This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON 279 0093 ZA

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route for
External Students

Auditing and Assurance

Candidates should answer FOUR of the following EIGHT questions: TWO from Section A,
ONE from Section B and ONE further question from either section. All questions carry equal
marks.

© University of London 2011

UL11/0210 PLEASE TURN OVER
D01 Page 1 of 6
SECTION A

Answer TWO questions from this section and not more than one further question. (You are reminded
that four questions in total are to be attempted with at least one from Section B.)

1. You are a partner in a firm of accountants. You recently obtained a new client, Mactar plc, and
conducted site visits to each of the company’s five bases of operations.

You discovered that Mactar owns a fleet of very large, very expensive road-laying machines
which are kept behind high security fences when not in use. Other general-purpose vehicles,
such as trucks and vans, are left overnight in the company car park or on the side of the road.
Mactar employs on average about 100 staff, of whom 20 are headquarters staff and the rest are
employed on the physical act of laying the roads. Of the manual staff, 10 are considered full-
time, consisting of 5 team-leaders and 5 assistant team-leaders. The remaining 70 employees are
drivers and labourers who are hired and released at a week’s notice.

One team leader told you that it is not unusual for employees to leave suddenly without
collecting their pay because they are wanted by the police. Good workers are rare in this
business and to keep such men for the next project ‘off-the-payroll’ cash incentives are paid to
prevent them finding alternative work with other companies. Such payments are entered in the
accounting records as ‘sundry material purchases’. The team leader is responsible for judging
who is a ‘good worker’ and for deciding how much of a cash incentive is needed to keep the
man. The only check on this activity is an occasional visit by the Human Resources Director
who asks the team leader to identify those who may be worth retaining. The total cost of these
incentives is immaterial in the context of the value of the typical project.

You spoke to the Contracts Director who is responsible for submitting tenders and obtaining new
contracts. You told him that you were surprised that Mactar’s results in terms of both revenue
and profitability have increased steadily despite the economic recession and the cut-backs in
spending by central and local government. He grinned and said that ‘There are ways of getting
business, even in a recession’. Seeing your reaction, he quickly became serious and emphasised
the high quality of Mactar’s work. You left that meeting with an uneasy feeling.

You next met with the Finance Director who was keen to stress how he ran a ‘tight ship’, though
you noticed on his desk a letter from the tax authorities. You could not read the letter upside
down but it looked similar to a letter received by another of your clients announcing an in-depth
investigation into the payroll and employee tax deductions systems. When you asked the
Finance Director if there were any ongoing or future problems of which you should be aware, he
stated that there were none.

Required:

(a) What are the significant inherent risk factors in the case of Mactar plc? (10 marks)

(b) What controls would you expect to find in place in the payroll system covering both
salaried and weekly paid employees? (15 marks)

UL11/0210
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2. You are the compliance partner for your firm. Your job is to ensure that the firm complies with
the legal and regulatory requirements as well as the ethical standards. Your firm has recently
acquired Barniere & Co., a firm of accountants based in a country which is making the transition
to a market economy. The country currently has only the most basic of rules for regulating the
stock market but its leaders are committed to bringing the country into line with the highest
standards prevailing in developed countries.

Your partners have asked you to review a sample of Barniere & Co.’s audit files for compliance
with the ethical standards generally accepted in the West. This review has revealed a number of
circumstances, with a different audit partner in each case, which catch your attention:

Client A: the name of one of the partners in Barniere & Co. appears on the list of shareholders of
Client A, a company listed on the local stock market. It has issued share capital of 10 million
shares, of which the partner owns 20,000 shares.

Client B: another listed company paid Barniere & Co. a total of $6m in fees last year. A note on
the file reveals that at the shareholders’ meeting the total fee was queried by an important
investor. Client B’s Chief Financial Officer disclosed orally that $2m was for the audit fee and
$4m was for other services.

Client C: a note on the file explaining why the audit work on this client was completed so much
more quickly this year reveals that the Client C’s newly appointed chief financial officer is an
ex-partner in Barniere & Co. He was therefore able to make sure that all the accounting records
were in order and the audit could be conducted with the least effort.

Client D: an audit which had proved difficult in the past produced no problems this year but had
taken three days longer than before. A note against the time records reported that the extra three
days were accounted for by the client treating the whole of the audit team to a long weekend on
a cruise ship.

Client E: is a company which has had a difficult time in tough trading conditions. It has been
short of cash for a while. This is the reason given for the audit fee remaining unpaid since the
completion of last year’s audit. The responsible partner in Barniere & Co. notes that he is
prepared to let the company have credit for up to three years’ worth of fees.

Required:

(a) Write a report to the partners in Barniere & Co. explaining why some aspects of their
relationships with Clients A-E cause you concern and setting out what you regard as
acceptable standards of ethical behaviour. (15 marks)

(b) Produce a list of action points which could be implemented to ensure that your firm
complies with the highest global standards of ethical conduct. (10 marks)

UL11/0210
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3. You are the senior partner in a firm of chartered accountants. One of your responsibilities is to
perform a final review of the audit files prior to the signing of the auditors’ report by individual
audit partners. You have just finished reviewing five audit files and the following are the issues
on which your audit partners have asked for your advice.

The audit of Adams plc revealed that the depreciation policy writes off motor vehicles over ten
years whereas most companies in the industry use estimated lives of between four and six years.
Adams consistently reports losses on disposal of the motor vehicles. Under the existing policy
the depreciation charge per annum is about £5m and net profits have averaged about £40m.

One of the directors of Brown Ltd is currently facing prosecution for fraud in connection with
the business of another company with which he is involved. This other company is not related to
Brown Ltd and no transactions have ever taken place between the two companies. Brown’s
directors do not want to refer to the matter in the notes to Brown’s financial statements.

The audit of Carew plc was hampered by the fact that in one of its branches, the stock-taking
records had been destroyed in a fire in the offices. The audit team had not attended that stock
count and were unable to obtain other forms of evidence to support the figure for inventory in
the financial statements. The branch inventory accounts for 10% of the total inventory of £20m
in Carew which is reporting profits of £80m this year.

Douglas plc is currently involved in litigation with a supplier concerning breach of contract. The
amounts in dispute are in the region of £15m. The net profit of Douglas plc this year is £45m.
The directors argue that no reference should be included in the notes to the financial statements
because they are confident that the supplier will not win the case and because disclosure might
prejudice the litigation.

Endecott plc has had a difficult past few years with falling profits and declining liquidity. It is
dependent on obtaining extended overdraft facilities from its bank with whom negotiations
continue. Endecott’s directors have made full disclosure in their report and in the notes to the
financial statements. The audit partner considers these disclosures are sufficient for a reader to
understand Endecott’s position.

Required:

(a) Explain how the matters referred to above will impact on the form and content of the
auditors’ reports for each of the clients. (15 marks)

(b) Describe the matters, apart from the true and fair view, on which auditors must form an
opinion before signing an auditors’ report under international auditing standards.
(10 marks)

UL11/0210
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4. The Quayside Ex-Servicemen’s Club is a not-for-profit organisation in the small town of
Dartweir. The club is popular because it is charges low prices. The club is governed by a
committee of volunteers who meet once a month to review the management accounts presented
by the only full time employee, the club steward. The steward receives a basic salary plus a
bonus of 10% of any surplus of income over expenditure. Since the club is a charity any
remaining surplus has to be spent for the benefit of the members.

The club steward is in charge of the day-to-day management of the club for which he is paid a
salary. He places orders with suppliers for drinks and food which he serves to the club members
at lunchtimes and in the evenings. At weekends when the club is busy, he hires part-time staff
and pays them in cash from the takings of the sales of drink and food. All transactions are for
cash except that suppliers of drink and food and the club’s overheads, such as telephone and
rent, are paid by cheques signed at the monthly committee meeting. The steward makes out the
payee and the amount, but two committee members are required to sign each cheque. This is
usually done at the end of the meeting so as not to delay proceedings. Originally the system had
required the steward to present along with the cheques the relevant invoices from the suppliers
who are to be paid; this is no longer done because it was too time-consuming. Instead the
committee review the management accounts paying particular attention to the gross profit
margin which has remained roughly the same for many years.

The club is only open to members who are ex-servicemen though each member can invite a
guest on payment of a small ‘one-day’ membership fee. This cash is put into a glass jar which is
kept behind the bar. Recently the club has become even busier and some members have
complained to the committee that it is taking too long to get served at the bar. They suspect that
outsiders have been admitted in excess of the one member/one visitor quota. They would like to
see a ban on all outside visitors. The steward argues that the club members get the benefit of any
financial surplus. Over the last three years various pieces of electrical equipment have been
purchased for the members but no proper fixed asset register has ever been kept.

Another complaint is that the club now stocks fewer basic cheaper beers and more premium
beers. The steward counters this by saying that there is a higher profit margin on these beers and
so it is better for the members in the long run. He explains that the reason there has not been an
increase in the overall profit margin is that not enough of the premium beers are being sold and
that as a result he has had to write off a number of barrels because they were past their sell-by
date.

The club also has three slot machines, programmed to pay out as cash prizes at least 10% of the
takings. Every week a collector from the company which owns the machines calls at the club to
empty the machines. The collector counts the cash, gives the steward the club’s agreed share
and a receipt for that amount and takes the remainder, which is due to the company which owns
the machines. A committee member has noticed that although more people seem to be playing
the slot machines, the takings according to the management accounts have declined. The
steward insists that he watches the collector count the cash very carefully and that he is sure that
there is no ‘leakage’ of money through that route.

Required:

(a) What problems do you envisage with the audit of the Quayside Ex-Servicemen’s Club?
(15 marks)

(b) Bearing in mind that it cannot afford extra staff, what recommendations would you make
to improve the control over the club’s finances? (10 marks)

UL11/0210
D01 Page 5 of 6
SECTION B

Answer ONE question from this section and not more than one further question. (You are reminded
that four questions in total are to be attempted with at least two from Section A.)

5. Critically evaluate the standard unqualified audit report in terms of what it says and what it does
not say for the benefit of the ordinary private investor.

6. Auditing standards apply to the audit of all financial statements. How realistic is it to expect that
the audit of small companies can be conducted to the same standard as that for larger
companies?

7. There have been many well publicised audit failures in the last 150 years. Describe those that
you regard as the most significant and explain what lessons can be learnt from the apparent
failure of auditors in these cases.

8. Auditing is concerned with creating trust. In addition to independence, what other qualities must
auditors have, and be seen to have, and why?

END OF PAPER

UL11/0210
D01 Page 6 of 6
 This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON 279 0093 ZB

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route for
External Students

Auditing and Assurance

Thursday, 19 May 2011 : 10.00am to 1.00pm

Candidates should answer FOUR of the following EIGHT questions: TWO from Section A,
ONE from Section B and ONE further question from either section. All questions carry equal
marks.

© University of London 2011

UL11/0211 PLEASE TURN OVER
D01 Page 1 of 6
SECTION A

Answer TWO questions from this section and not more than one further question. (You are reminded
that four questions in total are to be attempted with at least one from Section B.)

1. This is the second year of your firm’s appointment as auditor of Coffee Central Ltd, a long-
established company which imports coffee beans from various producers and sells wholesale to
retail outlets. It operates from a large warehouse in the outskirts of London which is where most
of its customers are based. The beans are of varying qualities from the basic, costing Coffee
Central £1 per kilo, to the premium beans costing £10 per kilo. Coffee Central aims to make
100% mark-up on the sale of coffee beans to its regular outlets and 200% mark-up on the sales
to the public via its small shop at the front of the warehouse.

The warehouse is run on very old-fashioned lines with manual records being kept. The system is
for deliveries of coffee beans to be checked as they arrive at the loading bay: the numbers of
sacks of each type of bean are counted and one or two are opened to check that the quality of the
bean inside matches the delivery note sent by the supplier. A goods-received note is completed
to enable the accounts clerk (who also helps out in the warehouse) to check suppliers’ invoices.
The beans are then stacked in the warehouse and the staff make sure that there is proper stock
rotation which is important as the beans will deteriorate if held too long. The five
warehousemen have been with the company for many years; the youngest is 63 years old. They
are so experienced that at the year end, they are able to produce a figure for the physical stock
count within a few hours.

The premium beans which account for about 20% of the total stock have been seriously hit by
the recession with customers buying less high quality coffee from their suppliers and coffee bars.
However, the lower value lines of beans have continued to sell well. The son of the founder of
Coffee Central, Chuck Rica, has just become chairman and chief executive and is keen to
expand the business by setting up a chain of coffee bars. This would require a substantial bank
loan but the company has always been able to service its loans in the past and has what it regards
as a good working relationship with the bank. In addition to the annual audit, you have been
asked to help put together a business plan to take to the bank.

You now discover that none of the recommendations which you included in last year’s
management letter have been implemented, for example engaging a commodities broker to enter
into forward exchange contracts to fix the future price of beans from suppliers and arranging
options to cover foreign exchange dealings. When you enquired why no action had been taken,
Mr Rica told you that he would run the company as his father had done and all your suggestions
would cost money. He ended by saying that if your firm did not want the audit then he could
easily find another firm that did.

Required:

(a) What concerns do you have about the client and how would you address them in the
forthcoming audit? (15 marks)

(b) Outline what you would regard as a proper system of control for the warehouse explaining
how your controls would counter the likely inherent risks. (10 marks)

UL11/0211
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2. One of your most important clients is Milo & Co, a firm of financial services specialists
operating in the financial district in the City of London. The firm is authorised to deal on its
own account as well as to receive and invest money on behalf of clients. The audit for the year
ended March 31, 2011 is nearly complete and you, as audit partner, are looking at the audit files.
The following items catch your attention:

The audit of bank and cash revealed that deposits of money received from clients on one day
often did not appear on the bank statements until the next week.

A cheque for £5,000 sent out to a client just before the year-end appeared on the bank statement
after the year-end as £15,000. The accounts clerk responsible for this bank account had thanked
the audit team for pointing this out to him explained that it was probably a bank error which he
would chase the bank to correct.

A cheque made payable to a client for £25,000 has appeared on the list of reconciling items for
the last six months and no further action has been taken.

The Chief Financial Officer has many different tasks, one of which is to check the
reconciliations for unusual items but the audit senior happened to notice his ‘check’ on one bank
reconciliation statement took no longer than thirty seconds.

A payment for £35,000 made from the clients’ bank account has been entered in the cash book
twice.

One of the firm’s own bank accounts had received a bank transfer of £10m three days before the
year end and three days after the transfer was reversed. The Chief Financial Officer had
explained that this was a normal short-term loan which just happened to straddle the year end.

One of your staff noticed that the cheque books for client bank accounts were kept in an
unlocked drawer. When the audit team member queried this with the client staff, she was told
that it did not matter as the cheques were never signed and as most clients preferred bank
transfers so few cheques were written these days that it was not worth the effort of taking the
cheque books to the strong-room for safe-keeping.

A cheque of £50,000 from a client to be used for making investments on his behalf had been
paid into the office bank account rather than the separate clients’ money bank account. This is a
clear breach of the regulations which require office and clients’ money to be kept separate. The
error was caused by an inexperienced staff member. The Chief Financial Officer is keen that
your firm should not report this incident to the regulator because it was a simple error for a very
small amount in the context of the firm. In addition there will be a fine which could well be
significant because this is the firm’s third breach of the regulations this year.

Required:

(a) Write a report to the Chief Financial Officer setting out those matters which you consider
to be serious and explaining why you have come to those decisions. (15 marks)

(b) Depending on the Chief Financial Officer’s response to your letter, outline the possible
courses open to you. (10 marks)

UL11/0211
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3. You are a partner in a firm of accountants. You recently obtained a new client, Lamey plc, and
conducted site visits to each of the company’s five bases of operations.

You discovered that Lamey owns a fleet of very large, very expensive road-laying machines
which are kept behind high security fences when not in use. Other general-purpose vehicles,
such as trucks and vans, are left overnight in the company car park or on the side of the road.
Lamey employs on average about 100 staff, of whom 20 are headquarters staff and the rest are
employed on the physical act of laying the roads. Of the manual staff, 10 are considered full-
time, consisting of 5 team-leaders and 5 assistant team-leaders. The remaining 70 employees are
drivers and labourers who are hired and released at a week’s notice.

One team leader told you that it is not unusual for employees to leave suddenly without
collecting their pay because they are wanted by the police. Good workers are rare in this
business and to keep such men for the next project ‘off-the-payroll’ cash incentives are paid to
prevent them finding alternative work with other companies. Such payments are entered in the
accounting records as ‘sundry material purchases’. The team leader is responsible for judging
who is a ‘good worker’ and for deciding how much of a cash incentive is needed to keep the
man. The only check on this activity is an occasional visit by the Human Resources Director
who asks the team leader to identify those who may be worth retaining. The total cost of these
incentives is immaterial in the context of the value of the typical project.

You spoke to the Contracts Director who is responsible for submitting tenders and obtaining new
contracts. You told him that you were surprised that Lamey’s results in terms of both revenue
and profitability have increased steadily despite the economic recession and the cut-backs in
spending by central and local government. He grinned and said that ‘There are ways of getting
business, even in a recession’. Seeing your reaction, he quickly became serious and emphasised
the high quality of Lamey’s work. You left that meeting with an uneasy feeling.

You next met with the Finance Director who was keen to stress how he ran a ‘tight ship’, though
you noticed on his desk a letter from the tax authorities. You could not read the letter upside
down but it looked similar to a letter received by another of your clients announcing an in-depth
investigation into the payroll and employee tax deductions systems. When you asked the
Finance Director if there were any ongoing or future problems of which you should be aware, he
stated that there were none.

Required:

(a) What are the significant inherent risk factors in the case of Lamey plc? (10 marks)

(b) What controls would you expect to find in place in the payroll system covering both
salaried and weekly paid employees? (15 marks)

UL11/0211
D01 Page 4 of 6
4. You are the senior partner in a firm of chartered accountants. One of your responsibilities is to
perform a final review of the audit files prior to the signing of the auditors’ report by individual
audit partners. You have just finished reviewing five audit files and the following are the issues
on which your audit partners have asked for your advice.

The audit of Allison plc revealed that the depreciation policy writes off motor vehicles over ten
years whereas most companies in the industry use estimated lives of between four and six years.
Allison consistently reports losses on disposal of the motor vehicles. Under the existing policy
the depreciation charge per annum is about £5m and net profits have averaged about £40m.

One of the directors of Brook Ltd is currently facing prosecution for fraud in connection with the
business of another company with which he is involved. This other company is not related to
Brook Ltd and no transactions have ever taken place between the two companies. Brook’s
directors do not want to refer to the matter in the notes to Brook’s financial statements.

The audit of Clift plc was hampered by the fact that in one of its branches, the stock-taking
records had been destroyed in a fire in the offices. The audit team had not attended that stock
count and were unable to obtain other forms of evidence to support the figure for inventory in
the financial statements. The branch inventory accounts for 10% of the total inventory of £20m
in Clift which is reporting profits of £80m this year.

Davis plc is currently involved in litigation with a supplier concerning breach of contract. The
amounts in dispute are in the region of £15m. The net profit of Davis plc this year is £45m. The
directors argue that no reference should be included in the notes to the financial statements
because they are confident that the supplier will not win the case and because disclosure might
prejudice the litigation.

Evan plc has had a difficult past few years with falling profits and declining liquidity. It is
dependent on obtaining extended overdraft facilities from its bank with whom negotiations
continue. Evan’s directors have made full disclosure in their report and in the notes to the
financial statements. The audit partner considers these disclosures are sufficient for a reader to
understand Evan’s position.

Required:

(a) Explain how the matters referred to above will impact on the form and content of the
auditors’ reports for each of the clients. (15 marks)

(b) Describe the matters, apart from the true and fair view, on which auditors must form an
opinion before signing an auditors’ report under international auditing standards.
(10 marks)

UL11/0211
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SECTION B

Answer ONE question from this section and not more than one further question. (You are reminded
that four questions in total are to be attempted with at least two from Section A.)

5. It has been said that auditors should not be exposed to a flood of litigation. Evaluate the changes
over time in the way in which auditors have been held liable in actions brought by third parties.

6. Audit evidence comes in many forms and generally the more evidence an auditor is able to
obtain the better. Explain the factors that auditors consider when weighing up both quantity and
quality of audit evidence.

7. A commonly held view is that ‘an audit of financial statements is primarily concerned with
detecting fraud.’ Write an explanation of the extent to which this view is correct in terms of
today’s external audit of financial statements.

8. Consider the main concepts of auditing and explain how they relate to auditing practice as you
understand it.

END OF PAPER

UL11/0211
D01 Page 6 of 6
 Examiners’ commentaries 2011

Examiners’ commentaries 2011

93 Auditing and assurance

Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 2010–11. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).

General remarks

Learning outcomes
At the end of this course, and having completed the Essential reading and
activities, you should be able to:
• explain why external audits and other types of assurance services are
conducted
• discuss the duties of auditors and other assurance providers and how
these have changed over time
• explain the meaning of concepts that are fundamental to auditing
and assurance services, such as ‘independence’, ‘evidence’, ‘risk’ and
‘materiality’
• describe, in general terms, the processes involved in auditing and other
assurance services
• distinguish between compliance and substantive testing and describe
various audit tests
• discuss the form, content and importance of the reports provided at the
end of the audit or assurance service
• discuss the issue of legal liability arising from audits and other
assurance services
• discuss current developments in auditing and assurance services.

Planning your time in the examination

As with any examination, it is vitally important that you manage your
limited time effectively. With the examination paper for this course
containing a number of choices, you must ensure that you begin the
examination by reading all of the questions on the paper before starting
the first answer. You should practise ‘skim reading’ so that you can quickly
assess what each question requires and you can then proceed to make
your selection of questions to be attempted.
Having selected which questions you intend to attempt, you need to allot
the remaining time to those questions. Since all questions carry equal
marks, you should in theory allow equal time to each question. However,
bear in mind that the case studies are about a page long and will need
to be read carefully before you attempt your answer. On the other hand,
the material in the case study will lead you to or may prompt you in your
answer; for this reason, some candidates find answering the case studies
less challenging than the essays which you must plan from a ‘blank page’.
1
93 Auditing and assurance

The approach you adopt is very much a matter of personal preference but
what you must strive to avoid is running significantly over the allotted
time on one or more questions with the result that you leave too little time
for the remaining question(s). The extra marks which you stand to gain
from providing a fuller answer in one question are unlikely to compensate
for the marks you will have lost on the question you rush through at the
end. This should not be the first time you will have been given this advice
but it is a recurring problem, with scripts repeatedly showing clear signs
that candidates have either poorly planned their time or not adhered to
their plan; marks always suffer from this lack of discipline.

What are the Examiners looking for?

The Examiners set questions which test candidates’ knowledge of the
technical and theoretical aspects of auditing and assurance services.
The case study questions can prove a challenge in presenting candidates
with situations that are often unfamiliar. The more capable candidates
quickly realise that they need to adapt what they have learned about
the principles of auditing and perhaps the procedures applied in other
situations. This adaptation requires a degree of imaginative thinking and
common sense. Weaker candidates may simply not attempt questions
which seem unfamiliar and this severely limits the scope of questions
that they do feel able to attempt. In some questions a detailed knowledge
of auditing standards or regulations can be a definite advantage;
for example, questions on auditor independence frequently turn on
identification of threats to auditors’ independence and the acceptable
means of dealing with such threats. A lack of knowledge of the IFAC Code
or similar national pronouncement is a serious disadvantage.

Key steps to improvement

Past examination papers are a good guide to the level of questions
you may expect to face. They are also good revision material and you
are strongly advised to obtain examples of past papers as part of your
revision. However, a word of warning: do not use past papers to ‘question
spot’, that is, to anticipate what may come up in the future. Be aware also
that new developments may have rendered past questions or references
obsolete. Moreover, the emphasis in or contents of the syllabus may have
changed since the paper was originally set.
Hard work and time spent reading the materials will be rewarded. The
main aim should be to acquire knowledge and understanding. If you
simply memorise lists of items you are unlikely to be able to use this
‘knowledge’ effectively. The subject guide for this course highlights the
areas on which you particularly need to concentrate. Be disciplined in
going through the guide in a methodical manner, doing the reading and
making sure that you attempt the exercises and activities. Finally, in the
examination itself, do justice to the effort you have put in preparing for
the examination; do not be timid and skip parts of questions for fear
of making mistakes. There is no negative marking so you will not be
penalised if what you have written is deemed to be irrelevant and there is
a good chance that in most cases what you have put down will be worth
some marks, even if it is not quite what the Examiners are looking for.

Comments on presentation
Generally the standard of the presentation of answers this year showed
a marked improvement on previous years. The hand-writing in the vast
majority of cases was neat and legible and the standard of English was
high. However, far too many students are still unaware of the need to

2
 Examiners’ commentaries 2011

break up their answers into paragraphs – as a general rule there should be

at least four paragraphs per page. Your aim should be to make the job of
the marker as easy as possible. You should avoid covering multiple points
in a single paragraph. Common sense and good exam technique require
each point to be made in a separate paragraph. This makes your answer
look more professional and makes the job of marking your exam paper
easier. Students who force the markers to sift through a page or more of
densely packed, unbroken text are unlikely to receive much sympathy
when it comes to judging marginal scripts. You are strongly encouraged to
take time during the exam to set out your answers as neatly as possible.
It is pleasing to report that overall the standard of presentation was
greatly improved over previous years and many students do seem to
have heeded similar advice from previous years. A very large number of
scripts were neatly presented with clear divisions between paragraphs and
very few scripts were difficult to read. However, one worrying aspect has
begun to appear: the habit of leaving four or five lines blank at the bottom
of each page often confuses the markers into believing that they have
reached the end of your answer. The appearance of a significant number
of blanks lines in the middle of an essay gives the impression that you
have not completely thought out the structure of your answer.
Finally, in relation to the Section A questions, it is of some concern that
a significant number of students are unable correctly to determine which
part of the question to address. Often material was produced in answer
to part (a) of a question that was relevant to part (b) and vice versa.
Some students interspersed part (a) answers with answers to part (b) and
although clearly labelled, this presentation made it difficult to mark. A few
others made no attempt to distinguish the two parts of the question and
their marks would have suffered as a result.

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Question spotting
Many candidates are disappointed to find that their examination
performance is poorer than they expected. This can be due to a number
of different reasons and the Examiners’ commentaries suggest ways
of addressing common problems and improving your performance.
We want to draw your attention to one particular failing – ‘question
spotting’, that is, confining your examination preparation to a few
question topics which have come up in past papers for the course. This
can have very serious consequences.
We recognise that candidates may not cover all topics in the syllabus in
the same depth, but you need to be aware that Examiners are free to
set questions on any aspect of the syllabus. This means that you need
to study enough of the syllabus to enable you to answer the required
number of examination questions.
The syllabus can be found in the ‘course information sheet’ in the
section of the VLE dedicated to this course. You should read the
syllabus very carefully and ensure that you cover sufficient material in
preparation for the examination.
Examiners will vary the topics and questions from year to year and
may well set questions that have not appeared in past papers – every
topic on the syllabus is a legitimate examination target. So although
past papers can be helpful in revision, you cannot assume that topics
or specific questions that have come up in past examinations will occur
again.
If you rely on a question spotting strategy, it is likely
you will find yourself in difficulties when you sit the
examination paper. We strongly advise you not to adopt
this strategy.

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Examiners’ commentaries 2011

93 Auditing and assurance – Zone A

Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 2010–11. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).

Comments on specific questions

Candidates should answer FOUR of the following EIGHT questions:
TWO from Section A, ONE from Section B and ONE further question
from either section. All questions carry equal marks.

Section A
Answer TWO questions from this section and not more than one further question.
(You are reminded that four questions in total are to be attempted with at least
one from Section B.)

Question 1
You are a partner in a firm of accountants. You recently obtained a new client,
Mactar plc, and conducted site visits to each of the company’s five bases of
operations.
[For the full question, please refer to the Examination paper.]

Question 1
Reading for the question
Porter et al., Chapter 6, pp.216–49; Chapter 8, pp.313–20; Chapter 9,
pp.350–59.
Gray and Manson, Chapter 7, pp.271–77; Chapter 9, pp.333–35.
Approaching the question
This scenario offered plenty of material for the well prepared student.
There were a number of circumstances that could have been identified as
inherent risk factors. One common mistake was to list them all in bullet-
point form with not even a brief explanation of why they were risk factors.
Better candidates realised the need to justify their selection of the risk
factors; for example, the issue regarding the letter from the tax authorities
raises a question about the integrity and honesty of the Finance Director
and his apparent reluctance to be open with you as an auditor. Weaker
answers also tended to focus almost exclusively on the control risks such
as the lack of segregation of duties. Generally however part (a) of this
question was very well done with many candidates obtaining maximum
marks.
Part (b) to the question was framed as an invitation to discuss typical
controls in payroll systems generally but a number of candidates

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interpreted this narrowly as simply relating to the case study. The sorts
of controls which needed to be covered were: procedures to ensure that
only bona fide workers are paid and they are paid only for work that is
actually done, controls to ensure that pay is properly calculated, that
deductions for tax, etc. are calculated correctly, proper security measures
for the delivery of cash to the locations of operations, and secure delivery
of the pay packets to the weekly paid employees. In the case study a major
weakness was the authority of the team leader for deciding the bonus to
be paid and the suggestion that the team leader also had access to the
uncollected pay packets of the workers who had suddenly left. The text
books provide quite detailed coverage of controls over payroll so it was
surprising that a good number of candidates who attempted this question
could manage to remember only one or two of the standard controls over
payroll.

Question 2
You are the compliance partner for your firm. Your job is to ensure that the
firm complies with the legal and regulatory requirements as well as the ethical
standards. Your firm has recently acquired Barniere & Co., a firm of accountants
based in a country which is making the transition to a market economy. The
country currently has only the most basic of rules for regulating the stock
market but its leaders are committed to bringing the country into line with the
highest standards prevailing in developed countries.
[For the full question, please refer to the Examination paper.]
Reading for the question
Porter et al., Chapter 4.
Gray and Manson, Chapter 3.
Approaching the question
This was a straight-forward question designed to test candidates’
knowledge and understanding of the regulations concerning auditor
independence. There were five situations in which an aspect of auditor
independence was in question. Candidates were required to identify the
issue and to point out what the firm’s position should be under acceptable
standards of behaviour. For example, in one case a partner in the firm held
shares in an audit client. Even if the partner takes no part in the audit the
appearance of independence is marred. In another situation, the audit
fee had remained unpaid for a number of years meaning that effectively
the audit firm was providing finance to the audit client. Ethical standards
state that auditors should neither borrow from nor lend to an audit client
since this sort of relationship would damage both the appearance and
potentially the actual independence of the auditor.
Part (b) required a little imagination to mould knowledge and
understanding of the subject to answer the question. Consequently this
part was generally poorly done. But it was not a difficult question. You
need to think: what would I do if I were in charge of a firm of accountants
and I was worried that one of my staff might breach ethical rules? An
obvious step would be to train all staff so that they are aware of the
international standards on ethics (the IFAC Code). Another would be to
circulate a list of all clients to every member of staff with a reminder that
under the Code staff are not allowed to hold shares in these clients. Other
examples include instructions to fee earners to collect their fees promptly,
instruct staff not to accept hospitality or gifts unless of a very small value
and policies to ensure that the firm’s independence is reviewed where
personnel move between audit firm and audit clients.
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Question 3
You are the senior partner in a firm of chartered accountants. One of your
responsibilities is to perform a final review of the audit files prior to the signing
of the auditors’ report by individual audit partners. You have just finished
reviewing five audit files and the following are the issues on which your audit
partners have asked for your advice.
[For the full question, please refer to the Examination paper.]
Reading for the question
Porter et al., Chapter 14.
Gray and Manson, Chapter 16.
Approaching the question
This question concerned auditors’ reports and the various factors that
impact on the contents of an auditors’ report. There were some very
well presented answers but also some which showed a significant lack
of understanding of even the most basic terminology. Most common was
the confusion about qualified and unqualified reports and a tendency
to talk of auditors ‘unqualifying’ their report. In particular, a very large
number talked of an unqualified report with an except for paragraph – if
a report has an except for paragraph it is by definition a qualified report.
To some extent this is the fault of the English language and the technical
terminology adopted by the accounting profession, but the Essential and
Further reading textbooks make such frequent reference to these matters
that to the well prepared candidate the correct terminology would come
to mind automatically.
Some candidates were keen to show the extent of their studying and
their power of recall: a number reproduced the decision flow chart with
a fair degree of accuracy even though this was not called for (and so it
was a complete waste of time) but then went on to demonstrate that
they did not actually understand the chart itself because their attempts
at answering the question contradicted the flow chart they had correctly
reproduced.
The matters which candidates were expected to identify and comment
upon were the possible disagreement with the accounting policy for
depreciation, which seemed to be inappropriate given other companies’
policies and consistently resulting in loss on disposal. Candidates were
often too keen to suggest that auditors should qualify where one of the
client’s directors had been charged with fraud even though the case did
not affect the company in question and no conviction had been obtained
against the director. It is hard to imagine, and those candidates who
made this suggestion were unable to provide, an example of the type of
qualification which might be suitable in this case. The last company in the
question was clearly facing a going-concern problem and many candidates
were very sure that the auditors report should be qualified; however,
those with a proper knowledge of the international auditing standards
knew that provided the financial statements make full and fair disclosure,
the report should not be qualified. It may be appropriate to include an
emphasis of matter paragraph without qualifying the opinion.
Part (b) concerned the other matters which auditors have to consider
in formulating their reports in addition to presenting their opinion on
the financial statements. This part was generally poorly done suggesting
insufficient reading of the texts and other teaching materials. Under the
international standards, auditors also have to consider whether they
have complied with the auditing standards, whether they have collected
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enough evidence, whether there has been compliance with other legal
and regulatory matters, whether there has been appropriate disclosure
of management’s responsibility for the financial statements and possibly
forming an opinion in relation to disclosures regarding internal controls.

Question 4
The Quayside Ex-Servicemen’s Club is a not-for-profit organisation in the small
town of Dartweir. The club is popular because it charges low prices. The club
is governed by a committee of volunteers who meet once a month to review
the management accounts presented by the only full time employee, the club
steward. The steward receives a basic salary plus a bonus of 10% of any surplus
of income over expenditure. Since the club is a charity any remaining surplus has
to be spent for the benefit of the members.
[For the full question, please refer to the Examination paper.]
Reading for the question
Porter et al., Chapter 10.
Gray and Manson, Chapter 9, pp.330–55.
Approaching the question
The audit of clubs can often prove problematic in practice because the
controls are often informal or non-existent. Any organisation that has a lot
of cash moving through it presents a potential risk for auditors since there
may be theft of some of the cash, the shortfall being masked by under-
recording of receipts or overstating of cash payments. The controls here
in this question were weak especially in relation to the supplies of beer
and purchase and custody of fixed assets and that may have allowed those
involved in running the club to misappropriate the cash or fixed assets.
Allowing non-members to use the facilities may be in breach of the club’s
constitution and there might be legal consequences, for example, under
the licensing regulations. Many candidates who attempted this question
identified a number of the issues but few obtained full marks. In reading a
question you must be on the look-out for every point that may be relevant.
It is unlikely that there will be irrelevant material in the question which
means that every point is capable of being used either in answer to part
(a) or part (b). You omit items at your own cost.
Part (b) required candidates to recognise a number of controls.
A number of controls which could be instigated without taking on more
staff, which the question clearly says cannot be done. For example, the
committee can insist on a full asset register being created and maintained
to record the club’s fixed assets. The committee might require the steward
to perform a weekly or monthly stock count and calculate stock losses and
gross profit margins. Requiring all visitors to sign a register will provide
a check on takings for temporary memberships and reduce the risk of
breaching licensing regulations. One of the committee could occasionally
do a surprise count of the cash to act as another check on the steward and
the accuracy of the record-keeping.

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Section B
Answer ONE question from this section and not more than one further question.
(You are reminded that four questions in total are to be attempted with at least
two from Section A.)

Question 5
Critically evaluate the standard unqualified audit report in terms of what it says
and what it does not say for the benefit of the ordinary private investor.
Reading for the question
Porter et al., Chapter 14.
Gray and Manson, Chapter 16.
Approaching the question
This question required candidates to demonstrate an understanding
of the explicit and implicit meanings and messages in an unqualified
report. In relation to the true and fair view, candidates should have been
able to expand upon underlying notions such compliance with accepted
accounting standards or practices, materiality, substance over form and
clear and understandable presentation of the information. Reference could
be made to the desirable characteristics of financial statements under the
IASB’s Framework.
Also explicitly stated in the standard auditors’ report are matters such as
the respective responsibilities of management and auditors for internal
control and candidates could have been expected to discuss matters such
as fraud, going concern and internal controls.
The standard unqualified auditors’ report contains a number of
paragraphs with additional information for the benefit of the reader.
Candidates were invited to show what they knew about these additional
paragraphs. Unfortunately, many of those that attempted this question
were unable to discuss the issues at length and instead gave a detailed
analysis of the various forms of audit report.

Question 6
Auditing standards apply to the audit of all financial statements. How realistic
is it to expect that the audit of small companies can be conducted to the same
standard as that for larger companies?
Reading for the question
Porter et al., Chapter 5, pp.166–69.
Gray and Manson, Chapter 5, pp.184–85.
Approaching the question
The question of whether there should be one set of standards for large and
small companies has tormented the accounting profession for years. At its
heart the problem concerns the idea that there can only be one concept of
audit which applies to all situations in which an audit is carried out. The
argument accepts however that different situations will call for different
methods to be used. This particular essay question wanted candidates
to debate whether it is possible in the context of the small company to
perform an adequate audit. Candidates were expected to rehearse the
arguments such as lack of formal controls and documentary evidence and
also suggest ways around these problems – for example, more extensive
detailed testing, perhaps greater use of analytical procedures and more

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reliance on evidence from outside parties. Perhaps wisely, very few

candidates attempted this question and of those that did, few showed a
proper appreciation of the issues involved.

Question 7
There have been many well publicised audit failures in the last 150 years.
Describe those that you regard as the most significant and explain what lessons
can be learnt from the apparent failure of auditors in these cases.
Reading for the question
Porter et al., Chapter 15.
Gray and Manson, Chapter 19.
Approaching the question
The question expected candidates to be able to discuss the main features
of the cases of litigation against auditors and to draw lessons from these
cases. This was a fairly open-ended question and given the amount of
coverage devoted in the text books to matters of legal liability, it should
not have been difficult for the well prepared candidate to discuss at length
six or seven cases. For example, one might have identified the Kingston
Cotton Mill (1896) case about which much has been written. This case
tested the reliability of management representations and essentially
supported the proposition that auditors were entitled to rely on the word
of management unless there were suspicious circumstances. That position
has evolved over the years and auditors today would be expected to do
more than automatically accept what they were told by management.
Another major case which might have been selected is the McKesson
and Robbins (1838) case involving stock and debtors which indicated
that auditors had to get positive evidence in support of the financial
statements, for example, attend the stock-count and obtain confirmation
of the debtor balances.
Another case might be that of the London and General Bank (1895) which
involved auditors who knew that the bank’s loans to customers were
unlikely to be collected and yet only hinted as much in their auditors’
report. In holding them to be negligent, the court sent out a clear signal
that auditors must be honest and clearly express themselves in framing
their reports.

Question 8
Auditing is concerned with creating trust. In addition to independence, what
other qualities must auditors have, and be seen to have, and why?
Reading for the question
Porter et al., inside cover; Chapter 3.
Gray and Manson, pp.23–25; Chapter 2, pp.40–42.
Approaching the question
For any student who had read the UK’s Auditor’s Code (referred to and
reproduced in the text books), this question would not have posed too
tough a challenge. The Code lists various qualities such as competence,
integrity and rigour. Even those who may have been unfamiliar with
the Code should have been able to suggest qualities such as these which
are obviously needed if auditors are to add credibility to the financial
statements.
Candidates were expected not only to produce an inventory of qualities
but also to discuss why these qualities are essential. Too often candidates

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who attempted this question simply reproduced a list with little or no

attempt at discussion. In fact, just a little thought and some common sense
should have been able to inspire some discussion on the reasons for the
need for such characteristics.