audit and assurance december 2011 marks plan

Audit & Assurance - Professional Stage December 2011

Copyright ICAEW 2012. All rights reserved Page 1 of 14

MARK PLAN AND EXAMINERS COMMENTARY The marking plan set out below was that used to mark this question. Markers were encouraged to use discretion and to award partial marks where a point was either not explained fully or made by implication. More marks were available than could be awarded for each requirement. This allowed credit to be given for a variety of valid points which were made by candidates. General comments It was pleasing to note a significant improvement in the standard of answers to the written test questions and, in particular, answers to the question on audit reports. However, the improvement in the standard of answers to the short form questions (SFQ), noted in recent sessions, was not sustained. This was mainly due to poor performances on SFQs 1, 2 and 3. In addition, some candidates are still failing to take advantage of the facility to present the short-form answers in note form. There is an increasing trend in candidates who hedge their answers, to questions requiring a conclusion, by providing a number of different scenarios to their answer in the expectation that one of these will be the correct one. This was particularly evident on SFQ 2 and questions 7b and 9a in this examination. Candidates are advised that the examiners take account of the way in which answers are presented and where hedging is evident candidates will lose marks. SFQ 1 Management threat Arises if a member of the firm is expected to make decisions E.g. selection of accounting policies or making accounting estimates Firm may become too closely aligned with the views and interests of management Auditors objectivity and independence may be impaired or perceived to be impaired Mitigate threats Not prohibited in UK as company not listed. Member of the firm must have no involvement in the audit of the financial statements. No initiating of transactions. No taking decisions or making judgements. Accounting services are of a technical, mechanical, informative nature. i.e. where management takes all decisions requiring the exercise of judgement and has prepared the underlying accounting records. Accounting services are reviewed by a partner or other senior staff member with appropriate expertise Independent review of audit work Ensure the existence of informed management. i.e. designated members of management have the capability to make judgements and decisions on the basis of the information provided. Refer to ethics partner. Responsibilities set out in separate engagement letter. Answers to this question were mixed. Stronger candidates focused on the management threat, as set out in the requirement, and were able to explain that, whilst assistance with preparing the financial statements was not prohibited for a non-listed client, the firm may be expected to make judgements that are properly the responsibility of management. Such candidates were then able to state a number of appropriate safeguards to mitigate the threat. Weaker candidates failed to answer the question, which was restricted to the management threat, and instead offered detailed explanations of other threats to independence and objectivity such as familiarity and self-interest. These points scored no marks.

Maximum marks ( mark per point) Total available

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SFQ 2 Business relationships are permitted under ES 2 as long as the arrangement is: - in the ordinary course of business - on an arms length basis - not material to either party Leasing properties is in the ordinary course of business for both parties Market rate implies arms length basis As both parties are large, Transaction is unlikely to be material to either Robinia has numerous properties and firm has 25 other offices Appropriate to accept Answers to this question were poor. Many candidates failed to appreciate that the business relationship was appropriate given that the leasing of property was in the ordinary course of business for both parties. Some candidates identified that the transaction was to be carried out at market rate, and hence appeared to be on an arms length basis but few candidates identified that it was unlikely to be material to either party. Many candidates believed that the threats to independence and objectivity were insurmountable and wasted time detailing those threats for which there were no marks. A number of candidates hedged their answers by providing reasons unrelated to the circumstances set out in the question as to why it was both acceptable and unacceptable to lease the property. Maximum marks ( mark per point) Total available

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SFQ 3 Senior person/partner within the firm or a suitably qualified external person Experience of the pharmaceutical industry Experience of listed companies Independent of the engagement team Not connected to Pharma Answers to this question were mixed. A high proportion of candidates understood that the requirement asked for attributes required of an individual appointed to undertake the engagement quality control review. Of these candidates, those that provided specific points such as needing experience in the pharmaceutical industry tended to score very well, often attaining full marks. However, others failed to be as specific, simply stating that experience was necessary and did not score as highly. A minority of candidates failed to read the question properly and provided a list of the activities that would be undertaken as part of an engagement quality control review and consequently scored no marks. Maximum marks (1 mark per point) Total available

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SFQ 4 Obtain the clients permission to contact the previous auditor for professional clearance. - if the client refuses, it may be an indication that management has something to hide. - the outgoing auditor may provide information in respect of unpaid fees, unlawful acts or disagreements. Obtain references from reliable third parties such as professional advisors or credit agencies - to identify deficiencies in the character or behaviour of the directors Undertake searches of relevant databases including those at Companies House - to ascertain whether the directors are listed as undesirable characters or disqualified directors Undertake internet/press cuttings searches - for evidence of scandals, adverse publicity, failed companies involving the directors which may provide

evidence about unscrupulous behaviour Hold discussions with the directors - which may provide evidence of a cavalier attitude towards business ethics or lack of social responsibility for

example willingness to pay taxes Undertake client identification procedures - to establish that the directors are who they say they are Inspect prior year audit reports - for evidence of disagreements or inappropriate accounting policies

Answers to this question were generally good. Candidates tended to be stronger at outlining the procedures that would be undertaken to assess the integrity of management, such as obtaining professional clearance from the previous auditor, but weaker at explaining how those procedures assisted in assessing managements integrity. Some candidates simply explained each procedure by restating that it would help assess management integrity no marks were awarded for such explanations.

Maximum marks ( mark per procedure, 1 mark per explanation) Total available

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SFQ 5 Fees should be determined with reference to: - seniority and professional experience of the members of the team; - number of staff required/time expended by each; - greater amount of time required in first year; - risk which the work entails; - inherent risk likely to be high in oil and gas sector - nature of the clients business and complexity of its operations - priority and importance of the work to the client - expenses properly incurred such as overseas travel - extent to which firm can rely on work of component auditors - extent to which reliance can be placed on internal audit - whether an auditors expert is required This question was generally well answered with many candidates scoring full marks. The most commonly overlooked factors were those relating to the first-year audit, the higher inherent risk in the oil and gas industry and the extent to which the firm might rely on the clients internal audit function.

Maximum marks ( mark per point) Total available

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SFQ 6 Consequences May not obtain the best price and/or value for money Nature and quality of items acquired may not be fit for purpose Use of friends/relatives/suppliers who give gifts/kickbacks or provide hospitality May result in budgets being breached Adverse impact on profits and cash flow Recommendations Communicate company policy to relevant employees Employees to confirm in writing that they understand company policy Employees in breach of company policy to be informed in writing Authorisation controls when placing orders to include ensuring three quotes obtained Monitor procedures to ensure compliance

This question was generally well answered with a high proportion of candidates scoring full marks. Most candidates appropriately identified that the failure to adhere to the company policy of obtaining three quotes before purchasing property, plant and equipment may lead to the company not achieving the best value for money. However, few candidates identified that it may result in budgets being breached. Most candidates were then able to cite appropriate recommendations such as communication of the policy to employees and disciplinary action for non-compliance. Monitoring of compliance with the company policy was the most commonly overlooked recommendation.

Maximum marks (1 mark per point) Total available

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Question 7 Total Marks: 40 General comments Answers to this question attained the second highest average on the written test questions. Answers to parts (b) and (c) were generally stronger than answers to parts (a) and (d). Part (a) Explain the self-interest and self-review threats arising from the provision of due diligence services to Fitco and outline how your firm should respond to those threats.

Self-interest threat Arises when the audit firm has interests, which might cause it to be reluctant to take actions that would be adverse to the interests of the firm. As the due diligence services involve regular work, fear of losing the lucrative fees may impair the firms objectivity resulting in the firm issuing an inappropriate audit opinion.

Safeguards The firm should monitor the fees from all regular services provided to Fitco to ensure they do not exceed 15% of the gross fee income of the firm. If the fees from Fitco are between 10% and 15% of gross fee income, additional safeguards should be implemented. These safeguards should include disclosure of the situation to those charged with governance and an external independent quality control review of the audit. If the company becomes listed in two years time, the above fee thresholds will reduce to 10% for the maximum fee and between 5% and 10% for the additional safeguards.

Self-review threat Arises when the product of a non-audit service performed by the auditor will be included in the financial statements or when a previous judgement has to be re-evaluated. This could arise in relation to target companies that are subsequently acquired and their financial statements are consolidated with Fitcos. In addition, the firm may have to review the financial statements of target companies previously audited by the firm if the target company is an existing client. The engagement team may rely too heavily on the work undertaken by their firm or may be reluctant to notify the client of errors in relation to the due diligence work or the previous audits.

Safeguards There should be separate personnel involved in the audit and due diligence work and an independent quality control review should be undertaken on the audit work. The firm may consider rejecting the due diligence work if the target company is a client. The ethics partner should be consulted in respect of both threats.

Generally answers to the self-interest threat arising from the provision of due diligence services were better than the answers to the self-review threat. In respect of the self-interest threat, many candidates often overlooked the need to monitor fees as a safeguard. Where this was correctly identified some candidates gave the incorrect fee thresholds for listed and unlisted companies. Many candidates were able to provide general explanations of the self-review threat. However, only a minority was able to appreciate that the threat arises if the firm reviews the financial statements of target companies that have already been audited by the firm. Even fewer appreciated that if target companies are acquired following due diligence reviews, their financial statements would be included in Fitcos consolidated financial statements that are audited by the firm. A number of candidates digressed and provided explanations of management and familiarity threats which were not a requirement of the question.

Maximum marks Total available

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Part (b) State, with reasons, how your firm should respond to the directors request for a partner in your firm to join the board of Fitco as a non-executive director.

Response The firm must refuse the request for the partner to join the board as a non-executive director as well as continuing as a partner in the firm. Reasons Dual employment is prohibited by Ethical Standard 2 (and also by the Companies Act 2006). As a board member, the partner will be involved in approving strategy and consequently, the management threat is insurmountable. Furthermore, there is the threat that the audit firm would become closely aligned with the views and interests of management and the auditors objectivity and independence may be, or perceived to be, impaired. Answers to this part of the question were good. Those candidates that knew that Ethical Standard 2 and the Companies Act 2006 prohibited dual employment usually went onto score full marks by successfully explaining the reasons why the request for a partner to join the board of directors should be refused. A number of candidates hedged their answers and suggested that the partner could join the board of directors if appropriate safeguards were in place but should resign if the management threat became too great. These answers did not score any marks. Disappointingly, some candidates thought it was acceptable for the partner to join the board whilst continuing as a partner of the firm.


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Part (c) Justify why the items have been identified as key areas of audit risk and, for each item, describe the procedures that should be included in the audit plan in order to address those risks.

Opening balances Justification

Opening balances are based upon the closing balances of the prior period and reflect the effect of transactions and events of prior periods and accounting policies applied in the prior period.

The firm has recently been appointed and is not familiar with the events or transactions of prior periods and consequently may not identify misstatements in opening balances.

Inventory Justification

Inventory has increased by 16% while purchases and revenue have increased by 9.8% and 8.2% respectively. The inventory movement is out of line with the movements in purchases and revenue, which may indicate an overstatement of inventory.

The inventory figure is extracted from records, which may not reflect the physical quantities if there is inadequate control over the periodic counts or if the records are not adjusted for differences between book and physical inventory.

The costing system may not reflect appropriate direct costs coupled with the fact that the allocation of production overheads involves the exercise of judgement.

Opening balances Procedures

Compare the opening balances to the audited prior year closing balances

Determine whether the opening balances reflect the application of appropriate accounting policies

Review the predecessor auditors working papers to obtain evidence regarding opening balances

Evaluate whether audit procedures performed in the current period provide evidence relevant to the opening balances

Inventory Procedures

Review and evaluate the results of the periodic inventory counts throughout the year

Obtain and evaluate the inventory count instructions Attend one of the inventory counts and observe and

assess procedures: perform two-way test counts; and note slow-moving/damaged items

Perform cut-off tests by vouching entries in the component inventory records to goods received records and vouching entries in the finished goods inventory records to despatch records

Components: Vouch cost of components to purchase invoices If applicable, reperform translations, checking rates

to a reliable external source Finished goods

Inspect specification costings and vouch to invoice and payroll details



The use of overseas suppliers may give rise to translation errors in respect of components if the overseas suppliers are paid in their local currency.

The returned faulty blood pressure monitors may be inappropriately included in inventory and, if included, inappropriately valued.

Trade payables Justification

The trade payables payment period has fallen from 40.9 to 37.9 days, which may indicate understatement. This is out of line with expectation as one would expect the balance to be higher as the company is using a more expensive supplier.

The use of overseas suppliers may give rise to translation errors if the overseas suppliers are paid in their local currency.

Provision for warranties Justification

The provision is estimated by the finance director and by nature is at greater risk of misstatement.

The provision represents 1% of revenue. This is the same percentage as the previous year and is out of line with expectation as one would expect it to be higher due to the product recall.

Discuss with management the basis of allocation of production overheads and ensure it is based on the normal level of activity

Reperform calculations Review post year-end inventory listing for items

which have a selling price below cost and ensure those items are included at net realisable value

Review post year-end aged inventory report for slow-moving items and discuss provision with management

Discuss with management their intentions regarding the returned faulty monitors. Where returned monitors are to be repaired and returned to customers, ensure they are excluded from inventory. Where customers are refunded or returned monitors replaced with new monitors, ascertain whether faulty monitors are included in inventory and the basis of managements valuation.

Trade payables Procedures

Evaluate and test controls over the recording of suppliers invoices and payments to suppliers

Reconcile payables balances in the purchase ledger with suppliers statements or consider direct confirmation where supplier statements are not available.

Perform cut off tests by tracing goods received records to invoice entries in the purchase day book and nominal ledger and vouch invoices recorded in the subsequent period back to goods received records.

Inspect after-date payments/invoices for items relating to the current year

Inspect the new supplier's contract for credit terms as tighter credit terms may explain the fall in payables days

Provision for warranties Procedures

Obtain the finance directors workings and discuss the basis of the provision and reperform any calculations

Ensure the provision includes anticipated costs relating to the 40% of monitors not yet returned

Inspect customer correspondence to identify complaints relating to any of the companys products

Inspect board minutes for an indication of problems with any of the companys products

Inspect returns records to ascertain the level of returns after the year end

Inspect records of repair costs post year end to assess amounts involved

Ascertain whether Fitco has insurance and assess impact on provision

Obtain a written representation from management stating that the assumptions used in the calculation are reasonable



This part of the question was generally well answered in respect of opening balances and trade payables, but the answers relating to inventory were mixed and the provision for warranties was generally not well answered. Many candidates were able to correctly interpret the extracts from the financial statements provided and use this information to help justify why inventory, trade payables and provision for warranties were identified as areas of audit risk. Disappointingly, a number of candidates did not make use of the extracts from the financial statements, whilst others drew incorrect conclusions from their analytical procedures. Previous examiners commentaries have noted that procedures used to address the audit risks were often vague and markers found this was common in this examination. For example, in respect of inventory, audit procedures such as verify the completeness of inventory or test whether inventory is stated at the lower of cost and net realisable value were too vague to be awarded any marks.

Opening balances Those candidates familiar with the audit procedures set out in ISA 510, Initial audit engagements opening balances, provided strong answers. A number of candidates incorrectly cited in detail the procedures for obtaining professional clearance from the previous auditor as an audit procedure to address the risk. The audit procedures most commonly overlooked were those relating to determining whether the opening balances reflected the application of appropriate accounting policies and the evaluation of current period audit procedures.

Inventory Most candidates were able to provide a number of reasons to justify why inventory was an area of audit risk and provide some relevant audit procedures. Very few candidates described relevant audit procedures in respect of the valuation of finished goods. Many failed to consider testing the reliability of the system and failed to use information provided in the scenario such as the inventory listing and aged inventory report to generate audit procedures.

Trade payables Those candidates that correctly identified that the trade payables payment period had fallen by 3 days and that this may indicate understatement of trade payables went on to score well. A number of candidates did not calculate payable days or consider the accounts payable balance alongside the increase in purchases. They cited that trade payables had increased by 2% but incorrectly believed that this was indicative of an overstatement of trade payables or an inability of the business to settle its liabilities as they fell due resulting in an uncertainty over going concern. Points most commonly overlooked were the evaluation and testing of controls over the recording of invoices and payments to suppliers and the inspection of the new suppliers contract to identify if there had been any change in terms that may explain the fall in payable days. Provision for warranties This part of the question was poorly answered with many brief answers. Many candidates correctly calculated that the provision had increased by 8.2% but failed to appreciate that revenue had increased by a similar amount. Consequently these candidates believed, incorrectly, that the provision for warranties was overstated and provided inappropriate audit procedures. Many candidates failed to appreciate that the design fault relating to the blood pressure monitors was likely to result in a need to increase the provision. Audit procedures commonly overlooked were those relating to post year-end correspondence and returns and the inspection of board minutes for an indication of problems with other products. Weaker candidates strayed beyond the requirement and attempted to deal with the former suppliers claim for damages, failing to appreciate that this was nothing to do with the warranty provision.


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Part (d) Explain why the legal claim by Comp should be considered by your firm in respect of the audit of the financial statements for the year ended 30 November 2011 and describe the audit procedures to be undertaken in respect of this matter. Reasons The claim arises from an obligating event prior to the year end and, depending on its materiality and expected outcome, it may impact on the financial statements and/or the audit report. If it is probable that the claim is successful, then a provision will be required and if it is possible then it needs to be disclosed by way of note as a contingent liability. If the claim is successful and damages are awarded against Fitco, it may affect its going concern status. Procedures Consult, with the clients permission, Fitcos lawyers about the expected outcome of the claim. Inspect the contract with Comp to ascertain whether there are penalties for early termination of the contract. Inspect board minutes for evidence of developments such as an out of court settlement. Discuss with management their intentions regarding accounting treatment. Obtain a written representation regarding managements intention to fight the claim or settle out of court. Consider events after the year end that indicate the likely outcome of the claim such as negotiations regarding an out of court settlement. Examine cash flow forecasts to ensure Fitco can continue to pay its debts as they fall due if damages are awarded against them Answers to this part of the question were mixed. The majority of candidates identified that the claim gave rise to an uncertainty and, if material, this had implications for the financial statements and possibly the audit report. Many also identified that, if the claim was successful, there may be going concern implications. Most candidates described one or two audit procedures to be undertaken. However a number of candidates lost marks by giving very short descriptions of standard audit procedures such as inspect minutes, discuss with management or inspect cash flow forecasts without providing any further detail of the procedure to be undertaken. Maximum marks Total available

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Question 8 Total Marks: 20 General comments Answers to this question attained the lowest average on the written test questions. Answers to part (c) were stronger than answers to parts (a) and (b).

Part (a) From the information provided in the scenario, identify the key receipts and payments that you would expect to be included in the cash flow forecasts prepared by the directors of Gourmet. For each receipt and payment, identify the specific matters you would consider when reviewing the reasonableness of the assumptions in forecasting that receipt or payment.

Receipts Sales receipts These should include sales from the new outlets and delivery service which should be staged to reflect the roll out. The inflow should reflect prior years patterns and, in respect of the new outlets, commence after the completion of the refurbishment. Consideration should be given as to whether amounts are prudent in light of the economic conditions and whether the introduction of the delivery service may impact on take away sales. Loan from bank The amount should be consistent with any negotiations, as evidenced by bank correspondence, be sufficient to cover the expansion costs and the inflow should be included prior to commencement of the new business. Payments Expenditure on refurbishment and vehicles including logo painting These should be based on suppliers price lists or quotes and the outflow should be reflected prior to the commencement of the new business. Payments to suppliers for ingredients and packaging These should reflect the level of forecast sales and payments for items other than fruit and vegetables should reflect the suppliers terms of trading. Vehicle running costs These should be based on the proposed number of vehicles and the anticipated usage following the introduction of the delivery service. Premises running costs These should include the extra costs (e.g. rent and utility costs relating to the two new outlets). The rent should reflect the terms of any lease agreements such as up-front premiums and rental periods (e.g. quarterly) and rent reviews. Wages and salaries These should reflect the increased number of staff for the new outlets, the drivers for the delivery service and rates above the industry sector. Any bonus should be based on the forecast profit. Sundry payments These should include advertising, training and recruitment costs relating to the new business and the outflow should be reflected prior to the commencement of the new business. Professional fees should include payments to the legal advisers and the reporting accountant. Loan repayments and finance costs Loan instalments should reflect the repayment terms being negotiated with the bank and finance costs should reflect market rates and the level of borrowings. All outflows in respect of these items should be reflected on the anticipated due dates. Tax payments PAYE, VAT and corporation tax should be consistent with the relevant figures in the profit forecast and paid on due dates. Dividend payments These should be in line with prior years policies or take into account any anticipated changes in policy which should be confirmed by the directors. General Sensitivity analysis should be undertaken on key variables e.g. customer receipts, finance costs and ingredients.



Answers to this part of the question were mixed. Weaker candidates incorrectly discussed non-cash related items such as accounting for depreciation, the distinction between capital and revenue items and cut-off issues. Another common error was to overlook the fact that the work involved examining a forecast and consequently cite verification procedures that would be undertaken on historical cost financial information such as checking amounts to invoices and bank statements. Some candidates, whilst identifying relevant receipts and payments, were unable to identify matters to be considered when reviewing the reasonableness of the assumptions underlying those receipts and payments and simply made comments such as check if reasonable. or check if they accounted for it correctly. These points are too vague to be awarded any marks.


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Part (b) Explain the role of written representations in the examination of and reporting on forecast information. Role of written representations When conducting an engagement to examine forecast information, written representations are obtained from management regarding: - the intended use of the forecast information; - the completeness of significant management assumptions; and - managements responsibility for the forecast information. The representations provide evidence that management accepts its responsibility regarding the assumptions and will reduce the risk of any misunderstanding regarding respective responsibilities (i.e. narrow the expectation gap). The representation regarding the intended use of the forecasts may protect the reporting accountant from claims for damages from unforeseen third parties. Answers to this part of the question were disappointing as many candidates were unaware of the requirement of ISAE 3400 The Examination of Prospective Financial Information to obtain such representations. Many candidates wasted time and wrote about the role of written representations in an audit of financial statements instead of their role in examining and reporting on forecast information. Although many identified managements responsibility for the forecast information, surprisingly few mentioned reduction of the risk of misunderstanding regarding respective responsibilities. A small number of candidates mistakenly thought that written representations were produced by the reporting accountant and tended to confuse them with the contents of a letter of engagement. Maximum marks Total available

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Part (c) Describe the differences between the conclusion expressed in an assurance report on forecast information and the opinion expressed in an audit report on financial statements. Give reasons for these differences. Forecast information The conclusion of the assurance report on the forecast information will include a statement of negative assurance (i.e. limited/moderate assurance) in the form of nothing has come to our attention which causes us to believe that the assumptions do not provide a reasonable basis for the forecast. It will also include an opinion on whether the forecast information is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting framework. Audit of financial statements The opinion in the audit report on financial statements will provide reasonable assurance that the financial statements: - give a true and fair view; - have been properly prepared in accordance with relevant generally accepted accounting practice; and - have been prepared in accordance with the requirements of the Companies Act 2006. Reasons Financial statements are mainly based on historical information whereas forecast information is based on assumptions about future events. The historical information can be verified to a greater degree whereas the forecasts are subject to uncertainty. This part of the question was generally well answered as the majority of candidates cited the basic points regarding the different levels of assurance provided by the conclusions within each report and gave an example of each. However, only a minority of candidates could provide plausible reasons why the conclusions were different. Many failed to indicate that audits of financial statements are based on historical information while forecasts are based on assumptions about future events and that consequently the figures in forecast information could not be corroborated to the same extent as with historical information. Weaker candidates strayed beyond the requirement and wasted time writing about the differences between the reports as a whole, instead of focusing on the conclusions in each of the reports. Maximum marks Total available

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Question 9 Total Marks: 20

General comments Answers to this question attained the highest overall average mark on the written test questions. This was generally due to very strong answers on part (a) as answers to part (b) were generally disappointing, particularly in respect of the quality control procedures. Part (a) For each of the three situations outlined, state whether you would modify the audit opinion. Give reasons for your conclusion and describe the modification(s), if any, to each audit report. Southerndown An unmodified opinion should be issued as the circumstances do not arise from an inability to obtain sufficient appropriate audit evidence (a limitation on scope) or a material misstatement (disagreement). There is a significant uncertainty regarding the going concern status of the company that is fundamental to users understanding of the financial statements. As the situation is appropriately disclosed in the financial statements, an emphasis of matter paragraph should be added to the audit report, following the opinion section. The paragraph should explain the issue giving rise to the uncertainty, draw the users attention to the note and include a specific statement our opinion is not qualified in respect of this matter. Belfry A modified opinion should be issued and the modification should be a qualified (except for) opinion. As the auditor is unable to obtain sufficient appropriate evidence, there is a limitation on the scope of the auditors work. The amount is material as it represents 6.6% of total assets and 19.6% of profit before tax. It is not pervasive as it is confined to specific items in the financial statements and does not represent a substantial proportion of the financial statements. The company is not reliant on the cash to continue operations as it has positive cash flow. There should be an explanation of the issue (reason and the amount involved) immediately above the opinion. The auditor should report by exception, after the opinion, that all information necessary for the audit has not been received. Turnberry A modified opinion should be issued and the modification should be a qualified (except for) opinion. As the managing director refuses to disclose the transaction there is a material misstatement (disagreement). The amount of the transaction is not material by size as it is only 0.25% of total assets and 1.5% of profit before tax. However, it is material by nature as it is a related party transaction due to the managing directors controlling interest in Valderama. It is not pervasive as it is confined to a specific item in the financial statements. There should be an explanation of the issue (reason and amount involved) immediately above the opinion. Many candidates scored high marks on this part of the question by identifying the issues (i.e. significant uncertainty, limitation on scope and material misstatement), calculating and commenting on materiality and reaching a conclusion on whether or not the opinion should be modified. However, a significant number of candidates lost marks by failing to reach a conclusion as to whether the opinion should be modified. The common shortcomings are detailed below. Southerndown

Many candidates ignored the information in the scenario indicating that the issue had been fully disclosed, to the engagement partners satisfaction, in a note to the financial statements and wasted time discussing the options if the issue had not been disclosed. There were no marks for discussing such options. Belfry A significant number of candidates failed to appreciate that the issue was not pervasive and stated, incorrectly, that the report should be modified with an adverse opinion. Of those who identified that the matter was not pervasive, many identified that the amount involved was confined to a specific item and did not represent a substantial portion of the financial statements. However, few appreciated the fact that the company was not reliant on the cash to continue in operation and therefore this was not a going concern issue. Turnberry A number of candidates hedged their bets and discussed the possibility of the issue being pervasive, thereby demonstrating a lack of understanding of what constitutes a pervasive issue. Maximum marks Total available

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Part (b) Describe the possible consequences for your firm if an inappropriate audit opinion on financial statements is issued and outline the quality control procedures your firm should implement to reduce the risk of issuing an inappropriate audit opinion. Consequences The firm may be subject to professional negligence claims from the audited entity and its shareholders and/or third parties where it can be demonstrated that the auditor owed the party a duty of care. Although damages awarded against the firm may be covered by professional indemnity insurance, the cost of future insurance will increase. The firm may be investigated by the regulatory bodies, which may result in penalties such as fines or withdrawal of registered auditor status. The adverse publicity associated with legal claims and disciplinary procedures may result in the loss of clients and in extreme cases financial collapse of the firm. Quality control procedures The firm should allocate competent and experienced staff to each engagement team. Junior members of the team should be supervised and all team members work should be subject to a review by a more senior member of the team. Consultation should take place on contentious issues and all such matters, including their resolution, should be documented. An engagement quality control review should be performed on audits of all listed companies and other audits where audit risk is considered higher than normal. The firm should undertake monitoring procedures to ensure that its policies and procedures relating to the system of quality control are relevant, adequate and operating effectively. The firm should undertake due diligence procedures prior to accepting new clients and deciding whether to continue with existing clients. The majority of candidates correctly identified a number of potential consequences for the audit firm, However, a significant number of candidates lacked an understanding of the quality control procedures required to reduce the risk of issuing an inappropriate audit opinion. Weaker candidates cited the objectives of quality control instead of the procedures to be exercised by the firm. A significant number of candidates stated, incorrectly, that agreeing liability caps and including a Bannerman paragraph in the audit report would reduce the risk of issuing an inappropriate audit opinion. These candidates failed to appreciate that such actions would only reduce the auditors exposure to damages in the event of an inappropriate opinion being issued and would not reduce the risk of issuing an inappropriate opinion. Some answers to this part of the question were short or not attempted indicating that those candidates had not managed their time across the paper. Maximum marks Total available

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audit and assurance december 2011 marks plan

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