ACCA. Paper F8. Audit and Assurance. Mock Exam. Marking scheme and suggested solutions

Transcription

1 ACCA Paper F8 Audit and Assurance Mock Exam Marking scheme and suggested solutions

2 SECTION A 1 B If an audit team member were to prepare Globe's financial statements then this represents a selfreview threat as they would be auditing information they had prepared. They may therefore adopt an uncritical attitude towards it, or could be unwilling to notify the audit team of any errors they do find in their work. Ownership of shares in Globe represents a self-interest threat as Mr White would have a personal financial interest in Globe's financial performance. The existence of overdue fees represents both a self-interest and an intimidation threat as Banham & Co may not ask for misstatements to be corrected, or may not question the directors for fear of the overdue fees not being paid. Globe's audit fee is significant to Banham & Co, so there is a risk that Banham & Co may not perform a sufficiently rigorous audit in order to reduce the risk of upsetting the client and losing the work. 2 C It is important that the overdue fees are recovered from Globe at the earliest opportunity. No further work should be carried out on the audit until the self-interest threat has been removed. 3 D The ACCA Code of Ethics and Conduct prohibits partners from owning shares in an audit client due to the insurmountable self-interest threat. As such Mr White should dispose of the shares at the earliest opportunity. It is possible for Banham & Co to withdraw from the audit engagement (option C) but this is not really a practical/commercial solution. 4 A The nature, timing and extent of risk assessment procedures should form part of the considerations for the audit plan, not the audit strategy. 5 C Limitations of Banham & Co's liability are a matter that may be covered in the audit engagement letter, but are not a matter which auditors are required to communicate to those charged with governance. 6 D Segregation of duties is a general control, not an application control. General controls relate to many applications, and support the effective functioning of application controls by helping to ensure the continued proper operation of information systems. 7 B Comparing receivables turnover and receivables days with the prior year is an analytical procedure that tests the valuation assertion. Matching the receivables listing to the control account tests primarily for completeness. Tracing shipping documentation to the sales and receivables ledger tests for completeness. Verifying the documentation and authorisation of price lists and terms of trade is a test of control, not a substantive procedure. 8 C Obtaining explanations for variances from the prior year is a purpose of analytical procedures at the planning stage, not at the overall review of financial statements. 9 C After the auditor's report has been signed, auditors still have a passive duty: they are not required to perform procedures or make enquiries to identify subsequent events, but if they become aware of a fact which may have caused them to amend the auditor's report, they should discuss the matter with management. This responsibility exists both before and after the financial statements are issued. 10 C It is possible that the litigation may give rise to a material uncertainty related to going concern. However, the financial impact of the case is currently unknown, so the auditor cannot determine whether a material uncertainty exists until further audit procedures are carried out. 11 C The audit concern here is that development costs have not been amortised once the asset is ready for commercial production/use as required by IAS 38 Intangible assets. Audit procedures should therefore focus on the calculation of the amortisation which should have been charged and an assessment as to whether it is material. It is not necessary to vouch a sample of invoices 2

3 which make up the $2 million capitalised cost as Figures & Co have already stated that the development costs have been correctly capitalised. 12 D The development costs are deemed to have a useful life of three years, being consumed 60% in year 1 and 20% in years 2 and 3, so the financial statements should show an amortisation charge of $300,000 ($2,000,000 60% 3 / 12). This amounts to 5% of profit before tax ($300,000 / $6,000,000) and is therefore material. As no appropriate resolution has been reached on the issue the audit opinion will need to be modified. It should be qualified on the grounds of material misstatement as sufficient appropriate evidence has been obtained in relation to the matter. 13 B The auditor's primary concern is to conduct the audit properly and to be in a position to give an opinion on the financial statements for the year ended 31 January 20X2. Occasion has only made a small number of cash sales and so the impact on the current year financial statements is unlikely to be material. Therefore a qualified opinion is probably not required although any modified opinion is likely to be modified due to insufficient appropriate evidence rather than due to material misstatement. The most likely action at the end of the current year audit is to report the issue to those charged with governance so that they can determine the best course of action especially if the volume of cash sales is likely to increase in future years. 14 D The written representation is a valid source of audit evidence, however it is not as effective as reviewing the cash flow forecasts and considering whether Occasion has managed to secure additional finance. AJ Co has already responded to the receivables circularisation and confirmed the balance owed, therefore there is no doubt as to the existence of the debt. The concern is whether Occasion will receive monies from AJ Co, and if not then whether it can continue as a going concern. 15 B The balance of $9 million owed by AJ Co does not appear to be recoverable, so both receivables and profit before tax are overstated. The amount represents 60% of profit before tax ($9m / $15m) and is certainly material. It may be both material and pervasive if it threatens Occasion's ability to continue as a going concern. As such, either a qualified opinion or an adverse opinion may be appropriate. Regarding disclosure in the auditor's report, the auditor should also include a 'material uncertainty related to going concern' paragraph to highlight the directors' going concern disclosures to shareholders. An emphasis of matter paragraph is not appropriate for going concern issues already disclosed, and this is not a key audit matter because it has given rise to a modified audit opinion. 3

4 SECTION B 16 All-parts Motor Company Marking scheme (a) (b) (c) (i) (c) (ii) (d) Marks Objectives of audit planning Appropriate attention devoted to important areas 1 Resolves potential problems on a timely basis 1 Auditor can properly organise and manage the audit 1 Assists in the selection of appropriate team/assignment of work 1 Facilitates the direction, supervision and review of work 1 Facilitates the co-ordination of work by others 1 Maximum 5 Control deficiency, implication and recommendation (only 5 issues required) Inventory count to be supervised by warehouse manager 3 Inventory count instructions not circulated in advance of the count 3 Inventory count sheets are not pre-printed or sequentially numbered 3 Warehouse staff count alone, rather than in pairs 3 Damaged inventory is to be valued by the warehouse manager 3 Large delivery expected during inventory count 3 Movement of inventories 3 Lack of segregation of duties 3 Maximum 15 Difficulties of using audit software Set up costs 1 Cost of experienced staff 1 Program errors 1 Dangers of live and non-live testing 1 Maximum 2 Procedures using audit software Cast inventory listing 1 Inventory ageing 1 Sample year-end inventory 1 Analytical procedures such as variance analysis 1 Maximum 4 Advantages of outsourcing internal audit work Staff do not need to be recruited 1 The firm has specialist skills 1 Immediate internal audit department 1 No staff training costs 1 Service contract can be for the appropriate time scale 1 Time scale is flexible, a team of staff can be provided 1 Maximum 4 30 Suggested solution (a) Objectives of audit planning Proper planning helps the auditor devote appropriate attention to important areas of the audit. It helps the auditor identify and resolve potential problems on a timely basis. It helps the auditor properly organise and manage the audit so it is performed in an effective manner. 4

5 (b) It can assist in the selection of appropriate team members and assignment of work to them. It facilitates the direction, supervision and review of work. It assists in the coordination of work done by auditors of components and experts. Note. Only five objectives were required. Deficiencies, implications and recommendations Deficiency Implication Recommendation The warehouse manager has overall responsibility for the inventory count. The inventory counting instructions are not circulated before the day of the count, and only a verbal briefing is provided to counters Inventory counters are provided with blank sheets of paper on which to record the results of their count. This may mean that the items counted are not recorded properly or in an organised way. Inventory counters are warehouse staff and are responsible for counting inventory on their own, rather than in pairs. The warehouse manager is not independent as he maintains dayto-day responsibility for the inventory of All-parts. He has a vested interest in the safe custody and recording of inventory and may be reluctant to record errors. Furthermore any fraud could go undetected. The counters will not have time (or may be too embarrassed) to ask any questions about how the count is to be conducted should they have any concerns about their role. This in turn could lead to inaccuracies or errors in the inventory count. If items are recorded in a haphazard way, it will be more difficult to reconcile the amounts counted with the inventory system after the count has finished. This may lead to errors, omissions or incomplete data. Also, because the count sheets are not pre-numbered and sequentially numbered, it is impossible to be certain that all sheets completed are collected at the end of the count. If staff count alone and a second count is not conducted by another staff member, then any errors or omissions by the first staff member could go undetected. The warehouse manager has specific knowledge of All-parts' inventory and so can assist in an advisory capacity. However the overall responsibility and supervision of the count should rest with an independent official, such as the finance director. The warehouse manager and the finance director should prepare written inventory count instructions and circulate these to all counters at least one week before the count is due to take place. They should also provide a contact point to which any questions or queries should be directed. Counters should be allocated count sheets that are pre-numbered and sequentially numbered. They should detail the inventory lines to be counted but not include the quantity per the inventory system. At the end of the count, a sequence check of the count sheets should be performed by a member of the accounts department to ensure the count sheets have all been returned. The inventory count should be carried out in pairs, ideally with one person from the warehouse staff and a second person who is not involved with the inventory on a day-to-day basis (for example a member of the accounts department). The counters should count independently and where there are discrepancies in the amounts counted, a third count should be performed. 5

6 Deficiency Implication Recommendation Damaged inventory is to be valued by the warehouse manager. All-parts is scheduled to take delivery of a large order of raw materials during the year-end count. There is movement of inventories throughout the count which increases the risk that the count may not be performed accurately. There is a lack of segregation of duties as the warehouse manager is responsible for overseeing the count, collecting the counters' sheets and inputting any changes on the inventory system. Note. Only five deficiencies were required. (c) (i) Difficulties of using audit software The warehouse manager has a vested interest in the inventory, and may deliberately overstate the value of the damaged inventory in order to hide any problems relating to the safe custody of inventory. If the delivery is not properly recorded and is included in the year-end count, then inventory may be understated at the year-end or cut-off errors may occur. This may lead to inventories being overstated (due to being counted twice), or omitted altogether, and inaccurate amounts recorded for inventory which could materially misstate the financial statements. The lack of segregation of duties leads to an increased risk of fraud and error. The damaged inventory should be separately identified and valued by the finance director in conjunction with the warehouse manager. Goods received on the day of the inventory count should be kept separately and their quantity recorded on the inventory count sheets, so that they are correctly recorded in the financial statements. Ideally there should be no movement of inventory during the count, however this does not seem possible given that a significant customer order is due out on the last day of the year. Inventory that is due to be despatched during the count must be controlled. It should be segregated and clearly labelled, and counters should be instructed that it is not to be included in the count. The duties described should be allocated as far as possible to independent officials. The finance director should supervise the count and a member of the accounts department should input any adjustments to the inventory system. These should also be authorised and reviewed. The costs of designing tests using audit software can be substantial, as a great deal of planning time will be needed in order to gain an in-depth understanding of the client's systems so that appropriate software can be produced. The overall audit costs may increase because experienced and specially trained staff will be required to design the software, perform the testing and review the results of the testing. If errors are made in the design of the audit software, audit time and hence costs, can be wasted in investigating anomalies that have arisen because of flaws in how the software was put together rather than by errors in the client's processing. If audit software has been designed to carry out procedures during live running of the client's system, there is a risk that this disrupts the client's systems. If the procedures are to be run when the system is not live, extra costs will be incurred by carrying out 6

7 (ii) procedures to verify that the version of the system being tested is identical to that used by the client in live situations. Audit procedures using audit software Test Re-cast the inventory listing. Re-perform the ageing of inventory in the inventory listing. Select a sample of inventory lines to count at the year-end inventory count. Perform variance analysis on inventory balances at the year end compared with prior year or budget. Reason To verify the accuracy of the calculation of the final inventory figure. To ensure that the ageing is accurate before using an aged listing to identify items that might be obsolete and hence need to be written down. This will be a quicker and more objective method of selecting a sample rather than doing so manually. Once established this is a quicker and more accurate method of performing the calculations. (d) The benefits of outsourcing the internal audit work include: Staff do not need to be recruited, as the accountancy firm has good quality staff. The firm has specialist skills and can assess what management require them to do. Outsourcing can provide an almost immediate internal audit department. Associated costs, such as staff training, are eliminated. The service contract can be for the appropriate time scale. Because the time scale is flexible, a team of staff can be provided if required. Note. Only four advantages were required 7

8 17 TYN Co Marking scheme (a) (b) (c) Marks 1 mark for an explanation of materiality and 1 mark for each factor explaining the impact of materiality on the audit Explanation of materiality 1 Which items to examine 1 Whether to sample 1 Whether to seek adjustment for misstatements 1 Whether to give a modified audit opinion 1 Maximum 4 Audit risks and responses (only 6 risks required) New accounting system introduced during the year 2 Accounts department overworked 2 Accounting treatment of rented shop 2 Risk of items held for repair being treated as inventory 2 Inventory valuation 2 Shop manager bonus based on sales 2 Calculation of redundancy provision 2 Maximum 12 Substantive procedures for the redundancy provision Inspect Board meeting minutes 1 Review supporting documentation to confirm present obligation 1 Recalculate provision 1 Written representation to confirm completeness 1 Review post year-end period to compare actual payments to amounts provided 1 Review disclosures for compliance with IAS 37 Provisions, contingent liabilities and 1 contingent assets Maximum 4 20 Suggested solution (a) Materiality and its impact on the external audit Misstatements or omissions are generally considered material (individually or in aggregate) if they can reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. An item may be material because of its monetary amount or its nature. Materiality will affect the external audit in several ways: Materiality helps auditors determine which items to test, as material items must be subject to substantive procedures. Materiality helps auditors determine whether to use sampling (for example, if all items in a population are material, sampling will be inappropriate). Materiality helps auditors to determine whether or not to seek for misstatements in the financial statements to be corrected. Misstatements should be considered both individually and in aggregate. Materiality helps auditors to determine what level of misstatement will lead to a modified audit opinion, and also whether the modification is material but not pervasive or both material and pervasive. Note. Only three points were required. 8

9 (b) Audit risks and responses Audit risk TYN introduced a new accounting system during the year, but the new system was not run in parallel with the old system. Any errors in the transfer of information from the old system to the new system, together with any errors which have occurred whilst the accounts department staff become familiar with the new system, could result in material misstatements in the year-end financial statements. The accounts department are currently overworked. This increases the risk that material misstatements occur in their work, and may also make it more difficult to obtain answers to audit queries because TYN's staff do not have sufficient time to deal with them. TYN has rented a fifth shop during the year however the rental costs appear to have been capitalised with the four properties which are owned. If the rental costs are not correctly classified, both PPE and profit for the year will be overstated. At the year end each shop will hold customer owned watches and jewellery which are in the process of being repaired. There is a risk that inventory will be overstated if these have been recorded in the year-end inventory figure. At the year end the finance director is planning to value inventory such as precious gemstones. Any errors in this valuation may result in inventory being over- or undervalued due to the specialised nature of the inventory. Shop managers will be paid a bonus based on the sales for the last quarter of the year. The shop managers may be tempted to overstate revenue in order to gain financially from the bonus, and this may lead to an overstatement of revenue in the financial statements. Four sales assistants have been made redundant during the year although the redundancy payment will not be made until the following year. There is a risk that the redundancy provision is not properly calculated and is understated, and that the relevant disclosure is not properly made in the financial statements. Auditor's response Perform detailed testing to confirm that the closing balances from the old system were correctly input in to the new system. Review journals posted to the new accounting system during the year to determine the level of errors which have occurred in the accounting system. Consider whether it would be appropriate to decrease the materiality level for the current year audit. Prepare a schedule of documents and other information required from TYN's accounts department, and provide this to them at the earliest opportunity so that they have sufficient time to gather the required information. Discuss the costs with the finance director to determine whether he has processed a journal entry to remove the rental costs from PPE. Obtain a breakdown of the costs recognised as PPE at the year-end, and review the costs to determine whether they include any rental costs relating to the fifth shop. Review TYN's inventory count procedures to determine the internal controls in place to segregate customer-owned items and ensure that they are excluded from the year-end count. Request that TYN engage the services of an independent valuer to determine the value of yearend inventory such as gemstones. Perform analytical procedures on the sales revenue for each shop during the last quarter of the year to determine whether the percentage increase in sales is consistent with the other shops and the prior period. Perform analytical procedures on the gross profit margin for the last quarter of the year to ensure that it is consistent with the rest of the year. Consider whether the requirements of IAS 37 Provisions, contingent liabilities and contingent assets have been satisfied and the provision correctly calculated and disclosed. Note. Only six audit risks and responses were required. 9

10 (c) Substantive procedures for the redundancy provision Inspect the minutes of the November/ December Board meetings to confirm that the decision to make the redundancies and to assess the probability that the redundancy payments will be paid. Inspect copies of letters sent to the four shop assistants to determine whether the decision was formally announced and they were notified before the year-end date. Discuss the basis on which the redundancy cost was calculated with the finance director, and recalculate the redundancy cost per shop assistant to confirm the accuracy and completeness of the provision. Obtain a written representation from the Board of TYN confirming the completeness of the provision. Review the post year-end cash book to determine whether the redundancy payments were made in January 20X2 and whether the amount paid agrees to the year-end provision. Review the disclosure note for the redundancy provision to ensure that it complies with IAS 37 Provisions, contingent liabilities and contingent assets. Note. Only four substantive procedures were required. 10

11 18 DRS Co Marking scheme (a) (b) (c) Marks Test of control and objective of each test (only 5 required) Recalculate sample of bonus payments 2 Review sample of hours worked from clocking in/ out record to payroll listing 2 Vouch sample of overtime payments to overtime schedule and recalculate rate 2 Observe employees clocking in/ out to ensure work recorded is done 2 Verify sample of new joiner details to ensure bona fide employees 2 Maximum Substantive procedures relating to payroll 10 Proof in total of payroll and agree to the financial statements 1 Review monthly payroll to prior year and budget 1 Compare total payroll to prior year 1 Verify joiners/leavers and recalculate first/ last pay 1 Agree sample of weekly overtime sheets to overtime payment in payroll records 1 Agree wages and salaries paid per payroll to bank transfer list and cashbook 1 Agree the individual wages and salaries as per the payroll to the personnel records 1 Recalculate gross and net pay 1 Recalculate statutory deductions 1 Cast payroll records ½ Agree wages and salaries per payroll to trial balance ½ Maximum Substantive procedures relating to PPE 6 Valuation Agree year end valuation to valuer's report 1 Consider basis of valuation 1 Consider whether to place reliance on valuer 1 Recalculate revaluation gain 1 Recalculate depreciation charge 1 Perform proof in total of depreciation charge 1 Rights and obligations Inspect title deeds and land registration documents 1 Vouch additions to invoices including directly attributable costs 1 Maximum 4 20 Suggested solution (a) Tests of control and the objective of the test Test of control Recalculate a sample of bonus payments to management by reference to the bonus criteria. For each staff grade, review a sample of hours worked from the clocking in/ out records to the payroll listing. For a sample of overtime payments vouch staff member's name and number of hours overtime claimed to the overtime schedule. Verify the schedule has been authorised and recalculate the rate at which overtime has been paid. Objective of the test To ensure that only valid bonuses have been paid, and also that they have been paid at the correct rate. To verify that only hours worked have been paid and paid at the correct rate. To ensure that overtime is only paid where it is valid and authorised and at the correct rate. 11

12 Test of control Observe employees clocking in/ out to ensure that employees only clock in/ out for themselves and are not clocking in/ out for other employees. For a sample of new joiners paid during the year verify the employee number, salary and bank details to the authorised new joiner form. Objective of the test To ensure all work recorded is actually done. To ensure the new joiners added to payroll records are bona fide employees. (b) (c) Substantive procedures relating to payroll Perform a proof in total of total wages and salaries, incorporating joiners and leavers and any annual pay increase. Compare this to the actual wages and salaries expense in the statement of profit or loss and investigate any significant differences. Obtain a breakdown of the monthly payroll charges for head office staff and manufacturing staff and compare this to the prior year expense and/ or current year budgeted cost. Discuss any significant differences with management. Compare the total payroll expense to the prior year and investigate any significant differences. Select a sample of joiners and leavers, agree their start/leaving date to their human resources contract and the new joiner report, recalculate that their first/last pay packet was accurately calculated and recorded. Select a sample of weekly overtime schedules and trace to overtime payment in payroll records to confirm completeness of overtime paid. Agree the total net pay per the payroll records to the bank transfer (BACS) listing of payments and to the cashbook. For a sample of employees, agree the individual wages and salaries per the payroll to their salary details according to their human resources records. For a sample of employees, recalculate the gross and net pay and agree to the payroll records to confirm accuracy. Re-perform the calculation of statutory deductions to confirm whether correct deductions for this year have been made in the payroll. Cast a sample of payroll records to confirm completeness and accuracy of the payroll expense. Agree the total wages and salaries expense per the payroll system to the trial balance, investigate any differences. Note. Only six substantive procedures were required. Substantive procedures relating to PPE Valuation: Obtain a copy of the independent valuer's report to determine the year end valuation for the two production facilities and the warehouse, and trace this balance through to the financial statements. Consider whether the basis on which the PPE has been revalued is consistent with prior years and in accordance with IAS 16 Property, plant and equipment, and whether this is disclosed in the financial statements. Consider the reputation, professional qualifications and experience of the independent valuer to determine whether they are sufficiently independent of DRS and sufficiently experienced/ qualified to perform the valuation. Recalculate the accounting adjustments made to recognise the revaluation in order to verify that the gain or loss recognised in other comprehensive income/revaluation surplus is appropriate. 12

13 For a sample of assets, recalculate the depreciation charge for the year to determine whether the second production facility was initially depreciated based on cost, and the other assets on their revalued amounts. Perform a proof in total calculation of depreciation, considering the timing of additions and disposals and compare this expectation to the actual charge. Investigate any significant differences. Rights and obligations: Inspect the title deeds and land registration documents relating to the second production facility in order to verify that the facility is owned by DRS. Vouch the balance capitalised for the new production facility to purchase invoices, including any professional fees which have been capitalised to verify that they are directly attributable to the acquisition. Note: Only four substantive procedures were required. 13

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