AUDITING PROFESSIONAL 1 EXAMINATION - APRIL 2009 NOTES: Section A - You are required to answer Questions 1, 2 and 3. Section B - You are required to answer any two out of Questions 4, 5, 6 and 7. (If you provide answers to more than two questions in this section, you must draw a clearly distinguishable line through the answer(s) not to be marked. Otherwise, only the first answers to hand for these four questions will be marked.) TIME ALLOWED: 3 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates' answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted. The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND AUDITING PROFESSIONAL 1 EXAMINATION - APRIL 2009 Time Allowed: 3 hours, plus 10 minutes to read the paper. Section A - You are required to answer Questions 1, 2 and 3. Section B - You are required to answer any two out of Questions 4, 5, 6 and 7. (If you provide answers to more than two questions in this section, you must draw a clearly distinguishable line through the answer(s) not to be marked. Otherwise, only the first answers to hand for these four questions will be marked.) SECTION A - Questions 1, 2 and 3 are compulsory. 1. You are the Audit Senior of WW plc and you are about to audit WW plc. WW plc is a wholesale distributor of frozen fruit, in business since 1971, which operates out of three countries; Ireland, France and Belgium. In each country the company has a distribution refrigeration warehouse. However, the administration, purchasing and accounting functions are centralised in the company s headquarters in Ireland. As part of your audit you will carry out a detailed examination of WW plc and its environment, including the company s internal controls. Internal control consists of the following components; (i) the control environment; (ii) the entity s risk assessment process; (iii) the information system, including the related processes relevant to financial reporting and communication; (iv) control activities; and (v) monitoring of controls. REQUIREMENT: a) Explain why it is important for the Auditor to obtain an understanding of the company and its environment including the company s internal controls. (5 marks) b) Explain what is meant by the term control environment and identify THREE major factors that will be reflected in the control environment of WW plc. (7 marks) c) List FOUR different control activities. (4 marks) d) For each control activity identified in your answer to c) above, provide ONE specific illustration of a control you would expect to find in the daily activities of WW plc. (4 marks) [Total : 20 marks] Page 1
2. You are doing the audit of ETU plc for the year ended 30 June 2009. The company is a publishing company. The company maintains a tangible non-current assets (fixed assets) register. The following schedule for tangible non-current assets has been prepared by the client: Property, Plant, and Equipment Freehold Publishing Office Office Total Property Equipment Equipment Furniture 01/07/08 Cost Brought Forward 0 109,210 102,100 83,428 294,738 Additions 675,000 92,242 18,204 5,200 790,646 Disposals 0 (81,499) (11,200) (904) (93,603) 30/06/09 Cost Carried Forward 675,000 119,953 109,104 87,724 991,781 Notes: (i) Additions to freehold property consist of a new head office and car park. The company previously rented premises. (ii) (iii) (iv) Additions and disposals to publishing equipment comprise two digital printers and four photocopiers respectively. The company purchased one server computer and disposed of one server computer during the period. Additions and disposals to office furniture comprise miscellaneous items bought, sold and scrapped. REQUIREMENT: a) (i) Explain why the emphasis in auditing tangible non-current assets is on the current period additions and disposals rather than on the balances in the account brought forward from the preceding year. (2 marks) (ii) Explain under what circumstances will the emphasis be on the balances brought forward? (1 mark) b) Prepare the substantive audit programme of work for the tangible non-current assets section of the balance sheet, detailing TEN audit procedures that might reasonably be applied by an Auditor to meet the following specific audit objectives: Existence or occurrence (EO); Completeness (C); Accuracy, classification and valuation and allocation (ACV); Rights and obligations (R); Presentation and disclosure (PD); in respect of the tangible non-current asset figures to be shown in the balance sheet of ETU plc for the year ended 30 June 2009. You are not required to consider income statement audit work. For each procedure mentioned in your programme, where appropriate, you should identify the associated objective(s). (15 marks) Presentation of audit programme. (2 marks) [Total : 20 marks] Page 2
3. As one of several Senior Auditors at a firm of Certified Public Accountants you are competing to be promoted to the position of Audit Manager. Because many of the firm s clients, including small, family owned businesses, rely on Information Technology (IT) to record and process business transactions, the Audit Partner wishes to ensure that the successful candidate has a good understanding of the impact of IT on the audit process. All candidates have therefore been requested to submit a memorandum to the Audit Partner which demonstrates an understanding of the following issues: What is meant by audit trail and why it is essential to both management and auditors? The typical uses of computer audit software. The problems associated with the use of computer audit software. The difference between general controls and application controls. REQUIREMENT: Write a memorandum to the Audit Partner which: a) Defines what is meant by an audit trail and explains why it is essential to both management and auditors. (5 marks) b) Describes and gives an example of FIVE typical uses of computer audit software. (5 marks) c) Highlights FOUR problems associated with the use of computer audit software. (4 marks) d) Distinguishes between general controls and application controls and give ONE example of each. (4 marks) Presentation of memorandum. (2 marks) [Total : 20 marks] Section B - You are required to answer any two out of Questions 4, 5, 6 and 7. 4. You are the Training Officer in a firm of Certified Public Accountants and you are giving an induction course to a new group of trainee audit staff. Upon questioning the trainees re their knowledge of auditing, a number of the trainees have stated that they are aware the cornerstone of any audit is the evidence gathered and evaluated by the Auditor and that reperformance is an example of one of the procedures used by Auditors to gather evidence. However, they are still a little hazy over the whole concept of audit evidence and the other auditing procedures used by Auditors to gather audit evidence. You decide to provide them with explanatory notes on the concept of audit evidence and other procedures used by Auditors to gather audit evidence and to use for training purposes the accounts of a furniture manufacturing company. REQUIREMENT: Prepare notes in any format for the trainee audit staff on your induction course which: a) Describes what is meant by auditing procedures and explains why is it important for auditing procedures to be carefully worded; (4 marks) b) Identifies the factors that determine the persuasiveness of audit evidence and explains how these factors are related to auditing procedures, sample size, items to select and timing; (6 marks) c) Identifies FOUR procedures as per ISA 500 Audit Evidence (in addition to reperformance ) which the audit team will use when gathering evidence on the audit of the accounts of the furniture manufacturing company. (2 marks) d) You are also required to give TWO examples of audit evidence that could be obtained from each procedure identified in your answer to c) above. (8 marks) Page 3 [Total : 20 marks]
5. You are auditing cash at bank for KS plc, an internet based company, for the year ended 30 June 2009. The company receives the majority of payments from customers by electronic deposit of cash direct to their bank account from credit card agencies making payments on behalf of customers. Gerry Lyons, the Bookkeeper for KS plc reconciles the bank account on a monthly basis. As part of your standard audit procedures, you have prepared a bank letter for forwarding to the client s bankers, ABI Bank. However, the Managing Director is reluctant to authorise disclosure to you by the bankers. In his opinion this is not necessary because all of the company s bank statements reconciled by Gerry Lyons, the Bookkeeper, will be given to you for the purpose of your audit. REQUIREMENT: a) Explain why the monthly reconciliation of bank accounts by an independent person is an important internal control over cash at bank. Which individuals are generally not considered independent for this responsibility? (4 marks) b) State how KS plc s bank reconciliation will reflect an electronic deposit of cash received by the bank from credit card agencies making payments on behalf of customers purchasing products from KS plc s online website, but not recorded in KS s records. (3 marks) c) Explain how bank confirmations differ from positive confirmations of trade receivables (debtors). Distinguish between them in terms of: the nature and type of information confirmed in each; (6 marks) the sample size; and (2 marks) the appropriate action when the confirmation is not returned after the second request. (2 marks) d) State the concern you would have and the action you would take if the Managing Director refused to authorise disclosure of the information required in the bank letter. (3 marks) [Total : 20 marks] Page 4
6. Choo plc is a distributor of high end fashion footwear. The company keeps a large inventory of shoe merchandise and miscellaneous shoe care products in a warehouse in Dublin. Shoes and shoe care products are distributed from this warehouse to high end shoe shops and department stores throughout Dublin. The warehouse is controlled by a Stores Supervisor and his Assistant using a computerised inventory recording system, to which only these two staff and the Financial Director of the company have access. Suppliers have online access to the inventory recording system via Choo plc s internet web site in order to have real time access to information about the description and quantities of shoe inventory held. The system identifies each shoe line / shoe care product by a shoe/ shoe care product number, shoe/ shoe care product description, price and location. It can be updated for quantity movements only and allows for referencing to goods received notes (receipts into inventory) or goods returned notes (issues out of inventory). All goods received notes, and goods returned notes are pre-numbered. The computerised inventory records are not independently checked during the year; therefore the Financial Director of Choo plc has issued instructions for a year end physical count, which is to take place immediately after the close of business on the last day of the financial year. You have received a copy of the instructions for review. REQUIREMENT: a) Give reasons why Choo plc would choose to provide online access of descriptions of shoe merchandise and on hand quantity levels to suppliers. State the risks associated with making that information available online and ways in which these risks can be reduced. (5 marks) b) In the verification of the amount of the inventory, one of your concerns will be that slow-moving and out of fashion /obsolete shoe merchandise be identified. Identify FIVE auditing procedures that you can use to determine whether slow moving or obsolete shoes/shoes merchandise have been included in inventory. (10 marks) c) Identify FIVE procedures and controls that Choo plc need to introduce in order to enable audit reliance to be placed on the computerised inventory record quantities as a basis for inclusion in the company s accounts. (5 marks) [ Total : 20 marks] 7. A firm of Certified Public Accountants has been considering the areas it needs to address in its documented policies and procedures that it intends to develop further. This is to provide it with reasonable assurance that the firm and its personnel comply with the professional standards and the applicable regulatory and legal requirements; and that reports issued by the firm or engagement partners are appropriate in the circumstances. The firm has four partners, four qualified audit staff, twenty trainee audit staff and four secretarial/technical staff. The firm has already a number of audit clients across a range of activities and has recently been approached by a plc company and asked to tender for their audit. Whilst most of the detailed audit work is carried out by trainee staff, each audit assignment is controlled by an engagement partner and supervised by a qualified member of the audit staff. If they take on the plc client, the firm are aware they will have to carry out an engagement quality control review. On recurring engagements, the engagement partner in charge of the audit reviews with the engagement team, the permanent audit file, audit programmes and other audit working papers from the prior audit while planning the current audit to determine their usefulness for the current engagement. REQUIREMENT: a) List the areas to be addressed in the documented polices and procedures in a system of quality control. (4 marks) b) State as per ISA-220 Quality Contol for audits of historical Financial Information what an engagement quality control review entails. (6 marks) c) List the purposes of audit working papers and explain why each purpose is important. (6 marks) d) Define what is meant by a permanent audit file, and list FOUR types of information typically included. (4 marks) END OF PAPER Page 5 [Total : 20 marks]
SUGGESTED SOLUTIONS THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND SOLUTION 1 AUDITING PROFESSIONAL 1 EXAMINATION - APRIL 2009 a) ISA 315: Identifying and assessing the risk of material misstatement through understanding the entity and its environment (para A1) explains: Obtaining an understanding of the entity and its environment, including the entity s internal control..is a continuous, dynamic process of gathering, updating and analysing information throughout the audit. The understanding establishes a frame of reference within which the auditor plans the audit and exercises professional judgement throughout the audit, for example, when: Assessing the riske of material misstatement of the financial statements; Establishing materiality and evaluating whether the judgement about materiality remains appropriate as the audit progresses Considering the appropriateness of the selection and application of accounting policies, and the adequacy of financial statement disclosures Identifying areas where special audit considerations may be necessary, for example, related party transactions, the appropriateness of management s use of the going concern assumption, or considering the business purpose of transactions; Developing expectations for use when performing analytical procedures; Responding to the assessed risks of material misstatement, including designing and performing further audit procedures to obtain sufficient appropriate audit evidence; and Evaluating the sufficiency and appropriateness of audit evidence obtained, such as the appropriateness of assumptions and of management s oral and written representations. (One mark for each point to a maximum of five marks) b) The control environment of a company refers to the environment created by the company s directors and executives, through their attitude, awareness and actions, regarding the company s internal controls and their importance in the company. (One mark for definition) Major factors that will be reflected in the control environment of WW Plc are: the manner in which the principles of integrity and ethical values are communicated and enforced within the company; management s consideration of the competence levels required for particular jobs and how these translate into requisite skills and knowledge; attitudes of the board of directors in particular, the directors independence from executives, their experience and stature, the extent of their involvement in the company, the information they receive, their scrutiny of the company s activities, the degree to which they raise and pursue difficult questions with executives, and their interaction with the entity s internal and external auditors; the philosophy and operating style of the senior executives, in particular, their approach to taking and managing business risks, and attitudes towards the accounting function, information processing and financial reporting; the organisational structure within which the company plans, and seeks to achieve, control and review, its objectives; how authority and responsibility for operating activities are assigned, and how reporting relationships and authorization hierarchies are established; and human resource policies and practices relating to, for example recruitment, orientation, training, evaluation, counseling, promotion, compensation and remedial actions. (Two marks per factors up to a maximum of six marks) Page 7
c) Categories of Control Activity Examples of specific procedures I would expect to find in the daily activities of WW plc Approval and control of documents Approval by a senior member of the accountancy staff, of a journal for posting to the company s nominal ledger. Approval of paid overtime sheets by a responsible manager Restricting direct access to assets Password protection over access to the sales price data and records master file. Restricting access to the cashier s department. Restricting access to the warehouse. Procedures for authorising transactions Authorisation of purchase orders by a responsible manager. Segregation of duties Adequate segregation of duties throughout all sales, administration and accounting departments. (One mark for each activity (4 marks) and each example (4 marks)) SOLUTION 2 a) The reason for the emphasis on current period additions in auditing tangible noncurrent assets is that there is an expectation that tangible noncurrent assets will be kept and maintained on the records for several years. The assets carried over from the preceding years can be assumed to have been verified in the prior years' audits. (One mark for each point to a maximum of 2 marks) If it cannot be shown through tests of controls and substantive tests of transactions that all disposals have been recorded, additional testing of the prior balance could be required. A first year audit also necessitates tests of the beginning balance. (One mark) b) Audit Programme for tangible noncurrent assets ETU plc Year ended 30 June 2009 Planned by.. Performed by:. Reviewed by:.. Test Associated Working Primary Paper Objective(s) Ref. (i) Ensure balance brought forward in tangible noncurrent assets account(s) in nominal ledger agrees to balance in Balance Sheet as at 30 June 2008. CP (ii) (iii) (iv) Review reconciliation of tangible noncurrent assets register to tangible fixed assets account in nominal ledger and obtain explanations for any discrepancies. Review results of tangible noncurrent asset verification checks carried out internally by company, as a basis for determining additional audit work to be carried out. Select sample of publishing equipment, office equipment and office furniture items brought forward, from tangible noncurrent assets register and carry out physical examination. C CE E Page 8
Test Associated Working Primary Paper Objective(s) Ref. (v) Select sample of categories of tangible noncurrent assets in existence and check for inclusion in tangible noncurrent assets register CE (vi) For items physically examined above, check condition and whether still in use by the company. Consider implications on value of tangible noncurrent assets at Balance Sheet date. VR (vii) Examine title documents and contracts R (viii) Check bank letter for details of securities, documents of title and assets in safe-keeping. ECR (ix) Complete company accounts disclosure check list. P (x) (xi) (xii) Obtain details of the company s tangible noncurrent asset budget for the year and enquire into any material variations from tangible noncurrent assets acquired. Review any notes of directors meetings and correspondence files for details of capital expenditure additions and compare to actual expenditure. Enquire into any material variations. Review the costs charged to repairs and maintenance and rental expenses in the nominal ledger to identify any costs incorrectly treated as revenue rather than capital expenditure items and to confirm costs normally associated with ownership. Resolve any inconsistencies identified with senior management of the company. C C CVPR (xiii) For all of the freehold property ensure that all expenditure has been properly authorised and vouch all additions to: authorised purchase invoices, and where applicable solicitors completion statement for the purchase of freehold property; goods received notes where applicable; documents of title (e.g., title deeds and land registry confirmations for the freehold property); entry in tangible noncurrent assets register; entry in nominal ledger. VRP (xiv) For additions of publishing equipment, office equipment and furniture select a sample of higher value additions ensuring proper authorisation of expenditure and vouch to: authorised purchase invoice; goods received note; entry in tangible noncurrent assets register; entry in nominal ledger. VRP (Fifteen marks will be awarded for identifying up to ten of the above procedures and the associated primary audit objective(s).) Two marks will be awarded for presentation Page 9
SOLUTION 3 a) An audit trail is a chain of evidence provided by coding, cross-reference and documentation that connects account balances and other summary results with original transaction data. (One mark) Audit trails are essential to both management and auditors; for example management uses the trail in responding to inquiries from customers or suppiers concerning account balances and auditors use the trail in vouching and tracing transactions. In computer information systems the audit trail may exist in electronic format only and sometimes may be deleted once the transaction has been verified (such as when the personal identification number (PIN) is read and verified at the initiation of a credit or debit card transaction). Special audit techniques are required to verify the audit trail, such as the use of embedded audit facitlities that trace the opeation of controls electronically. (One mark for each point to a maximum of four marks) b) Typical uses of computer audit software There are numerous examples of how auditors can use computer audit software. These include: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) The selection of exceptional items for testing by the auditor. Example: the selection of sales invoices raised in excess of 100,000. The recalculation and verification of balances. Example: totaling the sales subsidiary ledger or inventory file. The comparison of data elements in different files for agreement and identification of differences. Example: the comparison of prices on sales invoices with a master file containing authorised prices. The selection of a random sample of representative transactions for testing from a specified population. Example: the selection of a sample of purchase invoices for audit testing. The production of an aged analysis of balances on a specified ledger. Example: ageing of balances on the trade receivables ledger. The identification of trends and possible areas of audit concern. Example: production of monthly sales analysis and proportion of sales by product type. The performance of completeness checks. Example: carrying out a sequence check on sales invoices to determine completeness of processing. The performance of data stratification. Example: stratification of balances on the trade receivables ledger as a basis for the sample of trade receivables for confirmation. The performance of unreasonableness checks. Example: identification of employees with weekly overtime paid in excess of 40 hours. The performance of rule violation checks. Example: identification of sales price discount in excess of 10% given to customers. (Five marks will be awarded for any five functions and examples identified.) c) The problems associated with the use of computer audit software These can be summarised as: (i) The initial set-up costs and costs involved in updating can be prohibitive. (ii) The software needs to be tested thoroughly before being used on the live data of audit clients. (iii) Audit staff needs to be trained specifically to use the software. (iv) Standard computer audit software may not be compatible for all specified computer applications. (v) Difficulties are often encountered in obtaining computer time from clients to use the computer audit software. (vi) Over elaborate computer audit software programmes may take up extensive computer time and reviewing time. (Four marks will be awarded for any four problems identified.) Page 10
d) General controls are those controls that apply to computer information systems (CIS) as a whole and examples include contols related to such matters as data centre organisations, hardware and systems software acquisition and maintenance, and backup and recovery procedures. (One mark each for explanation and example) Application controls are those controls that apply to the processing of specific types of transactions such as invoicing customers, paying suppliers and preparing payroll. Whether they are in a computerised or a manual environment, application controls may be further classified into the following categories: Proper authorisation Documents and records Independent checks An example of an application control is a programmed control that verifies that all time cards submitted are for valid employee ID numbers included in the employee master file. SOLUTION 4 (One mark each for explanation and example) (Memorandum presentation 2 marks) a) Auditing procedures are methods and techniques used by the auditors to accumulate audit evidence. Each procedure has a particular advantage for obtaining evidence for an assertion. In selecting a procedure, auditors must take care to balance the potential effectiveness of the procedure in meeting specific objectives against the cost of performing the procedure. Because audit procedures are the methods and techniques to be followed in obtaining evidence, they must be worded carefully to make sure the methods and techniques are clear. (One mark for each point to a maximum of four marks) b) ISA 500 states that: The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion. The two determinants of the persuasiveness of evidence are sufficient and appropriate. Appropriate (relevant and reliable) refers to the degree to which evidence can be considered believable or worthy of trust. Appropriate relates to the auditing procedures selected, including the timing of when those procedures are performed. Sufficiency refers to the quantity of evidence and it is related to sample size and items to select. (One mark for each point to a maximum of six marks) c) The following procedures will be used by the audit team when gathering evidence on the audit of the accounts of the toy manufacturing company:- (i) (ii) Inspection of documents Examples: examining a recent payroll to check authorisation; examining a sample of purchase invoices to determine whether the goods or services received are reasonable of the type normally used by a furniture manufacturing company; read the minutes of the board of directors meeting and summarise all information that is pertinent to the financial statements in the audit file; trace a sample of sales transactions from the sales journal to sales invoices, and compare customer name, date, and the total value of the sale; vouch a sample of recorded purchase transactions to suppliers invoices and good received notes. Inspection of assets Example: inspecting a furniture-molding machine to verify existence; count a sample of 50 inventory items and compare quantity and description to furniture manufacturing company s counts. Page 11
(iii) (iv) (v) (vi) Observation Examples: observing the year end inventory count by employees; observing the cashier pay petty cash to an employee; observing furniture being dispatched to customers. Inquiry and Confirmation Examples: sending a bank letter to the bank of the furniture manufacturing company and receiving confirmations from the bank as requested; performing a trade receivables circularisation and receiving appropriate confirmations from the customers of the furniture manufacturing company; requesting and receiving information from the directors of the company as to whether there is any obsolete inventory on hand at the balance sheet date; requesting and receiving information from the lawyers of the company concerning the probable outcome of litigation. Analytical Procedures Examples: calculating the liquidity ratio of the company when evaluating the status of the company as a going concern; comparing sales figures achieved to those budgeted as a means of assisting in the verification of the completeness of the sales figures; comparing the bad debt and sales figures to those in the previous year to facilitate verification of the bad debt provision in the company s accounts; Compute the inventory turnover ratios and compare with those of previous years as a test of inventory obsolescence. Recalculation Examples: recompute the unit sales price times the number of units of furniture for a sample of sales invoices and compare the totals with the calculations; total the sales journal for a one month period and compare all totals with the nominal ledger. (Ten marks will be awarded for any two appropriate examples (eight marks) given for four procedures (two marks).) SOLUTION 5 a) The monthly reconciliation of bank accounts by an independent person is an important internal control over cash balances because it provides an opportunity for an internal verification of the cash receipts and cash deposit transactions, investigation of reconciling items on the bank reconciliation, and the verification of the ending cash balance. [One mark] Anyone responsible for the following duties would not be considered independent for the purposes of preparing monthly bank reconciliations: Issuance of cheques Receipt and deposit of cash Other handling of cash Record keeping (One mark for each point to a maximum of four marks) b) The company s bank reconciliation should include an adjustment for this transaction, which would increase the book balance of cash and decrease trade receivables from credit card agencies. (Three marks for correct accounting treatment) Page 12
c) Bank confirmations differ from positive confirmations of trade receivables in that bank confirmations request several specific items of information, namely: (i) Full titles of all accounts in all currencies together with the account numbers and balances thereon including nil balances, held at 30 June 2009. Confirmation of these details would be sought on any account to which the company had title (including accounts held jointly or in a trade name). (ii) Full titles and dates of closures of all accounts closed during the period between 1 July 2008 and 30 June 2009. (iii) Details of any interest or charges accrued but not charged or credited at 30 June 2009. (iv) The amount of interest charged during the period 1 July 2008 to 30 June 2009 if not already disclosed in the company s bank statements. (v) Particulars of any written acknowledgement of set-off, comprising date, type of document and accounts covered. (vi) Details of overdraft and loans repayable on demand, other loans and other facilities. (vii) Details of any known company assets held as security, whether by a formal charge or informal charge. (viii) Details of other company assets held, including share certificates, documents of title and deed boxes. (ix) Details of any known contingent liabilities of the company at 30 June 2009. (x) A list of banks, other branches of the same bank or associated companies where a relationship with KS plc had been established during the period between 1 July 2008 and 30 June 2009. (xi) Details of any personal guarantees or personal assets of the directors of KS plc, held by the bank in connection with loans or facilities offered by the bank to the company. (One mark for each point to a maximum of four marks) Positive confirmations of trade receivables request of the customer to confirm an account balance stated on the confirmation form or designate a different amount with an explanation. The auditor anticipates few exceptions to trades receivables confirmations, whereas with bank confirmations he expects differences that the client must reconcile. Bank confirmations should be requested for all bank accounts, but positive confirmations of trade receivables are normally requested only for a sample of accounts. If bank confirmations are not returned, they must be pursued until the auditor is satisfied as to what the requested information is. When no response has been received after the second (or third) positive confirmation request to a customer, auditors should perform alternative procedures. The two main alternative procedures are examining subsequent collections and vouching unpaid invoices and supporting documentation comprising customer balances. (One mark for each point to a maximum of four marks) The reason why more importance is placed on bank confirmations than trade receivables confirmations is that cash, being the most liquid of assets, must be more closely controlled than trade receivables. In addition, other information such as liabilities to the bank must be known for purposes of the financial statements. Finally, there are usually only a few bank accounts and most bank accounts have a large volume of transactions during the year. (One mark for each point to a maximum of two marks) d) I would be extremely concerned if the managing director of the company refused to authorise disclosure of the information requested in the bank letter. I would explain that the letter comprised routine enquiries with regard to the affairs of the company and ensure that the managing director was fully aware of its contents. If I was not satisfied with the reasons given for the lack of co-operation by the managing director (it is unlikely that there could be any justifiable reason for non-co-operation), then I would have to consider the possibility of fraud and review my audit procedures accordingly. e) In the event of non-co-operation the scope of my audit work would be limited and consequently this would be reflected in my report, on the truth and fairness of the accounts, to the members of the company. I would issue either a disclaimer of opinion or a qualified opinion. [One mark for each point to a maximum of three marks] Page 13
SOLUTION 6 a) Companies provide online access to descriptions of inventory products and on-hand quantity levels to key inventory suppliers because this information helps the suppliers work with management to monitor the flow of inventory items. (One mark) There are risks associated with providing this information, howeverthere is a risk that sensitive proprietary information may be made available to unauthorised users. The use of the Internet and other e-commerce applications may also lead to financial reporting risks if access to inventory databases and systems is not adequately controlled. (One mark for each risk to a maximum of two marks) The risks of providing online access to inventory information can be reduced by the use of authentication or identify verification of suppliers, firewalls, encryption and other IT management controls. (One mark for each control to a maximum of two marks) b) Auditing procedures to determine whether slow-moving or obsolete items have been included in inventory are: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) Obtain a sufficient understanding of the shoe business to aid in recognizing inventory that is no longer useful in Choo plc's business. Review the perpetual records for slow-moving items. Discuss the quality of the inventory with management. Ask questions of management and sales personnel about the extent of the sale or nonsale of particular shoe lines. Make observations during the physical inventory for signs of deterioration or obsolescence, inventory in unusual locations, and unusual amounts of dust on the inventory. Be aware of inventory that is tagged obsolete, spoiled, or damaged, or is set aside because it is obsolete or damaged. Examine obsolescence reports, scrap sales, and other records in subsequent periods that may indicate the existence of inventory that should have been excluded from the physical inventory or included at a reduced cost. Analyse inventory holdings relative to recent or future budgeted turnover to identiify excessive holdings. This analysis can often be performed with the use computer audit software. Review sales after the balance sheet date. (Two marks for each procedure to a maximum of ten marks) c) In order to enable audit reliance on the computerised inventory record quantities, I would recommend that the following procedures and controls be introduced: (i) (ii) (iii) (iv) (v) (vi) authorised staff be formally trained to update the inventory record quantities each time there is a movement in inventory; systems to ensure that inventory records are accurate at all times, these systems will include continuous inventory counts on a test basis throughout the year. In normal circumstances the programme of counts will cover all inventories at least once during the year; continuous inventory counts to be properly supervised and subject to comprehensive written instructions; adequate provisions for identifying slow moving and obsolete inventory during the year; immediate investigation of material differences between inventory records and physical inventory quantities with records being updated as appropriate; regular unscheduled visits to the warehouse by a responsible official of the company, to monitor daily activity and ensure that shoe/shoe merchandise inventory procedures are carried out in accordance with formal instructions. (One mark for each procedure/control to a maximum of five marks) Page 14
SOLUTION 7 a) The system of quality control is required to include documented polices and procedures addressing: (i) leadership responsibilities for quality within the firm; (ii) ethical requirements; (iii) acceptance and continuance of client relationships and specific engagements; (iv) human resources; (v) engagement performance; (vi) engagement quality control review; (vii) monitoring. (One mark for area to a maximum of four marks) b) Engagement quality control review Such reviews are required for all fiancial statement audits of listed entities. The firm is also required to set out criteria against which other audit, assurance and related service engagements should be evaluated to determin whether they should be subject to engagement quality control reviews. An engagement quality control review includes an objective evaluation of the engagement team s evaluation of independence, significant risks identified and responses, the significant judgements made by the engagement team, appropriateness of consultations, the significance of misstatements identified, matters to be communicated to management, those charged with governance and other parties, whether working papers reflect the work performed and conclusions reached, and the appropriateness of the report. The review involves discussion with the engagement partner, a review of the financial statements or other subject matter of the report. The actual extent and depth of review depend on the complexity and risk of engagement as well as the experience of the engagement team. (Two marks for each point to a maximum of six marks) c) The purposes of audit working papers are as follows: (i) (ii) (iii) (iv) To provide a basis for planning the audit in accordance with the auditing standards. The auditor may use reference information from the previous year in order to plan this year's audit, such as mthe evaluation of internal control, the time budget, etc. To provide a record of the evidence accumulated and the results of the tests. This is the primary means of documenting that an adequate audit was performed. To provide data for deciding the proper type of audit report. Data are used in determining the scope of the audit and the fairness with which the financial statements are stated. To provide a basis for review by supervisors and partners. These individuals use the audit working papers to evaluate whether sufficient competent evidence was accumulated to justify the audit report. Audit documentation are used for several purposes, both during the audit and after the audit is completed. One of the uses is the review by more experienced personnel. Working papers serve to monitor the progress the audit, especially where responsibility for separate tasks is allocated to different staff members. A second is to provide a guide to the planning and performance of audits in subsequent years. A third is to demonstrate that the evidence is sufficient and appropriate to support the audit opinion (Two marks for each purpose to a maximum of six marks) Page 15
d) The permanent file contains data of an historical and continuing nature pertinent to the current audit. (Two marks) Examples of items included in the file are: (i) (ii) (iii) (iv) Extracts or copies of the memorandum and articles of association Copies of important long-term operating agreements or contracts Analysis of accounts that are important to the audit each year A descripton of the entity s accounting and internal control systems: a. flowcharts b. internal control questionnaires (v) (vi) Results of previous years' analytical procedures, including ratios and percentage analysis of trend statement for various items. Information relevant to audit planning, such as the master copy of the audit programme, information on accounts or locations tested on a rotation basis. (Half mark for each example to a maximum of two marks) Page 16