Audit and
Assurance
Mock Answers
1
Fundamental Level – Knowledge Module, Paper AA – Audit and Assurance
Section A
1 B
The audit team have previously been offered a 15% discount on luxury home appliances from BJ Electronics
which will potentially have a high value. As only goods with a trivial and inconsequential value can be received,
if the same discount is again offered, it will constitute a self-interest threat.
2 D
As the audit senior is involved in prepration of financial statements so if he performs the audit then he will
review his own work, this is an example of self review threat as a safe guard the audit senior should be
removed from the audit team.
3 A
The fee income from BJ Electronics is 19% of Steve & Co's total fees. If, after accounting for non-recurring fees
such as the secondment, it remains at this percentage of total fees on a recurring basis there is likely to be a
self interest threat because of undue dependence on this client. Where recurring fees exceed 15% for listed
companies, objectivity is impaired to such an extent that mandatory safeguards are needed according to the
ACCA Code of ethics and conduct (ACCA Code).
4 C
The partner and finance director of BJ have been on holiday together and appear to have a longstanding close
relationship. This results in a familiarity and self interest threat.
5 B
Outstanding fee is an example of intimidation threat in this case the audit firm may not be robust enough
when disagreement with management due to the fear of recovery of the outstanding fee. In this case the
audit firm should seek a legal advice to know their rights in this particular situation.
6 A
Every listed company should be headed by an effective board of directors which should be comprised of equal
number of exevutive and non executive directors.
7 B
Two different individuals should be working as a CEO and Chairman of the company. In this company Mr Griss
should resign from one position and should refrain from appointing his brother as CEO and Chairman of the
company.
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8 B
Only the non executive directors can become the member of audit committee. It should have thee non
executive directors as members one of them should have previous audit experience. Executive directors
cannot become a part of this committee.
9 B
The auditors are appointed by shareholders of the company; the audit committees will only recommend their
reappointment as auditors to the board.
10 C
The audit committee will appoint the head of internal audit and also set the scope of internal audit
department but the other employees of the audit department are appointed by the management of the
company.
11 C
IAS 16 permits non-current assets to be revalued. However, if an item of property, plant and equipment is
revalued, the entire class of property, plant and equipment to which that asset belongs
must be revalued. Xono Co is therefore entitled to revalue the restaurant, but they will also need to revalue
all of them if it is to comply with IAS 16. The revaluation does constitute a change of accounting policy, so
disclosures do need to be reviewed. Under IAS 16, all non-current assets used by the entity should be
depreciated, Repairs and maintenance costs should be expensed as incurred, not capitalised.
12 B
Existence, classification and presentation are all assertions related to tangible non-current assets.
Completeness and accuracy, valuation and allocation are also relevant assertions.
13 B
Physically inspecting assets listed in the non-current assets register tests for existence. Recalculating
net book values tests for accuracy
14 A
Material items will require more evidence to support them than immaterial items, which might be tested by
comparative analytical review only. The size of the account is considered in determining materiality (ie
materiality may be determined as 5% of profit before tax), but the auditor’s judgement regarding the
sufficiency of audit evidence depends on the level of audit risks associated with each account.
15 B
All the options are valid written representations, but only 2 and 4 are required in all circumstances by ISA 580.
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Section B
16 (A)(i) Audit risk is made up of the following components:
Audit Risk = Inherent Risk x Control Risk x Detection Risk
Inherent risk is the susceptibility of an assertion about a class of transaction, account balance or disclosure to
a misstatement that could be material either individually or when aggregated with other misstatements,
before consideration of any related controls.
Control risk is the risk that a misstatement that could occur in an assertion about a class of transaction,
account balance or disclosure and that could be material, either individually or when aggregated with other
misstatements, will not be prevented, or detected and corrected on a timely basis by the entity's internal
control.
Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably
low level will not detect a misstatement that exists and that could be material, either individually or when
aggregated with other misstatements. Detection risk is affected by sampling and non-sampling risk.
(A)(ii) Professional judgment
Professional judgment is the application of relevant training, knowledge and experience in making informed
decisions about the appropriate courses of action in the circumstances of the audit engagement. The auditor
must exercise professional judgment when planning an audit of financial statements.
Professional judgment will be required in many areas when planning. For example the determination of
materiality for the financial statements as a whole and performance materiality levels will require professional
judgment.
Professional judgment will also be required when deciding on the nature, timing and extent of audit
procedures.
B (i)
Audit Risk Response
Rio has recently been appointed as auditor. There is a Adopt procedures to ensure opening balances are
lack of cumulative knowledge and understanding of properly brought forward and corresponding
the business, which may result in a failure to identify amounts are correctly classified and disclosed.
events and transactions which impact on the financial Review previous auditor's working papers.
statements.
The directors only work part time at Handy Car and The controls will need to be documented and
there is no finance director. This may promote a weak evaluated. If these are weak the level of substantive
control environment, resulting in undetected errors testing will need to be increased accordingly.
or frauds.
The requirement for customers to pay 50% on Enquire of management the point at which revenue is
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ordering and the remainder following delivery could actually recognised, and review the system of
result in revenue recorded before it should be, if the accounting for deposits to ensure they are not
deposit is recorded as a sale and not deferred until included in revenue until goods delivered and signed
delivery. This would result in revenue being for.
overstated.
The two year guarantee on the cars gives rise to a Establish the basis of the amount provided for and
provision, the measurement of which involves a high assumptions made by the financial controller. Re-
degree judgement, and therefore carries a risk of perform any calculations and establish the level of
misstatement. warranty costs in the year.
Contractors are required to invoice at the end of each Review invoices and payments to contractors after
month but often there is delay in receiving these. the year end, and if they relate to work undertaken
There is therefore a risk the company will not accrue before the year end, ensure they are included as
for costs, resulting in incomplete liabilities and accruals.
understatement of expenses.
The current year raw materials costs for materials For a sample of materials to include the cost of parts,
also in inventory last year are based on prices at least compare material costs to actual prices on invoices.
a year old. They should be based on the actual cost or Investigate and resolve any significant differences and
reasonable average cost. evaluate the potential impact on the inventory value
in the financial statements.1
The finished goods value is to be estimated by Mr. For cars awaiting dispatch, establish the lower of cost
Jones, who appears to be basing his estimate on and NRV and compare with the figures provided by
order value rather that applying the IAS 2 rule that Mr. Jones. Investigate any differences evaluate the
goods should be valued at the lower of cost and NRV. potential impact on the inventory value in the
This could result in inventory being overstated in the financial statements.
financial statements.
The new workshop is undergoing refurbishment that Obtain a breakdown of the related costs and establish
could result in inappropriate treatment of capital or which are included as noncurrent assets and which
non capital items, potentially misstating noncurrent are treated as repair costs. Review the nature of
assets, or repair costs in the statement of profit or items included in non-current assets to ensure only
loss. capital items included and review repairs to ensure
no capital items are included.
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(B)(ii)
ISA 501 Audit evidence – specific considerations for selected items sets out the responsibilities of auditors in
relation to the physical inventory count. It states that where inventory is material, auditors shall obtain
sufficient appropriate audit evidence regarding its existence and condition by attending the physical inventory
count.
At the count attendance, Rio & Co will need to evaluate management's instructions and procedures for
recording and controlling the result of the physical inventory count.
They must also observe the performance of the count procedures to assess whether they are properly carried
out.
In addition Rio & Co should inspect the inventory to verify that it exists and look for evidence of damaged or
obsolete inventory. They will also perform test counts to assess the accuracy of the counts carried out by the
company.
(C) Procedures in relation to property valuation and related disclosures
Obtain a copy of the valuer's report and consider the reliability of the valuation after taking account of:
- Independence/objectivity
- The basis of valuation
- Qualifications
- Experience
- Reputation of the valuer.
Compare the valuation with the value of other similar properties in the locality and investigate any significant
difference.
Re perform the calculation of the revaluation adjustments and ensure the correct accounting treatment has
been applied.
Inspect notes to the financial statements to ensure appropriate disclosures have been made in accordance
with IFRSs.
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17 The following significant accounting ratios are based on the accounts provided in the question.
Ratio Formula 20X2 20X3 20X4 20X5 20X6
Gross profit (%) Gross profit / Sales 23.52% 10.93% 14.18% 20.17% 19.72%
Other expenses: sales
(%) Other expenses / Sales 14.08% 10.93% 14.36% 14.45% 15.31%
Interest: sales (%) Interest / Sales 0.96% 1.14% 5.17% 5.42% 6.22%
Net profit (%) Net profit / Sales 8.48% -1.14% -5.35% 0.30% -1.81%
Current ratio Current assets / Current liabilities 1.39 0.91 0.73 0.73 0.76
Liquidity or quick (Current assets - inventory) / Current
ratio liabilities 0.80 0.59 0.46 0.37 0.34
Leverage (%) Total debt / (Total debt + Total equity) N/A N/A 82.42% 81.30% 89.82%
Inventory (months) Inventory / Cost of sales x 12 1.61 2.28 2.26 2.78 3.57
Receivables (months) Receivables / Sales x 12 1.75 3.66 3.24 2.26 2.32
Payables (months) Payables / Cost of sales x 12 2.26 5.43 4.43 4.43 5.09
(a) The various factors in the accounts which may be indicative of going concern problems are as follows.
I. Only losses or low profits are being made and the company is not generating sufficient funds to
finance the expansion required
II. There has been a dramatic increase in the level of overdraft over the last year and there seems
little prospect of the borrowing being reduced this shows that company is facing cash flow
problems.
III. There are signs of overtrading as the expansion has been financed by borrowings and the increase
in current assets is being financed by trade accounts payable.
IV. The leverage is low and decreasing, with very little security being available for the loans.
V. There is a low current ratio and short-term funds are being used to finance long-term assets.
VI. The liquidity ratio is low and decreasing and the company's ability to meet its liabilities on demand
must be very questionable.
VII. Inventory levels are increasing, suggesting that one or more of the following problems may exist:
deteriorating sales, poor inventory control, obsolete or slow-moving inventories.
VIII. The value and age of trade accounts is increasing: some suppliers must be having to wait a
considerable time before being paid and it can only be a matter of time before pressure is put on
the company by one or more of its creditors.
IX. High and increasing interest charges make the company very vulnerable, especially in a period of
recession and high interest rates.
X. The fluctuating gross profit would suggest that the company's profit margins are under pressure.
The present level of gross profit does not seem sufficient given the company's high level of
expenses.
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(b) The other important steps to be taken by the auditors in determining whether or not the company may be
properly regarded as a going concern at the year-end would include:
I. Review carefully the cash and profit forecasts for the next year to see if they suggested any
improvement in the company's position
II. Seek some evidence that the company's bank is prepared to continue supporting the company
III. Review the level of post balance sheet trading to see if this supports the forecasts and show any
signs of improvement in the company's position
IV. Examine correspondence files for any evidence that suppliers might be putting pressure on the
company for repayment of monies owing
V. Consider how the company's position compares with similar companies in the same business
VI. Discuss generally the situation with management and review any recovery plans which they may
have in mind
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18
(a) Problems at BNH due to poor internal controls
I. The local decision making on purchasing may lead to BNH missing out on discounts that would be
available if goods were bought in large quantities. This will also increase the bargaining power of
BNH.
II. Due to the nature of the business the inventory may contain items with short expiry dates and
hazardous substances so good inventory control are very important.
III. If the local managers are not making good decisions regarding purchasing there could be stoke outs
of certain lines of goods, losing potential sales and future business if customers decide to shop at
other stores with better stocks.
IV. There is a lack of centralization in accounting system. Any error arising on the stand alone
accounting system in each superstore may go undetected and the management will not have good
quality information for decision making.
V. There is no regular system of inventory counting any misappropriation of inventory may go
undetected. The goods are at high risk of being stolen by either by staff or others.
VI. Management accounts are produced after every six months this reduces their usefulness. Any
fraudulent activity could go undetected for several months before there is any chance of it being
identified by management.
(b) Recommendations to the board of BNH
I. A new computerized accounting system should be implemented integrating sales, purchase and
inventory accounting systems.
Advantage
This would give the board and senior management up to date information about the inventory levels
so that purchases orders can be places on time to avoid stock outs.
This will also help the management to plan for purchasing in medium and long term.
II. Management accounts should be prepared monthly and reviewed by senior managers. The accounts
should be prepared separately for each superstore.
Advantage
This will allow managers in the head office and the board to take prompt actions if any superstore is
not performing well. Lose making goods can also be identified and dropped from the superstore
range.
III. Sales pricing decisions should be taken centrally.
Advantage
This will help the business maximizing the profit by charging appropriate prices for products.
IV. There should be regular inventory counts at superstore.
Advantage
Inventory counting is essential for good decisions regarding purchases and sales prices. It is also
important due to the nature of inventory of BNH. This should also act as a deterrent against any staff
pilferage of goods.
