this has not been done.

Using the same useful economic life for all intangibles is not likely to be reasonable. Even if it is, then 15
years seems far too long because technology moves fast and certain things will become obsolete quickly.

The current amortisation policy using a blanket 15 years will mean that assets are overstated and
expenses are understated.

b) Goodwill audit procedures

Recalculate the goodwill computation that has been prepared by management in order to confirm
accuracy.

Agree the cost of investment paid to the company cashbook and bank statement.

Inspect the purchase contract in order to confirm the percentage of shares acquired, the voting rights and
any conditions concerning the contingent consideration.

Inspect the fair value calculation of the net assets at acquisition to ensure that the valuation is reasonable
and is in accordance with group policy.

Confirm the accuracy of the non-controlling interest calculation by comparing it to the company share price
at acquisition. This should be the market price at the time.

Obtain a copy of the due diligence report and confirm the reasonableness of the asset and liability
valuations used.

Recompute the contingent consideration and obtain a management representation that the discount rate
that has been used is appropriate.

c) Control Effectiveness

It is entirely appropriate to reduce the amount of substantive procedures if the control testing has revealed
that the controls in a system are operationally effective.

This is a recognised audit approach and will not adversely affect the quality of the audit work, as long as
the decision to rely on control testing is justified.

In this case, this has NOT been done effectively. The management assertion that the controls have not
changed since last year is insufficient. This is especially true of Lynx because it is loss making and we are
already questioning management integrity.

Therefore, reliance on management representations will be less than usual, including the specific
statement relating to the company controls.

The component auditor should perform some tests of control this year if we wish to rely on a test of control
based approach.

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 The impact on the group audit could be more work for us as group auditor. If Vulture do not change their
audit strategy to include some control testing this year, then we would have to do it instead.

Internal Audit

It is acceptable to use internal auditors to help with our audit work in certain circumstances.

We would have to ensure that there are no local regulations that restrict this.

We would also need to assess the skills and competence of the internal auditors, as well as ensuring that
they have a degree of autonomy within the organisational structure of Lynx.

It would also be essential to review their work to ensure the desired level of quality is being achieved.

There are specific ethical issues here, though.

There is a self-review threat because the internal auditors have worked on receivables during the year and
will now help to form an opinion on work that they have carried out which means that they are less likely
to spot errors in tasks that they undertook in the first place.

Evaluation of the level of receivables allowance will involve the application of judgement by the internal
auditors. Any work that they carry out for us is not supposed to involve judgement, so this work is not
appropriate.

The impact on the group audit would be, again, more work for us as group auditor because we should not
use the internal audit team for the receivables work in this case.

d) The Integrated Report

Other assurance services of this kind are permitted as long as the ethical and professional threats created
can be managed and safeguarded against , assuming they are significant enough to be concerning.

There is a self-review threat here. We will audit the financial statements and will have to ensure that the
integrated report is generally consistent with them. If we help develop the report and the figures that it
contains, then we may find it difficult to be objective about the information included.

There is also a management threat. We may be advising the company on how and what to calculate. This
is not our job, so can result in us making decisions on behalf of the client.

We also need to ensure that our firm has the necessary expertise to be able to carry out this task. The
integrated report assurance may require a level of specialist expertise that we do not have.

This additional service will also be time consuming, so we would need to ensure that we have sufficient
resources available, at the right time, to be able to “fit“ this work in with our other existing commitments.

Adequate safeguards must also be in place, such as a separate review carried out by a partner who is not
involved in the provision of the actual service.

We should also clarify with management that they are aware of their responsibilities, so we do not make
decisions on their behalf.

If we feel that these safeguards are adequate, then this offer could be accepted.

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 Coram & Co
a i) Lease Equipment

The carrying value of the unrecognised lease equipment is material because it is 2.2% of total assets.

There is an exemption, under IFRS 16 that allows short term lease payments to be expensed through the
statement of profit and loss account.

All short term leases must be treated consistently, however, which is not the case with Clark co at present.

They either need to capitalise the $475,000 to bring it into line with the treatment at the other two sites. If
this is not done , then assets and liabilities will be understated.

Alternatively, they need to derecognise the carrying values of the other two so that they are all taking
advantage of the exemption. If this is not done, then assets and liabilities will be overstated.

If no adjustment is made, then the audit opinion will need to be qualified on the grounds of a material
misstatement.

This would be material but not pervasive because it is only an isolated misstatement.

ii) Legal Claim

This is material because it represents 5.5% of total assets.

The claim meets the provision definition in IAS 37. There is a past event that creates an obligation to pay
and a reliable estimate is available, so a provision should be recognised.

The receipt from the insurance company is virtually certain, so that should be recognised as well.

Currently, both assets and liabilities are understated.

If no adjustment is made, then the audit opinion will, again , be qualified on the grounds of material
misstatement.

This will be material and not pervasive because it is an isolated error.

iii) Impairment

The current claim by Clarke Co that there is no impairment is wrong because they have used the wrong
fair value less costs to sell when justifying their claim.

The cost of removing the asset should be included whilst the re-organisation costs should be excluded.

Therefore the fair value less costs to sell are:

(3.9m – 126,000- 174,000-85,000) $3,515,000.

The impairment is therefore $85,000 ( $3.6m - $ 3.515m)

The $85,000 is not material because it is only 3.6% of profit and less than 1% of total assets.

There will be no impact on the audit opinion for this error in isolation. The aggregate effect of all three
errors is, however, material , but even the aggregate effect is unlikely to be pervasive because of the
isolated nature of the misstatements.

Page 92 of 146
 b) Loan offer to audit staff

The loan may be a self-interest threat.

If a member of the audit team has a personal financial interest in a client, then that may mean the audit
work carried out by that person is not thorough enough because they are more interested in protecting
their interest than they are in carrying out the audit work.

It is unclear as to whether or not this is a threat because we do not know if the rate is a preferential one.

If the loan is being offered at a competitive, but commercial rate then it is not a threat and could be
accepted.

The offer does suggest that it is not at a normal commercial rate because it is described as “ the very best
deal we can offer”.

The matter should be discussed with the client in order to confirm the nature of the offer and, it is probably
the best course of action for Janette to consider refusal of the loan.

Secondment

There is a self-review threat here.

The staff member may help prepare the payroll information and then also be involved in the audit of the
same figures. This could result in less scepticism when gathering audit evidence.

The seconded staff member must also be careful not to assume management responsibility when helping
with the payroll preparation, such has getting involved with staff salary reviews.

Turner Co is a listed company so we should not be providing any accounts preparation help to them unless
the role assumed is insignificant to the client.

This is very unlikely to be the case, so we should probably decline the work after discussing with the client
and explaining the reasons why we are unable to accept.

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 Jansen & Co
ai) Matters to consider before acceptance

We would need to consider both ethical and practical issues- I will deal with the ethical ones first.

There is an advocacy threat here because we may be seen as promoting the client to the bank in order to
help obtain the loan.

There could also be a self-interest threat.

We may be tempted to allow the application to show the client in a very positive light so that they are not
upset and look for another audit firm to carry out the audit in the future.

A self-review threat may arise if the assurance report relies upon information in the previously audited
financial statements. There is a danger that we will over rely on this information and not gather sufficient
evidence.

Safeguards would need to be implemented in order to manage these threats, such as the use of separate
teams for each assignment, review of work by an independent partner and a clarification of management
responsibilities.

There are also practical considerations.

We would need to ensure that our firm has the necessary skills competence and capacity to cope with this
extra work. Taking on too much can result in poor quality and additional liability claims against us.

We would also need to clarify the use, distribution and period covered by the report so that we can plan
adequately and assess our exposure to potential liability from different user groups.

This type of assignment is not prohibited and could be accepted with sufficient safeguards and professional
care.

aii) Procedures

Do a recalculation of the forecast to confirm mathematical accuracy.

Obtain copies of the market research reports in order to confirm the reasonableness of the growth patterns
that have been predicted for revenue and costs.

Obtain copies of any quotations for new Tangibles, such as HGV vehicles to confirm the existence and
the initial valuation.

This can then be used to review and confirm the amount of depreciation that is being charged in the
forecast profit and loss account.

Obtain copies of any new, or existing contracts with customers in order to justify the estimated levels of
revenue.

Obtain copies of any existing loan agreements as well as a draft copy of the new agreement, if available.
These can be used to confirm the accuracy and completeness of finance costs.

A breakdown of operating expenses should be obtained and it should be confirmed that all expected
expense are included and justified.

For example, advertising and marketing expenses can be agreed to the marketing campaign.

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 Recent electricity and gas bills can be used as a basis for estimating projected future costs.

There should be a comparison made between the accounting policies used in the latest audited financial
statements and the ones used to prepare the forecast information to ensure that they are consistent.

A management representation should be obtained to confirm that all of the estimates and assumptions
used in the preparation of the forecast are reasonable.

b) Quality issues

Staff

There appears to be an insufficient number of staff allocated to this audit. There are only two which could
result in corners being cut and insufficient evidence being gathered.

Monitoring

There has not been enough monitoring and supervision during the audit. The manager was not replaced
quickly enough and the initial review is only just being done. These issues can result in budget over runs
and unnecessary work being carried out.

Expert

The valuation work that was carried out by the external expert has not been assessed appropriately.
“Checking out “ on line is not sufficient in order to confirm the skills, competence and independence of the
expert.

Insufficient audit evidence has been gathered in respect of this matter.

Competence

The request to follow last year as planning guidance is either due to a lack of professional competence or
a lack of integrity by Rodney.

If last year is replicated this year, then any new areas of concern will be missed.

Share based payment scheme

The scheme was not identified at the planning stage of the audit which demonstrates a lack of general
audit awareness as well as a lack of competence.

It is correct that the scheme is immaterial in value because it is only .3% of profit and .8% of total assets.

It is, however, material in nature because the scheme involves transactions with directors of Watson. The
failure to realise this is also a lack of competence.

The share based payment scheme should be disclosed as a related party transaction in a note to the
financial statements and this has not been done.

The scheme is also being valued incorrectly. This is a cash settled scheme, so it should be valued using
the fair value of the SAR s at the year-end and not the fair value at the grant date.

There should be an expense and a corresponding liability entry in the financial statements, so the equity
entry is incorrect.

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 It is likely that the errors relating to the share based payment scheme have not been identified because
the audit firm does not deal with these type of transactions on a regular basis. In other words, they do not
have the necessary skill and experience to carry out this audit.

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 Cathy & Co
This is a debrief of an ethics question from 2016. It is a 20 mark question divided up into two parts.

(a) The first part is for 6 marks and asks how professional scepticism should be applied to the
statements made by the management of Sue.

Type of evidence
The type of evidence obtained is verbal only which is cause for concern because it is the least reliable
type.

This is coupled with the refusal to provide a support letter-this suggests there is something to hide, so
professional scepticism should require us to follow this up rigorously.

Refusal
The refusal to discuss the matter should, again, arouse our suspicion. One reason for this could be an
attempt to conceal and we, as auditors, are duty bound to follow up if our suspicions are ever aroused,
which they should be here.

Group auditor
The nature of the behaviour of the group engagement partner is cause for concern.

It is unusual for someone to say these things and will, again, make us wonder why they are being said.

All of the above statements should make us question why we are being obstructed from doing what
we would normally do and further arouse our scepticism.

We have to form a specific opinion on the going concern status of Sue, as is now the case for all
normal audits-and we are being prevented from arriving at what is an essential part of our audit report
which should make us even more suspicious.

(b) Part b) is for 14 marks and asks for the professional and ethical issues relating to both the
support offered by Sue and the request not to modify the report.

The support
The evidence here is clearly insufficient. Verbal evidence is not a reliable source and we have nothing
else.

Even if we can obtain a support letter, we would still have to confirm the ability of the parent company
to support the subsidiary as well as its intention.

Unless further evidence can be obtained it is highly likely that a modified opinion would be given.

This could be using a material uncertainty relating to going concern or perhaps an adverse opinion if
the basis of preparation is deemed to be wrong.

It would be advisable to obtain direct confirmation from lawyers and inspect the board minutes for any
evidence concerning the likelihood of outcome on the court case to help us reach a conclusion.

Behaviour
The statements made by the client and their desire to restrict our access to evidence would be grounds
for modifying the audit opinion due to an imposed limitation on scope which would result in a disclaimer
of opinion.

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 We should consider reporting the issue to those charged with governance (the audit committee if there
is one) and this issue is so serious that it could result in our resignation from the assignment.

Request not to modify

The request made by the group auditor shows a lack of integrity, one of the fundamental principles of
the ACCA code of conduct.

We are being intimidated here, which is a specific ethical threat.

The threat to transfer the debt to another part of the group is also worrying because it looks like the
engagement partner is making a decision that the client management would usually make, a clear
management threat.

This behaviour should be reported internally to the ethics partner within your firm and could also be
grounds for disciplinary procedures to be undertaken against the engagement partner for breaching
the ethical code of conduct.

If Thornhill does resign from the audit as a result of these problems, they should issue a statement of
circumstances that outline all the problems encountered so that any potential incoming auditor is fully
aware of the situation before they accept the work.

Making Sue aware that this could happen may encourage them to cooperate!

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 Red & Co
This is a debrief of an ethics and reporting question from 2016. It is a 20 mark question divided
into two parts worth ten marks each.

(a) Part a) asks for professional and ethical matters as well as implications on governance of the
proposed listing.

Professional and ethical matters

– The request to second an audit partner for six months is too much of an ethical threat and should
be refused. There is the potential for a self-review threat in the longer term if that person returns
to our audit firm and then takes part in the audit of Green Co.

During the course of the secondment there would be a familiarity threat due to the proximity of the
working relationship between the partner and the client.

The request for a high level member of staff suggests that skill and experience is required by Green
Co which could result in a management threat if the partner gets involved in the decisions that the
client would usually be expected to make.

It would be possible for a lower level member of staff to fulfil the secondment role as long as it was
clarified that they would not be a part of any decision making on behalf of the client.

– The request to help recruit new board members should also be refused. This would be a
management threat because the audit firm would appear to be making staffing decisions for the
client.

There is also the possibility of a familiarity threat as we get too close to the client and their staff as
a result of the process.

In both cases, the threats are not manageable with safeguards so the requests should be refused.

– Implications of the listing;

Currently, there are not enough non-executive directors. There should be a balance between
executive and non-executive which will need to be addressed immediately. The fact that the Brown
family is heavily represented on the current board demonstrates a lack of independence of board
members. This will be addressed if further non-executive directors are appointed, however.

It may also be the case that there is insufficient financial experience on the board at present so
some of the new directors will need to have this expertise.

– An audit committee will be required in order to;

• Assess risk
• Monitor the internal controls
• Communicate with the external auditors
• An internal audit function should also be established and should report to the audit committee.

– There should also be a nominations committee and a remuneration committee in order to comply
fully with the code of corporate governance. At present, Green is not proposing to do hardly any
of these so they should be made aware of their importance as soon as possible.

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 (b) Part b) is also for 10 marks and asks for implications for the audit report and any further actions
necessary in two short scenarios.

Research project
The research costs in question represent 10.8% of profit and are material to the financial statements.
There appears to be a lack of evidence available and this restriction of access is being forced on the
auditor.

This is an imposed limitation on scope and should result in a modified opinion if the auditor is unable
to persuade the client to lift the restriction. Due to the severity of the situation, this should result in a
disclaimer of opinion which means that the auditor is saying they have been unable to form an opinion
as result of this restriction.

An explanation of the reasons for this would be included in an extra paragraph in the basis of opinion.

Further actions would be to inform those charged with governance of the problem and the proposed
modification.

Perhaps we could encourage them to help resolve the issue and avoid a modified opinion.

Fire
This appears to be a material issue because profits have fallen this year by $46m which is a 41 % fall.
There does not seem any need to modify the audit opinion because there is no misstatement, the
issue has been fully disclosed in the financial statements.

There is also no lack of evidence. However, an uncertainty does exist. Neither we nor the client know
for exactly how long production will be delayed.

Seeing as this uncertainty has been disclosed properly in the financial statements we should include
an emphasis of matter paragraph in the audit report.

This paragraph will refer to the disclosure note that is already included in the financial statements and
will state clearly that the opinion is not being modified.

This issue is not serious enough to require a going concern paragraph.

The format change to the report would be the only further action needed, although we would have to make
sure that all necessary going concern audit tests have been carried out just to be sure that the situation is
not more serious than we originally thought.

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 Morgan & Co
This is a debrief of an ethics and procedures question from 2016. It is a 25 mark question.

(a) Part a) is for 13 marks and asks for ethical, professional and quality control issues in a given
scenario.

Materiality
A planning level of materiality should be initially set, as is the case here, but it should be reviewed
throughout the course of the audit and changed if it is considered appropriate to do so.

There is no evidence of this having been done in any of the audit working papers.

This is a quality issue because of insufficient work carried out -no review of the materiality level- and
because of inadequate documentation.

Packing Machine
The evidence obtained to confirm the treatment of the packing machine is insufficient and unreliable.

The machine is material to the financial statements, $1.6m compared to the initial materiality level of
only $1.5m.

The new asset should have been physically verified by the audit staff as this would be auditor
generated evidence - one of the more reliable types.

Work should have been done to assess the reasonableness of the useful economic life and the
accuracy of the depreciation charge.

Without this, it is not possible to draw a reliable conclusion on the appropriateness of the machine
valuation in the financial statements.

Inventory
Inventory of $2m is above materiality level.

The issues identified at the inventory count suggest control deficiencies which should be reported to
those charged with governance- usually the audit committee.

This has not been done.

These errors should be extrapolated before being compared to the level of materiality which has also
not been done.

No follow up work, such as a net realisable value test or agreeing the count figures to the final financial
statements-has been done at the final audit, so insufficient work has been carried out

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 Quality of the review work
The review work is substandard.

The partner and manager should not try to review at the same time.

The manager should review first, then the partner at a slightly later date, so this could include a review
of the manager’s work.

Some review could have been done a lot earlier in the audit process to allow for adjustments to, and
refocus of, the audit work with minimal disruption.

The actual review work done by the partner is also far too informal and not detailed enough.

They should not rely upon verbal assurances that everything is ok and should allow sufficient time to
carry out a decent level of review, instead of a quick skim.

Ethical Issues
The work providing a consultancy service is an ethical issue.

There is a self-interest threat because a member of the auditor’s family is receiving remuneration as a
result of this relationship.

There is also a familiarity threat, this arose in the first place because of the close personal relationship.

The self-interest threat may be even greater if the audit engagement partner actually receives a referral
fee.

The comments made by the partner to the audit junior lack integrity and could be interpreted as
intimidation, attempting to pressurise the junior member of staff into ignoring something that they
believe should be documented.

The audit junior should feel able to disclose this matter, especially the nature of any remuneration
involved.

The partner should be disciplined here and possibly removed from this audit in order to demonstrate
an attempt to comply with the ethical code.

(b) Part b) is for 12 marks. It is divided into two sections.

(i) Part (b – i) is for 7 marks and asks for matters to be considered and actions to be taken in
a given scenario.

The work in progress is material because it is 4.7% of total assets.

The deferred income is also material because it is 2.7% of total assets.

The evidence of cancellation is an adjusting event in accordance with IAS 10 because it provides
additional evidence on conditions that existed at the year end, so it seems as though the current
treatment is incorrect.

The assets could be overstated by the amount of the work in progress if they should have been
written off.

The deferred income may also have been mistreated, it may need to be repaid in which case it
can remain as a liability. If it is to be kept, then it should be included as part of revenue.

No mention in the integrated report.

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 • Auditors have a duty to ensure that any information in an integrated report is consistent with
the financial statement information.

• The loss of this contract is a significant event, it is one of only seven contracts, so failure to
include reference to it in the integrated report would need to be addressed because it currently
means that there is inconsistency.

Actions
• The management of Knot should be given the opportunity to make the necessary changes to
the financial statements and the integrated report.

• If no changes are made, then the incorrect accounting treatment and the inconsistency
between the financial statements and the integrated report should be communicated to those
charged with governance- probably the audit committee.

• If no changes are still made then the audit report would need to be modified due to both the
misstatement and the material inconsistency.

(ii) Part (b - ii) is for 5 marks and asks for relevant audit evidence for the above matter.

These would include;

• Inspection of the correspondence with Knot that showing the cancellation of the contract, this
would confirm that the work in progress is currently overstated.

• Inspection of the contract to confirm the initial terms and length.

• Inspection of the contract could also confirm any obligation to repay the income -thus clarifying
whether or not there should be a liability in the financial statements.

• Inspection of the bank records to confirm that the $200,000 has actually been received.

• Inspection of the board minute to see if there have been any discussions concerning alternative
uses for the work done so far.

• Inspection of the integrated report to identify any other potential inconsistencies with the
financial statements.

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 Yes Co
This is a debrief of a fraud/ethics question from 2016. It is a 20 mark question.

(a) Part a) is for 7 marks and asks for an explanation as to why revenue is subject to fraud and
what our response to this risk should be.

Volume
Revenue is usually one of the largest figures in a set of financial statements which makes it easier to
conceal some fraudulent transactions, they can be ‘lost’ within a big population.

Manipulation
Revenue is often used as a basis for staff remuneration. Employees are frequently paid a bonus based
upon the achievement of target sales levels.

Therefore, there is the possibility that revenue would be deliberately manipulated in order to achieve
the target and receive the bonus.

Judgement
Revenue recognition includes a number of significant judgements that have to be made, which
increases the chances of those decisions not being made responsibly.

Complexity
Sometimes it is difficult to identify the type and value of revenue due to the complexity of the
transaction.

For example, it is not always easy to unbundle different types of transaction- the sale of a computer,
the software and a related service agreement would need to be split out, this is not always easy to do.

Technical Knowledge
IFRS 15 is quite new and it would be quite easy for someone preparing financial statements to
manipulate revenue and then blame it on a lack of knowledge.

Auditors could also suffer from not having up to date knowledge of the changes so it would perhaps
be easier to deceive them or for them to make mistakes.

Assertions
Certain assertions-such as completeness and cut off- are very important for all profit and loss classes
of transaction -revenue in particular.

If insufficient audit work is done in respect of these particular assertions , then fraud is more likely to
go undetected.

Actions

• Auditors should maintain their professional scepticism at all times when auditing revenue.

• They must ensure that risk assessment is carried out properly to give themselves a decent chance
of identifying things like sales related bonuses.

• Auditors must also ensure that they have both sufficient general business knowledge and detailed
knowledge of the particular client’s systems and activities.

This will enable them to spot potential problems.

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 (b) Part b) is for 13 marks and is divided up into two subsections. In both cases we are asked for
implications for the completion of the audit and further actions that should be taken.

(i) Part (b - i) is for 7 marks

Cash Transfer
The transaction is material because it is 1.3% of total assets.

It is also a high risk transaction because it is cash, therefore more susceptible to loss or theft.

There is a lack of segregation of duties over the cash transactions of Yes as one person has sole
responsibility, which increases the chances of errors or fraud occurring and not being addressed.

It is also concerning that no documentary evidence has been received meaning that we do not
have sufficient evidence to form an opinion on the validity of the transaction.

This is a potential money laundering issue which needs to be investigated further.

Large cash transactions involving overseas bank accounts with little or no documentation are key
potential indicators of money laundering activities.

Actions

• This event should be reported to our Money Laundering Reporting Officer (MLRO)
immediately.

• It is then their responsibility to report it externally if they think it is necessary to do so -it is

always advisable for them to do so.

• We should also try to obtain more information about this transaction and to try and establish
whether there are any other similar transfers.

• While we are investigating this, we must also be careful not to ‘tip off’ we must not alert the
client to what we are doing.

So confidentiality is absolutely key.

(ii) Part (b - ii) is for 6 marks

Legal Dispute
This is a material amount because it represents 6.8% of profit.

Putting a provision in the financial statements in one year and then reversing it out in the following
year could be appropriate.

It could also be earnings management, which is unethical, so this transaction should be treated
with professional scepticism and investigated further.

At the moment, there is insufficient audit evidence on this matter and, more concerning is the fact
that Mr. Jones appears to be avoiding us.

This should further increase our professional scepticism.

Actions

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 • We should review IAS 37 and try to decide whether or not the provision criteria applies in either
year for this event.

• We should try to obtain direct confirmation from Yes’s lawyers - a very reliable external source
of evidence.

• We should re try to contact Mr. Jones and ensure all attempts and potential responses are fully
documented.

It would also be necessary to include and potential adjustment in a list of unadjusted misstatements and
make sure that Yes realises that the audit opinion would be modified if this is an error and it is not corrected
by the client.

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 Circus & Co
This is a debrief of quality control question from 2017. It is a 25 mark question divided into three
parts. Each part gives us a separate scenario and asks for quality control and professional issues,
then further procedures to undertake before the audit report is finalised.

(a) Issues

Control problems
The decision made to test controls demonstrates a lack of technical competence at the planning stage.
If controls are assessed as being weak, then a substantive based approach should be used. There is
no merit in deciding to rely on control testing if the controls are not working properly!

As a result, insufficient audit evidence will have been obtained.

Intra group balances

Professional competence is again called into question by the statement that no testing is needed on
the intra group balances because they are only going to end up getting cancelled out.

Firstly, they will still affect the individual company figures and secondly, if they are wrong, then the
wrong amounts would be cancelled out so the group figures would be incorrect as well.

Capital Expenditure
If the controls over the capital expenditure are assessed as strong for Harry, then a test of control
based approach may be used for the audit of that particular component. However, it is not reasonable
to assume that the controls are effective throughout all of the other components, these should be
assessed separately.

Overall, there seems to be a lack of adequate skill demonstrated at the planning stage of this audit,
perhaps due to a lack of relevant experience - and little or no communication between the auditors of
the different components.

Procedures
More substantive testing needs to be done on the intra group balances, such as;

• Reconciliation of all intra group balances

• A sample of intra group sales and purchases should be selected and agreed to the source invoices.

• A comparison with previous period balances for reasonableness.

The control weaknesses should be reported to those charged with governance, this would usually be
the audit committee if there is one. We should also explain the consequences of the weaknesses and
suggest ways in which improvements could be made so that we could, perhaps, adopt a test of control
based approach next year.

For capital expenditure, the controls should be assessed on the capital expenditure system for the
other group components. Then the audit approach can be designed accordingly.

If controls are strong, then a test of control based approach can be adopted for the group as a whole.
If not, then a substantive approach would be needed. Either way, more audit work will be required
before the audit report can be produced.

(b) Documentation

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 There is a lack of documentation for the work done on Gerry which makes it impossible to review
adequately or to demonstrate what work has actually been carried out. Any subsequent external review
process would be highly critical of this.

The statement that Gerry is immaterial to the group as a whole is incorrect because the total assets of
Gerry represent 23% of group assets. The conclusion drawn here shows a lack of technical
competence .Even though the profit for Gerry is well below materiality when compared to the group as
a whole, the assets are not, so this is a big problem. There is a danger that insufficient audit evidence
has been obtained.

Analytical procedures are an acceptable method for gathering evidence but are likely to be insufficient
on their own, especially if the decision to rely exclusively upon them is based upon the wrong
assumption in the first place.

Procedures

• A review of the group planning procedures needs to be undertaken to try and prevent this kind of
wrong application of materiality happening again.

• The group auditor should ensure that adequate documentation exists on the audit file to justify any
decisions that are made.

• The audit approach should be revisited in the light of Gerry being material to the group and more
substantive work should be carried out.

(c) At least in this case it would appear that a decent level of business understanding has been obtained
which should make the group audit easier and of a better quality. However, there is a danger of over
reliance on the opinion of the component auditor.

Although the assets and profit are well below the group component materiality levels (6% of assets
and less than 1% of profit when the benchmark is 15% for either), the circumstances may make this
material in nature.

If so, it is not appropriate to rely totally on the opinion given by the component auditor - some
substantive work will need to be carried out by the group auditor.

Also, this issue may impact directly on the activities of some of the other group components which
could increase the significance of the matter.

On an individual company level, the goodwill may be overstated if it has not been tested for impairment.
Goodwill is material because it is 2.3% of total assets so could have an impact on the audit opinion if
it has not been dealt with correctly.

Procedures

• The work done by the auditors would need to be reviewed in detail, especially for;

o The impact of the government legislation and any provisions or sales adjustments;
o The work carried out on goodwill and any potential impairment.

• The going concern of the individual company and the group as a whole will need to be re-evaluated
and it is quite possible that more audit work will need to be done in this area.

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 Friday & Co
This is a debrief of an ethics question from 2017. It is a 20 mark question divided into 3 parts.

(a) Part a) is for 10 marks and asks for ethical and professional issues in a given scenario.

Issues

• The review work carried out is a hot review as it is taking place before the audit report is produced
which is an efficient way of guiding and focussing the audit work. The audit team have correctly
identified an inventory valuation issue that is probably material to the financial statements,
demonstrating a degree of professional competence.

• The finance director is not behaving appropriately. By refusing access to records they are
restricting our ability to obtain all information and explanations that we consider necessary in order
to do our job properly.

• The finance director should also be aware that the client will have signed a letter of engagement
that states all records will be made available, so this contractual agreement is now being breached.

• The finance director is creating an intimidation threat by saying they will try to get us barred from
the premises and by trying to tell us what to do and what not to do. The remit and parameters of
the audit work are for the audit firm to decide, not the client.

• The inventory has probably been overvalued but it is going to be very difficult for us to confirm this
not that the inventory has vanished. The assets of mouse are likely to be materially overstated.

To summarise here, all the unethical actions are carried out by the client, not the audit staff, but they
still need to be addressed.

Actions

• Every stage of this process needs to be documented. It is quite possible that this will end up with
some kind of action taken against the finance director so it essential for the purpose of review and
self-protection that every action is evidenced in writing.

• Because Mouse is breaching regulations by selling controlled medicine past its sell by date, the
breach will need to be reported externally to the relevant authorities. This will not create a breach
of confidentiality because we have a legal duty to report it.

• The actions of the finance director should also be reported within Mouse to those charged with
governance - the audit committee- and we should expect appropriate action to be taken by them.

• In view of the threats from the finance director it is probably advisable for our audit firm to obtain
legal advice.

• As it stands, if no adjustments are made to the financial statements, then it will be necessary to
modify the audit opinion.

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 • In view of the deliberate concealment of evidence and the general attitude of the finance director,
it is probable that a disclaimer of opinion would be issued because of the imposed limitation on
scope.

• Ultimately, due to the seriousness of the issue, we may consider resignation -we would not want
to be associated with a client with such a poor reputation.

(b) Part b) is for 3 marks and asks for the difference between a performance audit and the audit of
performance information.

A performance audit gives a company some comfort on how well a particular activity is being carried
out.

We would conclude upon the effectiveness and efficiency of an activity or a group of activities within a
company.

An audit of performance information is where we, as the practitioner, form an opinion on some
performance information provided by a client.

The first one reviews how well an activity is being carried out -the second one concludes on how well
the activity is being measured.

(c) Part c) asks for procedures to audit the performance information of Mouse.

General procedures include;

• Obtain confirmation of performance targets form local authority guidelines.

• Inspect minutes of performance review meetings to ensure monitoring is carried out on a regular
basis.

• Recalculate any management computations to ensure accuracy.

Specific Procedures;

• Patient nurse ratio

o Inspect payroll and HR records to confirm staff numbers.

o Inspect appointments register to confirm the number of patients that have been seen.

• 75% annual usage

o Physically verify the number of surgical rooms and agree to the asset register.
o Inspect the booking schedule for the surgical rooms.
o Inspect cancellation notices for unfulfilled procedures.
o Inspect contracts of surgeons to confirm how many hours’ worth of resource is available.

• Rate of re-admission

o Inspect patient admission records for evidence of repeat treatment.

o Confirm with management the definition of repeat treatment as this probably involved quite a
lot of judgement.

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 Mike Group
This is a debrief of a planning question from 2016 and is for 35 marks. This includes 4 professional
marks that are awarded for the normal presentation formalities (headings, clarity, use of English)

Part a) is for 14 marks and asks for audit risks relevant to the planning of Mike.

To: Sammi Yaffa

From: Engagement Manager
Subject: Briefing notes

Introduction
These briefing notes summarise the major audit risks relating to Mike, as well as covering the degree of
reliance on the internal audit function and a summary of some major audit procedures.
Joint Venture

The cost of the joint venture is 7.5% of total assets and is material to the financial statements of Mike.

This should be equity accounted for and there is a risk that this has not been done.

It is not always the case that sharing the ownership of share capital in a 50:50 split is actually a joint
venture anyway.

There is a risk that this is not a joint venture because Mike may have control through an operating
agreement or the ability to appoint the majority of board members.

Licence to Operate
This has been initially recorded as an intangible which is correct. The cost is 10.9% of total assets and is
a material amount.

This should be amortised over the useful life of the asset and there is a risk that this has not been done
correctly.

The useful life starts halfway through the current year so six months charge should be made in the
statement of profit and loss.

Both the licence value and the profit will be misstated if this has not been done.

Impairment of the Licence

The fall in customer demand is an impairment indicator so the licence should be tested for impairment.
If this has not been done, then there is a risk that the licence is overstated.

Alternatively, the impairment may have been recorded but miscalculated - another audit risk.
Revenue

The first-time adoption of IFRS 15 increases the risk of misstatement because it may not be done correctly
due to a lack of relevant knowledge on the part of the preparer.

The new rules require a certain amount of judgement to be applied which may not have been done
appropriately.

Change in Policy
The new application of IFRS 15 will probably result in a change in accounting policy which may not have
been quantified correctly or disclosed properly in the financial statements.

Network Rights

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 The cost of the new rights is 3% of total assets and is material.

It states that the seller decides which networks will be used by Mike which suggests that there has not
been a transfer of risk and reward and that the rights should not be recorded as an asset by Mike.

This means assets are materially overstated.

Segmental Information
There is a risk that the segmental information is not disclosed in enough detail in the financial statements.

There is also a risk of misclassification of revenue between segments- especially with South East Asia
which is much higher than last year, and America which is much lower.
When extrapolated from 8 to 12 months these differences are even larger.

It is also possible that centralised costs have not been allocated appropriately or that inter segment items
have not been removed.

Control risk
Despite the fact that the internal audit department states that the controls are working well, there were two
issues identified during the year to suggest that control risk may actually be higher than expected.

We will need to do some analysis work on the strength of the control environment and the procedures in
place in order to effectively manage overall audit risk

Part b) is for 8 marks and asks for the matters to consider in determining the assistance level and
the degree of reliance that can be placed upon the internal audit function.

Qualifications/Experience
The internal audit department is managed by a qualified person which suggests professional competence.

However, it should be confirmed that the other members of the department are either qualified or are
training to be qualified.

It should also be confirmed that all internal audit staff have been updated on IFRS 15 as this is new and
an area requiring significant judgment, so the staff may not possess the necessary skills here.

Degree of Independence
Mike is a listed company, so the internal audit department should be answerable to the audit committee to
ensure as much autonomy as possible.

The internal audit report is addressed to the finance director, so this reduces the amount of autonomy and
results in us, as auditors, placing less reliance on it
Control weaknesses

There have been control weaknesses identified so we will need to ensure that all information relating to
these has been documented properly and that the internal audit department felt free to carry out any follow
up work in either area.

Any possible restriction imposed upon them would result in a lower level of confidence in their work.
Any use or reliance on the internal audit function will require written agreement and an acknowledgement
that information will remain confidential at all times.

This is needed in order to rely on anything done by the internal audit function.

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 Part c) requests audit procedures to confirm the classification of the joint venture (4 marks) and
the measurement of the licence to operate in Farland (6 marks).

Joint Venture
Inspect the initial Joint Venture agreement to confirm:
– The number of shares acquired
– The voting rights per share
– Any profit sharing arrangement

Inspect the board minutes to ensure that any decisions are actually made jointly by both parties.

Confirm that the board structure is reasonably balanced between the two parties by inspecting the
organisation chart or payroll.

Inspect any separate operating agreement that may exist to confirm again that all decisions are made
jointly.

Licence Measurement
Inspect the licence to confirm that it runs for ten years. Also look to see if there is the facility to extend the
licence beyond ten years as this would affect the amount of amortisation.

Inspect some customer contracts to ensure that the start dates are July 1 - confirming the beginning of the
useful economic life.

Re-perform the impairment calculation and ensure that it is only for six months in the first year.

Inspect any impairment calculations carried out by management and confirm the reasonableness of any
value in use calculations by inspecting any budgets produced.

Inspect the acquisition contract to confirm the initial cost and agree the cash paid to bank records.

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 Hook Co
This is a debrief of an assurance question from 2016. It is a 20 mark question divided into two
parts.

(a) Part a) is for 14 marks and asks for the appropriateness of and the procedures relating to a
cash flow forecast prepared by our client.

Level of forecast receipts

The actual receipts have not altered much over the periods up to September 2016, but the forecast
levels increase by much more; between 2 and 3%.

This suggests an over optimistic income forecast and over inflated results- there would only need to
be quite a small reduction to result in negative cash flows for all the forecast periods.

Salaries
The level of salary payments are not forecast to rise in line with the change in sales volume.

Significant sales increases may well require more staff and this does not appear to have been reflected
in the forecast, resulting in potentially understated expenses.

Sale of investments
The cash expected from the sale of the investments is 43% higher than the current value of the
investment, so may be significantly overstated.

If this is the case, then Hook may struggle to repay the director’s loan.

Bank loan
The assumption that the existing bank loan can be repaid by simply obtaining a new loan for the same
amount may not be realistic -putting further potential strain upon liquidity.

Missing payments
A number of significant expense payments appear to be missing which would overstate the final cash
position. There are no tax, dividend payments or capital expenditure.

Interest payments are also not shown separately although it is possible that they are included in
operating expenses.

Procedures

• Obtain a management representation to confirm the reasonableness of the assumptions that

underly the forecast as a whole.

• Confirm the projected level of inflation is in line with government estimates.

• Inspect the non-current asset register to confirm the age of the assets, in case lots are old and will
need replacing in the forecast period.

• Inspect the two existing loan agreements to confirm the dates and amount of repayment for both,
as well as whether there are any late payment penalties.

• Enquire as to whether any initial discussion has taken place to assess the possibility of new loan
finance by obtaining direct confirmation from the bank or just by inspecting the correspondence
between Hook and the bank.

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 • Inspect the payroll and enquire with HR to confirm the reasonableness of the payroll expenses.

• It would also be worth examining previous forecasts, if any that have been produced by
management to see how accurate they have proved to be in the past.

• Finally, an inspection of both the existing loan agreements and a global proof of the interest
expenses could be carried out. A comparison of forecast interest expenses with potential rate rises
could help confirm the estimated expenses relating to the future loan as well.

(b) Part b) is for 6 marks and asks for matters to consider and audit procedures for the loan to Mr.
Smith Matters.

The loan to Mr Smith will be a related party transaction so will be material in nature, irrespective of the
value.

This means that full disclosure of the loan will need to be made in the financial statements, including
the nature of the relationship, the value and the terms of repayment.

Any failure to do this would result in a modified audit opinion on the grounds of material misstatement.

The loan is a financial liability and should be measured in accordance with IFRS 9. If this is not done,
this would also be grounds for opinion modification.

Procedures

• Inspect the financial statements of Hook for the existence and adequacy of the related party
disclosures.

• Inspect the loan agreement to confirm the amount, the repayment terms and any potential penalty
for late or non-payment.

Obtain a management representation to confirm that there are no other related party transactions.

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 Mint Co
This is a debrief of a planning question from 2016. It is a 35 mark question that is divided into three
parts, as well as including the normal 4 professional marks that are always available for
presentation and clarity.

To Engagement partner
From Audit manager
Subject Violet Group Planning

Introduction
This set of briefing notes discusses the importance of analytical procedures, then explains the key
audit risks for the planning of the Violet group and then discusses relevant ethical issues.

Any calculations are included in the appendix.

(a) Pat a) is for 5 marks and asks for the general importance of analytical procedures at the
planning stage of an audit.

• Analytical procedures are compulsory at the planning stage, but even if they were not, they are a
great way of identifying audit risk which will help with an efficient audit.

• They also require an auditor to gather specific knowledge about the client if they are to be done
well, which also increases the chance of misstatements being identified.

• Unusual transactions can be spotted early so there is sufficient time to follow these up and obtain
explanations for them.

• They enable us to focus our audit work on specific, high risk areas, so will help us devise an audit
strategy.

Overall, analytical procedures will enable us to manage detection risk and minimise any possibility of
liability claims against us.

(b) Part b) is for 18 marks and asks for audit risks relating to the group and requires this to be
supplemented by using analytical procedures to help us do this.

1. Current Ratio
The current ratio has fallen from 0.9 to 0.8 which suggests potential misstatement of either current
assets or current liabilities, or both.

This appears to be mainly due to the deterioration of the cash position over the two years. It is
possible that other figures within net current assets have been manipulated to counteract this.

Receivables days has increased from 52 days to 60 days and suggests that receivables could be
overstated because not enough allowance and / or write off has been included for any irrecoverable
debts.

As well as overstating current assets, this would also overstate profit due to the missing expense.

2. Inventory
Inventory days is almost the same for both years (37) which may be a bit concerning- seeing as
revenue has increased by so much we may expect a corresponding increase in inventory.

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 It should be confirmed as to what this inventory actually is- a company that offers distribution and
handling services would not be expected to have much inventory of its own.

Inventory could be consistently overstated here.

3. Revenue
The claim is made by the group finance director that no major changes have taken place this year,
but revenue has increased by 19%!

This is a large increase and needs further investigation.

It could be a deliberate overstatement of both revenue and profit by, perhaps, manipulating the
year end cut off position allowing Violet to record revenue too early.

4. Operating Margin
Despite the increase in revenue, the operating margin has fallen from 12.1% to 7.2% so costs have
increased at a higher rate than revenue -this needs to be investigated.

It is possible that some of the modernisation expenses have been misclassified.

If they have been included incorrectly as revenue expenses when they should have been
capitalised, then this would explain the increase to operating expenses.

This would result in an understatement of both profit and tangible non-current assets.

5. Depreciation
There is a risk that depreciation is misstated.

It could be too low if some expenses have been treated as revenue expenses when they should
have been capitalised.

Also, the different component parts of the warehouses, layout, computer systems and electrical
systems, will have different lengths of useful economic lives and may not have been depreciated
separately, leading to further potential misstatement.

6. Finance Costs
Interest cover has fallen form 12.7 times to 6.8 times which could be partly due to an overstatement
of finance costs, they have increased from $3m to $4m.

There has been a new loan taken out during the year but it is likely that any borrowing cost relating
to this loan would qualify to be capitalised under IAS 23 because it is specifically related to the
warehouse modernisation.

If this is the case, finance costs are overstated and tangibles are understated.

7. Disposal
The profit on disposal of the 5% share capital is material because it is 30% of profit before tax.

This could be miscalculated in which case it is misstated.

It is also recognised in the wrong place and has overstated profit for the year by $10m

This change in ownership does not result in a loss of control by Violet so should not be recognised
as part of the profit statement.

It should be recorded as a reserve and non-controlling interest adjustment in the statement of

changes in equity- so the financial statements are currently wrong. Goodwill

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 Goodwill is material because it is 8.2% of total assets and it is unchanged for the two year period.

Goodwill should be tested annually for impairment .If this has not been done, then assets are
overstated.

8. Deferred Tax
The deferred tax asset is material because it is 2.7% of total assets and it could be overstated.

It arose from unutilised losses and it may be the case that those losses are no longer recoverable
meaning that the deferred tax asset may need to be reduced further or removed in full.

9. Provision
The provision for the onerous contract has halved but still represents 1.6% of total assets so is
material.

This could be legitimate because some of the contracts may have expired, but it could also be a
deliberate understatement and needs to be investigated further.

(c) Part c) is for 8 marks and asks for ethical issues and recommended actions to be taken.

Tax investigation
This creates the ethical threat of advocacy because the audit firm will be representing the client’s
position at the tax tribunal.

It also may create a possible self-review threat seeing as we will end up providing an opinion on the
financial statements that are under the scrutiny of the tax authorities.

This second threat is reduced somewhat by the fact that we did not carry out the tax work in the first
place but the threat does still exist.

The threat may well be too high to mitigate against and could result in the refusal of the role, but some
safeguards could be implemented, such as;

1. Segregate duties so the staff involved in the tax tribunal advice are not the same as the staff
carrying out the audit.
2. Having regular and independent review of all of the work carried out.

Appointment
The request to have a partner appointed as a non-executive director is fraught with ethical issues.

This partner is supposed to be part of the audit committee who review the independence of the external
auditor so there is a clear self-review threat here at the very least.

There is also a management threat because the partner would be involved in the client’s decision
making process.

Also, there would be a self-interest threat because the partner would probably be receiving
remuneration for the role.

This request should be refused. It is too much of an ethical issue and it is specifically prohibited,
auditors are not allowed to be officers of the audit client.

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 Appendix

Ratio Calculations
2016 2015

Current ratio 97/120 = 0.8 83/95 = 0.9

Operating Margin 27/375 x 100 = 7.2% 38/315 x 100 = 12.1%

Receivables Collection Period 62/375 x 365 = 60 days 45/315 x 365 = 52 days

Inventory Holding Period 35/348 x 365 = 37 days 28/277 x 365 = 37 days

Interest Cover 27/4 = 6.8 times 38/3 = 12.7 times

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 Hello & Co
This is a debrief of a planning and evidence question from 2017. It is a 35 mark question and
contains the normal 4 professional marks for presentation and clarity of work.

To: Audit Engagement Partner

From: Audit Manager
Subject: Group audit planning

Introduction
These briefing notes cover key risks of material misstatement relating to the Lolly group and
summarises any additional information that would help us with the analytical review.
They also cover principal audit procedures for some key areas.

Any calculations are included in the appendix.

(a) Par a) is for 16 marks and asks for risks of material misstatement in a given scenario. Students
are asked to use analytical procedures to identify these risks.

Operating profit
Operating profit has fallen from 19% to 15.9% which needs further investigation and could be due to
a misstatement of either or both sales revenue and operating expenses. If the one off impairment of
$30m is removed from operating expenses, then operating expenses have decreased from last year
which is not consistent with the increase in revenue.

This suggests that operating expenses have been understated, potentially by a material amount.
The increase in revenue is inconsistent with the impact of the fact that the Chip products have been
withdrawn from sale. This would suggest that revenue should have fallen, so revenue may well have
been overstated.

Interest Cover
Interest cover is virtually the same in each year, 5.3 last year and 5 this year. Finance cost is also the
same, $7m for both years. This is not consistent with the fact that a new loan was taken out in early
2017.

We would expect finance costs to be higher as a result and perhaps cover to be lower, seeing as the
loan has only been available for a few months and has yet to generate any significant extra profit. This
suggests an overstatement of profit due to the omission of the new finance costs.

Current ratio
The current ratio has increased dramatically from 4.3 to 7.5. This could suggest overstatement of
current assets and /or understatement of liabilities. Given the situation with the Chip range, it is
possible that the inventory is overstated if it has not been written down as a result of the impairment
to the brand.

Current liabilities have fallen by $6 m which is 24% of last year’s level - they may well be deliberately
or accidentally understated.

Additional loan
Non-current liabilities may well be understated by the amount of the additional $130m loan to help
finance the acquisition of Azalea. If the purchase is going to take place in early June 2017, then the
loan may need to be recognised before the end of May 2107 if the agreement was in place at that
time, in which case non-current liabilities are too low.

Gearing

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 Gearing has risen from 26.6% to 30.4% which could be expected due to the new loan that has
increased non-current liabilities. However, Gearing may be too low if the other loan for $130m has
been omitted.

Development Costs
It says that $20m has been spent on development but the development asset has only increased by
$15m. This may mean that non-current assets are understated by $5m. Alternatively, some of the
expenditure may not qualify as development so has been written off as part of operating expenses.

This is unlikely as we already believe operating expenses to be too low rather than too high. Perhaps
some of the cash is still in current assets as a bank balance, which would partly explain both the
increase in current assets and the increase to the current ratio.

Tangibles
The change in depreciation rate during the year could be a deliberate attempt to understate expenses
due to the profitability problems from which the company is suffering.

This is a change in estimate and would need to be disclosed as such in the financial statements, there
is a risk that this has not been done.

Impairment
The impairment is 8.4% of total assets and is material to the financial statements. The $30m
impairment is lower than the total decrease to intangibles of $35m, so the reason for the other $5m fall
needs to be established. This could be an error so intangibles may understated by $5m.
(b) Par a) is for 16 marks and asks for risks of material misstatement in a given scenario. Students
are asked to use analytical procedures to identify these risks.

The additional information that would help with the analytical review would be as follows;

• A breakdown of operating expenses so we can see whether any expenses have been omitted,
seeing as we suspect that the figure is too low.

• An analysis of sales by range so that we can determine the full extent of the fall in the sales of the
Chip range and try to establish why sales has actually increased.

• Details relating to both bank loans are required. The agreements for both should be inspected to
confirm the completeness of both finance cost and non-current liability.

• Support for the change in depreciation rate is also needed.

• We need to inspect the board minutes to establish the actual replacement frequency.

• We could also use the non-current asset register to establish the age of the assets and the
frequency with which they are being replaced, which would help to validate the change in method.

(c) Part c) is for 10 marks and asks for audit procedures to verify the impairment of the Chip brand
and the acquisition of Axe; 5 marks for each.

(i) Chip brand

• The initial carrying value of the brand before impairment, including the amount of amortisation
charged so far, should be agreed to the financial statements and the calculations that should
already have been performed by management.

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 • Inspect the schedule of operating expenses to ensure that an impairment is included.

• Recalculate the amount of impairment and try to confirm the recoverable value by;

o Inspect budgets for future cash inflows to confirm the value in use;
o Obtaining an external valuation to confirm the fair value less selling costs.

• Obtain a management representation that the amount of the impairment is sufficient and
that no other brands have suffered any impairment.

(ii) Acquisition of Axe

• Inspect the board minutes of the Lolly group to ensure that the acquisition has been authorised.

• Inspect after date records to ensure that the cash paid to acquire Axe has been recorded in
the cash book and on the bank statements.

Obtain bank correspondence and, if it exists yet, the loan agreement to ensure that the finance
is in place and has been authorised.

• Inspect any due diligence reports that have been carried out on the new acquisition to
determine its commercial and financial viability.

• Inspect any articles of association for the acquired company and confirm the shares that need
to be acquired in order to gain control and confirm how the voting rights correspond to the
number of shares.

Appendix

2017 2016

Operating Margin 35/220 x 100 =15.9% 37/195 x 100 = 19%

Interest Cover 35/7 = 5 times 37/7 = 5.3 times

Current Ratio 143/19 = 7.5 times 107/25 = 4.3 times

Gearing 100/329 x 100 = 30.4% 80/301 x 100 = 26.6%

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 Orange Co
This is a debrief of a matters and evidence question from 2017. It is a 20 mark question on matters
and evidence and is divided up, as is normal for this type of question, into 3 parts.

(a) Part a) 7 marks

Matters

• The inventory is 1.1% of total assets and 19.6% of profit so is material to the financial statements.

• The method of inventory valuation is always subject to a risk of misstatement due to the amount
of judgement that could be used. In this case, we could argue that more judgement than normal is
being used, forecast wages and estimated hours instead of using any actual figures and forecast
units of production for overhead allocation.

Inventory could be either over or understated as a result of the use of so much estimation.

• The significance of the inventory figure could result in a modified audit opinion if the amount is
wrong or cannot be verified.

Evidence
The evidence normally expected would be;

• The cost of inventory raw materials could be agreed to purchase invoices.

• Inspection of the annual budget to confirm the total forecast level of wages costs and production
overheads

• Inspection of the company payroll to confirm the actual number of staff, verifying any starters and
leavers, to agree the staff numbers used in the estimation.

• Recalculation of any work done by management, such as the overhead allocation, for accuracy.

• A comparison between this year and last year calculations for payroll cost and overhead cost taking
into account any inflation and any pay increments to ensure overall reasonableness.
(b) Par b) 7 marks

Matters

• The impairment is material because it is 8.4% of profit.

• Impairments include judgement when calculating recoverable value-both the value in use and the
fair value less costs to sell are subjective to a degree. Therefore the risk of misstatement is high.

In this case the fair value less selling costs appears to be a reasonable average figure but the
value in use does not seem to be so reliable.

Taking the historic cash flows for all outlets and assuming that they will all increase by the same
amount moving forwards is not likely to be accurate. There is a good chance here that the value
in use and, as a result, the recoverable value are too high which would overstate both assets and
profit.

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 This may have been done deliberately or accidently.

• The way in which the impairment has been allocated is wrong. Goodwill should be impaired first,
then the remaining impairment should be spread across the tangibles on a pro rata basis using
their carrying values. At present, goodwill is overstated and tangibles are understated.
Evidence

• Obtain a copy of the management calculation of the future cash flows and recalculate to confirm
accuracy.

• Inspect copies of the written offers received for the retail outlets to confirm the fair value used in
the impairment calculation.

• Inspect copies of performance forecasts for the various outlets and compare current and previous
forecasts to try to establish whether a 1% increase is reasonable.

• Obtain a copy of the written quote for disposal costs to help confirm the fair value less selling costs.

(c) Part c) 6 marks

Matters

• The value of the year end provision is only 0.3% of total assets but it is material because it is 6.5%
of profit for the year.

• Seeing as there is a reversal this year of some unutilised provision, it is likely that the provision is
overstated in both this and previous years.

• Provisions always require a degree of judgement in their assessment which increases the risk of
misstatement. Here it is the sales director that is applying judgement. While they may be in a good
position to estimate future sales, they may not be best placed to estimate returns.
Alternatively, the sales director may deliberately overstate sales, due to perhaps receiving a sales
related bonus, and so has to overstate returns to counteract this.

• The unutilised provision adjustment is not material but could suggest a much wider problem of
profit manipulation resulting in creative accounting.

Evidence

• Inspection of previous correspondence with customers to confirm the normal level of returns.

• Recalculate the management’s provision computation for accuracy.

• Inspect a sample of sales invoices to confirm the normal length of warranty given to customers.

• Inspect after date sales /returns records to ensure no window dressing is taking place- lots of credit
notes being processed very soon after the year end to remove fictitious sales included just before
the end of the year.

Comparison with previous years of the unused provision adjustment to see if there is continuous
overstatement.

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 Faster Jets Co

(a i) Additional Information

It is essential to manage time and volume by restricting the number of points to match the
marks available. As an example, in part (a - i) 5 points are made for 5 available marks.

- Method of purchase
We would need to know if the land was acquired for cash or leased so that we can confirm that it
has been treated correctly in the financial statements.

- Source of purchase
We would need to confirm the details of the vendor in case it is someone connected to Faster Jets.
If so, then there may be some kind of related party relationship.

- Relaibility of the value increase

The land has increased by $2m during a relatively short space of time. We should try to confirm
the origin of the fair value increase and the exact date of purchase to confirm the reasonableness
of the increase.

- Confirmation of ownership
The revalued amount for the land is nearly 6% of total assets. Such a material amount would
require confirmation of ownership so the location of the title deeds should be obtained so that they
can be inspected.

- Purpose of purchase
We should ask the management of Faster Jets what they propose to do with the land. If it is going
to be used then a classification under IAS 40 is not appropriate. If it is going to be built on and the
subsequent property is then used by Faster Jet, then perhaps IAS 16 would be more appropriate
at a later date.

It is possible to reclassify from IAS 4O to IAS 16 but it would be useful to know as soon as possible
whether or not this is likely to happen.

(a ii) Matters to be Considered

The use of subheadings is highly recommended in all answers.

An auditor’s expert must be evaluated for relying upon their work as a source of audit evidence.

1. Competence
This can be verified by ensuring that the expert of a recognised professional body. In the case of
land valuation, we would hope that the expert is perhaps a member of the Chartered Institute of
Surveyors. If this is the case, then the work of the surveyor can be expected to be of the required
standard.

2. Skills and Experience

We would like to confirm that the expert has done the same kind of work before, demonstrating
that they have the necessary skill and experience to deal with the specialised nature of the
engagement. For Faster Jet, it would be necessary for the expert to have experience in the
valuation of industrial land both for business and private rental, depending upon the intention of
Faster jet.

3. Independence

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 The independence of the expert would need to be confirmed, just like an external auditor would
need to demonstrate that they are independent. We would do this by ensuring that the expert had
no personal relationship with or financial interest in the company. We would also ensure that there
is no related party relationship between the client and the expert that would reduce the degree of
autonomy.

4. Scope of Work
We would need to confirm with the expert the objective of the work carried out, the key assumptions
that will be used and the actual purpose for which the work is being done, as well as the time frame
involved.

5. Previous Knowledge
We could rely on our previous knowledge of the said expert .If we have used them before and they
have proved to be knowledgeable and reliable, then it is more likely that we can use them again
with a minimal amount of assessment of them.

However, some assessment will still be necessary because the status and circumstances of the
expert may have changed.

(b i) Difficulties
It can be difficult to identify the key stakeholders in some cases. The performance indicators should
be designed to fulfil the information needs of one or more of the stakeholder groups, but it is difficult
to decide upon relevant performance indicators if you are not sure of who the key stakeholders actually
are.

Some key performance indicators are very difficult to measure. Most traditional accounting information
uses monetary value as the main measure but some performance indicators, like one in the question
that says the aim is to reduce the environmental impact of operations, are almost impossible to
measure in monetary terms, making it much harder to assess.

Some environmental performance indicators can be measured but a traditional system of the recording
of financial information may not have the facility to measure certain things. Assessing the value of a
non-current asset is a normal requirement of any decent accounting system and should present any
problems. However, measuring the gas emissions or level of water pollution will not fall within the
normal range of the accounting system and, consequently, will be harder to do.

It is also very difficult to compare different environmental performance indicators produced by different
companies. Accounting information will be produced in a consistent way by all firms as long as they
follow the accounting standards, but the absence of environmental performance guidelines makes
meaningful analytical review virtually impossible.

(b ii) Procedures

In part (b - ii) an extra point has been made to make up for the fact that agreeing to the cashbook
is a bit of a light point and may only get 1/2 a mark.

• Inspection of the bank statements and cashbook to confirm the payments that have been made.

• There should be correspondence from the various charities that are being supported that will
confirm that the donations are actually received by the correct body.

• We could carry out analytical procedures to confirm the value of the free flights given. Faster Jet
should have valued the free flights using a reasonable average of their normal market value flights
so we can confirm that this has been done and is reasonable.

• The number of free flights given can be agreed to the passenger list.

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 • The number of miles travelled and the amount of fuel used can be verified by inspecting the
expense claims for fuel and the vehicle logs for miles travelled .This can then be compared with
the figures for the previous year and calculations re performed to confirm that the percentage
changes are accurate.

• The classroom attendance registers can be inspected to confirm the number of children attending
the education days.

We could examine press releases that will advertise the free flight scheme and the education programme
in order to confirm the existence of both.

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 Paul Co
This is a debrief of an evidence and reporting question from 2016. It is a 25 mark question split
between three different issues. In each case we have to comment on the quality of the evidence,
any further required procedures and what should be included in a report to those charged with
governance.

(a) Assets held for sale (9 marks)

Evidence
The evidence obtained here lacks detail and will not be sufficient. The arithmetical accuracy of the
journal is a start but more work is needed.

Currently it is not possible to confirm the presentation as an asset held for sale from the limited
evidence obtained so far.

Further Procedures

• Enquire of the company management as whether the factory constitutes a discontinued operation-
it may well be a separate identifiable part of the business.

• Inspect the board minutes to confirm that the factory has been approved for sale.

• Obtain direct confirmation from estate agents that the factory is being actively marketed, an
essential part of the held for sale criteria.
•
• Confirm the reasonableness of the impairment calculation by agreeing the fair value used to an
expert valuation report.

Reporting issues
There are two major issues here.

Firstly, any internal control deficiencies need to be reported and it appears that there is a lack of control
over the period end financial accounting adjustments.

Secondly any independence issues suffered by the external auditors need to be reported as well.

There appears to be a self-review issue because the auditor has reviewed the decision to classify as
held for sale and then carried out some audit work as well.

(b) Capital Expenditure

Evidence
There is no doubt that a fair amount of audit work was done here , but the decision to largely proceed
as planned means that the work was not tailored enough to address the specific issue that was
identified.

The audit work does not appear to cover enough of the financial statement assertions, nor does it
appear to investigate in enough detail the reasons for the control failures.

Further Procedures

• Inspect the ownership documents for the vehicles to confirm that they do actually belong to our
client.

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 • Physically inspect the vehicles to confirm existence and ensure that they are included in the non-
current asset register for completeness.

• Ensure normal ownership costs are incurred for these vehicles by inspecting repairs invoices and
insurance contracts.

Reporting issues
Any internal control deficiencies should be reported to those charged with governance.

This needs to be the case for the lack of authorisation and the absence of proper segregation of duties.

The consequences of these failings should be fully explained as well, along with some suggestions as
to how the internal control function could be improved such as authorisation of all capital expenditure
before the acquisition takes place.

(c) Payroll

Evidence
The guidance on reliance on a service organisation has not been followed here.

The report provided is a control that needs assessing just like any other control and this has clearly
not been done.

Insufficient work has been carried out on the casual wages payments as well, so overall not enough
evidence has been obtained.

Procedures

• Inspect the service agreement with Gene to confirm exactly what they provide.

• It is essential to evaluate and document the controls implemented by Gene over the work carried
out for our client so that we can form an opinion as to how well the work is being monitored.

• A certain amount of substantive work will be necessary (a test of control based approach is never
sufficient on its own), so we should agree some payments from the bank to payslips and to HR
records.

• For the casual workers, we should re-compute the tax and NI amounts to ensure there are no
unpaid liabilities.

Reporting
Any non -compliance with regulations should be reported to those charged with governance and this
includes the casual worker payments not being processed through the payroll.

The consequences of this - possible fines - should also be explained in full.

The failure to adhere to the guidelines on using service organisations should also be reported to those
charged with governance along with a suggestion that this needs reviewing and amending.

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 Brick Co
This is a debrief of a reporting question from 2016. It is a 20 mark question.

(a) Part a) is for 14 marks and asks for the matters to be discussed with management, and the
impact on the financial statements, of four separate uncorrected misstatements.

Impairment
The growth rate used to calculate the value in use is not the most appropriate one. As a result, the
current impairment is wrong and overstates both assets and profit. They should have used the rate for
the factory instead of the rate for the company as a whole, which means the impairment is currently
understated.

The adjustment of $400,000 is less than 1% of total assets but it is material to the financial statements
because it is 6.3% of profit for the year. This error should be discussed with management. We should
explain that the wrong growth rate has been used and that the impact on the financial statements is
material.

We should also explain that if the financial statements are not adjusted, than we would have no option
but to modify our audit opinion.

Interest Charges
The interest charges have not been treated correctly. They would be qualifying borrowing costs and,
in accordance with IAS 23, should be capitalised as part of the value of the asset that is being
constructed.

As a result of this, both non-current assets and profit are understated. The amount of misstated finance
cost is immaterial because it is less than 1% of total assets and only 1.2% of profit for the year.

The full effect of this misstatement should be communicated to management but they should also be
made aware that the effect upon the financial statements is immaterial. The chances are that this will
remain an uncorrected misstatement due to its size.

Allowance
The notification that no further payment will be received means that the rest of the receivable should
be written off as irrecoverable - it is an adjusting event in accordance with IAS 10. Currently, both
assets and profit would be overstated if no further adjustment is made.

The amount is immaterial to the financial statements because it is only 1% of profit and less than 0.1%
of total assets. Even so, the error should be discussed with management and they should be
encouraged to make the adjustment.

Shares in Nub
The investment should be re measured at the year end at fair value with any gains or losses being
recognised as part of the profit statement because it has been classified as fair value through profit
and loss. This has not been done, so assets and profit will both be understated.

However, the transaction is immaterial to the financial statements because it is 0.7% of profit and less
than 0.1% of total assets. This error would still be discussed with management and they should still be
encouraged to make the necessary adjustment.

(b) Part b) is for 6 marks and asks for the impact on the audit opinion if the above errors are not
corrected.

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 The total adjustment is for $465,000 which is material because it is 5.4% of profit. The only single
adjustment that is material on its own is the impairment of $400,000. Therefore, this would definitely
need adjusting in order to prevent the need for a modified audit report.

The other three errors could remain as uncorrected misstatements and not result in a modification
although, as previously stated, management should be encouraged to make these adjustments as
well.

If the impairment is not corrected then the audit opinion will be modified on the grounds of material
misstatement.

The one misstatement is not likely to justify a pervasive modification, so it will be a qualified opinion
only.

An explanation of the reasons for the correction should be included in the basis of opinion, immediately
after the opinion section itself.

The other uncorrected misstatements will not be referred to in the audit report at all, they will have no
impact because they are all immaterial.

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 Tame & Co
This is a debrief of a reporting question from 2017. It is a 20 mark question.

(a i) Part (a - i) is for 7 marks and asks for matters and actions to be considered before the audit
report is signed.

Matters

• The revenue of $17m is 1.2% of total revenue and 12.2% of profit so it is a material amount.

• There is a danger here that this revenue has been recognised too early and resulted in an
overstatement of both revenue and profit. Revenue should only be recognised when any
contractual obligations have been fulfilled which, in this case, includes the customer inspecting the
goods.This has not been done so the obligation is still outstanding. As a result, it is likely that this
revenue should not be recognised yet.

This may be part of a systematic manipulation of profits by management who may be under
pressure to maintain results in order to sustain the share price and the company reputation within
the market.

Actions

• Further investigation of any other potential manipulation in other areas of the financial statements
should be carried out.

• Management should be asked to remove the $17m from revenue.

• If necessary, the matter should be reported to those charged with governance which would be the
audit committee seeing as this is a listed company.

• If nothing is changed, then the client should be told that the audit report will need to be modified.

(a ii) Part (a - ii) is for 5 marks and asks for the impact on the audit report if no adjustments are made.

If no adjustment is made for the $17m, then the report would need to be modified on the grounds of
material misstatement.

This is an isolated misstatement so will be material only and not pervasive.

There is no uncertainty and no missing evidence so an emphasis of matter and a qualified opinion due
to a lack of evidence are not appropriate.

A qualified opinion will be given, commonly called an ‘except for’ qualification.

A description of the circumstances that create the need for a modification will be included in the basis
of opinion immediately below the opinion itself.

(b) Part b) is for 8 marks and asks for a critical appraisal of a proposed assurance report.

User
The user of the report will not be the shareholders so the addressee is wrong. The user of the report
is likely to be either the directors of Tough or potential finance providers. The addressee needs
changing.

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 The scope
The actual documents and page numbers reviewed need to be mentioned, at present there is
insufficient detail on the type of forecast information, the period covered and the preparer so an
introductory paragraph needs to be inserted.

Vagueness
At present the phrase ‘prepared in accordance with the relevant standards’ is too vague. The actual
guidance is included in ISAE 3400 on prospective financial information and this should be stated clearly
in the report.

Disclaimer
There should be a third party disclaimer included in the report in order to restrict the use of the report
to the intended user only. This will help the assurance provider restrict their liability.

Wording
The wording used here is for a report that gives positive assurance, too high a level of assurance for
this type of service.

With reports on prospective financial information, it is usual to give negative assurance which usually
states that nothing has come to our attention, so we need to change the wording so it gives negative
assurance instead of positive.

Unnecessary extra statement

The sentence at the end is unnecessary and contradictory to what has been said previously. It is
misleading to first say that everything looks ok but then to say that the assumptions are likely to be
inaccurate, this last sentence should be removed.

No responsibilities section
All assurance reports need a clear statement of management and assurance provider’s responsibilities
-this is not here and needs to be included.

Overall, it would be suggested that this report is redrafted using the new audit report format as far as
is possible for clarity and uniformity.

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 Rockwell & Co
(a) Draft Audit Report Appraisal

It ends up being the case that the major issues with the report are discussed at the end of this
section. This is fine. The important thing is to make sufficient points, it does not matter what
order they are in.

No Quantification
The amount of the contingent consideration has not been stated in the report which makes it very
difficult for the user to evaluate the impact of the misstatement. Usually, the exact value would be
stated which would also allow the report to make a specific comment on the materiality of the
consideration.

At present the comment on materiality is very weak and a definite statement of whether the error
actually matters could be made if a value was included and a relevant percentage calculated- probably
a percentage of total assets, the most relevant benchmark.

There should also be a quantification of the impact upon the goodwill calculation if the error is
corrected.

Size of the Error

Although we do not know the value of the contingent consideration, we do know that this is a big group
with high levels of total assets and profit. It is possible that the consideration is immaterial as a
percentage of both of these benchmarks. If so, then the report should not be modified at all if the
guidelines are actually applied properly.

Wording
The use of the word 'may' when discussing whether or not the error is material is not precise enough.
The prepare should be in a position to be able to state whether or not the item has a material effect by
showing the value of the consideration and comparing it against the relevant benchmark. 'May' is non-
specific and should be removed or replaced.

No Mention of the Specific Standard

There should be specific reference to the relevant accounting standard that is not being observed
here- in this case IFRS 3 Business Combinations-instead of the general discussion of what is wrong
that has been included instead.

More ‘poor’ wording

The phrase 'we do not feel ' does not give the impression of the degree of authority and certainty that
you would expect from a professional assurance provider.

A positive statement should be made confirming that the goodwill is either right or wrong, in this case
it is wrong.

Opinion
When the opinion is modified, the report should state clearly state the specific reason for the
modification .In this case this is not done. The 'basis for modified opinion' phrase should make direct
reference to the fact that an adverse opinion is being used, so it should be changed to 'basis for
adverse opinion'.

Use of an adverse opinion

An adverse opinion is relevant when there is a pervasive misstatement, in other words the financial
statements, as whole, are seriously misleading. This is highly unlikely to be the case here because it
is only one part of the goodwill calculation that is incorrect.

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 This is probably an isolated error that would perhaps merit a qualified opinion on the grounds of a
material misstatement, but an adverse opinion is simply too extreme.

Emphasis of matter paragraph

This should only be used if there is an uncertainty that exists and that uncertainty has been disclosed
adequately in the financial statements. In this case there is no uncertainty, the goodwill figure is wrong,
so an emphasis of matter paragraph is not relevant.

If it was necessary, it would be correct to refer to the note in the financial statements that gives more
information on the nature of the uncertainty. However, it is not necessary and the entire paragraph
should be removed.

(b) Actions and audit report implications

There is no mark split in the question between actions and implications so they have not been
used as separate sub-headings.

The lack of evidence to support the research expenditure may be due to a control deficiency at Seurat
Sweeteners so we should consider including this in our report to those charged with governance-all
control deficiencies would normally be reported in this way.

We may decide that the evidence is deliberately being concealed by the management in order to
manipulate the financial information. If this is the case, then this should also be reported because it
represents a potential problem encountered during the course of the audit.

We may also require further detail on the matter to be provided to us by the component auditor-
representations and working papers, and we may even decide that extra work needs to be performed
in this area if we believe it to be significant enough.

The materiality of the research expenditure will need to be established .We would first need to ensure
that the $1.2 m is material to the component, which is not possible to do here as the benchmarks are
not available for the component company.

Assuming that it is material, then a qualified opinion on the grounds of a lack of evidence would appear
to be appropriate. The research expenses are NOT material to the group as a whole because they are
less than 1% of both profit and total assets.

As a result, there will be no impact on the group audit report - the lack of evidence is not material to
the group figures.

In summary, the group audit report will not be modified as a result of any issues involving Seurat
Sweeteners, but the report to those charged with governance should refer to the control deficiency
and the possible withholding of evidence.

(c) Quality control procedures

• Seeing as this is a listed company audit, there should be a review carried out by a quality control
reviewer.

• This person should communicate extensively with the engagement partner on all relevant matters,
concentrating on any judgements that have been made and ensuring that they are reasonable.

• They should definitely discuss the thought process that led to the modification due to the goodwill
figure being misstated and the decision not to modify the group report due to the lack of evidence

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 to support the research expenditure. It is essential that the reviewer is happy that both decisions
are appropriate and are supported by sufficient evidence.

• The reviewer should also ensure that all relevant matters are included in the report to those
charged with governance, such as the control deficiency.

• Finally, the reviewer should ensure that adequate documentation exists on the audit file to support
all of the decisions made .It is likely that any listed company audit will be subject to further review,
perhaps by a professional body, at a later date so full and clear documentation will help with this.

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 Nidge & Co
(a) Flyover Co

In each part of the question, the same sub headings have been used. This is not necessary but
it does help with structure and forces the answer to stay relevant.

Materiality
The profit from the contract is material because it represents 22.2% of the total profit before tax for the
year.

Accounting Treatment
The management of Flyover are wrong to state that the accounting treatment is correct .This contract
spans more than one accounting period and, therefore, falls under IFRS15 revenue recognition as a
long term construction contract. There is only one thing being sold here, the bridge construction, so
there is no need to split the revenue between different activities.

However, the revenue and the related costs should be spread across the length of the contract
according to percentage completion .The contract is 15 months long so the revenue should be spread
over this period, recognising it all in the first accounting period is incorrect. It may be an error or it could
be an attempt to inflate the first year profit figure, so creative accounting.

Further Actions
Further actions could include requesting the management to correct the figures-if they do not then we
would have to consider the potential impact on the audit report, which is discussed below. We made
need to extend our audit work to cover the other contracts that are also being worked on, it says that
three are worked on at any one time. This could be an ongoing problem so perhaps it would be
necessary to review previous period accounting treatment as well.

If the profit is spread over the 15 months, that would result in only 7 months’ worth of profit being
recognised up to the end of January 2015 which is $2.3m. This means that profit is currently overstated
by $2.7m which is 12% of this year's profit before tax and is material.

The stage of completion of the contract should be confirmed. It may not be appropriate to spread the
revenue evenly over the 15 months, it depends upon the nature of the work and a number of other
factors so it is dangerous to assume that a pro rata split is always relevant.

Impact on the Report

This is likely to be an isolated error so not pervasive, therefore an adverse opinion is not appropriate.
There is no missing evidence so the opinion would not be modified on the grounds of a lack of
evidence.

The most likely impact on the report would be to qualify the opinion on the grounds that revenue is
materially misstated. This is commonly known as an except for opinion due to its isolated effect.

There should also be an extra paragraph in the basis of opinion section that explains the nature of the
qualified opinion.

(b) Newbuild Co

Materiality
The amount claimed represents 10.8% of assets and is, therefore, material. It would also change this
year's profit to a loss in the financial statements if an adjustment is made, so this could end up having
an impact on the going concern status of Darren if they are found liable.

Accounting Treatment

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 It would appear that the accounting treatment is correct. In accordance with IAS 37, accounting for
provisions, if it is less than 50% likely that Darren will have to pay out, then a disclosure should be
made but no adjustment is necessary. This appears to be the case.

Further Action
Further action would include making sure that any disclosure made in the financial statements is
sufficient. Details of the nature, amount and timing of any payment would need to be disclosed, if the
disclosure is not sufficient then this could impact upon the audit report -which is discussed later.

Impact on the Report

Assuming that the disclosure is detailed enough, there would be no need to modify the audit opinion
because there would be no misstatement and no missing evidence.

However, an extra paragraph would need to be included under the heading 'material uncertainty
relating to going concern'.

This is essentially an emphasis of matter paragraph but it needs highlighting specifically in this way
because the issue is likely to have an impact upon the going concern status of Darren.

This extra paragraph should refer to the note in the financial statements that discloses the details of
the case and the potential payment. This paragraph should also clearly state that we are not modifying
then audit opinion in respect of this matter, we are just highlighting something.

If the disclosure of the uncertainty in the financial statements is not adequate then the audit opinion
should be qualified on the grounds of material misstatement, this would not be a pervasive modification
because it is an isolated issue-just a disclosure. Therefore, as already mentioned above, it is essential
to carry out sufficient audit work to confirm that the details are both sufficient and accurate.

(c) Integrated report

Treatment
Whilst the integrated report forms part of the annual report and financial statements of Darren, it is not
specifically covered by our audit report. As a result, we will not perform any detailed audit work on it,
but we do have to ensure that it is generally consistent with the financial statement information. In this
case it is not!

Materiality
The claim that profit has increased by 20% from the previous year is clearly wrong. An increase from
$20m to $22.5m is an increase of 12.5%, not 20%. Assuming that the adjustment in (a) is actually
made then the percentage increase is even less. Therefore, the statement made is materially incorrect.

If the integrated report and the financial statements are inconsistent and it is the report that is wrong,
then there is no modification to the audit opinion because there is no missing evidence and there is no
misstatement in the financial statements themselves.

This would appear to be the case, our normal audit work will have enabled us to conclude that the
financial statements are right.

Impact on the Report

We will, however, need to draw attention to the inconsistency in the integrated report by including an
'Other matter ' paragraph in the audit report.

This should be included below the opinion paragraph and should fully explain the issue, whilst also
stating that the audit opinion is not modified as a result of this.

Obviously, if the management of Darren are willing to alter the percentage in the report then the audit
report will not need to be modified.

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 Further Action
Further actions here should include communicating the issue to those charged with governance in the
hope that they would be able to persuade the directors of Darren to make the necessary amendments.

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 Cold & Co
This is a debrief of an ethics question from 2016. It is a 20 mark question divided into two parts.

(a i) Part (a - i) is for 4 marks and asks for the difference between an audit and a limited
assurance review.

The audit of historical financial information is a legal requirement for all limited companies above
a certain size, whereas an assurance review is optional.

The level of detailed work carried out will be different for the two assignments.

An audit uses lots of detailed substantive procedures with a large amount of sampling involved.

An assurance review is likely to be much more general in the type of evidence obtained, relying
heavily on enquiry and analytical procedures.

An audit provides positive assurance upon the subject matter examined, whereas an assurance
review gives negative assurance.

This does not mean something is wrong, it is just a way of providing a lower level of assurance.

This brings us to the major difference, the level of assurance provided:

An audit always provides the user with a high level of assurance, whilst an assurance review gives
a much lower level due to the lack of detailed work carried out and, normally, the narrower scope
of the assignment.

(a ii) Part (a - ii) is for 8 marks and asks for the advantages and disadvantages for a particular
company of having a full audit as opposed to an assurance review.

Advantages

1. The full audit would give a higher level of confidence to the users of the financial statements.
This is especially important to Damp because there is a major shareholder who has no
involvement in the day to day running of the business. A full audit is much more likely to keep
them happy that the company is being run effectively, giving them the confidence to keep their
shares and perhaps even make a further investment.

2. A full audit may make it easier for Damp to obtain further borrowing. They do have an existing
bank loan but that will need reviewing, and hopefully extending, soon. Banks are more likely
to lend if a full audit has been done due to the additional confidence they would be able to
place upon the audited figures.

3. Audited figures will help the management of Damp as well. Having the confidence in the
historic performance information will allow the management to be more confident in their ability
to use this as a benchmark for budgeting and any future expansion plans that they may have.

4. Damp is expanding and will probably end up exceeding the audit threshold in the near future
anyway, when an audit will become compulsory. Early acceptance and adoption of the
requirements of a statutory audit will mean more time to fine tune and a better chance of being
ready and able to adhere to the process when it becomes compulsory.

5. A full audit would have a much better chance of ensuring that Damp complies with any new
regulations relating to the overseas expansion.

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 6. It would also be more likely to provide useful information on the adequacy of the internal control
systems that are very likely to have to be improved as a result of the expansion plans.

Disadvantages

1. A full statutory audit will take longer to complete than a limited assurance review, so is likely
to cost more. A full and detailed testing of comparative information in year one will significantly
add to the cost, although this will only be the case in the first year

2. It can also be quite disruptive for the accounts staff of Damp because it will involve more of
their time being taken up by the auditors who will have lots of questions and queries.

(b) Part b) is for 8 marks and asks for ethical and professional issues for a given scenario, as
well as recommended actions.

The request to provide an internal control review as well as the normal statutory audit would mean
a potential provision of other services.

If the review is a one off request, it probably is, then we would not have to worry about undue
dependence on fee income because the review work would be non-recurring.

The responsibility for reviewing the adequacy of a system of internal controls belongs to the client
management.

If we do this there is a management threat, we could be seen to be making decisions that should
be made by the client.

We would also need to ensure that we have enough professional knowledge to carry out this work.
This should not be a problem.

There would be a self-review threat because we would be suggesting improvements to the system
of internal controls and then evaluating them as part of our audit risk assessment.

In some circumstances, safeguards, such as segregation of duties and ensuring Messy’s

management are informed, that they know we cannot make decisions for them-could be sufficient
to allow us to accept the offer.

This is a listed company, however, so this request will have to be refused if the review covers the
review of financial controls which it probably does.

Actions

• The request should be refused with an explanation as to why it is not possible.

• A review of the audit plan should also be undertaken.

• It seems to be the case that the client has identified these control deficiencies, not the auditor.

• We should ensure that adequate planning has and will occur on future audits to try and
minimise the risk of this happening again. .

We are supposed to review the internal controls as part of our normal audit work so it is possible that the
previous audit quality was not up to the required standard.

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 Raphael & Co
(a) Purpose and Scope of Due Diligence

(6 marks so divided down into two lots of 3 paragraphs)

Purpose
The purpose of due diligence is to give some assurance to investment decisions. One company wishes
to buy another, but will first get some advice as to the performance and prospects of the target
company, so that any acquisition costs are invested wisely and with some external assurance.

Due diligence will normally concentrate on certain issues and factors within the target company.

It is essential to try to obtain comfort that the assets and liabilities of the target company are complete
and are valued appropriately which is quite a high risk task due to the judgement involved in a lot of
valuations-hence the need for assurance in the form of due diligence.

It is also important to assess the integrity and the commitment of the management of the target
company. Assessment of the honesty and reliability of future working partners must be carried out,
including whether or not key personnel will remain with the company after acquisition.

Scope compared to a normal audit

The level of assurance provided will be different. With a traditional audit a high, or reasonable, level of
assurance is always given. With a due diligence review the level of assurance will be lower, usually
referred to as negative assurance.

In some cases the due diligence review will merely be a fact finding exercise with no opinion at being
expressed. If this is the case then it is not an assurance engagement but just an agreed upon
procedure.

The type of work carried out will be different as well. An audit will use all the required methods of
obtaining evidence with inspection and recalculation/re performance being paramount. A due diligence
report will use more enquiry and analytical procedure -so much more general in the evidence gathering
that is undertaken.

The focus of work for a due diligence investigation is likely to be more predictive than a traditional
audit. An audit will concentrate on historic financial information in order to form the opinion, whereas
a due diligence report will attempt to evaluate future prospects and performance to a far greater extent.

(b i) Additional Information on Intangibles

The question says the two parts of b) carry equal marks so it is essential to balance our answer.

The intangibles could include some items that relate to the customer database as well as the
purchased brand so they are dealt with separately.

The Database
The database is internally generated so should not be recognised as an intangible BUT there may
have been some acquired items when the database was set up in the first place.

We would expect to have access to any invoices relating to the acquisition of any initial software to be
used in order to develop the database.

There may be a maintenance agreement or support contract that exists so we can confirm that the
database in actually running effectively.

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 We would expect summaries of all sales made through the database over the last few accounting
periods, along with a forecast of expected future sales which would help assess any potential useful
economic life for the intangible should the acquisition go ahead.

There may be external market valuations available for similar databases that could assist us in any
subsequent valuation of the intangible.

Purchased Licence
We would expect to be able to agree the initial cost of $5m for the licence by inspecting the acquisition
contract.

The initial contract would also confirm the expiry date for the licence, if there is one, which will help
establish the useful economic life.

The initial contract would also confirm whether or not any further payments are due based upon the
future sales of the tyres.

We would also expect to have a breakdown of both current and future sales levels for the tyres to
assess both the long and short term viability of the licence.

(b ii) Management enquiries concerning the Contingent Liability

Seeing as this part of the question actually asks for enquiries, it would be ok to actually phrase
the answer as a series of questions, the first point made is written in this form as well as an
illustration.

• We should ask management how long the faulty parts have been being used. OR How long have
the faulty parts been used as part of the engine production?

• We should ask them whether any claims have been settled during the year or since the year end.

• We need to know if the manufacturer has accepted responsibility for the fault so we can ask to see
any relevant correspondence.

• We would need to obtain a representation from management that confirms that, to the best of their
knowledge, all claims have now been received.

• We should ask management whether this is the only faulty product or whether similar problems
have been encountered with others.

• We should ask whether or not the management have taken legal advice on the likely of outcome
of the case, whether it is them or the manufacturer that could be to blame.

• We should request that the management allow us to contact their lawyers in order to confirm the
current status of the claim.

• We should ask management to confirm that they believe any counter claim against the company
will compensate for any payments that they may have to make to their customers.

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 James Ltd
Part A

Benefits of Due Diligence to James Ltd

Valuation / Pricing

A due diligence review will assign a value to Poppy Co, the target company. The value will not be precise
but it will give a very clear indicator as to the current and future value to James of going ahead with the
acquisition.

The due diligence review will concentrate upon asset and liability values for Poppy Co, so will give James
a very good idea as to what kind of price they should be paying for Poppy Co.

Company Operations

A due diligence review will also provide James with quite a lot of detail about the operations of Poppy Co.
As well as information about the day to day operations, it will be possible to find out more about certain
key issues, such as the likely outcome of the court case and whether or not there are any others.

Information relating to the operations of Poppy Co can be used by James, along with the previous point
concerning asset /liability valuation, in order to establish a reasonable purchase price.

Independent View

James should take a great deal of comfort from the fact that the due diligence review is being performed
by an independent company. Your firm should be unbiased in any conclusions reached and advice given
which gives James assurance on what is a very big business decision.

James could decide to carry out a due diligence investigation themselves - there is nothing to prevent them
from doing so. However, the acquisition of another company will probably involve a considerable amount
of investment by James and an independent assessment of the target company is definitely advisable.

Part B

Ethical issues if both services are provided

Self Interest

It is tempting to say that there will be an increased self interest threat if both services are provided because
of potential undue dependence on a higher level of fee income BUT the due diligence work is non-recurring
so would not be part of the calculation and would not affect the percentage.

However, there still may be a self interest threat that is relevant. If we do the due diligence work and say
that this is a good company to buy, then we may be tempted to ignore anything that is found during the
audit that may contradict the due diligence findings.

We are basically saying that an audit firm may be perceived to be reluctant to criticise their own work and
it would be in their interest not to do so as it would be them look bad.

We can also argue that not doing a good job would make the audit firm look even worse!

There is definitely a potential self-interest threat here though.

Self-Review

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 Our firm will be reviewing the operations of Poppy Co and then, assuming that the acquisition goes ahead,
Poppy Co will form part of the audit for the year so we will be reviewing our own work.

This can be safeguarded against by segregation of duties - ensuring that different teams of staff carry out
each part of the overall assignment.

Management /Advocacy

Just carrying out an audit can be a management threat , but this is increased significantly with the
acceptance of the due diligence work. A management threat exists when there is a danger that the audit
firm could make decisions that should really be made by the client.

In this case, we must make sure that the ultimate decision to buy, or not to buy Poppy Co is made by
James and not by us.

Part C

Additional Information and why it is needed

Organisational Structure

It would be very useful to know what kind of management structure there is in place at Poppy Ltd. The key
personnel would definitely need to be identified so that James knows which employees they will be most
keen to keep on after the acquisition takes place.

This information will help with a smooth transition and ensure that vital business knowledge is not lost.

Contracts

The employee contracts of all members of staff at Poppy Co, especially the ones in key management
positions, should be inspected.

This would help us establish the costs associated with severance for the staff that James does not want
to keep and the cost of keeping,and perhaps, ' locking in ' the key staff members.

Details of the new premises /land

We would inspect and purchase documents of lease agreements that relate to both the building and the
recently acquired land.

The question says that the building is owned and the land has been acquired but we would still need to
confirm that the two are not leased.

It is acceptable if they are but, if so, then the lease length, the payments outstanding and any potential
early termination penalties would need to be identified because perhaps James will want to relocate Poppy
Co once it has completed the acquisition.

Audited Financial Statements

The audited financial statements of Poppy Co should be obtained for the last 2- 3 years.

These documents will tell us a lot about the past performance of Poppy Co and its current financial position.

We will be able to perform analytical procedures more efficiently to identify any areas of the financial
statements that may be cause for concern.

Contact with Outsourcers

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 As well as the financial statements themselves, we would obtain direct confirmation from the company that
operates the accounting function for Poppy Ltd.

We may not have to contact them because, hopefully, any reports that they produce and send to Poppy
Co would be readily available to us anyway.

Management account / Forecasts

Both current and previous sets of management accounts and any other forecast information produced by
Poppy Co should be obtained.

The current forecasts can be used to help confirm the viability of Poppy Co as a going concern and the
past forecasts can be compared against the actual, historic performance of Poppy Co.

This will give some comfort that the forecasts are likely to be reasonable.

Finance Details

The bank should be contacted to obtain copies of the loan agreement and details of the overdraft facility.

This will be used to assess the financial health of Poppy Ltd, so we would look for details relating to the
loan repayment terms and the date of review / renewal of the overdraft facility.

Contact with the bank would also tell us whether or not there is the possibility of additional finance being
provided in the future, should it be required.

Court Case

Information relating to the court case, such as the likelihood of outcome and the possible payout, should
be available from the legal advisers to Poppy Co.

There would probably also be press statements and newspaper articles that should be inspected.

This would give information relating to the financial impact of losing the case as well as the potential effect
upon the reputation of Poppy Co.

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