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ACCA
Paper F8 (INT)
Audit & Assurance
June 2011
Interim Assessment – Answers
To gain maximum benefit, do not refer to theseanswers until you have completed the interimassessment questions and submitted them for marking.
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PAPER F8 ( INT) : AUDIT & ASSURANCE
2 KAPLAN PUBLISHING
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INTERIM ASSESSMENT ANSWERS
KAPLAN PUBLISHING 3
1 Voyager
Key answer tips
It is vitally important to plan your time effectively when answering the 30 mark
question. After your reading time is over you have 1.8 minutes per mark. Mark sure
you allocate your time against each requirement and do not overrun.
Following this it is vital to plan your answer so that you structure it effectively to
answer the requirement and so that you know how many points to write.
For part (a) and (b) you are asked to list points relevant to a scenario. This requires
application skills so is worth 1 mark per item listed. Notice that you are then asked to
explain each deficiency and make a recommendation for each deficiency. You will
receive 1 mark for each explanation and 1 for each recommendation. Therefore 5
linked points are required for 3 marks each to a total of 15.
If all the elements of the question are linked a table format (like the one below) is
appropriate. Alternatively you could present your answer in normal prose. However, if
you chose this you must give one deficiency plus an appropriate explanation and one
recommendation.
(a) Sales & Receivables
Deficiency Explanation Recommendations
Orders are processed
without
authorisation or
without performinga credit check on
customers.
Goods may be supplied to
high credit risk customers.
This increases the risk of
bad debts and financiallosses for Voyager.
(NB: credit will also be
given for increased fraud
risk and risk that goods are
not available to be able to
satisfy orders in a timely
fashion).
All new customers should
undergo a credit reference check
before being accepted as new
customers.Credit limits should be set for all
customers and Mr Jones, the
executive director and the sales
rep should meet to identify
those customers close to or
exceeding their limits every
month to avoid selling goods on
credit to risky customers.
All orders over a certain limit
should be authorised by the
executive director and confirmed
with clients prior to processing.
Nobody matches the
GDN to the original
order prior to
despatch and no-one
signs the GDN to
confirm that the
correct quantity of
goods has been
despatched.
Sending too few items
could lead to a loss of
customer goodwill.
Sending too many items
could lead to incorrect
invoices and lost revenue.
Before orders are despatched by
courier, the factory supervisor
should check the quantity and
quality of goods to the despatch
note and compare this to the
original order. The supervisor
should then sign the despatch
note to confirm this check has
taken place.
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PAPER F8 ( INT): AUDIT & ASSURANCE
4 KAPLAN PUBLISHING
Deficiency Explanation Recommendations
Nobody checks that
all orders have been
despatched.
Unfulfilled orders could
lead to customer
complaints and a loss of
customers.
Mr Jones should keep a copy of
all orders and match them to
GDNs. At the end of each week
he should check unmatched
orders and enquire why a GDN
has not been raised.
There are no
procedures to
ensure the
completeness and
accuracy of sales
invoices.
The company could suffer
financial loss if invoices are
not raised or are prepared
inaccurately.
All GDNs should be matched to
the invoice and filed together. At
the end of each week Mr Jones
should perform a review of
uninvoiced GDNs to ensure all
despatches have been invoiced.
The customer order file should
be reviewed periodically by Mrs
Singh, who should confirm thatthe order, GDN and invoice
details all match.
GDNs are not
retained on file.
In the event of customer
query, there is no
documentation to confirm
the quantities of goods
despatched to support the
value of the invoice raised.
A copy of the GDN should be
retained in the warehouse
(where there is more filing
space) in numerical order.
Mr Jones should record the
despatch note number on each
invoice so that, in the event of
query, the warehouse copy canbe found.
A sales day book is
not maintained.
Invoice posting errors are
likely to go undetected and
could result in loss of
revenue (e.g. if amounts
are understated by a
transposition error or the
invoice is omitted).
Mr Jones should use the SDB
facility and post the daily total
sales to the sales ledger and
sales ledger control account.
Mrs Singh should review a
sample of daily postings in
comparison to original invoices
and a sample of daily totals in
comparison to the ledgers to
ensure that accurate entries are
being made into the system.
Lack of segregation
of duties as Mr Jones
records transactions
and handles cash.
Mr Jones could make
errors in the recording of
transactions (either
fraudulent or accidental)
including failure to record
transactions. Errors and
omissions could go
undetected (and therefore
uncorrected).Understatement of sales
A receivables ledger and a
receivables ledger control
account should be maintained by
Mr Jones. These should be
reconciled monthly by Mrs
Singh.
Mrs Singh should open all post
and list remittances received
from customers before they areprocessed.
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INTERIM ASSESSMENT ANSWERS
KAPLAN PUBLISHING 5
Deficiency Explanation Recommendations
invoices and/or cash
receipts could result in
financial loss to the
company.
The executive director should
perform a monthly review of the
control account reconciliation,
the cash book and the aged
receivables ledger.
No hard copies of
receivables ledger
accounts are
produced. They are
therefore not
reviewed by
management.
Management does not
have the information
necessary to facilitate
credit control decisions.
This deficiency could lead
to ineffective credit control
and an increase in bad
debt.
An aged receivables ledger
should be scrutinised monthly by
Mr Jones, the executive director
and the sales rep.
Discussions regarding overdue
payments and chasing overdue
amounts should be supported by
sending monthly statements of
account to customers.
Marking Guide
General approach: 1 mark per deficiency, 1 mark per implication and 1 mark per
recommendation.
Only 1 explanation and 1 recommendation mark to be awarded per deficiency
discussed. Therefore a maximum of 3 to be awarded per deficiency addressed.
Maximum of 15 to be awarded for answer.
(b) Purchases & Wages
Deficiency Explanation Recommendations
Mrs Singh can
amend the payables
master file.
There is a significant risk of
unauthorised amendment
to the master file. This
could lead to fraud, e.g.
the setting up of a fake
supplier.
Amendments to supporting
master files should only be
performed by the director. All
such files should have restricted
access, e.g. password protection.
Alternatively (although this is a
weaker control) amendments
should be recorded on an official
form and authorised by the
director. Copies of all authorised
forms should be retained.
Prints of changes/
updated files are not
made or reviewed.
There is a risk that errors in
updating the system will
not be identified.
A current printout of the master
file should be kept by the
director and should be
compared to the underlying
system data periodically to
ensure that it has not been
amended without authorisation.
Supplier statement
reconciliations are
not scrutinised by
the director.
Mrs Singh could simply not
perform this vital control
or could manipulate the
reconciliation to cover up a
Ultimately the reconciliation
should not be performed by the
individual responsible for
preparing the purchase/payables
ledger. This should be performed
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PAPER F8 ( INT): AUDIT & ASSURANCE
6 KAPLAN PUBLISHING
Deficiency Explanation Recommendations
fraud.
This could lead to
unrecorded liabilities and
delayed payments to
suppliers.
by Mr Jones.
At the very least the
reconciliations should be
scrutinised by the director and a
sample of reconciling items
checked to source documents.
Supplier statements
(and the consequent
reconciliations) are
not retained on file.
There is no audit trail to
confirm the completeness
and accuracy of payables
balances at the year-end.
All reconciliations should be
retained on file to assist with the
preparation of year-end accruals
and in times of disputed
payments.
The director does
not review the
destination or nature
of cheques before
signing them.
Payments could be made
to false suppliers or for
incorrect amounts. Adco
may also have negotiated
extended terms with
certain suppliers that the
Mrs Singh is not aware of.
The director should be presented
with the cheques and a copy of
the aged payables ledger to
scrutinise.
The director should check the
payables back to the authorised
list of suppliers on the master
file.
Mr Jones should prepare month
end cheques to improve
segregation of duties.
Expense claims are
not always
supported by
receipts.
Fraudulent claims could be
processed.
Recovery of VAT would be
jeopardised without
supporting documentation.
Expense claims without
supporting evidence for all
amounts should be rejected.
All claims should be authorised
by the director, who would
check that the receipts are
sufficient evidence and that
claims are relevant to the
business.
Marking Guide
General approach: 1 mark per deficiency, 1 mark per implication and 1 mark per
recommendation.Only 1 explanation and 1 recommendation mark to be awarded per deficiency
discussed. Therefore a maximum of 3 to be awarded per deficiency addressed.
Maximum of 15 to be awarded for answer.
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INTERIM ASSESSMENT ANSWERS
KAPLAN PUBLISHING 7
2 ISA 500 & ISA 240
Key answer tips
Question 2 always requires repetition of knowledge, usually with regard to an
International Standard of Auditing or other fundamental auditing principle.
As there is no application to scenarios the general marking principle is ½ mark for
listing of points of knowledge and ½ for consequent explanations of those points. You
can use a similar rough marking guide when tackling ‘discussion’ based question 2’s.
Therefore, for 5 marks, in both (a) and (b) you are looking for 5 identified and
explained points.
Remember: you only have 18 minutes on question 2!
(a) Sufficient Appropriate Evidence
'Sufficient' means having enough documentary evidence on file to support a
reasonable audit opinion. There is no threshold as to how much evidence is
sufficient; this is simply a matter of professional judgement.
When deciding the quantity of evidence to gather the auditor must consider
audit risk: the greater the risk the greater the need for evidence to be able to
reach satisfactory conclusions.
Materiality also affects the design of audit tests: the higher the materiality
threshold the greater the requirement to gather evidence to be able to
conclude upon whether material misstatement (either individually or in
aggregate) has occurred.
'Appropriate' breaks down into two qualities: reliable and relevant.
To be relevant evidence must fulfil the particular objective of the audit
procedure. This includes testing balances to confirm a specific assertion, such as
completeness or accuracy, but also testing for overstatement or
understatement of particular balances. In order to be sufficient evidence must
be gathered to support the whole range of financial statements assertions.
Auditors should always try and gather the most reliable evidence available. In
the worst case scenario, if reliable evidence is not available then the auditor
may have to disclaim their opinion. Reliable evidence is considered to have the
following characteristics:
• Independent external evidence
• Evidence obtained directly by the auditor
• Documentary evidence
• Original evidence.
Marking Guide
General approach: ½ mark to be awarded for basic points of knowledge listed. A
further ½ mark should be awarded for explanations of those points. Therefore a
maximum of 1 mark available per point discussed.
A maximum of 5 to be awarded for the answer.
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PAPER F8 ( INT): AUDIT & ASSURANCE
8 KAPLAN PUBLISHING
(b) Responsibilities Re. Fraud
The primary responsibility for the prevention and detection of fraud rests with
those charged with governance and management.
They must place a strong emphasis on fraud prevention and reduce the
opportunities for this to take place. This involves a commitment to creating a
culture of honesty and ethical behaviour and the implementation and
maintenance of strong internal controls.
An auditor has a responsibility to obtain reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether
caused by fraud or error.
In order to satisfy this responsibility an auditor must carefully consider the risk
of fraud when planning an audit. This includes assessing and testing systems of
internal control to identify opportunities for fraud to take place. In response to
this risk assessment the auditor then designs appropriate audit procedures to
gather evidence to be able to conclude upon the financial statements.
Auditors must always remain professionally sceptical throughout the audit,considering the potential for management override of controls and recognising
the fact that audit procedures that are effective for detecting error may not be
effective for detecting fraud.
Overall the risk of non-detection of fraud is higher than that of detecting error
because of the likelihood of sophisticated fraud mechanisms and the inherent
limitations of audit procedures. To this end the auditor is considered to have
only a secondary responsibility when it comes to detecting fraud.
Marking Guide
General approach: ½ mark to be awarded for basic points of knowledge listed. A
further ½ mark should be awarded for explanations of those points. Therefore a
maximum of 1 mark available per point discussed.
A maximum of 5 to be awarded for the answer.
3. Collins Cosmetics
Key answer tips
This question is typical of the exam style: there are some marks for simple repetition
of knowledge and some for application of knowledge to a scenario.
NB!! The marks for simple repetition are never sufficient to pass the question. You
must practice applying basic principles to specific, and often unique, circumstances.
For part (a) to get a full mark per definition you must fully explain your points.
Lightweight responses (such as brief bullet-pointed lists) will pick up a maximum of ½
mark.
Part (b) asks you to apply your knowledge of audit risks to a scenario. Remember what
the definition of an audit risk is. You must identify possible sources of misstatement in
the financial statements. You then have to consider how this affects the audit
approach. To assist with this revisit your notes with regard to audit strategy. On this
question you will score 1 mark for each relevant audit risk and 1 mark for the impacton the audit approach.
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INTERIM ASSESSMENT ANSWERS
KAPLAN PUBLISHING 9
Part (c) requires two well explained points that address the basic concept of the audit
risk model.
(a) Meanings
Audit risk is the risk of forming the wrong conclusion from audit procedures.
This means giving an unmodified opinion when a modified opinion would bemost appropriate (or vice versa).
Inherent risk is the risk that material errors may arise from the nature of the
business, its transactions, or its industry, irrespective of the control system in
place.
Control risk is the risk that the client’s internal control system may fail to
prevent and/or detect errors and omissions in financial reporting systems that
could then pass into the financial statements.
Detection risk is the risk that the auditor’s substantive procedures fail to detect
material misstatement in the financial statements. Detection risk is likely to
increase as sample sizes are reduced. Also, detection risk can be reduced by
increasing the experience and general quality of the audit team.
Marking Guide
General approach: 1 mark per thorough definition. ½ marks may be awarded for
incomplete or weaker definitions.
A maximum of 4 to be awarded for the answer.
(b) Factors to consider
Audit Risk Audit Approach
Going concernDeclining profits suggest the
company’s future may be in doubt.
The company have also lost a
significant member of staff, which
could have implications for the long-
term health of the business.
If the company is not a going concern
the accounts should be prepared on
an alternative basis (i.e. break-up
basis).
The audit team should compromise
at least one individual with extensive
experience of the cosmetics industry
who is able to scrutinise the forecasts
of the business in light of known
economic and industry specific
changes.
Given the downturn in performance
it will be vital to assess the financial
resources available to the client.
Poor Performance
Declining profits, combined with a
desire to achieve a listing and the new
performance based incentive scheme,
will increase the pressure to overstate
the profits of the company.
This could lead to fraudulent
misstatement in the financial
statements.
The audit will need to be conducted
with a high level of professional
scepticism. The ability to scrutinise
uncertainties and misstatements with
necessary scepticism usually requires
reasonable levels of experience.
Therefore it appears appropriate to
use reasonably senior audit staff for
this engagement. Such staff will also
have the confidence to challengemanagement over such issues.
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PAPER F8 ( INT): AUDIT & ASSURANCE
10 KAPLAN PUBLISHING
Audit Risk Audit Approach
Inventory
The incentive scheme may lead to
over-production, which may lead to
inventory that cannot be sold which istherefore overvalued in the statement
of financial position.
The poor performance of the business
also indicates that Collins are finding it
difficult to compete, which may
further indicate that inventories
cannot be sold and are therefore
overvalued.
Experienced staff should be allocated
to the audit of inventory balances.
Importantly, provisions requiresignificant management estimates
and judgements. It is difficult to
gather reliable evidence when such
judgement exists so it will be
necessary to understand the system
that management adopts and to test
any controls that are implemented.
The audit team will also need to plan
to obtain written representations
from management regarding the
completeness of the provision.
Products are made for specific
customers. If Collins loses any
customers the items produced for
them may be unsaleable to anyone
else, again suggesting that inventory is
at high risk of overvaluation.
The audit team will need to sample
test year-end inventories to ensure
that they are selling after the year-
end (at a price greater than cost).
Given the risk surrounding this area a
non-statistical approach, focussing on
the most significant, material
inventories may be appropriate.
Multiple Manufacturing Sites
Multiple locations make internal
controls more complex and difficult to
implement effectively. In particular,
given their manufacturing status,
there is increased risk of poor controls
over stock quantification and, hence,
valuation.
This is particularly the case when
there are significant changes at
boardroom level.
It will be vital (this year in particular)
for the audit team to visit all five of
the manufacturing sites to observe
counting procedures and perform
test counts.
If this is successful there will be a
significantly reduced need for
extensive substantive procedures on
inventory balances at the final audit.
If attendance at all five is not possible
then a greater substantive approach
will be necessary.
Control risk
Recent board changes are likely to
result in the control systems being, at
least, temporarily weakened.
This will be heightened by the FD’s
move to part time status.
The weakening of internal controls has
perhaps been reflected by the
worsening profitability of Collins.
The audit team will need to revisit all
their systems notes and update them
to reflect any changes in internal
controls.
These systems (and the controls) will
then need to be tested to help design
further audit procedures. It is
therefore likely that a significant
interim audit is appropriate this year.
This is particularly important given
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INTERIM ASSESSMENT ANSWERS
KAPLAN PUBLISHING 11
Audit Risk Audit Approach
the increased fraud risk due to poor
performance, performance targets
and desire to float the company.
In all likelihood risks are going to be
perceived as high and for that reason
a fully substantive approach appears
likely this year.
Family Owned Status
In a privately-owned family company,
directors may be treating personal
expenditure as business expenditure,
leading to an understatement of
directors’ emoluments.
It is essential that all directors and
related party transactions are
disclosed fully in the financial
statements. A careful review of the
cash book for unusual payments, or
payments to directors, will be
required.
Marking Guide
General approach: 1 mark per audit risk factor/indicator identified relevant to the
scenario. An additional 1 mark to be awarded for relevant and linked discussion of the
impact on the audit approach.
A maximum of 1 to be awarded for approach implications linked to an audit risk
indicator (i.e. can’t have 1 mark for risk and 2 marks for audit approach implication).
A maximum of 14 to be awarded for the answer.
(c) High Inherent Risk
If inherent risk is high the auditor has to consider how effectively the client’s
systems of internal control prevent and detect misstatement. If the control
systems are considered strong there is a lower risk of material misstatement in
the financial statements and the auditor may be able to reduce substantive
testing.
However, if the control environment is considered insufficient to prevent and
detect material misstatement then detection risk will need to be lowered using
a combination of the following strategies:
• Increased volume of substantive testing at the final audit stage (e.g. by
selecting larger samples);
• Less biased sample selection (i.e. by using statistical sampling);
• Using a more experienced audit team; and
• Increasing the frequency of senior management review procedures and
by using a second partner to review working papers.
Marking Guide
1 mark for discussing link between inherent, control and detection risk.
½ mark for each strategy suggestion if risk assessed as high to a maximum of 1.
Maximum of 2 to be awarded for the answer.
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PAPER F8 ( INT): AUDIT & ASSURANCE
12 KAPLAN PUBLISHING
4. Mart & Border Travel
Key answer tips
Ethics is a fundamental element of modern auditing and will feature regularly in the
F8 exam (as well as all of the professional level papers).
In questions it is vital that candidates can explain the five elements of the code of
conduct. It is also vital that these concepts can be applied to scenarios. In particular,
candidates must be able to identify threats to a firm’s ethical position and recommend
appropriate safeguards.
As question 4 (a) is scenario based candidates will receive 1 mark for each ethical
threat/issue identified, 1 mark for the consequent explanation of the threat and 1
mark for each appropriate safeguard recommended.
In part (b) students should aim to obtain 1 mark for each ethical matter discussed
relevant to the scenario and 1 mark for each recommended safeguard. Note that themarks are split (and this allocation is fixed/capped) between two different issues.
These issues should be discussed in turn and not together as part of a longer answer.
(a) Ethics
Ethical Issue Explanation Safeguard
Being the largest fee
generating client there
is a risk of fee
dependency, which is a
self-interest threat to
objectivity.
The auditor may act
with bias for fear of
losing such a lucrative
client. This could lead to
the signing of inappropriate assurance
reports.
Total fees from Mart
should be regularly
reviewed to ensure
recurring fees remain
below acceptable
thresholds (10-15% of
total practice income). If
fees from Mart exceed
these limits one, or
more, engagements
should be declined.
Acting for a client for 20
years increases the risk
of familiarity threat to
objectivity.
If, at any point, the
relationship between
auditor and client
crosses professional
boundaries then theobjectivity of the auditor
must be questioned.
The auditor may
become too trusting of,
and reliant upon,
management
representations rather
than more reliable forms
of evidence.
Senior staff should be
periodically rotated to
bring in new,
independent staff.
If listed, audit partners
should be rotated after
five to seven years,
depending on local
customs/regulations.
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INTERIM ASSESSMENT ANSWERS
KAPLAN PUBLISHING 13
Ethical Issue Explanation Safeguard
Providing additional
services increases the
risk of self-review threat
to objectivity.
This occurs when staff of
the same firm are
reluctant to challenge
the outcome of a
previous engagement
because it could impact
adversely on a colleague
(e.g. tax planning and
audit staff)
Separate teams should
be used with separate
reporting lines and
separate engagement
partners.
If there is particular
concern a second
partner review should
be performed.
The provision of
multiple services may
also create a self
interest-threat to
objectivity.
Low-balling (i.e. low
audit fees charged to
retain other more
lucrative consultancy
work) detracts from
audit quality and
therefore auditor
neutrality.
Independent partner
reviews can be
conducted when there
are concerns over
engagement quality.
Self-interest threat to
objectivity due to tax
planning for both
directors and company.
The auditor may be
tempted to favour one
party at the expense of
the other to try and
boost consultancy fee
income.
Separate teams with
different partners
should be used to
conduct corporate and
private tax planning
engagements.
Former employee
joining client gives riseto a familiarity threat.
Audit staff will know the
new FD too informally
and may place too much
reliance on their
representations.
The audit may need to
be handed over toanother department
who are unfamiliar with
the ex-staff member.
If this is not possible a
second partner review
would be advised.
There may have been a
self-interest threat to
objectivity in previous
years due to the auditmanager manufacturing
a career move.
It is possible the audit
manager has used the
audit as a springboard to
a more lucrative positionwith a client and for that
reason may have not
acted objectively.
The firm should review
previous working files
and current planning
files affected by the oldaudit manager’s
judgements.
Marking Guide
General approach: 1 mark to be awarded for identification of ethical threat. Up to 1
further mark to be awarded for explanation of the threat and a further 1 mark for
recommending a safeguard. Therefore a maximum of 3 to be awarded for each threat
discussed.
A maximum of 9 to be awarded for the answer.
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PAPER F8 ( INT): AUDIT & ASSURANCE
14 KAPLAN PUBLISHING
(b) (i) The statutory audit
Ethical Matters
Before tendering for the audit Midway LLP must consider if they have
appropriate professional competence to perform the audit. With little
experience in the travel sector it is unlikely the firm will understand the
industry specific risk factors.
In addition to considering knowledge of the industry Midway must also
consider whether they have adequate resources to conduct the
engagement with appropriate standards of due care. Most significantly
they must identify if they have the staff available in their ‘busy’ firm to
adequately plan, perform and review the audit given their current client
commitments.
Midway must also consider that they have no resources on the South
coast and would therefore incur significant travel and subsistence costs
performing the audit; a cost that would be passed on to the client.
The scenario states that Border Travel would provide a ‘significant sourceof fee income.’ This increases the risk of self-interest threat; i.e. Midway
becoming over-dependent on one client and thus conducting their audit
without the necessary objectivity.
Safeguards
Although Midway have no industry specific knowledge this does not
mean they have to turn down the engagement. They could send a
member of staff (most likely a partner or senior manager) on an external
training course. Alternatively, someone with industry specific knowledge
could be recruited.
Generally, for non-public interest clients, recurring fee income from oneclient should not exceed 15% of the total practice income. A budgeting
exercise should be performed, where forecasts of future fees from
Border Travel are compared to total forecast practice income. At the
point that the threshold is exceeded Midway will have to resign from one,
or more, of the services.
(ii) The provision of other services
Preparation of Financial Statements
Ethical Issues
Whilst audit firms routinely assist with the preparation of financial
statements this does create a significant ethical threat when performedfor an audit client: mainly self-review and making management decisions.
Both of these are significant threats to objectivity.
Self-review arises because the audit firm will effectively be auditing
financial statements that they have prepared. The auditor may also be
required to make late adjustments to the accounts and/or the notes,
which increases the risk that they are taking decisions on behalf of the
client.
Safeguards
An engagement letter must be prepared and signed by the client
confirming that they are responsible for the preparation of the financial
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statements, including all post-audit adjustments, and the maintenance of
all underlying records.
Separate teams, with separate reporting channels, should be used to
prepare the accounts and perform the audit to reduce any self-review
risk.
Systems review
Ethical Matters
Once again this poses a self-review risk to Midway LLP. As auditor they
will review internal systems and controls, including IT systems that form
part of the financial reporting system. If they have previously performed
a review of IT systems – and helped to update those systems – on a
separate engagement then they would be reviewing their own work. This
would create a significant threat to objectivity.
Midway must also consider if they have the technical competence to
advise on the IT systems of Border Travel. Such engagements require
significant technical IT expertise, which is not a prerequisite of an auditfirm.
Safeguards
If Midway have no IT specialists they should politely decline the offer to
perform IT systems reviews.
If they do have the expertise then those experts must be separate from
the audit team and have separate reporting channels.
Marking Guide
General approach: 1 mark to be awarded for discussion of the ethical matters relevant
to each scenario. 1 mark may also be awarded for each relevant safeguard suggested
in response to the matters identified.
A maximum of 5 to be awarded for the answer to part b(i) and a maximum of 6 to be
awarded for the answer to part b(ii).
5. Lopit
Key answer tips
Parts (a) to (d) require the repetition of basic points of knowledge concerning auditor
rights, responsibilities and objectives. As there is no application students should again
work on the principle of receiving ½ marks for simple lists of knowledge. To turn these
into full marks students must explain their points fully.
Part (e) requires application of knowledge to the scenario given. As a result each point
of explanation will be awarded 1 mark.
(a) Auditor Duties
The duties of the auditor of Lopit are defined by auditing standards (such as
ISAs) and by local statute (such as the Companies Act 2006). An audit is an
independent, professional examination of, and expression of an opinion on, the
financial statements of the company.
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The opinion is given as to whether a true and fair view is presented of the
company’s affairs as at the end of its financial year, and of the company’s profit
or loss for its financial year, and whether the financial statements have been
properly prepared in accordance with an identified financial reporting
framework (e.g. IFRS/IASs)
The auditor is also typically required to report on other specific matters; forexample, when:
(i) Proper returns have not been received from branches not visited.
(ii) The financial statements are not in agreement with the underlying
accounting records and returns.
(iii) Proper accounting records have not been kept.
(iv) All necessary information and explanations have not been obtained.
(v) Information disclosed in the directors’ report is inconsistent with that
given in the financial statements.
Certain information may also be required to be disclosed in the audit report if
the company fails to disclose it in the financial statements, e.g. details of the
directors’ emoluments and particulars of loans to officers.
In addition to local statutory requirements, it will also be necessary for the
auditor to ensure that the audit is performed according to the auditing
standards in force (i.e. International Standards of Auditing).
The directors may extend the scope of the audit beyond the statutory
requirements if the auditor is agreeable, but they cannot limit the scope of the
audit or indemnify the auditor against any legal action arising from the non-
performance of duties at the directors’ request.
(b) Relationship Between Auditor and Directors
As Lopit is a newly-formed company, the directors may typically appoint thefirst auditor to hold office until the conclusion of the first AGM. The auditor has
no relationship with the directors other than as the practical means by which
the company enters into a contract with the auditor.
The directors are responsible for the preparation of financial statements, and
the auditor for the formation and expression of an opinion on those statements
to the members of Lopit for a fee.
(c) Legal Rights of an Auditor
As an auditor of a limited liability company, the following rights are typically
given by legislation:
(i) To receive notice to attend and be heard at all general meetings.
(ii) To obtain access at all times to all accounting records.
(iii) To be informed of any proposal for dismissal, and to take certain actions
in that event.
(iv) To obtain all necessary information and explanations, as required, from a
subsidiary and its auditor and, in any other case, to require information
to be provided by the parent company.
(d) Director’s Authority
The directors do not generally have the authority in their capacity as directors
to dismiss the auditor.
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An auditor is removed from office by the passing of a resolution by the
members in a general meeting.
Marking Guide
General approach: ½ mark to be awarded for simple listing of points and brief/weak
answers. A full mark may be awarded for thoroughly explained points. A maximum: of 6 to be awarded for (a); 2 for (b); 4 for (c) and 2 for (d).
(e) Acceptance Procedures
Practical matters to be considered:
It would be impossible to accept the appointment as specified by the directors.
The scope of an audit cannot be limited at the request of directors.
If, however, the firm still wishes to pursue the appointment it will be necessary
to discuss the matter with the directors and eliminate the misunderstanding
regarding the duties of the auditor.The auditor must consider whether the audit makes commercial sense. A
cost/benefit analysis should be performed to identify whether the auditor has
the relevant expertise/resources to perform the audit efficiently and whether
the perceived income outweighs the costs.
The above analysis should consider the risk of performing the audit. Whilst Lopit
is not listed (and therefore low reputational risk for the auditor) the first year of
audit may be difficult if Lopit have not previously been audited.
As Lopit is a newly-formed company there will be no requirement to contact
existing/previous auditors for professional clearance.
Ethical matters to be considered: Is the practice sufficiently large to satisfactorily perform the audit with
appropriate standards of competence and due care, or is the audit during a
particularly busy period for the practice?
The recurring fees from this appointment should not exceed 15% of total
practice income, given that Lopit is newly formed and unlikely to be listed.
The audit firm should perform an independence review before accepting the
engagement. This would consider any personal relationships between senior
audit staff and the officers/employees of Lopit. Such personnel should be
excluded from the audit team.
Such a review would also consider any financial involvement with the company,
including audit staff shareholdings or loan to or from the company.
Marking Guide
General approach: 1 mark to be awarded for explanation of points relevant to the
consideration of accepting appointment as auditor to Lopit.
A maximum of 6 to be awarded for the answer to (e)