15112557 ACCA CAT Paper T8 Implementing Audit Procedures Solved Past Papers

(International Stream)

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL MONDAY 14 JUNE 2004

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

Paper T8(INT)

Implementing Audit Procedures

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ALL FOUR questions are compulsory and MUST be attempted 1

M, a large manufacturing company limited by liability, has all of its production, stores and head office buildings situated on a single site. The buying and accounts departments are located in the head office building. Following a recent take-over of the company, the new directors have been informed that there is an inadequate level of internal controls over the Purchases and Trade Payables system. Weaknesses include an absence of control procedures and adequate documentation. Similarly there has been no attempt to use supplier statements to supplement other controls within the system. A ‘batch entry batch processing system’ is used throughout the company’s accounting system, which incorporates fully integrated payables and general ledgers. Required: (a) State FOUR objectives of having internal controls in a Purchases and Trade Payables system.

(4 marks)

(b) Identify the internal controls that should exist in M over the following: (i)

Requisitioning and authorisation of purchases;

(ii) Acknowledgement of the receipt of goods and the return of goods to suppliers; (iii) Checking and authorisation of purchase invoices prior to batching for processing through the computerised accounting system. (15 marks) (c) Explain how supplier statements should be used to supplement other controls in the Purchases and Trade Payables system of M. (3 marks) (d) State the meaning of the term ‘batch entry batch processing system’ and explain the use of control totals in such a system. (3 marks) (25 marks)

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2

J.J. is a small limited liability company which sells mineral water dispensing machines and bottles of mineral water. The company’s only shareholders, directors and employees are brothers Joe, Jim and Josh Alsage. The company’s manual accounting system is simple in design and includes a sales day book, a cash book and trade receivables and general ledgers. Josh maintains the books of prime entry but not the trade receivables and general ledgers. These ledgers are written up by an independent qualified bookkeeper. J.J. focuses on achieving bulk order high value sales to multi-site corporate customers. Consequently during the year ended 31 May 2004 there were only 48 sales invoice transactions. All sales are made on credit terms and invoices are priced from a standard product price list authorised by the directors. The control procedures employed over sales include the use of pre-numbered multi-part despatch notes and sales invoice stationery. You have been assigned to the audit of the financial statements of J.J. for the year ended 31 May 2004. Your audit manager has explained why a direct verification (vouching) approach to the audit will be adopted as opposed to a systems based approach, and your first task will be to work on the area of sales. You are not required to verify entries in the company’s trade receivables ledger or general ledger. Required: (a) (i)

Summarise what is meant by a ‘systems based’ approach to an audit. Your answer should refer to the stages of such an approach. (10 marks) and

(ii) Summarise what is meant by a ‘direct verification (vouching)’ approach to an audit, explaining why the approach is often more appropriate when auditing the financial statements of a small limited liability company. (8 marks) (b) State TWO main common objectives of vouching despatch notes, sales invoices and the sales day book, when auditing the sales of J.J. (4 marks) (c) State THREE checks you would carry out to verify the completeness of processing of individual invoices, and THREE checks you would carry out to verify the accuracy of processing of individual invoices when vouching the sales invoices of J.J. (3 marks) (25 marks)


[P.T.O.

3

An analysis of the trade receivables of Zais, a limited liability company, as at 31 May 2004 reveals the following: Balance Level Over $15,000 $10,001 to $15,000 $7,501 to $10,000 $2,501 to $7,500 $0 to $2,500 Credit Balances Total

Number of Balances 3 10 19 51 146 7 236

Value $94,107 $139,406 $165,100 $174,842 $130,975 ($621) $703,809

Janice, your audit supervisor, has instructed you to obtain direct confirmation of trade receivables using a sample size of 70 trade receivables balances. You are to use the positive confirmation method. In the course of her conversation with you, Janice mentioned that it is not always appropriate to adopt a sampling approach when testing various populations during the course of an audit. Required: (a) State FOUR circumstances during the course of an audit when it would not be appropriate to adopt a sampling approach to testing. (6 marks) (b) (i)

Explain the difference between the ‘positive’ and ‘negative’ methods of obtaining direct confirmation of trade receivables balances and describe the circumstances in which the latter should be used. (5 marks)

(ii) Explain why none of the employees of Zais should have any influence on the selection of trade receivables balances to be confirmed. (2 marks) (c) Explain the significance of including: (i) All accounts with balances in excess of $7,500; (ii) Some accounts with zero balances; in the sample of trade receivables balances of Zais to be confirmed.

(6 marks)

(d) Describe the other types of account in addition to those stated in (c) above, which would require special attention and would need to be represented in the sample of trade receivable balances to be confirmed. (6 marks) (25 marks)


4

(a) Provided an auditor possesses professional objectivity, he does not have to be seen to be independent. Required: Comment on the above statement ensuring that you include an explanation of the term ‘professional objectivity’ and include commentary on the validity of the statement. (10 marks) (b) ACCA’s Rules of Professional Conduct describe various situations and relationships, which if existing, could pose a threat to auditor independence. The guidance notes provide examples of appropriate actions that can be taken to safeguard against the loss of independence where such situations and relationships exist. At a recent training seminar, the following scenarios were presented for discussion: –

On 20 May 2004, the audit engagement partner of Poynt and Co visited the offices of Geeclubs, a limited liability company, to plan the final audit procedures for the year ending 31 July 2004. A week later, each of the five partners of Poynt and Co received an unsolicited letter from the Managing Director of Geeclubs offering one year’s free membership at one of the company’s golf and country clubs with effect from 1 August 2004. Individual annual membership normally costs $3,000 and the offer was not made to anyone else.

–

The wife of one of the audit managers at Pebury and Company – a large audit firm and auditors of Adlin, a limited liability company, has recently been appointed as the Financial Director of Adlin. Immediately prior to her appointment she had been employed by one of Adlin’s competitors. Each of the directors of Adlin is entitled to an annual bonus based on the reported profit of the company.

–

Bollies, a long established firm, audit the financial statements of two private limited liability companies owned by Thomas Arn, an entrepreneur with a very dominant personality. The annual total fee income of Bollies is $830,000 and the combined audit fees attributable to the two companies is $72,000. Thomas Arn has recently approached Bollies with a view to appointing them as auditors to a third limited liability company under his control. The projected annual fee attributable to the third company is $80,000.

Required: For each of the above scenarios: (i)

comment on any concerns you may have regarding the threat to auditor independence and objectivity.

(ii) recommend the appropriate action to be taken by the audit firm to safeguard against any threat identified. (15 marks) (25 marks)

End of Question Paper


Answers

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ACCA Certified Accounting Technician Examination – Paper T8(INT) Implementing Audit Procedures (International Stream)

June 2004 Answers

M, A Large Manufacturing Company 1

(a)

The objectives of a Purchases and Trade Payables system are to ensure that: (i)

Goods and services for an entity are only requisitioned when required.

(ii)

Goods and services are supplied in accordance with the requirements of an entity in terms of quality and quantity and at the best available price.

(iii) Only goods and services required by an entity are accepted as a basis for subsequent payment. (iv) Invoices paid by an entity relate to goods and services actually received. (v)

Payment is made to suppliers on a timely basis for goods and services received by an entity.

(vi) All bona-fide transactions relating to the purchases of goods and services are entered on a timely basis into the accounting records of an entity. (Full marks will be awarded for identifying FOUR of the above or other appropriate objectives). (b)

The following procedures and control documentation should exist over the: (i)

Requisitioning and authorisation of purchases – – – – –

(ii)

The task of requisitioning for the purchase of goods and services should be allocated only to specified responsible employees of the company. Requisitions for the purchase of goods and services should be communicated on specified forms with uniform detail requirements including justification for the purchase. The task of raising purchase orders should be allocated to responsible buying officials of M separate from the goods received and accounting functions. Strict controls should be maintained over the security of purchase order stationery which should be pre-numbered. Purchase order stationery should be multi-part, with copies being provided to the accounts department for matching to subsequent goods received documentation and invoice(s) as appropriate. A copy should also be forwarded to the goods received department for checking to subsequent deliveries.

Acknowledgement of the receipt of goods and return of goods to suppliers. – – – –

Goods received personnel should be separate from the ordering and accounting functions of M. All goods received should be inspected and checked to copy purchase orders as to classification, quality and quantity. Goods accepted should be recorded on pre-numbered multi-part stationery with one copy being forwarded to the accounts department for subsequent matching with purchase order(s) and invoice(s). Goods returned to suppliers should be recorded on pre-numbered multi-part stationery with one copy being forwarded to the accounts department for matching to credit note(s). A copy should also be despatched with the specified goods returned for acknowledgement of delivery and returning to M.

(iii) Checking and authorisation of purchase invoices prior to batching. – – – – – –

– – (c)

Individuals involved in the processing of purchase invoices through the company’s accounting system should be separate from the ordering, goods received and payment functions. All purchase invoices received by M should be immediately forwarded to the company’s accounts department. Invoice details and arithmetical accuracy should be checked (and evidenced as such) and discrepancies resolved before further processing. Invoices should be ‘matched’ with purchase order(s) and goods received note(s) and discrepancies resolved before further processing. Matched invoices should be forwarded to the appropriate responsible official(s) in the company for authorisation and approval of accounts (general ledger) coding as appropriate. There should be separate approval procedures, involving appropriate responsible officials of M, for the approval of invoices relating to utilities and other sundry services received not subject to the normal purchase ordering and goods received procedures. Where invoices are forwarded to responsible officials of the company, a detailed register should be maintained to track their progress as appropriate. Prior to batching, invoices should be pre-numbered in sequential order to facilitate completeness of processing.

Where received, statements from suppliers should be reconciled as soon as practicable with the relevant supplier accounts in the trade payables ledger of M. Reconciliations should be prepared by individuals separated from the processing of purchase invoices and payments to suppliers (to prevent the possibility of fraudulent activity), but where this is not practical they should be subject to close independent supervisory control.


The reconciliation of supplier statements supplements other controls over purchases and trade payables by helping to ensure completeness of, and to identify errors in processing of purchase ledger transactions. Any differences identified between supplier statements and trade payables ledger accounts may reveal the existence of unprocessed invoices for goods or services received, or even perhaps payments made on accounts but not received by suppliers. Any omissions or errors so revealed should be subject to immediate enquiry. (d)

The term ‘batch entry batch processing system’ is used to describe a computer-based accounting system, through which data is entered and processed in discrete batches. Controls should ensure strong segregation of duties between the preparation of data for processing and the actual input and processing of the data through the computer system. Preparation procedures should involve the use of control totals (pre-lists) established by monetary value, number of documents or a ‘hash total’ against which users can check data subsequently processed through the computer system and returned to them. If there is imparity between a pre-listed total and processed totals, then immediate reconciliation is required in order to ensure the integrity of processing.

J J, A Limited Liability Company 2

(a)

(i)

A ‘systems based’ approach to an audit describes the approach adopted when reliance is placed on an entity’s system of internal control, to determine the level of detailed testing of transactions and balances. In summary when adopting this approach an auditor needs to: – – – –

(ii)

Ascertain and record the internal control system in operation. Evaluate the extent to which it appears that reliance can be placed on the system to prevent error, omission or fraudulent activity. Perform tests of control (compliance tests) to confirm whether or not the preliminary evaluation of the control system is correct. Determine the level of detailed testing of transactions and balances to be carried out dependent on the outcome of the tests above. If in a particular area, internal control procedures are deemed to be strong then the level of detailed testing may be reduced. Conversely, where controls are weak then the level of detailed testing will have to be increased.

A direct verification (or vouching) approach to an audit describes the approach when no reliance is placed on an entity’s system of internal control, to determine the level of detailed testing of transactions and balances. The approach will be adopted when the number of transactions and balances subject to audit is very low. It will also be adopted when there is an absence of internal controls or where control is very weak. Consequently, dependent on the relative materiality of transactions and balances, where appropriate, it is not uncommon for testing levels to be set at between 50% and 100% of the population. This approach is often more appropriate when auditing the financial statements of a small limited liability company because: – Internal control procedures are often weak or easily overridden. – Internal controls used by large entities are usually not practical in small business e.g. limited segregation of duties, supervisory control may be lacking or inadequate. – Due to regular fluctuation from one year to the next in sales, profitability, overhead costs and asset purchases, the use of analytical review as a substantive test is less effective. – The number of transactions and balances subject to audit will often be very low. – Record keeping is unsophisticated and easy to audit. More efficient audit approach.

(b)

The main objectives are: (i)

To confirm that all goods supplied during the period were duly invoiced.

(ii)

To confirm that all invoices raised during the period related to sales of the company.

(iii) To confirm the reliability, accuracy and completeness of accounting for sales. (Full marks will be awarded for stating any TWO of the above or other appropriate objectives). (c)

I would: (i)

Check for completeness of processing of invoices by: – – –

(ii)

Testing the numerical sequence of the sales invoice raised. Comparing sales invoices to customer orders and goods despatched notes. Vouching invoices to the sales day book.

Check for accuracy of processing by: – – –

Comparing prices charged on sales invoices to the authorised price list. Checking calculations and additions of invoices (including any government taxes). Vouching individual invoices to the sales day book.


ZAIS, A Limited Liability Company 3

(a)

A sampling approach to testing would not be appropriate in the following circumstances: (i)

Where there is a statutory requirement to disclose specific items in the financial statements, for example directors’ remuneration.

(ii)

Where the population is very small and the results from sampling could not be relied on, for example when conducting certain compliance tests.

(iii) Where the population is small in number but comprises material individual balances or transactions, for example property additions. (iv) Where the population is not homogenous and requires subdivision before sampling can be attempted, for example purchase invoices and credit notes. (v)

When the auditor is put ‘on enquiry’ for example when testing for fraud.

(vi) Where the costs of sampling outweigh the benefits as compared to 100% testing. (Full marks will be awarded for identifying FOUR of the above or other appropriate occasions). (b)

(i)

The positive method of obtaining direct confirmation of trade receivables balances is the process whereby letters are sent to customers asking them to forward written confirmation (or to provide details of any differences) of the balance on their account as shown in the audit client’s records. The negative method requests that customers should only respond if they do not agree the balance on their account as shown in the audit client’s records. This type of confirmation should only be used when: – The audit client has a strong internal control system over sales and trade receivables. – Other good corroborative evidence with regard to the existence of trade receivables has already been obtained from other tests carried out. – There are a large number of small balances. – A substantial number of errors is not expected. – The auditor has no reason to believe the debtors will disregard the request.

(c)

(d)

(ii)

Whilst the main objective of obtaining written confirmation is to confirm the existence of debts outstanding, a secondary objective is to test the propriety of controls actually exercised over the sales and trade receivables function. Clearly if employees have been circumventing controls to conceal any (for example fraudulent) activity, they would have a vested interest in diverting the auditor’s attention away from balances on accounts subject to such activity.

(i)

By confirming all customer account balances in excess of $7,500, we will ensure coverage of some 57% of the total value of the population before taking account of further balances for inclusion. This is a significant proportion of the total value of the population and inclusion should therefore assist us in reaching a confident conclusion on the accuracy of the reported trade receivables figure. It will also assist us in interpreting the materiality of any errors brought to our attention from the balance of accounts tested.

(ii)

Whilst we may not have any reason to doubt the existence of zero balances on customer accounts, there are a variety of reasons as to why these could be stated incorrectly. For example, as a consequence of cut-off errors (sales not recorded in the correct financial period), mis-posting of cash receipts (payments made in advance of a sales transaction) or fraudulent activity (diversion of cash received from a customer combined with suppression of sales activity). Confirmation of zero balance accounts will test for the occurrence of these events.

Accounts requiring special attention would include: (i)

Those which have exceeded the normal credit period.

(ii)

Those which regularly exceed the authorised credit limit.

(iii) Those which have credit balances. (iv) Those which show higher/lower balances at the balance sheet date as compared to other times during the year. (v)

Those accounts on which balances have been written off as bad debts or in respect of which provision has been made.

(vi) Those on which there are regular contras with supplier accounts in the company’s trade payables ledger. (vii) Those on which round sum payments are constantly received. (viii) Those to which credit notes have been regularly posted. (ix) Those to which journal credits or journal debits have been regularly posted. (x)

Those which appear to have received unusually favourable treatment with regard to credit limits, payment period and discounts allowed.

(xi) Those which apply to customers who are known to be ‘connected’ to Zais or its employees (related parties). (xii) Accounts with nil balance. (xiii) Accounts which have been paid by the date of the examination. (Full marks will be awarded for identifying SIX of the above or other appropriate types of account).


PROFESSIONAL OBJECTIVITY 4

(a)

The Code of ethics as set out in ACCA’s Rules of Professional Conduct, requires that members should strive for objectivity in all professional and business judgements. Objectivity is ‘the state of mind which has regard to all considerations relevant to the task in hand but no other’. The Association’s Code of ethics then goes on to explain that (professional) ‘objectivity is a state of mind, but in certain roles the preservation of objectivity needs to be protected and demonstrated by the maintenance of a member’s independence from influences which could affect his/her objectivity’. The job of an auditor represents such a role. The belief that a company’s un-audited financial statements lack credibility, is fundamental to the supposition that they need to be audited. There is an assumption that the company’s management may have lacked objectivity when preparing the financial statements, therefore in order to add credibility to them it is important that they are audited by impartial professionals, who are free from any influence and pressure which might impair their judgement when carrying out their audit work. The nature of the audit function therefore demands that auditors are mentally independent and as such are totally objective in their audit approach. However, given that their independence is ‘mental’, no matter how they may argue that they are objective in their audit approach, the only people actually aware of their (mental) state of independence are auditors themselves. Given the above, I consider the statement made to be invalid. In order to add credibility to their reporting function it is important that auditors remain visibly independent. If they do not and are therefore not seen to be independent, shareholders and users of financial statements may (albeit mistakenly), take the view that the auditors have not been objective in their approach, with the consequence that they will not place reliance on the auditors’ opinion.

(b)

Poynt & Co ACCA’s Code of ethics gives clear guidance on the risk posed to objectivity, by the acceptance of goods and services from an audit client, stating that ‘goods or services should not be accepted by a practice or anyone closely connected with it unless the value of any benefits is modest’. The value ($3,000) of individual golf club membership would not be considered to be modest and the threat to the audit objectivity of Poynt and Co (if the memberships are accepted) is compounded by the fact that the total value of offer to the firm is $15,000 (5 x $3,000). On this basis, I would be concerned that objectivity could be, or be perceived to be threatened, and would strongly recommend that the partners politely decline the offer. In addition to the above, I would also be concerned as to the motive of the managing director in making the offer. Given the total value of the offer, the timing of it (soon after the start of audit work) and the fact that it was made solely to the partners would alert me to the possibility that in return for the free membership, the company may have unreasonable expectations as to how the audit firm may respond when coming across contentious issues in the company’s financial statements – for example, the adoption of unacceptable accounting policies. Pebury and Company ACCA’s Code of ethics gives clear guidance on the risk posed to objectivity as a consequence of family and other personal relationships stating that ‘objectivity may be threatened or appear to be threatened as a consequence of a family or other close personal or business relationship’. The fact that an audit manager of Pebury and Company is married to the new financial director of one of the firm’s audit clients, clearly poses a potential threat to audit objectivity. Given that the financial director is responsible for the preparation of the company’s financial statements, there may well be a perception of impropriety with regard to the figures reported therein if her husband (as a senior member of the audit team) has a role in the audit function. To avoid such a threat I would strongly recommend that the firm ensures that the audit manager has no involvement whatsoever with that audit (or any other) assignment relating to Adlin. Given the size of the firm this should not unduly affect its operational efficiency. My concern as to the possibility of perceived impropriety with regard to the figures reported in the financial statements, would be compounded by the fact that the financial director of the company will be entitled to an annual bonus based on the reported figures. Clearly she would have a vested interest in a high reported profit. Given this situation it is important that Pebury and Company should be seen to be totally objective in their audit approach. Such an approach involves careful selection of staff for specific assignments such that all members of the audit team are totally impartial. Bollies ACCA’s Code of ethics gives clear guidance on the risk posed to objectivity as a consequence of undue dependence on an audit client stating that ‘objectivity may be threatened or appear to be threatened by undue dependence on any audit client or group of connected clients’. The Code points out that the public perception of a firm’s objectivity is likely to be in jeopardy where the fees for audit and other recurring work paid by one client or group of connected clients exceed 15% of the gross practice income. The figure stated of 15% is an indicative figure only, relating to non-public interest and non-listed companies. Currently fees receivable from the two connected companies owned by Thomas Arn, represent 8·7% ($72,000/$830,000) of Bollies’ gross practice income. This would not appear to represent a threat to the perceived objectivity of the firm with regard


to the existing audits. However, acceptance of the third audit appointment would mean that 16·7% ($152,000/$910,000) of the firm’s gross practice income originates from the three companies owned by Thomas Arn. This could call into question the firm’s objectivity with regard to all three audit assignments, and in the circumstances it may be prudent for Bollies to politely decline the further audit appointment. Commercial considerations may encourage the partners of Bollies to accept the third audit appointment, notwithstanding any doubts as to their perceived objectivity. However Thomas Arn is an entrepreneur with a very dominant personality. Given this trait, the partners should be alert to the possibility that situations might arise on any of the audit assignments wherein he could use the threat of the loss of all three audit assignments (and associated fees) to put undue pressure on the firm. For example, he may request the firm to take an unusually optimistic view as to the recoverability of unpaid debts. The partners should pay particular attention to the possibility of this potential threat before deciding whether to accept the further appointment. If the firm does proceed with the additional appointment I would strongly recommend that they should protect against the loss of independence on each of the audits by implementing additional safeguards to maintain objectivity. Such safeguards should be subject to an annual independent review by a partner unconnected with the audits and may include the employment of a different audit engagement partner and suitably qualified audit teams on each of the three audits. (Full marks will be awarded for coverage of any FIFTEEN relevant points pertaining to each scenario with a maximum of NINE marks being available for each scenario).




June 2004 Marking Scheme

The marking scheme generally indicates that 1 mark or 11/2 marks are awarded for each point. However, consideration should be given to the depth and relevance of points provided by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 point whilst a detailed discussion could be worth up to a maximum of 2 points. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answer is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%. M, A Large Manufacturing Company 1

(a)

Stating objectives of the internal controls exercised over a Purchases and Trade Payables system. Generally 1 mark per objective up to a maximum of

(b)

(4 marks)

Identification of the internal controls that should exist over: (i)

Requisition and authorisation of purchases.

(ii)

Acknowledgement of the receipt of goods and the return of goods to suppliers.

(iii) Checking and authorisation of purchase invoices prior to batching for processing through the computerised accounting system. Generally 11/2 marks per point, with a maximum of 9 marks (6 x 11/2) for each function (i), (ii) and (iii) up to a maximum of (c)

Explanation of how suppliers’ statements should be used to supplement other controls. Generally 1 mark per point up to a maximum of

(d)

(15 marks)

(3 marks)

Stating the meaning of the term ‘batch entry batch processing system’.

(1 mark)

Explanation on the use of control totals in such a system. Generally 1/2 mark per point up to a maximum of

(2 marks) Total (25 marks)

J J, A Limited Liability Company 2

(a)

(i)

Summarised explanation of what is meant by a ‘systems based’ approach to an audit. Generally up to 11/2 marks per point up to a maximum of

(ii)

Summarised explanation of what is meant by a ‘direct verification (vouching)’ approach to an audit and explanation of why the approach is often more appropriate for the audit of a small limited liability company. Generally up to 11/2 marks per point up to a maximum of

(b)

(8 marks)

Statement of TWO main objectives of vouching despatch notes, sales invoices and the sales day book. Generally 1 mark per point up to a maximum of 2 marks for each objective (2 x 2)

(c)

(10 marks)

(4 marks)

Statement of SIX sales invoice checking procedures. Generally 1/2 mark per point up to a maximum of



ZAIS, A Limited Liability Company 3

(a)

Statement of FOUR circumstances when a sampling approach would not be appropriate: Generally 11/2 marks per occasion up to a maximum of

(b)

(i)

(6 marks)

Explanation of the difference between the positive and negative confirmation methods. Generally 1 mark per point up to a maximum of

(2 marks)

Description of circumstances when a negative method should be used. Generally 1 mark per point up to a maximum of (ii)

(3 marks)

Explanation as to why employees should have no influence on the selection of the trade receivables balance to be confirmed. Generally 1 mark per point up to a maximum of

(c)

(2 marks)

Explanation of the significance of inclusion in the sample of: (i)

Accounts with balances in excess of $7,500

(ii)

Some accounts with zero balances.

Generally 1 mark per point with a maximum of 3 marks for (i) and (ii) up to a maximum of (2 x 3) (d)

(6 marks)

Description of SIX types of activity which would require special attention and representation in the sample: Generally 1 mark for each type of activity up to a maximum of (6 x 1)


PROFESSIONAL OBJECTIVITY 4

(a)

Comment on statement including definition of (professional) objectivity. Generally 1 mark per point up to a maximum of

(4 marks)

Other commentary: Generally 1 mark per point up to a maximum of (b)

(6 marks)

Commentary on objectivity/independence issues arising from the scenarios involving: – Poynt & Co – Pebury and Company – Bollies Generally 1 mark per point for commentary on the various issues, including specific concerns and recommendations with a maximum of 9 marks (9 x 1) for each scenario up to an overall maximum of




ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL MONDAY 13 DECEMBER 2004


Paper T8(INT)


Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall



Opiniol is a limited liability company which carries out public opinion surveys. The company employs an interviews manager to control 40 interviewers who conduct interviews with members of the public at random. The interviewers are paid monthly in arrears for hours worked, with hourly rates and productivity bonus payments being dependent on surveys undertaken. They submit their monthly time sheets to the company’s head office for processing and the company operates a separate monthly payroll specifically for interviewers’ wages. The company’s wages software program produces on request: 1.

A master file update report – detailing the update report number, the amendments made since the last report, and the number of existing employees on file.

2.

A current period payment details report – showing gross payment, deductions and net payment amounts – by employee and in total.

3.

Wage slips – the computerised production of which is requested only after other control procedures employed have ensured that information provided on the current period payment details report (above) is in agreement with a hash total representing gross wages input.

The interviews manager is based at the company’s head office, together with the accounting and administration departments. He is responsible for the recruitment of interviewers, deployment to assignments, overseeing of interview work and for the authorisation of pay rates and bonus payments. The company has a good control environment including appropriate segregation of duties throughout the specific areas of the business. Head office employees include a company accountant, a wages supervisor and three wages clerks. Required: (a) State FOUR objectives of the internal controls that should be exercised over a wages system.

(4 marks)

(b) State the internal control procedures that Opiniol should adopt over the updating of its wages master file with regard to interviewer starters and leavers. (9 marks) (c) State the internal control procedures that Opiniol should adopt over the completion and authorisation of, and the computer processing of interviewers’ time sheets, prior to the request being made for the production of the monthly computerised wage slips. (12 marks) (25 marks)


2

The directors of Wizzin have asked your firm to quote for the appointment as the company’s new auditors. The next financial statements due for audit will be those for the year ending 31 March 2005 and from discussions with the directors your firm’s audit engagement partner has ascertained the following information: 1.

Wizzin is a long established, limited liability company, trading as builders’ merchants. Owing to a large influx of competitors into the market place, the company has had declining profits in recent years, although the directors appear not to be unduly concerned about the company’s ongoing trading.

2.

The company operates from 14 sites around the country. All sites comprise a shop and a yard with the largest site also accommodating the company’s head office. In order to attract new customers all of the shops have recently undergone major repair and refurbishment programmes. The costs of these programmes were substantial and have been financed by bank borrowing.

3.

Each site sells a wide range of products including timber and consumable materials, decorating and general building products. Ranges of tools and equipment are also available both for sale and for short-term hire, whilst very large stockpiles of sand and gravel are kept in each yard to meet customer demand.

4.

A cash sales policy applies to most customers, but where credit terms are granted, customers may either collect goods directly or take advantage of the company’s delivery service.

5.

Wizzin owns a large volume of mobile plant and machinery to service its yard and delivery operations. These include mechanical shovels, dumper trucks, lorries and vans.

6.

Each site is open throughout the year, closing only for public holidays. Consequently 18 full-time shop and yard staff are employed at each site together with varying numbers of part-time and temporary employees.

Required: (a) Describe THREE matters the audit engagement partner of your firm should consider before deciding whether to quote for the appointment as auditors to Wizzin. (9 marks) (b) State with reasons FIVE factors that would affect the initial assessment of inherent risk associated with the audit of the financial statements of Wizzin. (16 marks) (25 marks)

3

(a) Required: Explain what is meant by the term ‘audit evidence’ and state what it comprises.

(3 marks)

(b) An auditor may obtain audit evidence by one or more of the following procedures: (1) (2) (3) (4)

Inspection Observation Recalculation Analytical Procedures

Required: (i)

Explain what each of these procedures involves.

(6 marks)

(ii) For each procedure provide TWO examples of its use during the course of an audit stating clearly in each example the purpose of carrying out the procedure. (16 marks) (25 marks)


[P.T.O.

4

Whilst there is a difference between the roles of internal auditors and external (registered) auditors, they often liaise on various matters and a Chartered Certified Accountant employed in either capacity has an obligation to adhere to the Fundamental Principles of the Code of ethics as set out in ACCA’s Rules of Professional Conduct. Required: (a) (i)

Contrast the objectives and scope of an internal auditor’s work for a limited liability company with that of an external (registered) auditor auditing its financial statements. (5 marks)

(ii) Discuss the extent to which each should be expected to detect fraud.

(4 marks)

(b) Explain FOUR matters that external auditors should consider when evaluating and testing work carried out by internal auditors with a view to relying on it to reduce their own work. (8 marks) (c) State FOUR of the fundamental principles of ACCA’s Code of ethics.

(8 marks) (25 marks)



Answers



ACCA Certified Accounting Technician Examination – Paper T8(INT) Implementing Audit Procedures (International Stream) 1

(a)

December 2004 Answers

The objectives of the internal controls that should be exercised over a wages system are to ensure that: (i)

wages are paid only to authorised employees of the company.

(ii)

wages are paid only in respect of work carried out or other authorised criteria.

(iii) wages are paid only at authorised rates of pay. (iv) wages deductions are properly accounted for. (v)

wages deductions are paid over in full to the appropriate third parties.

(vi) wages transactions are recorded completely and accurately in the accounting records. (Full marks will be awarded for identifying FOUR of the above or other appropriate objectives.) (b)

The following control procedures should be adopted: (i)

employees involved in the actual input and processing of wages data should have ‘read only’ access to the wages master file.

(ii)

there should be formal procedures requiring the interviews manager to provide detailed written notification to a responsible official (for example the wages supervisor) of starters and leavers.

(iii) the responsible official (above) should maintain an independent record of the cumulative number of authorised employees on file and after preparing appropriate input documentation should update this record to show the revised number of authorised employees that should exist on the master file. The written notification received from the interviews manager should be retained for reference as appropriate (see below). (iv) after updating the wages master file, the responsible official should request a master file update report, and check that: –

the report number is in line with expectations.

–

the amended details agree with the written notifications from the interviews manager.

–

the number of authorised employees on file agrees with the independent record maintained.

Any discrepancies should be investigated immediately. (v)

after completion of the foregoing procedures the master file update reports should be filed securely together with input documentation and written notifications from the interviews manager.

(vi) at random intervals a more senior responsible official of the company (for example the company accountant), should access the wages master file and check its contents to the manual records maintained, input documentation and notifications from the interviews manager as appropriate. (Full marks will be awarded for stating procedures similar to those above.) (c)

The following control procedures should be adopted: (i)

the interviews manager should issue standardised time sheets to all interviewers in advance of work to be undertaken. Time sheets should be easily identifiable to individual interviewers.

(ii)

interviewers should submit their time sheets to the interviews manager on a timely basis for monthly processing. Interviewers should be pursued for time sheets not submitted. Time sheets should be checked and evidenced as such for authenticity and hours worked, by the interviews manager.

(iii) pay rates applicable for hours worked and bonus payments due should be either noted on the time sheets by the interviews manager or noted on separate documentation as appropriate, for the attention of the wages clerk (below). (iv) all authorised time sheets and pay rates/bonus documents should be forwarded intact to a wages clerk for the calculation of gross wages by the interviewer (employee). (v)

having calculated gross wages, the wages clerk should prepare the data for input by batching and the calculation of a batch input total, using a hash total represented by the total gross wages due.

(vi) all data documentation prepared should then be passed to the wages supervisor for checking, and authorisation prior to passing to another wages clerk for computer input and processing following password access. (vii) on completion of processing, the input documentation should then be passed together with the computer produced ‘current period payment details’ report, to the wages supervisor for cross checking of report totals. Any discrepancies should be noted for re-input. (viii) on satisfactory processing of re-input data and cross checking to a further ‘current period payment details’ report as required, a request should be made for the computerised production of the interviewers’ wage slips. (Full marks will be awarded for stating procedures similar to those above.)


2

(a)

The audit engagement partner (audit partner) should consider the following general matters: (i)

the reason why the directors of Wizzin wish to appoint new auditors to the company. If it is because they have refused to respond positively to a reasonable request from the existing auditors, resulting in a breakdown of the working relationship with them, then the audit partner of your firm may not be interested in quoting for the appointment.

(ii)

any risk of breaching the independence of the firm. There may be a risk of a threat to the independence or perceived independence of the firm if it is considered that it would become unduly dependent on Wizzin as a consequence of the size of the fee charged to it. ACCA’s Rules of Professional Conduct provide detailed guidance notes on this issue. Similarly if any of the firm’s partners are connected to Wizzin in any way, then legislation founded in order to maintain auditor independence may prohibit the firm from acting as auditors to it.

(iii) the ability of the firm to carry out an efficient audit. This will be determined by the reporting deadline set by the company and the audit resources available to the firm. Given the nature, size and spread of locations of Wizzin’s activities, the audit partner would need to carefully consider whether the firm could properly service this particular audit assignment. The availability of staff with sufficient technical knowledge and expertise may be dependent on other audit assignments to which the firm is already committed. (iv) general commercial considerations. The audit partner would need confidence that the firm could build a successful audit/client working relationship with the company. He would also need to ensure that such a relationship was commercially viable from the firm’s perspective. Consequently he would need to consider the integrity and working practices of Wizzin’s directors together with the financial strength of the company. (Full marks will be awarded for describing THREE of the above or other relevant matters.) (b)

The following factors would affect the assessment of the inherent risks associated with the audit of the financial statements of Wizzin: (i)

The company is operating in a competitive market place, has suffered declining profits and has substantial bank borrowings. The directors appear not to be unduly concerned about the company’s trading position. However they may be predisposed to misstating the financial statements in order to present a more favourable trading and balance sheet position and to instil greater third party confidence in the company. The assessment of inherent risk would need to take into account these factors, together with the possibilities of potential going concern problems being encountered by the company.

(ii)

The geographical spread of the company’s activities over 14 sites would, in isolation, increase the possibility of material misstatement in the company’s financial statements. The nature of the company’s operation appears to be quite complex, with large volumes of purchases, sales and accounting transactions generally. There would therefore be concern as to the completeness and accuracy of recording of transactions in the company’s accounting records and the reflection of the same in the financial statements.

(iii) The company has incurred substantial costs on repair and refurbishment programmes at all 14 sites around the country. These costs would have a material effect on the company’s financial statements and initial concerns would centre around the completeness and accuracy of recording, including the correct categorisation of costs between revenue (repair) and capital (improvement) expenditure in the financial statements. (iv) The company has extensive retail operations selling a wide range of products. Sales are predominantly for cash, which is particularly susceptible to loss or misappropriation and this together with the ‘collect or delivery’ flexibility given to credit sale customers increases the likelihood of unrecorded sales. The nature and mix of sales at each site including the hiring of tools and equipment, would lead to audit concern as to the possibility of unrecorded sales and the incorrect categorisation of sales in the company’s accounting records. (v)

Inventories would represent a significant proportion of the company’s assets and there would be initial concern over this area of the company’s financial statements. Concerns would centre around the basis of the quantification and valuation of inventories for inclusion in the company’s balance sheet. As regards quantification, there may be particular concern as to the measurement of stockpiles of sand and gravel and concerns about valuation may be founded primarily on the values ascribed to inventory lines and individual items of inventory held at each site. Owing to the portability of inventory lines and open access to them, there would also be concern as to the likelihood of loss or misappropration of inventories.

(vi) The company’s tangible non-current assets include a large volume of high value mobile items. This would cause initial audit concern and would render this area of the company’s financial statements being allocated a high inherent risk factor. Any mobile or transportable assets owned by a company are susceptible to loss or misappropriation, but this characteristic is particularly applicable to the non-current assets stated as owned by the company, including the range of tools and equipment available for hire. As well as the issue of existence, the valuation of individual assets may cause concern given the possibility of damage and shortened assets’ lives brought about as a consequence of the relatively harsh operating environment of the company. (vii) The company employs 252 (14 x 18) full-time shop and yard staff supplemented with part-time and temporary employees, in addition to those employed at its head office. Given the likelihood of starters and leavers throughout the year and other payroll complexities including the possibility of overtime and bonus payments, the company will have a large volume of payroll transactions. This would lead to concerns over the completeness and accuracy of recording in this area and the potential of unauthorised payments of salaries and wages. (Full marks will be awarded for stating and commenting on FIVE of the above or other relevant factors that would affect the initial assessment of inherent risk.)


3

(a)

The term ‘audit evidence’ describes the information obtained by the auditors in arriving at the conclusions on which the audit opinion is based. Audit evidence comprises source documents and accounting records underlying the financial statements (subject to audit) and corroborating information from other sources.

(b)

(1) Inspection (i) Consists of examining records, documents or tangible assets. (ii)

Example – the physical inspection of a freehold office building to verify existence of the building. Example – the examination of a purchase invoice to vouch the validity of an entry in the trade payables ledger.

(2) Observation (i) Consists of looking at a process or procedure performed by others. (ii)

Example – the observation of the counting of inventories by an entity’s personnel to ensure that they are counted in accordance with procedures authorised by the management of the entity. Example – the observation of the opening of the mail of an entity to ensure that at least two employees are present to receive and witness the receipt of monies received by the entity.

(3) Recalculation (i) Consists of checking the mathematical accuracy of documents or records. (ii)

Example – checking the accuracy of extensions of balance sheet inventory calculations to verify the accuracy of the valuation of reported inventories. Example – checking the depreciation calculations as applied to non-current assets to ensure that depreciation rates are in accordance with the stated policy of the entity.

(4) Analytical Procedures (i) Consists of evaluations of financial information made by plausible relationships among both financial and nonfinancial data. (ii)

Example – the calculation of the average remuneration (total wages and salaries divided by total employees) paid to the employees of an entity, to assess the reasonableness of the reported wages and salaries costs as compared to a previous equivalent period. Example – the calculation of an entity’s trade receivables ratio to help assess the reasonableness of bad debt provisions, the effectiveness of credit control and the possibility of under/over statement of reported sales.

4

(a)

(i)

The objectives and scope of the work of an internal auditor may vary widely and depend on the size and structure of the company and requirements of its management. Ordinarily, internal auditing activities include one or more of the following: – – – –

Review of the accounting and internal control systems. Examination of financial and operating information. Review of the economy, efficiency and effectiveness of operations. Review of compliance with laws, regulations and other external requirements and with management policies and directives and other internal requirements.

The objective of the work of an external auditor, employed to audit the financial statements of a limited liability company, is to enable the auditors to express an opinion as to whether the financial statements are prepared in all material respects, in accordance with an identified reporting framework. The scope of the work required to meet these objectives is determined by the auditor having regard to any terms of the audit engagement and reporting requirements together with the requirements of International Standards on Auditing, relevant professional bodies, legislation and regulations. (Full marks may be awarded for answers including only some of the above or other relevant points.) (ii)

The extent to which an internal auditor should be expected to detect fraud will vary dependent on the tasks he is asked to carry out by management, the scale of any fraudulent activity and the resources with which he is provided to detect fraud. An external auditor should design audit procedures to obtain reasonable assurance that misstatement arising from fraud that is material to a company’s financial statements will be detected. The auditor must maintain an attitude of professional scepticism throughout the audit, notwithstanding the auditor’s past experience about the honesty and integrity of management and those charged with governance. However, it is often accepted that fraud may not be easy to detect, particularly when carried out by senior managers of a company, since it is ordinarily accompanied by acts specifically designed to conceal its existence. Consequently the extent to which an external auditor should be expected to detect fraudulent activity is dependent on the scale, the degree of concealment and the level of the resultant misstatement in the financial statements. (Full marks may be awarded for answers including only some of the above or other relevant points.)

(b)

External auditors should consider whether: (i)

the work has been performed by persons having adequate technical training and proficiency as internal auditors and the work of assistants has been properly supervised, reviewed and documented.


(ii)

sufficient appropriate audit evidence has been obtained to afford a reasonable basis for the conclusion reached.

(iii) conclusions reached are appropriate in the circumstances and any reports prepared are consistent with the results of the work performed. (iv) any exceptions or unusual matters disclosed as a consequence of the work have been properly resolved. (c)

The fundamental principles of the ACCA’s Code of ethics are: (i)

members should behave with integrity in all professional, business and personal financial relationships. Integrity implies not merely honesty but fair dealing and truthfulness.

(ii)

members should strive for objectivity in all professional and business judgements. Objectivity is the state of mind which has regard to all considerations relevant to the task in hand but no other. It presupposes intellectual honesty.

(iii) members should not accept or perform work which they are not competent to undertake unless they obtain such advice and assistance as will enable them competently to carry out the work. (iv) members should carry out their professional work with due skill, care, diligence and expedition and with proper regard for the technical and professional standards expected of them as members. (v)

members should behave with courtesy and consideration towards all with whom they come into contact during the course of performing their work.

(Full marks will be awarded for stating any FOUR of the above principles.)



December 2004 Marking Scheme

The marking scheme generally indicates that 1 mark or 11/2 marks are awarded for each point. However, consideration should be given to the depth and relevance of points provided by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 point whilst a detailed discussion could be worth up to a maximum of 2 points. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answer is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%. 1

Opiniol (a)

Stating objectives of the internal controls exercised over a wages system. Generally 1 mark per objective up to a maximum of

(b)

(4 marks)

Stating the internal control procedures that the company should adopt over the updating of its wages master file with regards to starters and leavers. Generally up to 11/2 marks for each stated procedure up to a maximum of (6 x 11/2)

(c)

(9 marks)

Stating the internal control procedures that the company should adopt over the completion, authorisation and computer processing of interviewers’ time sheets. Generally up to 11/2 marks for each stated procedure up to a maximum of (8 x 11/2)

(12 marks) (Total 25 marks)

2

Wizzin (a)

Describing general matters the audit engagement partner should consider in deciding whether to quote for the audit appointment. Generally up to 1 mark per point up to a maximum of 3 marks for each matter with an overall maximum of (3 x 3)

(b)

(9 marks)

Stating with reasons factors that would affect the initial assessment of inherent risks associated with the audit of the financial statements. Generally up to 1 mark for each point with a maximum of 4 marks for each factor with an overall maximum of



3

Audit Evidence (a)

Explanation of the term ‘audit evidence’ Statement of what it comprises

(b)

(i)

(11/2 marks) (11/2 marks)

Explaining what the following procedures involve: (11/2 (11/2 (11/2 (11/2

Inspection Observation Recalculation Analytical Procedures (ii)

marks) marks) marks) marks)

Providing TWO examples of the use of each of the procedures. Generally up to 1 mark for each example up to a maximum of (4 x 2)

(8 marks)

Explanation of the purpose of the procedure stated in each example. Generally up to 1 mark for each explanation up to a maximum of (4 x 2)


4

Internal Auditors and External (Registered) Auditors (a)

(i)

Contrasting the objectives and scope of the work of internal auditors and external (registered) auditors. Generally 1 mark per point up to a maximum of

(ii)

(5 marks)

Commenting on the extent to which each should be expected to detect fraud. Generally 1 mark per point up to a maximum of

(b)

(4 marks)

Explanation of the matters that the external auditor should consider when evaluating and testing work carried out by internal auditors. Generally up to 1 mark per point pertaining to each matter up to a maximum of (4 x 2)

(c)

(8 marks)

Stating the fundamental principles of ACCA’s Code of ethics. Generally up to 2 marks for each principle stated up to a maximum of (4 x 2)




ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL MONDAY 13 JUNE 2005


Paper T8(INT)





Recruitment Co is a limited liability company which operates as a prestigious, executive recruitment agency. Its most recent financial statements are those for the year ended 31 March 2005. The directors of the company have developed a strong control environment in the company and have introduced effective internal controls. These include the review of monthly management accounts at formal monthly board meetings and the use of a non-current assets register. The company has 36 employees, most of whom are provided with an executive type of company car. It is company policy to purchase only new cars and to replace them when they are two years old. Employees are allowed to purchase replaced cars, and they do so by forwarding sealed bids to the company as and when replaced cars become available. To protect the company from receiving only low bids from employees, sealed bids are also received from independent motor car dealers. During the year ended 31 March 2005 the company purchased large quantities of office furniture, as part of an ongoing expansion programme. This included $30,000 of furniture which was ordered on 18 February 2005 but in respect of which the company had not been invoiced by 31 March 2005. The company’s accounting records show that the furniture was delivered on 31 March 2005 and that the associated supplier invoice was received on 31 May 2005, some two weeks after the company’s financial statements were presented for audit. Required: (a) State FOUR objectives of the internal controls that should be exercised over non-current assets. (4 marks) (b) Explain how Recruitment Co’s non-current assets register, if properly maintained, may be used by the company to facilitate control over non-current assets. (4 marks) (c) (i)

Explain why it is particularly important that there should be strong internal controls over the disposal of cars by Recruitment Co; (3 marks)

(ii) Suggest FIVE internal controls that Recruitment Co should employ over the disposal of cars. (10 marks) (d) With regard to the delivery of office furniture to Recruitment Co on 31 March 2005: (i)

State how Recruitment Co should have reflected the transaction in its accounting records;

(2 marks)

(ii) Briefly describe TWO procedures the company’s auditors should carry out to verify that the delivery occurred on that date. (2 marks) (25 marks)


2

Sweet Scents Co is a wholesale supplier of cosmetic, beauty and perfumery products. The company’s inventories are stored in a central warehouse and a computerised system, updated from goods received notes and goods despatched notes, identifies quantities of inventories held by product number and description. Inventories are counted only at the company’s year end date. In discussions with the auditors about their forthcoming audit of the company’s financial statements for the year ending 30 June 2005, Sweet Scents Co’s financial director made the following statements: (1) ‘Our employees will carry out a thorough count and valuation of all inventories as at 30 June 2005. However, because employees of your firm will be in attendance at the count and will check inventory values, your firm will be responsible for the accuracy of the reported inventories figure.’ (2) ‘Most of the company’s inventories are stored in sealed cardboard boxes, as delivered to the company, which are labelled with product descriptions, quantities and use by dates. This will make inventories easy to identify and easy to count.’ (3) ‘On 31 May 2005 a flood at the warehouse caused varying degrees of damage to some of the inventories. The damaged inventories were not covered by insurance but as we will be valuing them at cost they will not be separately identified at the inventory count on 30 June 2005.’ (4) ‘Approximately five per cent of the value of our inventories is represented by Fleurs Bleu perfumery products. These were purchased in July 2004 in anticipation of a high demand, but due to a public health scare we haven’t sold any. We are resigned to the fact that these products are worthless but we’ll wait until the next financial year before we throw them out and write them off.’ Required: (a) Comment on the validity of statement (1) of the financial director as to the audit firm’s responsibility for the accuracy of the inventories figure at 30 June 2005. (5 marks) (b) With reference to each of the statements (2), (3) and (4) made by the financial director to the auditors of Sweet Scents Co: (i)

Identify and explain the concerns the auditors should have with regard to the accuracy of the inventories figure to be reported in the company’s financial statements for the year ending 30 June 2005; and

(ii) State the action the company should take both at the inventory count and in the valuation process to overcome these concerns. (Note: parts (i) and (ii) above carry equal marks.)

(15 marks)

(c) Describe the procedures the auditors of Sweet Scents Co should carry out on goods despatched notes and sales invoices to test sales cut-off at the year end date. (5 marks) (25 marks)


[P.T.O.

3

Jip Co, a limited liability manufacturing company is an established audit client of your firm. In March 2005 an audit team from your firm visited Jip Co to review the company’s internal control system in preparation for the final audit of the company’s financial statements for the year ending 31 July 2005. As part of the final audit team you, together with other team members, have been instructed to attend a briefing meeting as part of the planning of the final audit of Jip Co’s year end financial statements. Required: (a) Detail the work that the audit team should have carried out in March 2005, in preparation for the final audit of Jip Co’s financial statements for the year ending 31 July 2005. (8 marks) (b) State FIVE matters that should be discussed at the audit briefing meeting as part of the planning process of the final audit of Jip Co’s financial statements for the year ending 31 July 2005. (5 marks) (c) For each of the sources of audit evidence identified below, provide FOUR practical examples of how members of your audit team may use such evidence to support their audit conclusions in respect of the final audit of Jip Co’s financial statements for the year ending 31 July 2005. (i)

Events after the balance sheet date;

(ii) Satisfactory internal control procedures; (iii) Written confirmation from third parties.


4

Your firm has selected you to attend a discussion workshop as part of your audit training programme. Attendees at the workshop will discuss the auditor’s responsibilities in the audit of financial statements regarding the appropriateness of the going concern assumption as a basis for the preparation of the financial statements. Required: (a) Explain the underlying assumption applying to an entity when its financial statements are prepared on a going concern basis. (4 marks) (b) State EIGHT financial indicators and FOUR operating or other indicators of risk that the continuance of an entity as a going concern may be questionable. (12 marks) (c) State SIX audit procedures to obtain evidence that the going concern assumption is appropriate for an entity. (9 marks) (25 marks)



Answers




1

(a)

June 2005 Answers

The objectives of the internal controls that should be exercised over a non-current assets system are to ensure that non-current assets: (i) are acquired only when necessary. (ii) are acquired on the most economic terms. (iii) are acquired only when authorised. (iv) are properly recorded in the accounting records. (v) are protected from loss and damage. (vi) are disposed of only when necessary. (vii) are disposed of only when authorised. (viii) are disposed of at the best possible price. (Full marks will be awarded for stating any FOUR of the above or other appropriate objectives.)

(b)

Recruitment Co’s non-current asset register should provide an up to date inventory of all non-current assets owned by the company. The format of the register should allow for the groups of assets (e.g. motor vehicles, office furniture, office equipment) as reflected in the company’s general ledger, to be identified by individual asset such that at any point in time reference may be made to individual assets as appropriate. Specific information relating to each individual asset as recorded in the register will normally include asset description, location, date of acquisition, cost, expected useful life, depreciation rate, depreciation charged and written down value. Such information above should facilitate the directors of the company in maintaining control over the use, safe custody and replacement of assets, some of which will be transportable, valuable and desirous and by their nature possibly subject to misuse or misappropriation. However, in order to maintain effective control, it is important that existence and condition checks are regularly carried out on the non-current assets of the company. Checks should be made in both directions from the register to assets and from assets to the register, by a responsible individual of the company, who is independent from the acquisition custodian, disposal and recording functions. Similarly, it is important that any discrepancies and damage noted when checking are brought to management’s attention and promptly resolved. (Full marks may be awarded to answers which do not contain all of the above points.)

(c)

(i)

Given that most of Recruitment Co’s employees are provided with a company car and that each car is replaced biannually, there is a relatively high frequency of car disposals by the company. This, combined with the value of each ‘executive type’ vehicle increases the risk of loss to the company in this area. Owing to the nature of each new car purchased, it is probable that there is a significant loss in value over each two year period of ownership as compared to the purchase price. However, because vehicles for disposal are likely to be highly desirable to prospective purchasers (both third party and employee) the disposal process should be carefully managed to ensure that losses are minimised. (Full marks may be awarded to answers which include only some of the points referred to above.)

(ii)

Recruitment Co should exercise the following internal controls over the disposal of cars: –

there should be formal written instructions as authorised by the board of directors, governing the company’s policy and procedures to be followed on the disposal of cars.

–

a responsible official should authorise the disposal of cars in accordance with company policy. The individual should be independent of the purchasing function and of recording in the company’s accounting records.

–

when cars are two years old, sealed bids to purchase should be obtained from at least three reputable independent car dealers in addition to bids from interested employees.

–

sealed bids should be forwarded to the responsible official for scrutiny, subsequent contact with the successful bidder and authority to dispose of the relevant car. Disposal should be to the highest bidder and all bid documents should be retained for future reference as appropriate.

–

by the authority of the responsible official, Recruitment should raise fully detailed invoices for the sale of the cars. Invoices should be checked for completeness and accuracy before issue. Given the possible loss to the company as a consequence of non-payment, cars should be released to buyers only when the company has received cleared funds in respect of sales. Procedures should encompass appropriate and clear lines of communication in this regard.

–

details of disposals of cars should be promptly and accurately recorded in the company’s accounting records, including the non-current assets register. These tasks should be carried out by personnel who are independent of the purchase and disposal functions, and should be subject to verification by an appropriate company official, for example, the company’s financial director.


–

the board of directors of the company should monitor the profits/losses arising on the disposal of cars as reported in the monthly management accounts to assess the appropriateness of the company’s depreciation policy and to oversee the effectiveness of the company’s disposal procedures, for example, by seeking detailed explanations as to the reasons for any particularly large losses on disposal. (Full marks will be awarded for suggesting any FIVE of the above indicative controls or other appropriate controls.)

(d)

(i)

Recruitment Co should have reflected the transaction in its accounting records as an addition (at cost) of $30,000 to non-current assets (office furniture) and made an appropriate accrual of $30,000 in respect of the supplier’s invoice not received at the balance sheet date.

(ii)

To verify the date of delivery the auditors should: –

confirm the date of receipt recorded on the supplier’s delivery note.

–

confirm the date of receipt recorded on goods received documentation issued by Recruitment Co.

–

confirm the date of delivery as stated on the supplier’s invoice, subsequently received.

–

make verbal enquiries to appropriate employees of Recruitment.

(Full marks will be awarded for describing any TWO of the above or other appropriate procedures.)

2

(a)

The director’s statement is invalid. It is the responsibility of the directors of Sweet Scents Co to prepare the annual financial statements for audit and to ensure that the financial statements show a true and fair view (or are presented fairly, in all material respects). Consequently, it is their responsibility to ensure that the amount at which inventories are reported in the financial statements represents inventories, which are physically in existence and are valued in accordance with generally accepted accounting principles and accounting standards. Arranging for Sweet Scents Co’s employees to count and value the company’s inventories is only part of the directors’ obligation in meeting their responsibility with regard to the financial statements. Whilst the auditors of Sweet Scents Co may attend the physical count and carry out tests to determine the accuracy of the count and subsequent valuation, the responsibility of the company’s directors in this regard is not reduced.

(b)

Storage of Inventories (i) The auditors should be concerned as to whether the company’s procedures with regard to the counting and valuation of inventories will be sufficiently thorough to ensure that the value of inventories is not materially mis-stated in the company’s financial statements. The fact that inventories are stored in sealed cardboard boxes presents risks to the process of ensuring that inventories are accurately quantified and valued. Much of the company’s inventory (cosmetic, beauty and perfumery products) will be of a perishable nature, as well as being valuable, easily transportable and desirous. Consequently there is a high inherent risk of inventory loss due to perishing goods and misappropriation throughout the year. (ii)

It is particularly important that there are sufficiently robust procedures at the company’s inventory count to identify inventories which are near (or past) their sell by date, as special attention will need to be applied to these inventories in valuing them at the lower of cost and net realisable value. Similarly, counters who should be independent of the inventory and warehouse functions should be alerted to the possibility that the contents of the sealed boxes may not be as labelled and therefore contents should be checked at random. Any boxes which arouse suspicion as to their actual contents (for example, boxes on which original seals appear to have been broken) should be opened and the contents checked thoroughly.

Flood Damaged Inventories (i) The auditors should be concerned that a large proportion of the company’s inventory as at 30 June 2005 has been flood damaged, and at present the directors of the company would appear to be unaware or be ignoring the impact that the damage will have on the value of inventory to be reported in the company’s financial statements. Inventory should be valued at the lower of cost and net realisable value in the company’s financial statements and the water damage caused to some product lines is likely to be such that their net realisable value is significantly lower than cost. There is therefore a risk that the company inventory valuation could be materially overstated in the financial statements if the issue regarding flood damaged inventories is not fully addressed by the directors. (ii)

The inventory count instructions should make full provision for the identification and separation of flood damaged inventory items. This should allow for the unpacking of all flood damaged boxes so that the extent of damage to individual items can be accurately assessed in order to subsequently attribute appropriate values to them for reporting in the company’s financial statements. The values to be placed on these items will vary depending on the extent of damage but will possibly be reflected as follows: – perished inventory – at no value; – partially damaged inventory – at net realisable value; – undamaged inventory – at cost.


Worthless Inventories (i) The auditors should be concerned that the directors’ intentions to value worthless inventories at cost do not follow the standard accounting treatment that should be adopted in the preparation of the company’s financial statements. Standard accounting treatment dictates that inventories should be valued at the lower of cost and net realisable value – consequently worthless inventories should be reported as having a nil value in the financial statements for the year ending 30 June 2005. Given that approximately five per cent of the company’s inventory value would be represented by the Fleurs Bleu perfumery products if included at cost, such a valuation would appear to represent a material overstatement of reported inventory values (and profit) in the company’s financial statements. (ii)

To overcome the auditors’ concerns, the company should ensure that all inventory items represented by Fleurs Bleu perfumery products are separated and clearly identified at the forthcoming inventory count, before the recording on inventory count sheets. Given the relative material value of these items it is particularly important that this aspect of the inventory count is well supervised. Having identified the Fleurs Bleu inventory items, the company’s management should ascertain whether in fact they have any sale value at all. If they have, and this value is lower than cost then they should be valued at net realisable value. If the inventory items are worthless then they should be given a nil value in the valuation process.

(c)

3

(a)

To check sales cut off: (i) When attending the warehouse for the inventory count on 30 June 2005 the auditors should select a sample of goods despatched notes for despatches made on that day. They should then select further goods despatched notes for despatches both soon before and soon after the year end date. (ii)

The sample of goods despatched notes should be traced to the associated sales invoices to ensure that sales invoices have been posted as sales in the correct accounting period. The auditors would be concerned to ensure that sales were not overstated due to the fact that goods despatched after the year end had been included as sales for the prior period, and conversely that goods despatched up to and including those on 30 June 2005 were not omitted from reported sales.

(ii)

The auditors should also carry out similar tests on sales invoices raised on and around the year end date by checking from sales invoice entries back to goods despatched notes.

At the audit visit in March 2005, audit staff should have: (i) ascertained the company’s systems of internal control recording any changes, as compared to the previous year, in the company’s permanent audit file. (ii)

evaluated the adequacy of the systems to meet control objectives.

(iii) carried out tests of control to determine whether controls identified in the systems evaluation process had been operated effectively throughout the accounting year to the date of the audit visit. (iv) designed and carried out tests in areas where controls were weak, to determine the extent to which records in these areas could be relied upon. (v)

(b)

formed a judgement as to the extent that the company’s systems of internal control, to the date of the audit visit, could be relied upon as a basis for reducing the level of detailed testing at the final audit stage.

The following matters should be discussed at the audit briefing meeting: (i) findings from the audit visit in March, for example new systems, areas of weakness. (ii)

areas of the audit which appear to have a high audit risk, for example, inventory.

(iii) the audit approach to be adopted. (iv) the audit programme to be used, for example, the firm’s standard programme, or a modified or specific programme. (v)

the assignment of audit staff to specific audit areas.

(vi) the timing of the audit work, including the deadline date for the provision of audited financial statements. (vii) Any special circumstances applying to working methods when carrying out the audit work at Jip Co’s premises. (Full marks will be awarded for identifying any FIVE of the above or other matters.) (c)

(i)

Events after the balance sheet date –

cash received after the year end – to verify the value of a debt.

–

invoices received after the year end – to verify the value of an accrual.

–

payment of an insurance premium after the year end – to verify the existence of a non-current asset.

–

sale of inventory after the year end – to verify the value of inventory.


(ii)

Satisfactory internal control procedures –

regular reconciliation of the trade payables ledger – to verify the value of trade payables.

–

issue of sequentially controlled goods despatched notes – to verify the completeness of sales.

–

authorisation of purchase invoices – to verify the value of purchases.

–

strong system of perpetual inventory controls – to verify the value of inventories.

(iii) Written confirmation from third parties –

direct confirmation of a trade receivables balance – to verify the existence of a trade receivables balance.

–

a bank certificate confirming the terms of charges held against the company’s assets – to verify the existence of charges held against company assets.

–

letter from a loan company, confirming the balance outstanding on a loan – to verify the loan liability of the company.

–

a certificate from a specialist, confirming the value of specific inventories held – to verify the valuation of inventories.

(Full marks will be awarded for providing examples as above or any other appropriate examples.)

4

(a)

Under the going concern assumption, an entity is ordinarily viewed as continuing in business for the ‘foreseeable future’ with neither the intention nor the necessity of liquidation, cessation of trading or seeking protection from creditors pursuant to laws or regulations. Accordingly, assets and liabilities are recorded on the basis that the entity will be able to realise its assets and discharge its liabilities in the normal course of business. The term ‘foreseeable future’ refers to a period which should be at least, but is not limited to, twelve months from the balance sheet date. (Full marks will be awarded for answers containing points similar to the above.)

(b)

Financial indicators of risk that the continuance of an entity as a going concern may be questionable include: – where there is a net liability or net current liability position. –

where there are fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment; or excessive reliance on short-term borrowings to finance long-term assets.

–

indications of withdrawal of financial support by debtors and other creditors.

–

negative operating cash flows indicated by historical or prospective financial statements.

–

adverse key financial ratios.

–

substantial operating losses or significant deterioration in the value of assets used to generate cash flows.

–

arrears or discontinuance of dividends.

–

inability to pay creditors on due dates.

–

inability to comply with the terms of loan agreements.

–

change from credit to cash-on-delivery transaction with suppliers.

–

inability to obtain financing for essential new product development or other essential investments.

Operating or other indicators of risk that the continuance of an entity as a going concern may be questionable include: –

loss of key management without replacement.

–

loss of a major market, franchise, licence, or principal supplier.

–

labour difficulties or shortages of important supplies.

–

non-compliance with capital or other statutory requirements.

–

pending legal or regulatory proceedings against the entity that may, if successful, result in claims that are unlikely to be satisfied.

–

changes in legislation or government policy expected to adversely affect the entity.

(Full marks will be awarded for stating EIGHT financial and FOUR operating or other indicators of risk.)


(c)

Procedures that auditors may carry out to obtain evidence as to the appropriateness of the going concern assumption for an entity include: –

analysing and discussing cash flow, profit and other relevant forecasts with management.

–

analysing and discussing the entity’s latest available interim financial statements.

–

reviewing the terms of debentures and loan agreements and determining whether any have been breached.

–

reading minutes of the meetings of shareholders, the board of directors and important committees for reference to financing difficulties.

–

inquiring of the entity’s lawyer regarding the existence of litigation and claims and the reasonableness of management’s assessments of their outcome and the estimate of their financial implications.

–

confirming the existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assessing the financial ability of such parties to provide additional funds.

–

considering the entity’s plans to deal with unfulfilled customer orders.

–

reviewing events after the period end to identify those that either mitigate against or otherwise affect the entity’s ability to continue as a going concern.

(Full marks will be awarded for stating SIX audit procedures that auditors may carry out.)





The marking scheme generally indicates that 1 mark or 11/2 marks are awarded for each point. However, consideration should be given to the depth and relevance of points provided by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 point whilst a detailed discussion could be worth up to a maximum of 2 points. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answer is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%.

Recruitment Co 1

(a)

Stating objectives of the internal controls exercised over non-current assets. Generally 1 mark per objective up to a maximum of

(b)

(4 marks)

Explanation of how the company’s non-current assets register may be used as a means of facilitating control. Generally 1 mark per point up to a maximum of

(c)

(i)

(4 marks)

Explanation of why there should be strong internal controls over the disposal of cars by Recruitment Co. Generally 1 mark per point up to a maximum of

(ii)

(3 marks)

Suggesting internal controls that Recruitment Co should employ over the disposal of cars. Generally 1 mark per point up to a maximum of 2 marks for each control with an overall maximum of (2 x 5) (10 marks)

(d)

(i)

Stating correct accounting treatment of purchase of office furniture. Generally up to 1 mark for each accounting entry up to a maximum of

(ii)

(2 marks)

Description of audit procedures to verify delivery date of office furniture. Generally up to 1 mark for each procedure up to a maximum of


Sweet Scents Co 2

(a)

Commentary on validity of financial director’s statement. Conclusion that the statement is invalid

(1 mark)

Reasoning of conclusion. Generally 1 mark per point up to a maximum of (b)

(4 marks)

(i)

Identification of audit concerns with regard to the accuracy of the inventories figure to be reported in the company’s financial statements.

(ii)

Stating action the company should take to overcome concerns. Generally up to 1 mark for each point, with a maximum of 3 marks for (i) and 3 marks for (ii) applied to each statement with an overall maximum for the whole section of (15 marks)

(c)

Description of audit procedures to be carried out on goods despatched notes and sales invoices to test sales cut-off at the year end date. Generally 1 mark per point up to a maximum of



Jip Co 3

(a)

Detailing work that the audit team should have carried out in March 2005. Generally 1 mark per point up to a maximum of 2 marks for each procedure detailed up to a maximum of

(b)

(8 marks)

Stating matters that should be discussed at final audit planning, briefing meeting. Generally 1 mark per point up to a maximum of

(c)

(5 marks)

Providing examples of how audit team members may rely on each source of audit evidence. Generally up to 1 mark for each example provided with a maximum of 4 marks for each type of evidence up to a maximum of (4 x 3) (12 marks) Total (25 marks)

Going Concern Workshop 4

(a)

Explanation of the underlying assumption applying to an entity when its financial statements are prepared on a going concern basis. For mention of and clarification of the term ‘foreseeable future’ up to

(1 mark)

Other points – generally 1 mark per point up to a maximum of (b)

(c)

(3 marks)

Stating indications of risks that the continuance of an entity as a going concern may be questionable. Financial indicators – generally up to 1 mark per point up to maximum of

(8 marks)

Operating or other indicators – generally up to 1 mark per point up to a maximum of

(4 marks)

Stating procedures that auditors may carry out to obtain evidence that the going concern assumption is appropriate for an entity. Generally 1 mark per point up to a maximum of 2 marks for each procedure – with an overall maximum of

(9 marks)

Total (25 marks)


(International Stream) ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL MONDAY 12 DECEMBER 2005


Paper T8(INT)





(a) State the FIVE components of internal control set out in ISA 315 Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement. (5 marks) (b) State FOUR objectives of the internal control which should be exercised over a sales and trade receivables system. (4 marks) (c) Haydn Co is a limited liability company and wholesale supplier of stationery products. It commenced trading in 2001 and now has 60 employees with separate sales and accounts departments. However at a recent board meeting, concern was expressed at some aspects of the company’s internal control, including those relating to sales and trade receivables. Jon May, the sales director is an excellent salesman and has been largely responsible for the company’s growth since 2001 and for the implementation of the control activities exercised over the company’s sales and trade receivables system. The following policies and procedures form part of the control activities exercised over that system. 1.

Haydn Co uses a networked integrated sales and general ledger accounts system. The company’s accountant and assistant accountant, together with Jon May and the trade receivables department clerks (sales clerks) have full access to all sales ledger files including the master file.

2.

Requests from potential customers to open a credit account are forwarded to Jon May, who carries out full credit checks before deciding whether to grant a credit facility. When credit facilities are granted a sales clerk updates the sales ledger master file with the new customer details. Credit limits are not applied to customer accounts as Jon May considers this to be a restricting factor in achieving sales targets. Slow or late paying customers are pursued for payment by Jon May.

3.

Customer orders received, in writing or by telephone, are directed to a sales clerk. After establishing that a trade receivables ledger account exists, the clerk uses a sales invoicing programme to generate a prenumbered sales invoice and accompanying goods despatch note addressed to customers for products as ordered. The programme prices sales invoices automatically using authorised prices stored in a standing data file. Full access to this file is restricted to Jon May and the sales clerks.

4.

Sales clerks post invoices as prepared to Haydn Co’s trade receivables ledger, and the automated accounting system immediately updates the company’s general ledger with the trade receivables ledger postings. On a daily basis: –

all invoices are mailed by the sales clerks to customers and the goods despatch notes are forwarded to the stores department to accompany goods as and when despatched.

–

a copy of each invoice is forwarded to the assistant accountant who is responsible for dealing with customers’ invoice queries, the issue of sales credit notes, as he deems appropriate, and the posting of credit notes to the trade receivables ledger.

Required: From the information provided on the sales and trade receivables system of Haydn Co: (i)

Identify FOUR weaknesses in the system;

(ii) Describe the implication of each weakness identified; (iii) Recommend improvements to address the weakness. You should assume that there is an adequate number of employees to implement any recommendations you make. (16 marks) (25 marks)


2

You have been assigned to your firm’s audit of the financial statements of Brahms Co for the year ending 31 December 2005. At the planning meeting, attended by all members of the audit team, the audit manager confirmed that the firm would adopt a risk-based approach to the audit, and for the benefit of the junior members of the team he explained the use of the audit risk model comprising inherent risk, control risk and detection risk. The manager also explained the importance of preparing good audit working papers and confirmed that he expected the header of every working paper to be properly completed. Required: (a) Explain what is meant by the term ‘a risk-based approach’ to an audit. Your answer should include commentary on the audit risk model. (14 marks) (b) Briefly explain the purpose of audit working papers and comment on the matters to be considered generally, in assessing the extent of working papers to be prepared. (7 marks) (c) List the information that should be included on the header of every working paper prepared in connection with the audit of the financial statements of Brahms Co for the year ending 31 December 2005. (4 marks) (25 marks)

3

(a) ISA 500 (Revised) Audit Evidence states that the reliability of audit evidence is influenced by its source and by its nature and is dependent on the individual circumstances under which it is obtained. The standard then states five generalisations about the reliability of audit evidence which may be useful. Required: State the FIVE generalisations about the reliability of audit evidence.

(10 marks)

(b) ISA 500 (Revised) explains that the auditor should use management assertions to form a basis for the assessment of risks of material misstatement and the design and performance of further audit procedures. Assertions about different classes of transactions and events for a period under audit are categorised as follows: 1. 2. 3. 4. 5.

Occurrence. Completeness. Accuracy. Cut-off. Classification.

Required: For FOUR of the above categories, state the implicit or explicit management assertions made about classes of transactions and events for the period under audit. (6 marks) (c) Describe SIX typical substantive procedures the auditor of the financial statements of a manufacturing company may carry out to verify the completeness of different classes of transactions and account balances. You are required to describe only SIX procedures in total and should set out your answer in the following format: Area of Financial Statements

Procedure to verify completeness (9 marks) (25 marks)


[P.T.O.

4

A university recently held a recruitment fair on its campus and invited local firms of auditors to attend, to interview students for audit junior positions. As an existing audit junior at your firm, you attended the recruitment fair to promote your firm and to talk informally to students. In conversation with you, students made several enquiries on audit matters. Required: In response to enquiries from students: (a) State, with reasons, FOUR personal qualities which a qualified external auditor should possess.

(6 marks)

(b) Explain what is meant by the term ‘materiality’.

(3 marks)

(c) (i)

Identify FOUR different situations during the course of an audit, where an auditor may need to obtain audit evidence in the form of reports, opinions, valuations or statements from an expert; and

(ii) For each situation identified (above), provide a practical example. (d) (i)

(6 marks)

Identify FOUR matters reflected in the financial statements of a limited company where management typically make accounting estimates; (6 marks) and

(ii) Outline the approaches that an auditor should adopt in the audit of an accounting estimate. (4 marks) (25 marks)



Answers




1

(a)


The FIVE components of internal control of an entity are: (i)

The control environment.

(ii)

The entity’s risk assessment process.

(iii) The information system, including the related business processes relevant to financial reporting and communication. (iv) Control activities. (v) (b)

(c)

Monitoring of controls.

The objectives of the internal control which should be exercised over a sales and trade receivables system are to ensure that: –

bad debts are minimised.

–

only bona fide orders received from customers are executed.

–

bona fide orders received from customers are executed promptly

–

all goods dispatched or services provided are properly invoiced

–

all goods dispatched or services provided are promptly invoiced

–

all debts due are collected in accordance with credit terms

–

credits are made to customer accounts only when properly due

–

sales invoice and sales credit documentation are promptly and correctly recorded in the books of account

–

the books of account accurately reflect sales and trade receivables information

(i)

Weakness The sales director and the sales clerks have full (amend) access to all trade receivables ledger files. Implication As sales department staff are responsible for the authorisation and administration of sales transactions and for recording transaction details in the company’s accounting records, there is a high risk of fraud and error arising on the sales and trade receivables area. Recommendations The responsibilities for the authorisation, administering and recording of sales transactions in the company’s accounting records should be allocated to separate individuals. Recording of sales transactions in the company’s accounting records should be carried out only by appropriately experienced accounts department staff. Sales staff should have ‘read’ access only to trade receivables ledger files.

(ii)

Weakness The sales director is responsible for granting credit facilities to new customers. Implication The sales director has a vested interest in granting new credit facilities in order to achieve sales targets. He is also in a position to enter into fraudulent arrangements with customers. As a consequence Haydn Co is exposed to the increased possibility of losses arising from bad debts and fraudulent transactions. Recommendations The responsibility to grant new credit facilities to customers should be vested in a responsible official of the company, segregated from the sales department and recording of transactions in the accounting records.

(iii) Weakness Credit limits are not applied to customer accounts. Implication There is a strong possibility that Haydn Co will incur bad debts if appropriate credit limits are not applied to customer accounts and strictly adhered to. Recommendations A maximum credit limit should be applied to each customer account, based on a customer’s financial strength and ability to pay. Customer accounts should be closely monitored by an independent credit controller to ensure that credit limits are not exceeded.


(iv) Weakness The sales director is responsible for pursuing late paying customers. Implication Haydn Co’s exposure to cash flow difficulties and bad debts could be increased. This is because the director may have a pre-disposition not to place undue pressure on late paying customers for fear of their withdawing custom with regard to future stationery purchases. Additionally the director may be exposed to beneficial offers from customers, made to him in his personal capacity, to allow advantageous payment terms on specific customer accounts. Recommendations The responsibility for credit control should be vested in a responsible official of the company, who is totally segregated from the authorisation, processing and recording of sales transactions. (v)

Weakness Telephone orders are accepted for the despatch of the company’s products. Implication Haydn Co’s exposure to losses is increased as a consequence of goods being despatched in response to unauthorised or bogus telephone orders. Recommendations Haydn Co should only accept written orders from bona fide customers. Procedures for ordering from Haydn Co should be made clear to all customers, through the issue of terms and conditions of trading, and these should be strictly adhered to by Haydn Co. Any doubts as to the authenticity of written orders received from customers should be removed before execution of those orders.

(vi) Weakness Sales clerks have full (amend) access to product price data contained in the standing data file of the sales invoicing programme. Implication The sales clerks are responsible for generating sales invoices to customers and therefore have the opportunity to influence, either fraudulently or erroneously, prices charged for the company’s products. Recommendations Access to the standing data file containing product price data should be restricted to the sales director and other appropriate senior responsible officials of the company. Strict controls should be exercised over the updating of this information and it should be regularly monitored to ensure that prices on file equate to those on Haydn Co’s authorised price list. (vii) Weakness Sales invoices are raised and forwarded to customers prior to the receipt of confirmation that goods have been despatched to customers. Implication Sales invoices could be forwarded to customers in the absence of goods being despatched to them. In such instances Haydn Co would be erroneously recognising the revenue from the sales transaction in its accounting records whilst also incorrectly recognising a trade receivable. Dependent on customers’ own internal controls, it is likely that relationships may become strained if customers constantly receive invoices in advance of the receipt of goods ordered. Recommendations Current procedures with regard to the production of sales invoices and goods despatch notes should be modified. The stores department should generate pre-numbered goods despatch notes to accompany all goods despatched and copies should be retained for control purposes. Sales invoices should be prepared and forwarded to customers only after the stores department have confirmed to the sales department that goods have been despatched, by for example forwarding a copy of the pre-numbered despatch note. Copy invoices should then be forwarded to the accounts department for posting to the accounting records by appropriately experienced employees, who should have no involvement in the receipt of monies from customers. (viii) Weakness The assistant accountant is responsible for dealing with customer invoices queries and the issue of sales credit notes. Implication As sales department staff deal with the preparation and processing of sales invoices, it is likely that the assistant accountant will not have the knowledge to deal effectively with customer queries. In addition, the company’s exposure to fraud and error is increased as a consequence of the assistant accounting having the discretion to raise credit notes whilst also having authority to post into the company’s accounting records.


Recommendations The assistant accountant should have no involvement in the decision to raise sales credit notes. Customer queries should be directed to individuals involved in the preparation of sales invoices. (Full marks will be awarded for answers identifying only FOUR weaknesses in the system, for relevant comments as to the implications arising from the weakness and for making appropriate recommendations)

2

(a)

Audit risk is the risk that the auditor expresses an inappropriate audit option when the financial statements are materially misstated. An auditor adopting a risk-based auditing approach obtains an understanding of an entity and its environment, and having assessed the risks of material misstatements in the financial statements at the assertion level, directs audit resources to the risky areas as appropriate. The risk of material misstatement at the assertion level consists of two components, these being inherent risk and control risk: Inherent Risk This is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming that there were no related controls. Control Risk This is the risk that a misstatement that could occur in an assertion and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control. Inherent risk and control risk are the entity’s risks and they exist independently of the audit of the financial statements. However the auditor is required to assess both of these components of audit risk as a basis for determining the level of substantive procedures to carry out. Detection risk relates to the nature, timing and extent of the auditor’s procedures. It is risk that the auditor will not detect a misstatement that exists in an assertion that could be material individually or when aggregated with other misstatements. It is the function of the effectiveness of an audit procedure and of its application by the auditor. The audit risk model used by auditors, dictates that for a given level of audit risk, the acceptable level of detection risk bears an inverse relationship to the assessment of the risk of material misstatement at the assertion level. For example, on an audit assignment where the risk of material misstatement at the assertion level has been assessed as high, in order to achieve a low level of audit risk, detection risk must be set as low. In such circumstances the auditor would need to direct an appropriate level of resources to the testing of the assertion in question. This will comprise adequate planning, proper assignment of personnel, the application of professional scepticism and supervision and review of the audit work performed. (Full marks will be given to answers containing points as above or other relevant points)

(b)

The purpose of audit working papers is to record information relating to a specific audit, on the planning of the audit work, the nature, timing and extent of audit procedures performed, the results thereof, and the conclusions drawn from the audit evidence obtained. Audit working papers record an auditor’s reasoning in arriving at conclusions on specific areas of an entity’s financial statements. This, together with other information included in the working papers, could be useful in the event of there being litigation against the audit firm in connection with the audit or for the planning of future audits. The extent of working papers to be prepared is a matter for the professional judgement of the auditor, and will depend on the auditor’s assessment of risk attaching to the audit assignment and the extent of substantive procedures carried out. It is generally accepted that the working papers prepared and retained should be sufficient such that they would provide another auditor, who has no previous connection with the audit, with an understanding of the work performed and the basis of the principal decisions taken. (Full marks will be awarded for answers including similar points to those stated as above or other appropriate points)

(c)

The following information should be included on the header of every working paper prepared in connection with the audit of the financial statements of Brahms Limited for the year ending 31 December 2005. (i) (ii) (iii) (iv) (v) (vi) (vii) (viii)

The The The The The The The The

client’s name – Brahms Co. balance sheet date – 31 December 2005. file reference of the working paper – normally standard within the audit firm. date the working paper was prepared. name or initials of the person preparing the working paper. subject of the working paper. date the working paper was reviewed. name or initials of the person reviewing the working paper.


3

(a)

(b)

The five generalisations about the reliability of audit evidence are: –

Audit evidence is more reliable when it is obtained from independent sources outside the entity.

–

Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are effective.

–

Audit evidence obtained directly by the auditor (for example, observation of the application of a control) is more reliable than audit evidence obtained indirectly or by inference (for example, inquiry about the application of a control).

–

Audit evidence is more reliable when it exists in documentary form, whether paper, electronic or other medium (for example, a contemporaneously written record of a meeting is more reliable than a subsequent oral representation of the matters discussed).

–

Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or facsimiles.

The implied or explicit management assertions made about classes of transactions and events for the period under audit are: (i)

Occurrence – transactions and events that have been recorded have occurred and pertain to the entity.

(ii)

Completeness – all transactions and events that should have been recorded have been recorded.

(iii) Accuracy – amounts and other data relating to recorded transactions and events have been recorded appropriately. (iv) Cut-off – transactions and events have been recorded in the correct accounting period. (v) (c)

Classification – transactions and events have been recorded in the proper accounts.

The auditor may wish to carry out the following substantive procedures to test for completeness. Area of financial statements Sales

Procedure to verify completeness Follow despatch notes through to sales invoicing and check for posting to sales account.

Trade payables

Review unmatched goods received notes on hand at the balance sheet date and verify posting to payables account.

Accrued expenses

Review charges to overhead expenses in period following balance sheet date and ensure none incorrectly omitted from accruals.

Provisions

Examine correspondence from company’s legal advisers to ensure that management have considered all payments relevant to current litigation.

Inventory

Attend year end inventory count to ensure that all inventories are listed for subsequent valuation.

Non-current assets

Identify assets owned by the company and check to ensure inclusion in non-current assets register.

(Full marks will be awarded for stating the above or other relevant substantive procedures)


4

(a)

A qualified external auditor should possess the following personal qualities. Integrity There is an expectation from users of audited information that an auditor will at all times be honest, fair and truthful. If an auditor does not display these attributes then it is unlikely that others will rely on his judgement or opinion. Objectivity As with integrity (above) an auditor’s objectivity must be beyond question if he/she is to report as auditor. Consequently a qualified auditor must have the ability to retain independence of mind whilst carrying out his/her professional duties, irrespective of any pressure that is brought to bear. Professional Scepticism During the course of an audit assignment, the auditor must find sufficient appropriate evidence to support the audit opinion. In determining the quantity and quality of this evidence, the auditor must know when it is prudent to exercise professional scepticism. For example, in deciding the extent of reliance to be placed on a specific verbal management representation. Good Communication Skills In order to carry out a satisfactory audit, the auditor must be able to communicate effectively with individuals, possessing varying levels of seniority, and experience and with different cultural backgrounds. If the auditor is unable to communicate effectively both orally and in writing, it is likely that ineffective audit procedures will be carried out. Good Information Technology Skills Most entities make use of information technology for financial reporting and operational purposes. Similarly, most audit firms use computer-assisted audit techniques to assist them in their audit work. Consequently if an auditor does not possess good information technology skills then he/she may not be able to contribute effectively to the audit process. Thorough Knowledge of Accounting and Auditing Issues Given that it is the auditor’s responsibility to prepare a report on the financial statements of an entity, it is important that the auditor retains contemporary knowledge of relevant accounting and auditing issues. This knowledge should include developments in both accounting and auditing standards. (Full marks will be awarded for stating the above or other appropriate qualities)

(b)

Materiality is concerned with errors in, or omissions from, a set of financial statements. It can be defined in the following terms: ‘Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.’ (Full marks will be awarded for definitions similar to the above)

(c)

An auditor may need to obtain audit evidence from an expert to provide an independent: – valuation of assets, for example land and buildings. – determination of quantities of assets, for example stockpiles of minerals. – determination of the condition of plant and machinery, for example a large engineering machine. – determination of a valuation using specialised techniques, for example in an actuarial valuation. – measurement of completed works, for example on a long term building contract. – legal opinion, for example on the interpretation of the terms of a legal agreement.

(d)

(i)

Management typically provide accounting estimates in connection with: – general provisions for the write down of inventory valuation – depreciation provisions – accrued revenue – provisions for losses on lawsuits – profits or losses on construction contracts in progress – provisions to meet warranty claims (Full marks will be awarded for identifying four of the above or other relevant matters)

(ii)

The – – –

auditor should adopt one or a combination of the following approaches in the audit of an estimate: review and test the process used by management to develop the estimate use an independent estimate for comparison with that prepared by management review subsequent events which confirm the estimate made.





The marking scheme generally indicates that 1 mark or 11/2 marks are awarded for each point. However, consideration should be given to the depth and relevance given by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 point whilst a detailed discussion could be worth up to a maximum of 2 points. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answer is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%.

Haydn Co 1

(a)

Stating the components of internal control. Generally 1 mark per component up to a maximum of

(b)

(5 marks)

Stating objectives of the internal control which should be exercised over the sales and trade receivables system of Haydn Co. Generally 1 mark per objective up to a maximum of

(c)

(4 marks)

Sales and trade receivables system. Generally 1 mark per point for identifying a weakness in the system, up to a maximum of

(4 marks)

Generally

11/2

mark per point for describing the implication of the weakness, up to a maximum of

Generally

11/2

mark per point for recommending an improvement to address the weakness, up to a maximum of (6 marks)

(6 marks)

Total (25 marks) Brahms Co 2

(a)

Explanation of the term ‘a risk-based approach to an audit’ Generally 1 mark per point up to a maximum of

(b)

(14 marks)

Explanation of the purpose of audit working papers. Generally 1 mark per point up to a maximum of

(4 marks)

Commentary on the matters to be considered generally in assessing the extent of working papers to be prepared. Generally 1 mark per point up to a maximum of (c)

(3 marks)

Listing of the information that should be included on the header of every working paper. Generally 1/2 mark per point up to a maximum of


Audit Evidence 3

(a)

Stating the generalisations about the reliability of audit evidence. Generally 2 marks per point up to a maximum of

(b)

(10 marks)

Stating management assertions made about classes of transactions and events for the period under audit. Generally 11/2 marks per assertion for up to four attributes, up to a maximum of

(c)

(6 marks)

Description of substantive procedures the auditor may carry out to verify the completeness of classes of transactions, account balances or disclosures. Generally 11/2 marks per procedure up to a maximum of



Student Enquiries 4

(a)

Stating personal qualities a qualified external auditor should possess. Generally 1/2 mark for each quality stated up to a maximum of

(2 marks)

Stating reason why auditor should possess quality. Generally 1 mark for each reason up to a maximum of (b)

(4 marks)

Explanation of the term ‘materiality’ of Generally 1/2 mark per point up to a maximum of

(c)

(i)

(3 marks)

Identifying situations during the course of an audit where an auditor may need to obtain evidence from an expert. Generally 1 mark for each situation identified up to a maximum of

(ii)

Providing a practical example for each situation identified above. Generally 1/2 mark for each example up to a maximum of

(d)

(i)

(2 marks)

Identifying matters where management typically provide accounting estimates. Generally up to 11/2 marks for each matter identified up to a maximum of

(ii)

(4 marks)

(6 marks)

Outline the approaches that an auditor should adopt. Generally up to 11/2 marks for each point up to a maximum of



(International Stream) ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL MONDAY 12 JUNE 2006


Paper T8(INT)





Rose Co, a haulage contractor company with sales of $7 million and profits of $1 million for the financial year ended 31 January 2006, recently dismissed its financial director for misappropriating company funds. Following his dismissal, the remaining directors of Rose Co asked your firm to carry out a full review of the company’s internal control system with a view to recommending improvements as appropriate to guarantee the effectiveness of the controls. An audit partner at your firm has written to the directors of Rose Co confirming that the firm will review the various components of the company’s internal controls, including control activities employed. He has explained however that any system of internal control can only provide reasonable assurance that the company’s financial reporting objectives will be achieved. The company has over 1,500 customers to whom it sells on credit terms and it employs a manager and five clerks in its sales accounting function. The circumstances of the financial director’s dismissal were that in the six month period up to 31 October 2005, he colluded with another senior manager of the company, to misappropriate individual sums totalling $9,682 received from the company’s customers. The directors discovered the fraud following a meeting between one of the customers and the managing director of Rose Co in April 2006, and have subsequently asserted that the auditors of Rose Co were negligent in not having discovered the fraud whilst auditing the company’s financial statements for the year ended 31 January 2006. The auditors have stated that the directors are being unreasonable in making this assertion and are confident that an independent review of their audit working papers will confirm that they have not been negligent in their audit work. Required: (a) Explain why it is important that the directors of Rose Co should ensure that the company has an effective system of internal control. (3 marks) (b) (i)

State FOUR types of control activity; and

(ii) For each type of control activity in (i), provide an example of how it may be employed on a day to day basis to control the sales accounting function of Rose Co. (8 marks) (c) Explain why any system of internal control can provide an entity with only reasonable assurance that the entity’s financial reporting objectives will be achieved. (8 marks) (d) Briefly comment as to whether the directors of Rose Co would appear to be justified in asserting that the company’s auditors were negligent in not detecting the fraud perpetrated by the company’s financial director and another senior manager during the year ended 31 January 2006. (6 marks) (25 marks)


2

Required: (a) Identify and explain FOUR matters that an auditor should consider when evaluating the control environment of an entity. (8 marks) (b) Your firm is about to tender for the appointment as auditors to Tulip Co, a company which provides adventure holidays for groups of school children. Having had an initial meeting with the directors of the company, John White, your firm’s audit engagement partner has established that the company has a good control environment. Your firm has no previous experience of auditing a company engaged in the adventure holiday sector. However, John is confident that by ensuring good audit planning, a thorough understanding of the business and properly directed substantive procedures, the firm will be able to carry out an efficient and effective audit of the financial statements of Tulip Co. John has had discussions with the audit manager who would be assigned to the Tulip Co audit, and together they have decided that if the tender is successful, the firm will use document flowcharts to record the company’s accounting and internal control systems. Required: (i)

Identify SIX areas of the business operations of Tulip Co on which your firm should obtain detailed knowledge, in order to obtain an understanding of the business, if it wins the tender for the audit of the company. (9 marks)

(ii) Explain the term ‘properly directed substantive procedures’ in the context of a risk based audit approach. (4 marks) (iii) Identify FOUR benefits of using document flowcharts to record a company’s accounting and internal control systems. (4 marks) (25 marks) 3

Bluebell Co is an audit client of your firm and has 200 employees. The company purchases land and develops it by building commercial premises, either for sale or for rental. In addition to its land development activity, during the year ending 30 June 2006, Bluebell Co has purchased an office building for its own use at a cost of $900,000. The purchase was financed by a further issue of ordinary shares in the company for $600,000 and by a $300,000 loan from an independent finance company. The loan is secured by a fixed charge over the office building and is repayable over a period of four years. You have been assigned to the audit of the financial statements of Bluebell Co for the year ending 30 June 2006 and have been instructed to arrange for a bank confirmation letter from the company’s bank and also to obtain copies of the minutes of the directors’ board meetings for the year. Your audit manager has confirmed that each of these is a good source of evidence as a means of verifying specific matters reflected in the company’s financial statements. Required: (a) Identify SIX specific matters with regard to the financial statements of Bluebell Co for the year ending 30 June 2006 which should be confirmed in the confirmation letter from the company’s bank. (9 marks) (b) Identify SIX specific matters in respect of which the minutes of the directors’ board meetings of Bluebell Co should provide useful evidence in the audit of the company’s financial statements for the year ending 30 June 2006. (6 marks) (c) State the audit procedures that your firm should carry out to verify the ownership and existence of the office building purchased during the year. (5 marks) (d) State the audit procedures that your firm should carry out to verify: (i) the amount of the loan from the finance company; (ii) the related interest charges; and (iii) the disclosure of the loan and of the related interest charges; in the financial statements of Bluebell Co for the year ending 30 June 2006.



[P.T.O.

4

(a) When an auditor concludes that the financial statements of a company give a true and fair view, in accordance with the identified financial reporting framework, then he should express an unqualified opinion in his auditor’s report on those financial statements. Required: Describe the circumstances in which each of the following should be expressed in an auditor’s report. (i) Qualified opinion; (ii) Disclaimer of opinion; (iii) Adverse opinion.

(3 marks) (3 marks) (3 marks)

(b) Auditors often use analytical procedures as substantive procedures to reduce detection risk relating to specific financial statement assertions. Required: Explain FOUR factors that determine the extent of reliance that auditors may place on analytical procedures to reduce detection risk. (10 marks) (c) It is standard practice during the course of an audit of a company’s financial statements for a letter on internal control (also referred to as a management letter or a letter of weakness) to be issued by the auditors. Required: Explain the nature and purpose of a letter on internal control, and state when and to whom it should be issued. (6 marks) (25 marks)



Answers



1

(a)

June 2006 Answers

As with any operating company, in order for Rose Co to function successfully the directors of the company must ensure that the company’s operations are effective and efficient, that it complies with applicable laws and regulations and that it has a reliable financial reporting system. If the company does not have an effective system of internal control, then it is probable that corporate objectives, with regard to these matters, will not be met thus adversely affecting the successful functioning of the company. (NOTE: Full marks will be awarded to answers containing the above or other appropriate points.)

(b)

Specific control activities and examples of how each may be employed on a day to day basis to control the sales accounting function of Rose Co include: (i)

Authorisation Example The authorisation of an increased credit limit for an existing customer, prior to updating the customer master file date.

(ii)

Performance Reviews Example Regular review of the company’s aged receivables list by a senior manager of the company to monitor the effectiveness of the company’s credit control procedures.

(iii) Information Processing Example The daily processing of customer sales invoices through an integrated general and account receivables ledger system. (iv) Physical Controls Example The restriction of access to computer terminals to authorised users only. (v)

Segregation of Duties Example Division of duties in the sales accounting function to ensure that individuals who accept orders from customers do not have any part in the processing of sales invoices or the receipt or processing of cash receipts from customers. (NOTE: Full marks will be awarded for stating FOUR of the above or other activities together with appropriate examples.)

(c)

Internal controls, no matter how well designed and operated, can provide an entity with only reasonable assurance about achieving the entity’s financial reporting objectives. The likelihood of achievement is affected by limitations inherent to internal control. These include the realities that human judgement in decision-making can be faulty and that breakdowns in internal control can occur because of human failures, such as simple errors or mistakes. Errors also may occur in the use of information produced by IT. For example, automated controls may be designed to report transactions over a specified amount for management review, but individuals responsible for conducting the review may not understand the purpose of such reports and, accordingly, may fail to review them or investigate unusual items. Additionally, controls can be circumvented by the collusion of two or more people or inappropriate management override of internal control. For example, management may enter into side agreements with customers that alter the terms and conditions of the entity’s standard sales contracts, which may result in improper revenue recognition. Also, exception checks in a software program that are designed to identify and report transactions that exceed specified credit limits may be overridden or disabled. Further inherent limitations in any system of internal control include the possibility that procedures may become inadequate due to changes in conditions – for example, in a company experiencing rapid growth in sales, existing control activities may be inadequate to cope with the volume of sales transactions. Additionally, there is an inherent weakness in any internal control system that is directed at routine transactions rather than non-routine transactions. For example, an accounting system which does not incorporate sufficient controls to properly identify and process transactions relating to the purchase of non-current assets, is inherently weak. (NOTE: Full marks will be awarded to answers not necessarily containing all of the above points.)


(d)

The amount of money defrauded from the company of $9,682 during the year ended 31 January 2006 represents less than 1% of reported net profit and is therefore not material in the context of the disclosures made in the financial statements of Rose Co. However the fact that the fraud was committed is indicative of a problem with the day to day systems of control within the company and the directors are therefore justified in having concerns about this. From the auditors’ perspective, unless their audit of Rose Co’s financial statements revealed evidence to the contrary, they were entitled to assume that there was no fraudulent activity during the year. However they should have planned and performed their audit procedures with an attitude of professional scepticism recognising that conditions or events could be found indicating fraudulent activity. It is generally recognised that it is often difficult to detect fraudulent activity when it is perpetrated by two senior managers of a company who collude to conceal the losses consequently incurred. Given that the total sum defrauded from Rose Co amounts to $9,682 over a six month (mid-year) period, it is probable that the fraud was carefully orchestrated by the financial director and the senior manager, so that only small individual amounts were targeted for fraud at a time when it was unlikely that the auditors would be present at the company. Given these factors and the immateriality of the sum involved, then providing a review of the auditors’ working papers does not reveal inadequacies in their audit procedures, it is unlikely that the auditors would be found to have been negligent in not detecting the fraud. Consequently the directors’ assertion appears to be unjustified. (NOTE: Full marks will be awarded to answers not necessarily containing all of the above points.)

2

(a)

When evaluating the control environment of an entity, an auditor should consider the following matters: (i)

Communication and enforcement of integrity and ethical values – essential elements which influence the effectiveness of the design, administration and monitoring of controls.

(ii)

Commitment to competence – management’s consideration of the competence levels for particular jobs and how those levels translate into requisite skills and knowledge.

(iii) Management’s philosophy and operating style – management’s approach to taking and managing business risks, and management’s attitudes and actions towards financial reporting, information processing and accounting functions and personnel. (iv) Organisational structure – the framework within which an entity’s activities for achieving its objectives are planned, executed, controlled and reviewed. (v)

Assignment of authority and responsibility – how authority and responsibility for operating activities are assigned and how reporting relationships and authorisation hierarchies are established.

(vi) Human resources policies and practices – recruitment, orientation, training, evaluating, counselling, promoting, compensating and remedial actions. (NOTE: Full marks will be awarded for identifying FOUR of the above or other appropriate matters.) (b)

(i)

The areas on which my firm should obtain detailed information include: –

The various income streams of Tulip Co. These may include for example, income from the provision of accommodation and from the sale of meals, refreshments and souvenirs.

–

Information about the market in which Tulip Co operates, for example, the size of the market, major competitors, the company’s market share, pricing policies and the marketing strategy and objectives of the company.

–

Information about the way the company conducts its operations for example, the range of adventure holidays offered, advance booking incentives for customers and details of expanding and declining activities.

–

The extent of the company’s involvement in electronic commerce, including internet sales and marketing activities.

–

The geographic spread of the activities of the company and the type and extent of activity at each location.

–

Employment practices within the adventure holiday sector generally and within the company. For example, the employment of specialist staff, use of temporary ‘seasonal staff’, staff training issues and remuneration levels within the sector.

–

Details of the company’s cost structures, including accommodation costs, employment costs, indemnity insurance costs and those relating to general administration.

–

Details of any alliances or joint venture activities entered into by the company together with details of any activities outsourced to third parties.

(NOTE: Full marks will be awarded to answers identifying any SIX of the above or other relevant matters.)


(ii)

When adopting a risk based approach to an audit, auditors should direct their substantive procedures to areas of the financial statements where there is an unacceptably high risk of material misstatement. This risk is a function of inherent risk and control risk as assessed by the auditor and can normally be reduced to an acceptably low level by using properly directed substantive procedures. For example, an auditor who has assessed an unacceptably high level of risk of material misstatement in the purchases area of a company’s financial statements may reduce this risk by employing properly directed substantive procedures on purchases transactions.

(iii) The benefits of using document flowcharts to record a company’s accounting and internal control systems are that they: –

enable the systems to be recorded in a standard format which is easily understood by specialist and non-specialist audit staff.

–

present systems information in a logical sequence.

–

highlight relationships between different parts of a system.

–

provide an overview of a system such that superfluous documents, bottlenecks and weaknesses are more easily identified.

–

Encourage a disciplined approach to the recording of a system in that the originator of a flowchart must have a good understanding of the system being recorded.

(NOTE: Full marks will be awarded for stating FOUR of the above or other perceived advantages.)

3

(a)

The following matters should be confirmed in the confirmation from the company’s bank: (i)

titles and account numbers of all bank accounts held in the name, joint name or trade name of Bluebell Co as at 30 June 2006, together with confirmation of balances held in those accounts.

(ii)

full titles and dates of closure of all accounts closed in the name, joint name or trade name of Bluebell Co during the year ending 30 June 2006.

(iii) full details of interest charged or received on accounts held during the year if not specified on bank statements. (iv) particulars of any written acknowledgement of set-offs relating to accounts and balances held on behalf of the company. (v)

details of overdrafts and loans repayable on demand together with details of other loans and facilities.

(vi) details of any assets of Bluebell Co which are held as security by the bank. (vii) details of any other assets held by the bank, for example share certificates, documents of title or deed boxes. (viii) full details of any contingent liabilities, for example the total of any bills discounted with recourse, for Bluebell Co. (ix) a list of branches of the bank, or other banks, or associated companies where it is known that a relationship has been established with Bluebell Co during the year ending 30 June 2006. (NOTE: Full marks will be awarded for stating SIX of the above or other relevant matters.) (b)

The minutes of the directors’ board meetings of Bluebell Co should provide useful evidence with regard to the authorisation of and further information on: (i)

the purchase of development land during the year by the company including the purchase terms.

(ii)

contracts entered into by the company during the year for the development of land.

(iii) sale and rental agreements in connection with completed development projects during the year. (iv) the purchase of the office building during the year including the purchase terms. (v)

the financing of the purchase of the office building including the further issue of ordinary shares and the acquiring of the loan from the finance company. The minutes should confirm the authority for these transactions together with information on the related costs arising.

(vi) the capital expenditure program of the company during the year, including capital commitments as at 30 June 2006. (vii) appointments of senior employees during the year. (viii) the company’s pay structure including the authorisation of general pay increases to employees. (ix) the payment for significant material items of overhead expenditure during the year – for example special advertising costs to find tenants for a completed commercial building. (x)

the valuation of work-in-progress to be reflected in the company’s financial statements for the year ending 30 June 2006.

(NOTE: Full marks will be awarded for stating SIX of the above or other appropriate matters.)


(c)

(d)

My firm should carry out the following procedures to verify the ownership and existence of the office building purchased during the year: –

examine purchase documentation, probably from legal representatives, confirming purchase of property during the year.

–

verify title to property by inspecting land registration document or obtain confirmation of title from company legal representatives.

–

verify existence by physical inspection of property.

–

obtain corroborative evidence of existence and ownership by vouching payments in relation to insurance of property, repairs to premises and utility bills.

–

examine entry in the company’s non-current assets register to ensure consistency with ownership and existence.

–

scrutinise minutes of directors’ board meetings of the company to obtain evidence of actions consistent with ownership/existence of the building.

My firm should carry out the following procedures to verify the amount of the loan from the finance company and its disclosure in the financial statements together with that of the related interest charges. (i)

examine the loan agreement to verify the amount of the loan, the rate of interest chargeable, the security provided and the repayment terms.

(ii)

confirm the actual amount of the loan received by vouching receipt into the company’s accounting records and by the company bank. If applicable examine property purchase documentation to verify direct payment of loan funds to third party seller of commercial property.

(iii) check the accuracy and disclosure of interest charge payments and accruals in the company’s profit and loss account. (iv) verify the amount of the loan outstanding at the balance sheet date and ensure that this is accurately stated and fully disclosed in the company’s balance sheet. The amount of the loan outstanding should be disclosed as repayable within 12 months and repayable after 12 months from the balance sheet date.

4

(a)

(v)

Check the note to the company’s financial statements to ensure that full disclosure is made with regard to the security for the loan.

(i)

Qualified opinion – A qualified opinion is expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management, or limitation on scope is not so material and pervasive as to require an adverse opinion or a disclaimer of opinion.

(ii)

Disclaimer of opinion – A disclaimer of opinion is expressed when the possible effect of a limitation on scope is so material and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence and accordingly is unable to express an opinion on the financial statements.

(iii) Adverse opinion – An adverse opinion is expressed when the effect of a disagreement is so material and pervasive to the financial statements that the auditor concludes that a qualification of the report is not adequate to disclose the misleading or incomplete nature of the financial statements. (b)

The extent of reliance that the auditor places on the results of analytical procedures is determined by the following factors: (i)

materiality of the items involved, for example, when inventory balances are material, the auditor does not rely only on analytical procedures in forming conclusions. However, the auditor may rely solely on analytical procedures for certain income and expense items when they are not individually material;

(ii)

other audit procedures directed toward the same audit objectives for example, other procedures performed by the auditor in reviewing the collectibility of accounts receivable, such as the review of subsequent cash receipts, might confirm or dispel questions raised from the application of analytical procedures to an ageing of customers’ accounts;

(iii) accuracy with which the expected results of analytical procedures can be predicted. For example, the auditor will ordinarily expect greater consistency in comparing gross profit margins from one period to another than in comparing discretionary expenses, such as research or advertising; (iv) assessments of inherent and control risks, for example, if internal control over sales order processing is weak and therefore control risk is high, more reliance on tests of details of transactions and balances than on analytical procedures in drawing conclusions on receivables may be required. (c)

A letter on internal control (also referred to as a management letter or letter of weakness) is a letter usually forwarded by an auditor to the senior management of a company. The letter should normally be forwarded immediately following the completion of the tests of control and before the commencement of substantive procedures.


The letter contains weaknesses identified in the entity’s system of internal control as identified by the auditor or members of his audit team, when performing tests of control and the purpose of the letter is to bring these weaknesses to the attention of management. The weaknesses identified in the main body of the letter should be those which could lead to fraud or material error in or omission from the company’s financial statements, and will be classified as those relating to: (i) (ii)

the design of the systems of accounting and internal control. the operation of the systems of accounting and internal control.

For both categories the implication(s) of the weakness(es) should be identified, however minor control issues which the auditor would wish to bring to the attention of the company’s senior management should be included in an appendix to the letter of weakness or in a supplementary report.




The marking scheme generally indicates that 1 mark or 11/2 marks are awarded for each point. However, consideration should be given to the depth and relevance given by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 point whilst a detailed discussion could be worth up to a maximum of 2 points. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answer is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%. ROSE CO 1

(a) (b)

Explaining the importance of an effective system of internal control. Generally 1 mark per point up to a maximum of (i) (ii)

(3 marks)

Stating four types of control activity. Generally 1 mark for each control activity up to a maximum of

(4 marks)

Providing an example of the employment of each control activity. Generally 1 mark for each relevant example up to a maximum of

(4 marks)

(c)

Explaining why any system of internal control can provide only reasonable assurance that financial reporting objectives will be achieved. Generally 1 mark per point up to a maximum of (8 marks)

(d)

Briefly commenting on the directors’ assertion that the company’s auditors were negligent in not detecting the fraud perpetrated. Generally 1 mark per point up to a maximum of (6 marks) Total (25 marks)

TULIP CO 2

(a)

Identifying and explaining four matters that an auditor should consider when evaluating the control environment of an entity. Generally 1 mark for each matter identified and 1 mark for explanation up to a maximum of (4 x 2 marks) (8 marks)

(b)

(i)

Identifying six areas of the business operations of Tulip Co on which an audit firm should obtain detailed knowledge. Generally up to 11/2 marks for each matter identified up to a maximum of (9 marks)

(ii)

Explaining the term ‘properly directed substantive procedures’ in the context of a risk based audit approach. Generally up to 1 mark per point up to a maximum of (4 marks)

(iii) Identifying four benefits of using document flowcharts to record a company’s accounting and internal control systems. Generally up to 1 mark for each advantage identified up to a maximum of (4 marks) Total (25 marks)


BLUEBELL CO 3

(a)

Identifying six specific matters with regard to the financial statements of Bluebell Co which should be confirmed in the confirmation letter from the company’s bank. Generally up to 11/2 marks for each matter stated up to a maximum of (9 marks)

(b)

Identifying six specific matters in respect of which the minutes of the directors’ board meetings of Bluebell Co should provide useful evidence in the audit of the company’s financial statements. Generally up to 1 mark for each matter stated up to a maximum of (6 marks)

(c)

Stating the audit procedures that the firm should carry out to verify the ownership and existence of the office building. Generally up to 1 mark for each procedure stated up to a maximum of (5 marks)

(d)

Stating the audit procedures that the firm should carry out to verify the amount of loan from the finance company and its disclosure together with that of the related interest charges in the financial statements of Bluebell Co for the year ending 30 June 2006. Generally up to 1 mark for each procedure stated up to a maximum of (5 marks) Total (25 marks)

FINANCIAL STATEMENTS OF A COMPANY 4

(a)

Describing the circumstances in which the following should be expressed in an auditor’s report: (i) Qualified opinion (ii) Disclaimer of opinion (iii) Adverse opinion Generally 1 mark for each point in respect of each of the above up to a maximum of (3 x 3)

(9 marks)

(b)

Explaining four factors that determine the extent of reliance that auditors may place on analytical procedures to reduce detection risk. Generally up to 1 mark per point with a maximum of up to 3 marks for each factor, with an overall maximum of (10 marks)

(c)

Explaining the nature and purpose of a letter on internal control and stating when and to whom it should be issued. Generally up to 1 mark for each point up to a maximum of (6 marks) Total (25 marks)


(International Stream) ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL MONDAY 11 DECEMBER 2006


Paper T8(INT)




ALL FOUR questions are compulsory and must be attempted 1

Rhodes Co provides entertainment for holidaymakers in a large resort, by staging local culture evenings at its indoor arena. The entertainment is provided every evening throughout the holiday season and comprises members of the local community performing dance routines in traditional costume and others demonstrating acrobatic skills. The arena forms part of a building which houses Rhodes Co’s administrative and accounting functions together with a snack bar used by customers attending the culture evenings. The company accepts only cash payment from culture evening customers and, in addition to staff who carry out specific tasks, a manager and three assistant managers are in attendance nightly to supervise activity at the arena. The following controls are exercised over the income from the culture evenings: Entry Charges The company does not issue entry tickets. Customers gain entry into the arena’s audience area through a turnstile located alongside the arena cashier’s kiosk in the foyer of the arena building. As customers pay and enter through the turnstile, a meter connected to it and located inside the kiosk, automatically counts the number of entrants. The kiosk does not have a cash register but it is furnished with a cash drawer, containing a small permanent cash float, for use by the cashier. At the end of each night the cashier ensures that the total cash takings in the drawer equate to the entrants counted on the turnstile meter multiplied by the standard entry charge as set by the directors of Rhodes Co. After zeroing the turnstile meter for future use she then e-mails, for the next day attention of the company’s accounts department, confirmation of the number of customer entrants and the total kiosk takings. Prior to finishing her work the cashier puts the takings into a designated cash wallet and deposits the wallet in the secure night safe of Rhodes Co. The safe is of a hole in the wall design, located in a secure room inside the company’s premises and allows ‘deposit only’ access to arena employees with full access being granted to specified accounts department employees of Rhodes Co who are responsible for the removal of deposits from the safe. Snack Bar Income This comprises snack bar sales and income from vending machines located in the snack bar area. The bar’s automated cash register (till), containing a permanent small cash float, is operated by the snack bar manager and his staff, all of whom have had training in its use. At the end of each night the snack bar manager obtains a listing from the till of all transactions registered and compares the total to the actual cash takings, which he counts without assistance, writing a note on the listing to explain any differences between the totals. He then empties the takings from the vending machines and puts these together with those from the snack bar sales and the till listing into a designated wallet, prior to depositing the wallet in the night safe of Rhodes Co. Required: (a) State THREE objectives of the internal controls that should be exercised over cash sales.

(3 marks)

(b) With regard to the controls exercised over sales income received from the culture evenings: (i)

Explain why the auditors of Rhodes Co could not rely on the controls as a basis for verifying completeness of sales income; (7 marks)

(ii) Recommend SIX improvements to address specific weaknesses in the controls over entry charges and the snack bar income. (9 marks) (c) State FOUR controls that Rhodes Co should employ over the subsequent access to and recording and banking of the sales income from the culture evenings as deposited into the company’s night safe. (6 marks) Note: You should assume that there are a sufficient number of employees to implement any required controls, in (b) and (c) above. (25 marks)


2

The auditors of Malaga Co, a large engineering company are now in the course of auditing the company’s financial statements for the year ended 31 October 2006. At the audit briefing meeting, the audit manager made the following statements: (i)

‘whilst we are all aware of the benefits that Malaga Co should have gained from using a computer-based accounting system, we need to be alert to the specific risks that a computer-based accounting system poses to an entity’s internal controls.’

(ii) ‘we will be using audit software.’ Required: (a) State FOUR benefits that Malaga Co should have gained from using a computer-based accounting system. (4 marks) (b) State SIX specific risks that the use of a computer-based accounting system poses to an entity’s internal controls. (9 marks) (c) Explain the term ‘audit software’.

(2 marks)

(d) Describe FIVE functions performed by audit software and for each function suggest how it could be used for a specific task by the external auditors of Malaga Co. (10 marks) (25 marks)


[P.T.O.

3

Paphos Co trades as a department store. It has 85 employees, some of whom are hourly paid, and a large administration and accounts department with appropriate segregation of duties, supervisory controls and authorisation levels throughout the various accounting functions. Your firm is auditing the company’s financial statements for the year ended 30 September 2006 and, together with an inexperienced audit junior, you have been assigned to the audit of wages. The company pays all employees on a weekly basis, using a computerised payroll system to process wages, prior to making payment directly into employees’ bank accounts. Wages costs are reported as $1·62 million in the financial statements of Paphos Co for the year ended 30 September 2006. You are about to commence tests of control on the wages system. However, from discussions with the audit junior, it is apparent that he does not understand the concept of obtaining evidence to verify the assertions made implicitly or explicitly by management and contained in a company’s financial statements. Similarly, he does not understand that there are several recognised methods that an auditor may adopt when selecting a sample of items to be tested from a population. Required: (a) State FOUR financial statement assertions made by the directors of Paphos Co, in reporting wages costs of $1·62 million in the financial statements of the company for the year ended 30 September 2006. (6 marks) (b) Explain the following terms as applied to audit sampling methods and contained in ISA 530 Audit Sampling and Other Means of Testing: (i)

Random selection;

(2 marks)

(ii) Haphazard selection;

(2 marks)

(iii) Systematic selection.

(3 marks)

(c) Identify SIX tests of control that you should carry out in connection with the audit of the reported wages costs in the financial statements of Paphos Co for the year ended 30 September 2006. (12 marks) (25 marks)


4

‘The auditors of a company operating a supermarket chain, could be more effectual by making use of appropriate analytical procedures, and by using the work of internal auditors and the work of an expert.’ Required: (a) Identify the stage or stages of an audit, during which an audit firm should use analytical procedures and explain the purpose of the use at each stage, as stated in ISA 520 Analytical Procedures. (6 marks) (b) For each of the efficiency measures listed below, set out the accounting ratio that should be used by a firm of auditors when analysing the financial statements of a company operating a supermarket chain: (i)

Working capital turnover;

(ii) Average inventory turnover; (iii) Payment period for trade payables; (iv) Total assets turnover; (v) Non-current assets turnover. (c) (i)

(5 marks)

Identify FOUR activities in which the internal audit department of a company, operating a supermarket chain, may be typically involved;

(ii) For each activity identified above, provide a practical example. (d) (i)

(8 marks)

Identify THREE areas in the financial statements of a company, operating a supermarket chain, where an audit firm may need to rely on the work of an expert;

(ii) For each area identified above, provide a practical example.




Answers



(a)


Three objectives of the internal controls that should be exercised over cash sales are: (i)

to ensure that all cash to which the entity is entitled is received.

(ii)

to ensure that all such cash is properly accounted for and recorded in the entity’s records.

(iii) to ensure that all such cash is banked promptly and intact. (b)

(i)

The auditors of Rhodes could not rely on the controls as a basis for verifying completeness of the sales income from the culture evenings because the controls do not meet the sales system’s objectives. The major problem associated with the current procedures is the lack of segregation of duties in both the entrance kiosk and snack bar area where the cashier and snack bar manager respectively, have unsupervised responsibility to collect sales revenues from customers and to count those revenues in preparation for banking by Rhodes Co. The activities of the cashier and bar manager are not subjected to any form of contemporary internal check procedure by other employees of the company. Existing controls over both the kiosk cashier and bar manager with regard to the receipt of sales revenues are open to easy override by them, or undetected error, thus resulting in possible loss of revenue by Rhodes Co as a consequence of misappropriation or error. In summary, irrespective of any representations to the contrary, the auditors could not rely on the current system due to the weaknesses identified above.

(ii)

I would recommend the following improvements to address the control weaknesses in the system: Entry Charges –

The company should issue unique pre-numbered entry tickets to all customers on entry to the arena as a basis for the subsequent reconciliation of total kiosk takings to tickets issued on a nightly basis. The inventory of un-issued tickets should be subject to rigid control by a responsible official of Rhodes Co, and the kiosk cashier should not have access to un-issued tickets, with tickets being mechanically/automatically issued to customers.

–

A secure cash register should be provided in the kiosk for use by the cashier.

–

The kiosk takings and float should be counted and reconciled to tickets issued by two responsible officials of Rhodes Co (being any two from the arena manager and the assistant managers). If the company is unable to introduce an improved turnstile counting mechanism, automatically linked to the ticket issue mechanism, then entries into the arena area as recorded on the turnstile meter should be agreed to ticket issues. Any discrepancies revealed in the reconciliation and checking process should be immediately investigated.

–

After counting the kiosk takings, a formal schedule should be prepared, reconciling the total kiosk takings to ticket issues and recorded turnstile entries into the arena area. The schedule should be annotated with any discrepancies for subsequent investigation and appropriate action by the management of Rhodes Co. The schedule, signed by both officials as evidence of checking, should then be put into the wallet together with the kiosk takings for the night ready for deposit into the night safe of Rhodes Co. A copy of the schedule should be retained by the arena manager, filed for future reference as appropriate.

–

Procedures for the depositing of the wallet containing the kiosk takings and accompanying documentation into the night safe of Rhodes Co should ensure that both officials (above) are responsible for jointly making the deposit.

–

The company should ensure that the duties allocated to responsible officials are frequently rotated around the management staff.

Note: Full marks will be awarded for stating the above or other similar points Snack Bar Income –

The snack bar sales takings and float should be counted by two responsible officials of Rhodes Co (being two from the arena manager and the assistant managers). The total takings from the bar till should be compared to the total shown on the cash register listing and explanation for any discrepancy should be sought from the snack bar manager and investigated as appropriate.

–

The task of emptying the takings from each vending machine should be undertaken jointly by the two responsible officials (above).

–

Procedures for the removal of takings from each vending machine on a nightly basis should facilitate the formal recording of the total amount of takings removed, evidenced by the signature of both responsible officials. This record should be retained by the arena manager, and be available for inspection and comparison by senior officials of Rhodes Co.

–

On completion of counting of the total cash takings, allocated between snack bar sales and vending machines, all monies should be put in a designated wallet, together with the cash register listing annotated as appropriate for any discrepancies, and a formal schedule signed by each of the responsible officials reconciling the total monies in the wallet to the snack bar sales and vending machine takings. A copy of the schedule should be retained by the arena manager, filed for future reference as appropriate.


–

Procedures for the depositing of the wallet, containing the snack bar income, into the night safe of Rhodes Co should ensure that both officials (above) are responsible for jointly making the deposit.

–

The company should ensure that the duties allocated to responsible officials are frequently rotated around the management staff.

(Note: Full marks will be awarded for making any six of the above or other relevant recommendations). (c)

The following controls should be employed by Rhodes Co over access to and the subsequent counting of income from the culture evenings: (i)

Access to monies deposited in the night safe should be restricted to a very limited number of responsible officials of Rhodes Co, all of whom should be independent of the recording and banking functions.

(ii)

On a daily basis, two designated officials should remove both wallets containing the culture evening sales income from the safe and count the total monies contained therein. Both officials should evidence their agreement by signing the accompanying documentation forwarded by the arena employees. Any discrepancies between the cash totals and that noted on the accompanying documentation should be brought to the attention of an appropriate senior manager of the company for immediate investigation and enquiry. Similarly, discrepancies noted by the arena employees should be brought to senior management’s attention, for investigation as appropriate.

(iii) Procedures should ensure that there is a segregation of duties with regard to the recording of sales revenues in the accounting records of Rhodes Co and the banking of those revenues. Consideration should be given to the employment of a security firm to safeguard company staff and monies being transported to the company’s bank. (iv) The underlying documentation contained in the wallets should be forwarded to the relevant person to enable sales income details to be recorded in the accounting records of Rhodes Co and for secure filing and future reference. (v)

Monies from the wallets should be forwarded to the relevant person for the preparation of the bank paying-in slip and immediate banking.

(vi) Procedures should ensure that a responsible official of the company independent from the recording and banking functions, verifies the amount on the bank paying-in slip to the underlying documentation – confirming sales income forwarded by the arena management. (Note: Full marks will be awarded for stating any four of the above or other relevant controls).

2

(a)

The use of a computer-based accounting system should benefit Malaga Co by enabling it to: (i)

consistently apply pre-determined business rules and perform complex calculations in processing large volumes of transactions or data.

(ii)

enhance the timeliness, availability and accuracy of information.

(iii) facilitate the additional analysis of information. (iv) enhance the ability to monitor the performance of the company’s activities and its policies and procedures. (v)

reduce the risk that controls will be circumvented.

(vi) enhance the ability to achieve effective segregation of duties by implementing security controls in applications, databases and operating systems. (Note: Full marks will be awarded for identifying any four of the above or other applicable benefits). (b)

A computer-based accounting system poses the following risks to an entity’s internal controls: (i)

reliance on systems or programs that are inaccurately processing data, processing inaccurate data or both.

(ii)

unauthorised access to data that may result in destruction of data or improper changes to data, including the recording of unauthorised or non-existent transactions, or inaccurate recording of transactions. Particular risks may arise where multiple users access a common database.

(iii) the possibility of IT personnel gaining access privileges beyond those necessary to perform their assigned duties thereby breaking down segregation of duties. (iv) unauthorised changes to data on master files. (v)

unauthorised changes to systems or programs.

(vi) failure to make necessary changes to systems or programs. (vii) inappropriate manual intervention. (Note: Full marks will be awarded for stating any six of the above or other applicable risks). (c)

The term ‘audit software’ describes the computer software used by auditors to assist them in their work, when examining the operations of, and testing the output of a computer-based accounting system.


(d)

Function Performed by Audit Software

Use by Auditors of Malaga Co

Highlighting of exceptions

–

To identify exceptional wages payments outside of stated parameters, for enquiry.

Highlighting of trends

–

To highlight reported inventory movement both immediately before and after reporting dates to identify possible manipulation of inventory figures.

Performance of sequence checks –

To verify completeness of sales reporting by ensuring that all invoices have been recorded.

Calculation checks

–

To ensure that overhead costs are totalled correctly in the general ledger.

Stratification of data

–

To subdivide the population of inventory lines with a view to examining only material balances.

Statistical analysis

–

To analyse inventory movement with a view to identifying slow moving items.

Selection of items for testing

–

To select trade receivables accounts for circularisation, to verify the existence of trade receivables.

(Note: Full marks will be awarded for identifying five of the above or other applicable functions, and for suggesting how each function could be used by the auditors of Malaga Co).

3

(a)

In reporting costs of $1·62 million for wages in the financial statements of the company for the year ended 30 September 2006, the directors of Paphos Co made the following assertions: (i)

the reported costs of $1·62 million were properly incurred and pertain to Paphos Co.

(ii)

the reported costs of $1·62 million are complete and there were no other wages costs incurred during the year ended 30 September 2006.

(iii) the reported costs of $1·62 million accurately reflect the total wages costs of the company for the year ended 30 September 2006. (iv) the reported costs of $1·62 million relate only to the costs incurred for the year ended 30 September 2006 by Paphos Co. (v)

the reported costs of $1·62 million have been properly classified as wages costs. (Note: Full marks will be awarded for stating four of the above or other relevant assertions).

(b)

(i)

Random Selection This is a method of selection in which items in a population have the same statistical probability of being selected. The method uses random numbers as a basis for selection.

(ii)

Haphazard Selection This is a method of selection in which the auditor attempts to ensure that all items in a population have the same statistical probability of being selected by choosing items haphazardly.

(iii) Systematic Selection This is a method of selection in which the auditor selects items using a constant interval between selections. The first item may be selected on a random or haphazard basis, and thereafter the sampling interval is derived by the auditor, for example, by dividing the population by the sample size. (c)

I should carry out the following tests of control in connection with the verification of the wages costs of Paphos Co: (i)

review a sample of employee files to verify that all starters, leavers or change of status details are authorised by a responsible official.

(ii)

test check master file data and amendments and verifying to appropriate independent documentation authorised by a responsible official.

(iii) examine a sample of employees’ time records to ensure authorisation by a responsible official. (iv) witness master file update/amendment procedures and payroll preparation procedures to ensure adequate segregation of duties with regard to the wages function. (v)

test check veracity of calculations of the company payroll programme.

(vi) test check of payrolls for correct treatment of deductions from salaries and wages. (vii) review a sample of payrolls for evidence of review and authorisation by a responsible official.


(viii) review a sample of payroll summaries of entries to be posted to the general ledger accounts and tracing through of the sample to ensure proper authorisation and entry into the appropriate accounts. (ix) trace a sample of net payment amounts due to employees to the company’s bank statements to ensure correct and timely payment of liability due. (Note: Full marks will be awarded for stating six of the above or other appropriate tests of control).

4

(a)

Analytical procedures should be used by an audit firm as follows: (i)

at the planning stage – to assist the auditor in planning the nature, timing and extent of other audit procedures. Use at this stage should add to the firm’s understanding of the business and identify risk areas to which audit resources should be targeted.

(ii)

at the detailed testing stage – in most instances analytical procedures should be used in conjunction with tests of detail to achieve a particular audit objective in relation to specific financial statement assertions.

(iii) at the final review stage – as part of the overall review of the financial statements to gain assurance that all of the audit objectives with regard to the financial statements have been met. (b)

The accounting ratios are: (i)

Total Sales –––––––––––––––– Net Current Assets

(ii)

Cost of Goods Sold –––––––––––––––––––– Average Inventory Held

(iii) Trade Payables x 365 –––––––––––––––––––––– Credit Purchases in Period (iv) Total Sales –––––––––– Total Assets (v)

(c)

Total Sales –––––––––––––––– Non-Current Assets

The internal audit department of a company, operating a supermarket chain, may be typically involved in the following activities: (i)

The review and monitoring of accounting and internal control systems, and in the making of recommendations relating thereto. For example, an assignment to review and monitor the sales accounting function of the chain with the objective of recommending appropriate improvements to increase efficiency.

(ii)

The examination of financial and operating information, including carrying out detailed testing of transactions and balances. For example, the internal audit department may routinely be tasked with carrying out detailed testing of transactions and balances to verify information included in the company’s monthly management accounts.

(iii) The review of the economy, efficiency and effectiveness of the operations including non-financial controls of the company. For example, the internal auditors may be engaged to compare performance measures – including inventoryturnover and slow moving inventory ratios of individual supermarkets. (iv) The review of compliance with laws, other external regulations and corporate policies and directives. For example, internal auditors may be required to visit supermarkets throughout the chain to review compliance with health and safety laws and regulations. (Note: Full marks will be awarded for stating four activities as above and relevant examples or for stating any other appropriate activities and relevant examples). (d)

Three areas in the financial statements of a company, operating a supermarket chain, where an audit firm may need to rely on the work of an expert are: (i)

non-current assets – for example in the valuation of land and buildings.

(ii)

inventories – for example in the quantification or valuation of inventories held at supermarkets.

(iii) provisions – for example in the quantification of a legal claim against the company. (iv) investments – for example in the valuation of financial securities or other investments as appropriate. (Note: Full marks will be awarded for stating three areas from the above and any relevant examples or for stating other appropriate areas and examples)




The marking scheme generally indicates that 1 mark or 11/2 marks are awarded for each point. However, consideration should be given to the depth and relevance given by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 point whilst a detailed discussion could be worth up to a maximum of 2 points. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answer is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%. Rhodes Co 1

(a)

(b)

(c)

Stating THREE objectives of the internal controls that should be exercised over cash sales. Generally 1 mark per point up to a maximum of

(3 marks)

Explaining why the auditors of Rhodes Co could not rely on the controls exercised over sales income received. Generally up to 1 mark per point up to a maximum of

(7 marks)

Recommendation of SIX improvements to address the weaknesses in the controls. Generally up to 11/2 marks per point up to a maximum of

(9 marks)

Stating FOUR controls that Rhodes Co should employ over the subsequent recording and banking of sales income. Generally 11/2 marks per control, up to a maximum of (6 marks) (Total 25 marks)

Malaga Co 2

(a)

Stating FOUR benefits that Malaga Co should gain from using a computer-based accounting system. Generally 1 mark for each benefit up to a maximum of

(4 marks)

(b)

Stating SIX specific risks that the use of a computer-based accounting system poses to an entity’s internal controls. Generally up to 11/2 marks for each specific risk up to a maximum of (9 marks)

(c)

Explanation of the term ‘audit software’. Generally up to 11/2 marks per point up to a maximum of

(2 marks)

Describing FIVE functions performed by audit software. Generally up to 1 mark for each function described up to a maximum of

(5 marks)

(d)

Suggesting how each function (described) could be used by the auditors of Malaga Co when auditing the company’s financial statements. Generally up to 1 mark for each relevant suggestion up to a maximum of (5 marks) (Total 25 marks)


Paphos Co 3

(a)

Stating FOUR financial statement assertions made by the director of Paphos Co, in reporting wages costs of $1·62 million in the financial statements of the company for the year ended 30 September 2006. (6 marks) Generally up to 11/2 marks for each assertion up to a maximum of

(b)

Explain the following terms as applied to the audit sampling methods: (i)

Random Selection Generally up to 1 mark for each point up to a maximum of

(2 marks)

Haphazard Selection Generally up to 1 mark for each point up to a maximum of

(2 marks)

(iii) Systematic Selection Generally up to 1 mark for each point up to a maximum of

(3 marks)

(ii)

(c)

Stating SIX tests of control in connection with the audit of the reported wages costs. Generally up to 2 marks for each test stated up to a maximum of


Effective Audit Procedures 4

(a)

Identifying the stages of an audit, during which an audit firm should use analytical procedures and explaining the purpose of them. Generally up to 1/2 mark for identifying planning, detailed testing and final review stage up to a maximum of (11/2 marks) Then 1/2 mark for each relevant point with a maximum of 2 marks for each point up to a maximum of 2 marks for each stage up to a maximum of (41/2 marks)

(b)

Setting out the following (efficiency measure) accounting ratios: (i)

working capital turnover;

(ii)

average inventory turnover;

(iii) payment period for trade payables; (iv) total assets turnover; (v)

non-current assets turnover. Generally up to 1/2 mark for each component in each ratio up to a maximum of

(c)

(d)

(5 marks)

(i)

Identifying FOUR activities in which the internal audit department of a company operating a supermarket chain may be typically involved. Generally up to 1 mark for each activity up to a maximum of (4 marks)

(ii)

Providing a practical example for each activity above. Up to 1 mark for each example up to a maximum of

(4 marks)

(i)

Identifying THREE areas in the financial statements of a company, operating as a supermarket chain, when an audit firm may need to rely on the work of an expert. Generally up to 1 mark for each area identified up to a maximum of (3 marks)

(ii)

Providing a practical example for each area above. Up to 1 mark for each example up to a maximum of



(International Stream) ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL MONDAY 11 JUNE 2007


Paper T8(INT)




7J–INTPA Paper T8INT 7J–INTAA Paper T8INT


Olive Co is a large electrical goods wholesaler operating from a warehouse with a goods received area, and administration, purchasing and accounts departments. Your firm will audit the company’s financial statements for the year ending 31 July 2007. You have been assigned to the audit of the purchases and trade payables function of Olive Co and are now familiarising yourself with this prior to commencing the audit work. In discussions with your audit manager, he confirmed that Olive Co uses a batch control system when processing trade payables invoices and that the company has a strong control environment. Required: (a) (i)

Explain the term ‘control environment’.

(5 marks)

(ii) Describe the effect that a strong control environment in Olive Co should have on your firm’s approach to the audit of the company’s financial statements for the year ending 31 July 2007. (5 marks) (b) State THREE objectives of the internal control that should be exercised over a purchases and trade payables system. (3 marks) (c) With regard to the purchase of electrical goods by Olive Co, state the control activities that should exist over: (i)

Ordering of goods;

(ii) Receipt of goods; (iii) Receipt and authorisation of supplier invoices prior to batch processing. Note: Your answer should describe any appropriate documentation and related controls.



7J–INTAB Paper T8INT

2

Palm Co is a manufacturing company preparing its annual financial statements to 31 August. It is a longstanding audit client of your firm and since September 2006 it has increased its level of operations significantly, having recently opened a second factory in order to meet production demand. As a consequence of the growth in operations, the company’s internal control system and control activities have changed as compared to the previous year. The company relies on a year end inventory count as a basis for valuing inventories for inclusion in its financial statements. It also uses a bank overdraft facility which is secured on its assets. Your audit manager has asked you to suggest the general planning matters, together with any special matters in the case of Palm Co, that should be considered when planning the audit of the company’s financial statements for the year ending 31 August 2007. He has also asked you to consider the various methods by which your firm can record the company’s system of internal control, and also to consider how your firm may use Internal Control Questionnaires (ICQs) and Internal Control Evaluation Questionnaires (ICEQs) in the audit process. Required: (a) Identify and explain FOUR matters that your audit firm should consider when planning the audit of the financial statements of Palm Co for the year ending 31 August 2007. Note: Your answer should include matters specific to the company as well as general matters. (b) State THREE methods by which your firm may record the internal control system of Palm Co.


(c) Explain how an Internal Control Questionnaire (ICQ) differs in nature and design from an Internal Control Evaluation Questionnaire (ICEQ). (6 marks) (d) List FOUR key questions that should be included on an ICEQ relating to the purchases and trade payables system of Palm Co. (6 marks)

7J–INTAC Paper T8INT

(25 marks)

3

Ash Co is a small engineering company with 14 employees and has recently appointed your firm as its auditors. You attended the company’s year end inventory count on 31 May 2007 and ascertained that the company had a material amount of work-in-progress. Now, you are preparing to carry out the detailed audit work on the company’s financial statements to 31 May 2007. Two junior members of the audit team have asked you to explain the process for obtaining audit evidence. They are aware of ISA 500 Audit Evidence, and want to know the factors that will influence your firm’s judgement in deciding what will be sufficient appropriate evidence when auditing the financial statements of Ash Co. They are also unsure about the specific procedures your firm will use to obtain audit evidence. Required: (a) State THREE factors that generally influence an auditor’s judgement in deciding what will be sufficient appropriate evidence, commenting on their relevance to your firm’s audit of Ash Co. (6 marks) (b) Describe each of the procedures listed below, used to obtain audit evidence, and for each procedure give TWO examples of when it may be used during the audit of the financial statements of Ash Co. (i)

Observation;

(4 marks)

(ii) Inquiry;

(5 marks)

(iii) Confirmation;

(5 marks)

(iv) Reperformance.



[P.T.O.

7J–INTAD Paper T8INT

4

Beech Co is a computer software design company. Its directors recently approached the audit engagement partner of Oaks & Co, an audit firm, to appoint the firm as the company’s new auditors. At a brief meeting between the directors and the partner, the formalities of the audit appointment process, including a letter of engagement and auditors’ rights were discussed. The partner is now about to commence his client screening procedures with regard to Beech Co. Required: (a) (i)

Explain the purpose of carrying out client screening procedures.

(4 marks)

(ii) State SIX matters that the audit engagement partner of Oaks & Co should consider when screening Beech Co. (9 marks) (b) (i)

Explain the purpose of a letter of engagement.

(ii) State FIVE important matters that should be included in a letter of engagement.

(3 marks) (5 marks)

(c) State the rights that the new auditors of Beech Co should have with regard to: (i)

Access to records;

(ii) Information and explanations.




Answers


7J–INTIX Paper T8INT 7J–INTAA Paper T8INT


(a)

(i)

June 2007 Answers

The term ‘control environment’ refers to the overall attitude, awareness and actions of the directors and managers of an entity concerning the entity’s internal controls and its importance in the entity. The control environment influences the day to day activities of an entity. For example in an entity with a good control environment, where management take an active role in maintaining efficient internal controls, there is likely to be a disciplined and structured approach to performing day to day administrative and accounting tasks. Conversely an entity with a weak control environment is more likely to be less effective in performing such tasks. In addition to reflecting the function and operating style of the directors and managers, the control environment of an entity is also reflected in: – – – –

its personnel policies and procedures, including recruitment, retention and dismissal, the existence of an internal audit function, methods of assigning authority and responsibility, the segregation of duties in the performance of tasks.

(Full marks will be awarded to answers including points similar to above or other relevant points) (ii)

The existence of a strong control environment in Olive Co should have a positive effect on our approach to the audit of the company’s financial statements. In assessing the risk of material misstatement in the financial statements, my firm should be able to place more reliance on the internal controls of the company, than would be the case if the control environment was weak. Consequently, provided the results from tests of controls we carry out show that controls employed do meet desired objectives, we should be able to accept a higher level of detection of risk and thus carry out a reduced level of substantive procedures. (Full marks will be awarded to answers including points similar to the above or other relevant points).

(b)

The objectives of the internal controls that should be exercised over a purchases and trade payables system are to ensure that: (i)

Goods and services are procured in a timely manner.

(ii)

Goods and services are procured at the best possible price on the best possible terms.

(iii) Goods and services received in inferior condition or of inferior quality are rejected or are accepted on negotiated terms. (iv) Invoices are accepted only for goods and services received for the benefit of the entity. (v) (c)

All liabilities pertaining to goods and services received are properly recorded in the accounting records of the entity.

Control activities should exist as follows: (i)

Ordering of electrical goods (1) Goods should be ordered only by responsible officers in the company’s purchasing department, from suppliers who have been authorised to supply Olive Co by the purchasing manager. The company should ensure that each responsible officer’s purchasing authority is appropriate given the level of their experience and qualifications. (2) All orders should be supported by official, pre-numbered multipart, company purchase order stationery raised and authorised in the purchasing department. Strict physical control should be maintained over this stationery, to ensure that unauthorised orders are not placed with suppliers. (3) Purchase orders raised should provide full order details including the date of the order, supplier name and address, description of goods and quantity, price, delivery address, expected delivery date, general ledger code posting reference, and the authorising signature of the responsible officer. Orders should be forwarded directly from the purchasing department to suppliers with a copy being retained and further copies being forwarded to Olive Co’s goods received area and accounts department.

(ii)

Receipt of electrical goods (1) Copy of the purchase orders received in the goods received area from the purchasing department, should be filed in numerical sequence, awaiting delivery of goods. These should be reviewed regularly and any orders on which there appear to be undue delays in delivery should be referred back to the purchasing department for follow up with suppliers. (2) Goods delivered should only be accepted against authorised purchase orders, and should be inspected for quantity, quality and condition by appropriately experienced staff. (3) Goods accepted should be recorded on securely stored pre-numbered, multi-part goods received notes, by the inspection personnel. These should indicate the date of receipt, the purchase order number, details of goods received and should be signed as approved by the inspection personnel. Goods received notes should then be forwarded to the accounts department for subsequent matching to purchase orders and supplier invoices. A copy of each goods received note issued, should be retained in sequential order in the goods received area for reference. (4) Separate procedures, including the use of multi-part goods returned note stationery, should be employed to control the return of goods, for any reason to suppliers.


7J–INTAA Paper T8INT

(iii) Receipt and authorisation of supplier electrical goods invoices prior to batch processing (1) All invoices received by Olive Co should be forwarded to the accounts department and logged in an invoice register as received, prior to detailed checking procedures. The register should be subsequently updated to indicate the whereabouts of the invoices in the system. (2) Invoices should then be matched with and checked against numerically filed copy purchase orders and goods received notes, by accounting personnel, prior to being forwarded to the purchasing department for authorisation. (3) Invoices relating to goods received and retained but on which there appear to be discrepancies (for example casting errors), or which relate only to partially completed orders, should be highlighted as such by accounts personnel prior to being forwarded to the purchasing department. (4) Invoices relating to goods that have been returned should be subject to separate control procedures including, where appropriate, the issue of authorised internal debit notes to supplier accounts – thus minimising the possibility of erroneous payments. (5) Matched invoices received by the purchasing department, should be checked to underlying documentation including the appropriate general ledger posting code and any discrepancies should be resolved prior to authorisation for payment by a responsible senior official. This official should not have had any direct involvement in the ordering process. Authorised invoices should then be returned to the accounts department to be prepared for batch processing. (6) The supplier invoice register, unmatched order file and unmatched goods received role file in the accounts department should be regularly reviewed by a responsible official and any undue delays in processing should be followed up.


(Full marks will be awarded to answers including points similar to the above or other relevant points)

2

(a)

The following matters should be considered when planning the audit of Palm Co’s financial statements for the year ending 31 August 2007. (i)

Specific issues arising from the previous year’s audit. A review of the previous year’s working papers should indicate any audit matters arising that are likely to impact on this year’s audit. For example, high inherent risk areas from the previous year are likely to present similar risk profiles this year.

(ii)

Major changes in the company’s operations. The significant growth experienced by Palm Co, together with the change in the internal control system will have a major impact on audit planning. As a consequence my firm will need to consider the additional audit resources required to carry out an efficient and effective audit on a company with a larger scale of operations. The requirement to ascertain, record and evaluate the company’s new internal control system will also need to be considered.

(iii) Timing requirements. We will need to liaise with the company’s management to prepare a timetable for the completion of our audit. The timetable should set out the agreed dates of our attending the company to carry out our work. This should include dates for inventory count attendance, the date draft financial statements will be available for audit and the date by which the company requires us to issue our audit report. Our planning procedures should include the issue of a timetable for our work, agreed by the directors of Palm Co. (iv) A review of interim or management accounts prepared by the company. Our firm should review a copy of any accounts already prepared during the year to date, in order to gain an insight into Palm Co’s performance and any matters arising which could have audit significance. For example a build up of longstanding trade receivables balances could indicate the existence of bad debts not recognised by Palm Co. (v)

Problems encountered during the year. We should meet senior management of Palm Co to identify and discuss any problems encountered by the company during the year which could impact on our audit work. For example, discussions may reveal significant repairs and maintenance expenditure was incurred following the continual breakdown of old plant and machinery. Similarly management may update us with the outcome of discussions they may have recently had to renew the company’s overdraft facility.

(vi) Changes in legislation or accountancy practice. Palm Co’s manufacturing activities are likely to be subject to stringent legislative requirements including health and safety regulations. Similarly the financial complexities involved in the day to day operations of the company are likely to require careful monitoring, to ensure that the company’s financial reporting function accords with the relevant contemporary accounting standards. My firm should consider any recent changes in legislation or accounting practice relevant to Palm Co. (vii) Work to be carried out by the client’s staff. Involvement of Palm Co’s staff in preparing/supplying reconciliation and analysis schedules (for example ageing of trade receivable balances), should facilitate a more efficient audit. Whilst we will still need to carry out specific procedures to verify information on such schedules, the provision of them should save time freeing audit resources to concentrate on more complex tasks. In order to determine the extent of assistance our firm can expect to receive from the staff at Palm Co, we should liaise with the company’s management.



(viii) Audit staffing. My firm should give careful consideration to the make up of the audit team, ensuring there is an adequate balance between the number of employees to be assigned to the audit, their experience and the fee chargeable to Palm Co for carrying out the audit work. When assigning audit staff, due consideration should be given to other commitments within the firm, staff availability and work experience training issues. (Full marks will be awarded for identifying any FOUR of the above or other relevant matters). (b)

My firm may record the internal control system of Palm Co by employing any of the following methods: (i)

Narrative Notes

(ii)

Flow Charts

(iii) Internal Control Questionnaires or check lists (iv) Organisation Charts (Full marks will be awarded for stating any THREE of the above). (c)

An Internal Control Questionnaire (ICQ) normally comprises a checklist of standard controls that should exist in a specified functional area (for example sales and trade receivables or purchases and trade payables). Questions about the existence of specified controls are usually phrased to generate a ‘Yes’ or a ‘No’ answer, with an affirmative answer confirming the existence of the control and a negative answer indicating the absence of the control and a weakness in the system. A problem associated with ICQs is that whilst they do identify areas where controls appear to be weak, they do not provide evaluation of those weaknesses. For example, whilst a ‘No’ answer may indicate weakness in controls, it is possible that other controls in the system, of which the auditor is unaware, may compensate for the weakness. Internal Evaluation Questionnaires (ICEQs) provide an alternative and improved means of evaluating control systems, by asking key questions about those systems. Key questions are phrased such that answers in the positive should alert the auditor to the fact that there are deficiencies in the systems because systems objectives are not being met. ICEQs are usually designed to include a list of points that the auditor should consider before answering each key question.

(d)

The following key questions should be included on an ICEQ relating to the purchases and trade payables system: (i)

Can liabilities be recorded for goods or services not received by the company?

(ii)

Can unauthorised goods be ordered?

(iii) Can unauthorised goods be accepted? (iv) Can liabilities be incurred but not recorded? (v)

Can liabilities be over or understated?

(vi) Can trade payable accounts be improperly debited or credited? (vii) Can unsupported payments be made to suppliers? (viii) Can charges be allocated to the incorrect general ledger account?


(Full marks will be awarded for listing FOUR of the above or other relevant questions).

3

(a)

The following factors will influence my firm’s judgement in deciding what will be sufficient appropriate evidence when auditing the financial statements of Ash Co. (i)

Knowledge of the company and the business environment in which it operates. As Ash Co is a new audit client, it is likely that we will need more evidence to arrive at our audit conclusion than we would otherwise need for a similar longstanding audit client, in respect of whom we had built up a cumulative knowledge base.

(ii)

The assessment of audit risk. This will depend on our evaluation of inherent risk factors, of the company’s control environment and of its internal control system. Ash Co is a small company and possibly has elements of a strong control environment. However, given the low number of employees it is likely that there is a lack of segregation of duties in its accounting system. In such circumstances we would need to obtain additional audit evidence from extended substantive procedures.

(iii) The nature and materiality of the item being tested. Generally the more complex and material an item is, then the more evidence will be required to arrive at an audit conclusion in respect of that item. For example, the valuation of work-inprogress held by Ash Co at 31 May 2007 is complex because it should include an appropriate amount of overhead cost. Given that the work-in-progress value is also material, a substantial amount of audit evidence will probably be required to support the valuation. (iv) The persuasiveness of audit evidence obtained. This will be governed by the source and reliability of it. For example, in determining the likelihood of recovering a long standing debt from a customer, my firm will place more reliance on documentation relating to the debt (e.g. correspondence from the customer or legal representatives) than on an optimistic assertion, from a manager of Ash Co, that the debt is recoverable.



(v)

Findings from audit procedures. If our audit work, with regard to Ash Co reveals fraudulent activity or extensive errors and omissions with regard to the accounting records, we may conclude that extensive substantive procedures are required in order to reduce audit risk. (Full marks will be awarded for stating any THREE of the above or other relevant factors).

(b)

(i)

Observation Observation consists of looking at a process or procedure being performed by others. Examples Watching the opening of the mail to ensure that there is adequate control over ‘money’ payments received through the post. Watching Ash Co’s physical inventory count to ensure that proper control and counting procedures are being followed.

(ii)

Inquiry Inquiry consists of seeking information of knowledgeable persons both financial and non-financial, throughout the entity or outside the entity. Examples Speaking to the directors of Ash Co to obtain information about the company’s depreciation policy. Writing to the company’s legal advisers to determine the existence of any legal claims outstanding against Ash Co.

(iii) Confirmation Confirmation, which is a specific type of inquiry, is the process of obtaining a representation of information or of an existing condition directly from a third party. Examples Writing a letter to Ash Co’s bank to obtain confirmation of the company’s bank account balances at the balance sheet date. Circularisation of a sample of Ash Co’s suppliers during the period to confirm the existence of trade payables balances at the balance sheet date. (iv) Reperformance Reperformance is the auditor’s independent execution of procedures or controls that were originally performed as part of the entity’s internal control. Examples Reperforming the extraction of a trial balance from the company’s general ledger. Using computer assisted audit techniques to re-perform the ageing of accounts receivable balances.

7J–INTAD Paper T8INT

(Full marks will be awarded for providing examples as above or any other relevant examples).

4

(a)

(i)

The purpose of client screening procedures is to determine whether the prospective client is suitable for the firm. Following the procedures, in arriving at the decision as to whether to accept an audit appointment the firm should evaluate the potential risk to the firm of acceptance. When a client is deemed to represent a high audit risk to the firm, the firm should carefully consider the implications arising should it fail in meeting its objective of giving an accurate audit opinion. If the firm is not confident that the benefit to be derived from accepting the appointment outweighs the potential risks (including financial and reputational risk of being sued), then the firm should decline the appointment.

(ii)

The audit engagement partner of Oaks & Co should consider the following matters: – – – – – – – – –

The state of the computer software design commercial sector and prospects for businesses engaged in it. The reason for the resignation/removal of the company’s previous auditor. The extent to which previous years’ audit reports relating to Beech Co have been qualified. The experience and qualifications of the company’s management and their attitude towards control environment issues. The current operating and financial position of the company. The directors’ understanding of the role of the external auditor. The availability of adequate audit resources within the firm to carry out an effective audit on Beech Co’s financial statements. The accounting policies used by Beech Co. Indications that Beech Co or its management may be engaged in fraudulent activity.

(Full marks will be awarded for stating SIX of the above or other relevant matters).


7J–INTAA Paper T8INT

(b)

(i)

A letter of engagement helps to avoid misunderstandings between the auditors and client as to the nature of the auditors’ appointment, the scope of the audit work to be carried out and the respective responsibilities of the auditors and the client. It forms the basis of the contract between the auditors and the client.

(ii)

The following important matters should be included in a letter of engagement: – The objective of the audit of financial statements; – Management’s responsibility for the financial statements; – The scope of the audit, including reference to applicable legislation, regulations, or pronouncement of professional bodies to which the auditor adheres; – The form of any reports or other communication of results of the engagement; – The fact that because of the test nature and other inherent limitations of internal controls, there is an unavoidable risk that material misstatements may remain undiscovered; – Unrestricted access to whatever records, documentation and other information requested in connection with the audit; – Arrangements regarding the planning and performance of the audit; – Expectation of receiving from management written confirmation concerning representations made in connection with the audit; – Request for the client to confirm the terms of engagement by acknowledging receipt of the letter; – Description of any other letters or reports the auditor expects to issue to the client; – Basis on which fees are computed and any billing arrangements. (Full marks will be awarded for stating any FIVE of the above matters).

(c)

The new auditors of Beech Co will have the following rights with regard to: (i)

Access to Records A right of access at all times to the books, records, accounts and documents of the company.

(ii)

Information and explanations A right to require from the company’s officers such information and explanations as they think necessary for the performance of their duties as auditors.


7J–INTMS Paper T8INT



The marking scheme generally indicates that up to 2 marks may be awarded for relevant points. Consideration should be given to the depth and relevance given by each candidate when answering the question; for example, if only a brief explanation is given then it may only be worth 1/2 mark whilst a detailed discussion could be worth up to a maximum of 2 marks. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answers is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%. Olive Co 1

(a)

(i)

Explanation of the term control environment. Generally 1 mark per point up to a maximum of

(ii)

(5 marks)

Describing the effect that a strong control environment in Olive Co should have on my firm’s audit approach. Generally up to 1 mark per point up to a maximum of

(b)

(5 marks)

Stating three objectives of the internal control that should be exercised over a purchases and trade payables system. Generally 1 mark per objective up to a maximum of

(c)

(3 marks)

Stating the control activities that should exist over the specified parts of Olive Co purchases and trade payables system. Generally 1 mark per point, up to a maximum of 6 marks for each specified part up to an overall maximum of (12 marks) (Total 25 marks)

Palm Co 2

(a)

(b)

Identifying and explaining four matters that should be considered when planning the audit of the financial statements of Palm Co for the year ending 31 August 2007. Generally 1/2 mark for identifying each specific matter and up to 2 marks for explanation thereof up to a maximum of (10 marks) Stating three methods by which firm may record the internal control system of Palm Co. Generally up to 1 mark per method up to a maximum of

(c)

Explanation of how an ICQ differs in nature and design from an ICEQ. Generally up to 1 mark per point up to a maximum of

(d)

(3 marks)

(6 marks)

Listing four key questions that should be included on an ICEQ. Generally up to 11/2 marks per question up to a maximum of



7J–INTMS Paper T8INT

Ash Co 3

(a)

Stating three factors that generally influence an auditor’s judgement in deciding what will be sufficient appropriate evidence and commenting on their relevance to Ash Co. For stating relevant factor, generally 1 mark per factor up to a maximum of

(3 marks)

For stating relevance to Ash Co of each factor. Generally up to 1 mark per point up to a maximum of (b)

(3 marks)

Description of each of the following procedures, used to obtain audit evidence: Observation Up to

(1 mark)

Inquiry, Confirmation, Reperformance Up to 1 mark per point up to a maximum of 2 marks for each procedure with overall maximum of

(6 marks)

Providing two examples of when each of the above procedures may be used during the audit of the financial statements of Ash Co. Generally up to 11/2 marks per example up to a maximum of (11/2 × 8))


Beech Co 4

(a)

(i)

Explaining the purpose of carrying out client screening procedures. Generally up to 1 mark per point up to a maximum of

(ii)

Stating six matters that the audit engagement partner should consider when screening Beech Co. Generally up to 11/2 marks per example up to a maximum of

(b)

(i)

(3 marks)

Stating five important matters that should be included in a letter of engagement. Generally up to 1 mark per point up to a maximum of

(c)

(9 marks)

Explaining the purpose of a letter of engagement. Generally up to 1 mark per point up to a maximum of

(ii)

(4 marks)

(5 marks)

Stating the rights that the new auditors of Beech Co should have with regard to: (i)

Access to records – up to

(2 marks)

(ii)

Information and explanations – up to



Implementing Audit Procedures (International Stream) Monday 10 December 2007

Time allowed Reading and planning: Writing:

15 minutes 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor.

Paper T8 (INT)

Certified Accounting Technician Examination Advanced Level

This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants



Starling Co manufactures a range of vacuum cleaners, operates from large factory premises and prepares its annual financial statements to 31 January. It has a stores area from which raw materials and parts are issued to production, and a finished goods store. In recent months the company has encountered severe difficulties in controlling its inventory resulting in losses, stopped production due to the shortage of parts and incorrect valuation of inventory. The company has been using a system of continuous inventory checking (also known as a ‘perpetual inventory system’) as a means of control, but the directors recognise that the system has failed during the current year. Consequently they have agreed that company employees will carry out a physical inventory count as at 31 January 2008, as a basis for valuing inventory for inclusion in the company’s annual financial statements. The directors have also agreed to seek advice from your audit firm in connection with the introduction of a satisfactory system of continuous inventory checking to be introduced from February 2008 and also in connection with the valuation of inventory. Required: (a) State FIVE objectives of the internal controls that should be exercised over inventory, including inventory records. (5 marks) (b) State FIVE procedures that Starling Co will need to incorporate in its revised continuous inventory checking system, if it is to be relied upon by the company’s auditors. (5 marks) (c) Describe SIX matters that should be covered by the physical inventory count instructions to facilitate an efficient and reliable count as at 31 January 2008. (9 marks) (d) (i)

Define the term ‘cost’ as applied to inventory;

(ii) Define the term ‘net realisable value’ as applied to inventory;

(2 marks) (2 marks)

(iii) State how Starling Co should value its inventory as at 31 January 2008 in accordance with IAS2 Inventories. (2 marks) (25 marks)


2

Finch Co operates eight hotels in various locations around the country. The following information relates to the company’s operations during the year ended 30 November 2007. (1) Following career moves by the ex-managing director and the ex-financial director, two replacement directors were appointed in February 2007. The new managing director has extensive experience of working in the hotel sector and adopts an aggressive management style whilst the new financial director is an unqualified accountant with only limited experience in the hotel sector. (2) The company’s directors, central administration and accounts department are located at its head office premises and wages payments to all employees together with all company supplier payments are made from there. Accounts staff at each hotel deposit hotel takings into the company’s bank account at their local branch of the bank. (3) The company’s accounting system, which comprises fully integrated general, trade payables and trade receivables ledgers, relies on daily sales and accounting information being input into remote terminals at each hotel, for transfer to a secure central computer based in the head office accounts department. The new financial director has changed some of the general controls of the system including those relating to the use of the remote terminals. (4) The company operates a cash or bank card payment policy for non-corporate customers with credit terms being offered only to corporate customers. (5) The remuneration package of each of the company’s directors provides for the payment of a bonus based on the profits of the company. Similarly, the remuneration package of each hotel general manager provides for a bonus based on the profits of their hotel. (6) Independent contractors were employed to construct a new hotel on land already owned by the company. Work commenced in January 2007 and the new hotel began trading in November 2007. (7) Each hotel offers restaurant, gym, conference and meeting facilities. The company owns all of the hotels’ land and buildings. During the year, two of the hotels were extended substantially to create additional restaurant space, whilst a swimming pool was constructed at another. (8) In keeping with the company policy, all hotels are furnished and equipped similarly with ongoing repairs, maintenance and replacement programmes for furnishings and equipment. (9) In September 2007, food poisoning at one of the company’s largest hotels resulted in hospital admission for eight of the hotel’s customers. The directors of Finch Co have received legal advice confirming that the company is likely to have to pay compensation to settle the legal claims that have been lodged against it in this regard. Required: (a) Explain the meaning of the term ‘inherent risk’.

(2 marks)

(b) State with reasons FIVE factors that would affect the initial assessment of the inherent risk associated with the audit of the financial statements of Finch Co for the year ended 30 November 2007. (15 marks) (c) Explain what is meant by the term ‘general controls’ as applied to a computer-based accounting system and state the objectives of such controls. (4 marks) (d) State FOUR general controls that should exist to prevent unauthorised access to Finch Co’s computer system from the remote terminals located at each hotel. (4 marks) (25 marks)


[P.T.O.

3

Your firm is the auditor of Owl Co, a small precision engineering company which makes parts for car engines. The company maintains a general ledger, together with trade receivables and trade payables ledgers. It also maintains a non-current assets register. You have been assigned to the audit of the company’s financial statements for the year ended 30 November 2007 and are aware that: (1) In May 2007 the company disposed of a large lathe machine for $30,000 and replaced it by purchasing two small but costly machines. (2) The company’s trade receivables ledger included several customers, with large credit balances on their accounts as at 30 November 2007. (3) Throughout the year the company’s cashier has been responsible for bank payments, the receipt and banking of trade receivables monies and the recording of all bank transactions in the company’s accounting records. As the cashier is a very trusted employee the company’s directors expect your firm to restrict its audit procedures in this area. (4) Your firm’s audit procedures will include checking a sample of Owl Co’s year-end supplier statement balances. Required: (a) (i)

Describe THREE audit tests your firm should carry out with regard to the disposal of the lathe machine;

(ii) Describe THREE audit tests that should be carried out with regard to the purchase of the two additional machines. (9 marks) (b) State FOUR possible causes as to why the credit balances could have arisen on customer accounts within the trade receivables ledger of Owl Co as at 30 November 2007. (6 marks) (c) Explain the extent of the substantive procedures your firm should carry out in the bank area of Owl Co. (5 marks) (d) Comment on the reliability of supplier statements as a source of audit evidence and state FOUR audit objectives of your firm checking a sample of Owl Co’s year-end supplier statement balances. (5 marks) (25 marks)


4

(a) At a recent seminar on audit independence, an auditor and ACCA member explained that his sister owned all of the share capital in Eagle Co and asked whether he should accept the appointment as auditor of the company. He is also the auditor of Robin Co, a company which rents out holiday cottages. The company has offered him free use of a cottage for a two-week period, which would normally cost $1,800 and the auditor is unsure whether to accept the offer. Required: (i)

State with reasons whether the auditor should accept the appointment as auditor to Eagle Co; (4 marks)

(ii) State with reasons whether the auditor should accept the offer of free holiday accommodation from Robin Co. (4 marks) (b) When carrying out audit sampling auditors need to consider whether to use statistical sampling. Required: (i)

Define the term ‘audit sampling’;

(2 marks)

(ii) State FOUR advantages of using statistical sampling rather than non-statistical sampling (judgemental sampling). (6 marks) (c) For recurring audits it is advisable to split working papers between permanent and current audit files, and in many firms working papers on the current audit file are automated. Required: (i)

List SIX examples of the working papers ordinarily contained in a current audit file;

(ii) State THREE advantages of using automated working papers.

(6 marks) (3 marks) (25 marks)



Answers


ACCA Certified Accounting Technician Examination – Paper T8 (INT) Implementing Audit Procedures (International Stream) 1

(a)


The objectives of the internal controls that should be exercised over inventory, including inventory records are to ensure that: (i)

Inventory records only include items that belong to the entity.

(ii)

Inventory records only include items that exist.

(iii) Inventory records only include items that are held by the entity. (iv) Inventory records are accurate. (v)

All movements of inventory are recorded.

(vi) Inventory is stored safely and securely. (vii) Inventory is valued correctly. (viii) Inventory quantities are maintained at efficient and economic levels. (Full marks will be awarded for stating five of the above or other objectives.) (b)

In order that the company’s auditors may rely on the company’s revised continuous inventory checking system Starling Co should ensure that: (i)

Inventory records are kept up to date.

(ii)

All inventory lines are counted at least once a year with higher value and desirable lines being counted more frequently.

(iii) The counting of inventory is carried out by suitably experienced independent individuals in a systematic and orderly manner. (iv) All corrections to inventory records are authorised by a responsible official of the company. (v)

Any material discrepancies noted between inventory records and physical quantities are investigated immediately and reported to management for immediate further follow up as appropriate.

(vi) There are satisfactory procedures with regard to cut-off and receipt/issue documentation at the time of inventory counts. (c)

The following matters should be covered in the instructions for the physical inventory count of Starling Co as at 31 January 2008: (i)

There should be adequate supervisory controls, with one individual assuming overall responsibility for the inventory count.

(ii)

Employees involved in the inventory count should be independent of those working in the stores and production areas, and counters should work in pairs with one counting inventory and the other recording and checking quantities counted.

(iii) Procedures should ensure that items are marked or tagged as ‘counted’ to avoid the possibility of double counting or omission. (iv) There should be adequate control over the issue and returning of inventory control sheets, possibly involving the use of pre-numbered sheets with returned sheets being agreed to issued sequences for completeness. (v)

Inventory sheets should be completed in ink and signed by the relevant individuals involved in the counting and recording process.

(vi) Movement of inventory during the count should be prohibited and a special quarantine area should be created in which to store any goods received. (vii) In order to minimise disruption to the production process, raw materials together with parts and finished goods inventories should be counted first with work-in-progress inventory being counted at the end of the working day. (viii) There should be stringent controls over cut-off issues with careful note being made of the number of the last goods received, goods returned and goods despatched and raw materials/parts issued notes prior to the inventory count. (ix) There should be adequate procedures to identify, count and record inventory that is slow moving or obsolete. (Full marks will be awarded for stating six of the above or other relevant matters.) (d)

(i)

Cost is defined as being that expenditure which has been incurred in the normal course of business in bringing the inventory to its present location and condition.

(ii)

Net realisable value is defined as the actual or estimated selling price (net of trade but before settlement discounts) less: – –

All further costs to completion All costs to be incurred in marketing, selling and distribution.

(iii) Starling Co should value its inventory at the lower of cost and net realisable value of the separate items of inventory or groups of similar items.


2

(a)

Inherent risk is the susceptibility of a financial statement assertion to a misstatement which could be material, individually or where aggregated with other misstatements, assuming that there were no related internal controls.

(b)

The factors that would affect the initial assessment of the inherent risk include: (i)

the geographic spread of the hotels operated by the company. The fact that each hotel has several income streams, in addition to accommodation and meals, combined with obvious expenditure requirements represents an inherent risk with regard to income and expenditure misstatement. The risk is increased significantly due to the distance of each hotel from the head office and accounts department of Finch Co.

(ii)

the existence of cash sales. Cash is a desirable and portable asset with high inherent risk of loss due to the possibility of misappropriation by dishonest individuals.

(iii) the appointment of a new unqualified financial director, with only limited hotel sector experience, during the year. This could impair the preparation of the financial statements of the company due to the adoption of incorrect accounting policies or the existence of material errors in the financial statements. (iv) the combination of an experienced and aggressive managing director with a potentially weak financial director. This could lead to undue pressure and influence being placed upon the financial director, by the managing director, to treat items incorrectly in the financial statements or not to include them in order to falsely represent the financial status of the company. (v)

the existence of profit related bonuses in the remuneration packages of the company’s directors and hotel general managers. This could lead individuals to overstate income, understate expenditure, or both, in order to increase reported profits for personal gain.

(vi) the construction of a new hotel during the year. Such a project would involve significant levels of expenditure by the company. Inherent risk would centre around the correct disclosures in the company’s financial statements as to capital expenditure and revenue expenditure and completeness of recording of any outstanding liabilities relating to the construction. (vii) expenditure during the year on new restaurant and swimming pool facilities. Whilst the majority of this expenditure would be of a capital nature, it is likely that some would be categorised as revenue (repairs & maintenance) expenditure. There is an inherent risk that material amounts of expenditure may have been incorrectly categorised in the company’s financial statements. (viii) the existence of ongoing repairs, maintenance and replacement programmes for furnishings and equipment. As with (vii) above, inherent risk considerations will focus on the possibility that capital and revenue expenditures have been categorised incorrectly in the company’s financial statements. (ix) the existence of small valuable and desirable non-current asset items. The nature of the hotel business is such that plant and equipment items owned by the business are open to loss due to misappropriation or theft by dishonest individuals. This would represent an increased inherent risk in the area of non-current assets of the financial statements. (x)

compensation claim arising from food poisoning at a company hotel. The inherent risk associated with this event is twofold. Firstly there is a risk that the provision included in the financial statements for the payment of compensation will be materially misstated. Secondly there is the risk (possibly remote) that the food poisoning event may have a catastrophic effect on the reputation of the company’s hotels generally, resulting in a downturn of activity. As such it is possible that the company was not a ‘going concern’ at the balance sheet date and there is a consequent risk that this fact is not reflected in Finch Co’s financial statements as at 30 November 2007.

(c)

General controls as applied to a computer-based accounting system are policies and procedures that relate to the application and support the effective functioning of applications controls by helping to ensure the continuous proper operations of information systems. Examples of such controls include those over data centres and network operations, systems software acquisition, change and maintenance, access security; and application systems acquisition, development and maintenance. The objectives of general controls are to ensure the proper development and implementation of applications, and the integrity of program and data files, and of computer operations.

(d)

General controls that should exist to prevent unauthorised access to Finch Co’s computer systems from the remote terminals located at each hotel include: (i)

ensuring that the facilities of each hotel terminal allow only for the forwarding of specified accounting information to the central computer system.

(ii)

Disallowing any access (read or amend) by hotel terminals to files held on the central computer system.

(iii) Restricting physical access to computer facilities by locating terminals at each hotel in a secure room. (iv) The use of passwords to ensure that only authorised employees gain access to computer facilities. (v)

Rigid controls over the issue and protection of passwords.

(vi) Restricting access from computer terminals to the main computer to specified times convenient to the head office accounts personnel for the receipt of information.


(vii) The use of a log at each terminal to record the password identity of each user and the time of access. (Note: Full marks will be awarded for stating any four of the above or other relevant controls.)

3

(a)

My firm should carry out the following tests: (i)

Disposal (1) check authorising documentation to ensure that the disposal was appropriately authorised and for proceeds of $30,000. (2) examine the sales documentation relating to the disposal and ensure that the sale details match those in the authorising documentation. (3) check that accounting entries with regard to documentation are recorded correctly in the general ledger with credit being made to non-current assets disposal account. (4) check accounting entries in the non-current assets register and general ledger relating to disposal ensuring correct removal from non-current assets account (credit) and opposite entries in non-current assets disposal account. Also check validity of entries relating to accumulated depreciation. (5) check calculations of profit/loss on disposal and corresponding entries in income statement. (Note: Three marks will be awarded for describing any of the above or other relevant audit tests.)

(ii)

Additions (1) check authorising documentation to ensure that additions were appropriately authorised. (2) check cost information from purchase invoice/purchase documentation. (3) check accounting entries in non-current assets register and general ledger with regard to cost of additions. (4) check that useful life on which depreciation rates have been based is reasonable. (5) check accuracy of depreciation charge. (6) ensure existence of new machines by physically verifying at balance sheet date. (Note: Three marks will be awarded for describing any of the above or any other relevant audit tests.)

(b)

Possible reasons for the credit balances on customer accounts include: (i)

payment being received from the customer in advance of supply being made by Owl Co.

(ii)

duplicated payment of an invoice from Owl Co.

(iii) omission of posting of an invoice to the specified customer account. (iv) incorrect posting of an invoice from Owl Co to another customer account. (v)

incorrect posting of payment received from another customer of Owl Co to the specified customer account.

(vi) incorrect posting of a credit note or journal credit to the specified customer account. (vii) posting of a credit note to the specified customer account in lieu of goods paid for, being returned. (viii) posting of a credit note to the specified customer account on settlement of dispute. (Note: Full marks will be awarded for stating any four of the above or other possible causes.) (c)

In order to minimise audit risk our firm should carry out extensive substantive procedures in the bank area. This is due to the high inherent risk factor associated with bank transactions and the fact that Owl Co’s internal control in this area is fundamentally weak. Irrespective of the point that the cashier may be a very trusted employee of the company: the lack of segregation of duties in the bank payments, bank receipts and recording functions is of a particular concern. The fact that these functions are not segregated, considerably increases the possibility of undetected fraud and error. Consequently, in directing additional audit resources to substantive procedures in this area, my firm would be seeking to reduce the detection risk with regard to fraud and error.

(d)

Evidence obtained from Owl Co’s supplier statements is from a reliable source of audit evidence because the suppliers represent an independent source outside of Owl Co. Consequently by checking year-end supplier statement balances, my firm would seek to obtain reliable evidence in connection with the audit objectives of confirming: (i)

completeness of payables – omissions from trade payable balances may become apparent following a comparison of statement balances and trade payables ledger balances.

(ii)

existence of trade payables balances – supported by equivalent balances on supplier statements.

(iii) the valuation of trade payable balances – supported by equivalent balances on supplier statements. (iv) confirmation that liabilities recorded in the trade payables ledger pertain to Owl Co – in this regard supplier statements should be addressed to the company.


4

(a)

(i)

Auditors must be independent and be seen to be independent at all times in connection with their professional work. ACCA’s Code of Ethics and Conduct sets out an auditor’s responsibility with regard to accepting an audit appointment to a company in which a member or their close family has a direct or material financial interest. The Code confirms that in such circumstances there is a threat to the independence in terms of familiarity and that therefore such an appointment should not be accepted. The relationship between the auditor in question and his sister who owns all of the share capital in Eagle Co, is one of a close family relationship. It therefore follows that the auditor should not accept the audit appointment.

(ii)

As in (i) above, with regard to their professional work, auditors must be independent and be seen to be independent at all times. ACCA’s Code of Ethics and Conduct provides guidance with regard to the acceptance of an offer of gifts or hospitality from audit clients, indicating that such an offer, if it has significant value, may compromise the auditor’s objectivity because it represents a threat to independence due to the self-interest threat. The Code confirms gifts or hospitality should only be accepted if the value of any benefit is modest, and therefore does not present a threat to objectivity. The value of the free holiday accommodation offered to the auditor of Robin Co is $1,800. This is clearly of significant value and, irrespective of the company’s motivation for making the offer, would represent a threat to the objectivity and independence of the auditor. The auditor should therefore politely refuse the offer.

(b)

(i)

‘Audit sampling’ is the application of audit procedures to less than 100% of the items within an account balance or class of transactions (a population) to enable the auditor to obtain and evaluate audit evidence about some characteristic of the item selected in order to form, or assist in forming, a conclusion concerning the population.

(ii)

The advantages of using statistical sampling rather than judgemental sampling (non-statistical sampling) include: (1) the size of the sample is determined objectively having regard to the degree of risk associated with the area being tested. (2) bias is eliminated. (3) results of statistical sampling can be more easily justified as being representative of the population as a whole, thus increasing the level of confidence in the results of testing the sample. As a consequence of this, the conclusion drawn from the results of sample testing are more easily justified where an audit client disputes the audit conclusions. (4) The emphasis on risk assessment by the auditor in the determination of the sample size encourages the auditor to concentrate on significant issues (for example a high degree of control risk), which may not otherwise be considered. (5) In instances when there is a large population, the use of statistical sampling techniques may reduce the sample size, and therefore the amount of audit work required, as compared to the sample size that would be selected using judgement sampling methodology. (6) The auditor may justifiably conclude with a definite level of confidence that the conclusions drawn from the sampling test is within stated precision limits. (Full marks will be awarded for stating four of the above or other advantages of using statistical sampling techniques.)

(c)

(i)

Examples of the working papers ordinarily contained in a typical current audit file include: – – – – – – – – – – – – – –

Evidence of the planning process including audit programmes and any changes thereto. Evidence of the auditor’s consideration of the work of internal auditing and conclusions reached. Analyses of transactions and balances. Analyses of significant ratios and trends. The identified and assessed risks of material misstatements at the financial statement and assertion level. A record of the nature, timing and extent of audit procedures performed in response to risks at the assertion level and the results of such procedures. Evidence that the work performed by assistants was supervised and reviewed. An indication as to who performed the audit procedures and when they were performed. Details of audit procedures applied regarding components whose financial statements are audited by another auditor. Copies of communications with other auditors, experts and other third parties. Copies of letters or notes concerning audit matters communicated to or discussed with management or those charged with governance, including the terms of the engagement and material weaknesses in internal control. Letters of representation received from the entity. Conclusions reached by the auditor concerning significant aspects of the audit, including how exceptions and unusual matters, if any, disclosed by the auditor’s procedures were resolved or treated. Copies of the financial statements and auditor’s report.

(Full marks will be awarded for listing six of the above or other relevant examples.)


(ii)

The advantages of using automated working papers include: –

Working papers should be neater thus facilitating the review process.

–

Where changes need to be made to working papers including those to summary schedules, automatic updating facilities should result in time savings and audit effort.

–

The risk of error is reduced, for example in the casting of numeric schedules.

–

Standard working paper stationery can be downloaded from remote locations at clients’ premises thus reducing the need to transport voluminous files and papers.

–

As completed working papers can be transmitted (for example via a modem) back to the audit office for review, there is a reduced requirement for supervising visits to clients’ premises. This can result in considerable time and cost savings. (Full marks will be awarded for stating three of the above or other advantages.)


ACCA Certified Accounting Technician Examination – Paper T8 (INT) Implementing Audit Procedures (International Stream)


The marking scheme generally indicates that 1 mark or 11/2 marks are awarded for each point. However, consideration should be given to the depth and relevance given by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 point whilst a detailed discussion could be worth up to a maximum of 2 points. Generally, marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answer is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%. 1

(a)

Stating FIVE objectives of the internal controls that should be exercised over inventory. Generally 1 mark per objective up to a maximum of

(b)

(5 marks)

Stating FIVE procedures that Starling Co will need to incorporate in its revised continuous inventory checking system. Generally up to 1 mark per procedure up to a maximum of

(c)

(5 marks)

Describing SIX matters that should be covered by the physical inventory count instructions to facilitate an efficient and reliable count. Generally up to 11/2 marks per matter up to a maximum of

(d)

(i)

(9 marks)

Definition of cost. Generally 1/2 mark per point up to a maximum of

(ii)

(2 marks)

Definition of net realisable value. Generally 1/2 mark per point up to a maximum of

(2 marks)

(iii) Stating how Starling Co should value its inventory as at 31 January 2008. Generally 1/2 mark per point up to a maximum of


2

(a)

Explanation of the term ‘inherent risk’. Generally 1/2 mark per point up to a maximum of

(b)

(2 marks)

Stating with reasons FIVE factors that would affect the initial assessment of inherent risk associated with the audit of the financial statements of Finch Co for the year ended 30 November 2007. Generally up to 1 mark for identifying each factor up to a maximum of (1 x 5)

(5 marks)

Up to 2 marks for stating reasons why each factor would affect the initial assessment of the inherent risk associated with the audit, with a maximum of (2 x 5) (10 marks) (c)

(d)

Explanation of what is meant by the term ‘general controls’ as applied to a computer-based accounting system. Generally 1/2 mark per point up to a maximum of

(21/2 marks)

Stating the objectives of general controls

(11/2 marks)

Stating FOUR general controls that should exist to prevent unauthorised access to Finch Co’s computer systems from the remote terminals located at each hotel. Generally up to 1 mark per control up to a maximum of



3

(a)

Describing THREE audit tests with regard to the disposal of the lathe machine and THREE audit tests with regard to the purchase of the two additional machines. Generally up to 11/2 marks per test up to a maximum of (11/2 x 6)

(b)

Stating FOUR possible causes as to why credit balances could have arisen on customer accounts. Generally up to 11/2 marks per cause up to a maximum of (11/2 x 4)

(c)

(9 marks)

(6 marks)

Explaining with reasons the extent of substantive procedures the audit firm should carry out in the bank area of Owl Co. Explaining risk associated with lack of segregation of duties Generally 1/2 mark per point up to a maximum of

(21/2 marks)

Explanation of other points. (21/2 marks)

Generally up to 1 mark per point up to a maximum of (d)

Brief comment on the reliability of supplier statements as a source of audit evidence.

(1 mark)

Stating FOUR audit objectives of checking a sample of Owl Co’s year-end supplier statements. Up to 1 mark for each objective up to a maximum of (1 x 4)


4

(a)

(i)

Confirming that auditor should not accept the audit appointment to Eagle Co.

(1 mark)

Mention of ACCA’s Code of Ethics and Conduct

(1 mark)

Other commentary. Generally 1/2 mark per point up to a maximum of (ii)

(2 marks)

Confirming that auditor should not accept the gift from Robin Co.

(1 mark)

Mention of ACCA’s Code of Ethics and Conduct

(1 mark)

Other commentary.

(b)

Generally 1/2 mark per point up to a maximum of

(2 marks)

(i)

Definition of the term ‘audit sampling’.

(2 marks)

(ii)

Stating FOUR advantages of using statistical sampling. Generally up to 11/2 marks per stated advantage up to a maximum of (11/2 x 4)

(c)

(i)

Listing SIX examples of the working papers ordinarily contained in a current audit file. Generally up to 1 mark per example up to a maximum of (1 x 6)

(ii)

(6 marks)

(6 marks)

Stating THREE advantages of using automated working papers. Generally up to 1 mark per stated advantage up to a maximum of (1 x 3)



Implementing Audit Procedures (International Stream) Monday 9 June 2008


15 minutes 3 hours


Do NOT open this paper until instructed by the supervisor.

Paper T8 (INT)


During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.




Peach Co is a manufacturing company employing 190 production employees, all of whom are paid through the company’s monthly wages system by bank credit transfer. The following controls are exercised over the system, with regard to the recruitment and payment of employees. (1) Potential employees are interviewed by the production manager who forwards the details of successful candidates, the job title and the rate of pay to the company’s personnel manager for an employment offer to be made. (2) On receipt of acceptance of an employment offer, the personnel manager forwards written details of the employee to the wages department. A wages clerk then immediately updates the wages master file with details of the future employee, including rate of pay, standard hours of employment and the employee’s bank details. (3) Employees are paid an hourly rate on the basis of time worked. In this regard the company operates a swipe card time recording system, operated by employees with individual uniquely coded swipe cards. On the first day of their employment, the production manager issues a swipe card to employees and updates the time recording unit master file with the new employee details. (4) Employees work a standard five-day week. Each day, employees register their arrival and departure by swiping their card through one of ten un-monitored entry/exit terminals. The terminals are connected to the time recording unit, which produces weekly and monthly summaries of employees’ attendance records. (5) The production manager has ‘amend’ and ‘download’ remote access to the time recording unit enabling him to read recorded data via his desktop computer, amend as required and then download hard copies of the information via his desktop printer. On a weekly basis, the production manager checks the hours worked for each employee and updates the electronic data file record for each employee with any appropriate amendments, including those for holiday and sickness entitlements. The time recording unit is programmed to provide a monthly summary of hours, only after the production manager has confirmed that all the required amendments have been entered. (6) The wages manager has ‘read’ and ‘download’ remote access to the data stored in the time recording unit. On a monthly basis, he downloads hard copies of the weekly and monthly summaries to his desktop printer. He then files the summaries and passes a copy of the monthly hours summary to a wages clerk for the input of hours into, and the running of, the monthly wages programme. (7) On completion of processing, prior to the update and closure of the programme, the following printouts are provided: (i)

Monthly wages summary. Showing, by employee and in total: hours paid, hourly rate, gross pay, statutory deductions, other deductions and net pay. (ii) Monthly bank credit transfer payments summary. Showing relevant bank account details for each employee and payments due. (iii) Monthly statutory deductions and other deductions summary. Showing deductions by category and payment instruction details. (8) The wages manager then scrutinises all summaries for completeness and accuracy of processing and investigates any apparent discrepancies. After satisfactory completion, a wages clerk then updates and closes the wages programme. All summaries are then filed chronologically by the wages manager, who then passes a signed approved copy of the ‘bank credit’ payments summary to the company’s cashier. The cashier then immediately instructs the company’s bank to make the relevant payments.


Required: (a) State FIVE objectives of the internal controls that should be exercised over a wages system.

(5 marks)

(b) State FOUR internal controls that should be exercised over the data contained in the wages master file of a company. (4 marks) (c) With regard to the wages system of Peach Co: (i)


(4 marks)

(ii) Describe the implication of each weakness identified;

(6 marks)

(iii) Recommend improvements to address the weaknesses.

(6 marks)

Note: you should assume that there are a sufficient number of employees at appropriate levels to operate effective controls. (25 marks)


[P.T.O.

2

In April 2008 your firm was appointed as auditors to Plum Co, a company operating three large garden centres within close proximity of each other. The company is long established, has an excellent control environment and a good system of internal controls. Its central administration and accounts departments are located at one of its garden centre sites and it prepares annual financial statements to 31 October. The directors of Plum Co have decided to update the company’s old computer-based accounting system with a more efficient system, incorporating superior application controls over the input and processing of data. Consequently, several accounts department employees will be made redundant whilst the tasks of other employees will change. The company would prefer to go ‘live’ with the new system on 1 September 2008. However the directors are unsure of the effect, if any, that such a change would have on your firm’s audit of the company’s financial statements for the year ending 31 October 2008. If changing to the new system on the preferred date would have anything other than a minor impact on your firm’s audit procedures, then the directors are prepared to bring forward or delay the implementation to a more convenient date. They are aware that your firm uses computer assisted audit techniques and that its existing audit software is compatible with the old system. Required: (a) (i)

List and describe THREE categories of application controls over the input and processing of data, which should be incorporated in the new computer-based accounting system of Plum Co; and (6 marks)

(ii) For each application control listed provide an example of its use.

(3 marks)

(b) Explain the effect that an implementation date of 1 September 2008 for the new accounting system would have on your firm’s audit of Plum Co’s financial statements for the year ending 31 October 2008, as compared to an earlier or later implementation date. (5 marks) (c) The following additional information is pertinent to the audit of Plum Co’s financial statements: (1) Each garden centre is open to the public throughout the year selling a comprehensive range of fertilisers, seeds, plants, shrubs and flowers. Additional product ranges comprise gardening tools and equipment; garden furniture and landscaping features. (2) Supplies of goods for re-sale are procured from various suppliers. However, large quantities of plants, shrubs and flowers are grown within the centres. Supplies are often transferred between centres to replenish low levels of fast selling inventory lines. (3) There are three gardening assistants at each garden centre, who work solely on the cultivation and maintenance of plants, shrubs and flowers prior to sale. (4) At each centre there is a large uncovered compound within which plants, shrubs and flowers are grown and displayed alongside other products. There is also a shop displaying retail products and housing the cashiering point and a busy café area. (5) Plum Co also operates as a landscape gardening contractor and employs its own workforce of 40 full-time employees, in addition to numerous sub-contractors in this regard. The company has an excellent reputation for the quality of its landscaping and consequently it often contracts to work on large projects of up to 18 months duration. Required: Identify the inherent risks associated with ascertaining the quantity and value of inventory (including work in progress), to be reported in the financial statements of Plum Co for the year ending 31 October 2008. (11 marks) (25 marks)


3

Pear Co is a long established building renovations company and prepares its annual financial statements to 30 April. The financial statements for the year ended 30 April 2008 revealed the following items, together with comparatives for the previous year. Item

Irrecoverable Debts Trade Payables Accruals Provision

30 April 2008 $ 56,000 315,000 37,800 81,000

30 April 2007 $ 18,900 205,200 63,000 –

The provision of $81,000 relates to a legal obligation to carry out repairs to a public building damaged by employees of Pear Co when renovating an adjoining building. The company’s reported pre-tax profit for the year ended 30 April 2008 was $990,000. Required: (a) For each of the items set out above, list FIVE substantive procedures that the auditor of Pear Co should carry out to verify the completeness and valuation assertions contained in the financial statements of Pear Co for the year ended 30 April 2008. (20 marks) (b) (i)

Explain why an auditor may decide NOT to carry out a circularisation of trade payables; and (3 marks)

(ii) Identify TWO situations when such a circularisation may be deemed appropriate.



[P.T.O.

4

(a) Review procedures form an important part of the audit process and audit firms may employ more than one method of review. Review types include: (1) ‘Hot’ Reviews (2) ‘Cold’ Reviews. Required: (i)

Explain the purpose of an audit review.

(5 marks)

(ii) For each of the review types listed above, state when and by whom it should be carried out and state what should be gained from a thorough review. (6 marks) (b) When determining whether the financial statements of a company give a ‘true and fair view’, an auditor should consider various factors. These include: (1) Materiality (2) Generally Accepted Accounting Principles and International Financial Reporting Standards (3) Objectivity (4) Disclosure. Required: For THREE of the factors listed above, explain its relevance to the auditor when determining whether the financial statements of a company give a true and fair view. (9 marks) (c) When an audit firm is in disagreement with management and is therefore unable to express an unqualified opinion as to whether the financial statements of a company give a true and fair view, it may opt to express a qualified opinion or an adverse opinion in its report on the financial statements. Required: Describe the circumstances, when due to disagreement, an audit firm should express: (i)

a qualified opinion;

(ii) an adverse opinion; in its report on the financial statements of a company.




Answers



(a)

June 2008 Answers

Internal controls exercised over wages should ensure that: (i) (ii) (iii) (iv) (v) (vi) (vii)

wages are paid only to genuine employees, wages are paid only for work done, hours worked or other agreed criteria, wages are paid only at authorised rates of pay, wages payments are correctly calculated, statutory and other deductions from wages are correctly calculated, all payments are made on a timely basis, all wages transactions are correctly and promptly recorded in the accounting records.

(Full marks will be awarded for stating any five of the of the above or other appropriate objectives) (b)

The following controls should be exercised over the data in the wages master file: (i) (ii) (iii) (iv) (v) (vi)

(vii)

(viii)

Segregation of duties should ensure that individuals responsible for the updating of the file should not be involved in the processing or payment of wages. ‘Read’ access to the master file should be available from specified terminals to responsible officials who have a need and authorised cause to access the information. ‘Amend’ access to the master file should be restricted to specific senior responsible officials of the company from specified terminals. There should be strict authorisation procedures in place to ensure that only appropriate senior responsible officials are able to add new employees and delete existing employees, and to amend wage rates of employees. Procedures should ensure that ‘starters’ and ‘leavers’ details are added to or deleted from the master file immediately after starting or leaving the company’s employment. An independent log of the number of authorised production employees should be maintained by a senior responsible official (for example – the company accountant), and regularly checked against the number of employees existing on the master file. A confidential list of authorised rates of pay for all employees should be maintained by a senior responsible official of the company (for example – the company accountant), and regularly checked against rates of pay existing on the master file. Controls should include a computer log which registers date and time access to the master file by the various users. This should regularly be reviewed by a senior responsible official of the company.

(Full marks will be awarded for stating four of the above or other appropriate controls) (c)

(1) Weakness The production manager has sole responsibility for recruiting employees to Peach Co. Implication The manager may be tempted to introduce non-existent employees into the system leading to the misappropriation of company funds by way of wages payments for non-existent employees. Recommendation Employees should be interviewed by the production manager and a responsible personnel official, such that potential employees can be properly identified and vetted prior to employment. (2) Weakness Wages clerks, responsible for the processing of wages, have ‘amend’ access to the wages master file. Implication A clerk could be tempted to manipulate data on the wages master file such that they, or their associates are able to benefit from subsequent misappropriation of company funds. For example, a wages clerk could enter details for a non-existent employee or increase the pay rate for a specified employee. Recommendation Wages clerks should have only ‘read’ access to the master file data. New employee details should be entered by a senior responsible official of the company or the wages manager. (See part (b) above). (3) Weakness The wages master file is updated prior to an employee commencing employment with the company. Implication There is an increased possibility that unauthorised wages could be paid to employees, prior to commencing employment. Recommendation New employee details should be entered on to the master file on a timely basis, after employees have commenced employment with Peach Co. (4) Weakness The production manager issues time recording swipe cards to new employees. Implication Given the apparent lack of accountability by the production manager over the recruitment of employees, there is an increased likelihood of the misappropriation of company funds by way of wages payments for non-existent employees, such payments would be supported by apparently bona fide attendance records.


Recommendation Stringent controls should be maintained over the issue of swipe cards to employees. Their issue should be controlled by a senior responsible official of the company, independent of the wages and production functions (for example the company accountant) and there should be measures to ensure that cards become operational only when issued. (5) Weakness The production manager is able to amend employee details on the time recording unit’s master file. Implication As with (4) above, the unfettered authority of the production manager to change master file data on the time recording unit adds to the likelihood of fraudulent wages payments being made. Recommendation Amendments to data on the master file of the time recording unit should be made only by a senior responsible official of the company, independent of the wages and production functions. The production manager should not have access to master file data. (6) Weakness The entry/exit terminals are not monitored. Implication Employees’ attendance records could be falsified, by for example one individual (arriving on time for work) swiping other late coming employees’ cards through a terminal. Recommendation Employees’ entry/exit terminals should be monitored to reduce the temptation to falsify records and thus limit the company’s exposure to payments being made for hours not worked. (7) Weakness The wages programme does not produce ‘exception’ reports detailing for example hours worked and payments due outside of expected ranges, or details of starters and leavers in the month. Implication Unauthorised payments made as a consequence of unauthorised working patterns or rates of pay may not be recognised. Similarly unauthorised payments to ‘starting’ or ‘leaving’ employees may not be recognised. Recommendation To facilitate ease of recognition of those payments as described (above), the wages system should be modified or updated to ensure production of monthly exception reports. These should be scrutinised by the wages manager and reviewed by the accountant along with other summaries as detailed (at point 8) below. (8) Weakness The company’s bank is instructed to make payments of wages without a prior check of the wages summary by an independent responsible official. Implication Notwithstanding other control measures built into the wages system, unauthorised wages payments could still be made by Peach Co. Similarly, as the summaries form the basis of wages posting entries into the company’s general ledger, erroneous journal entries could be made into the ledger. Recommendation Prior to the closure of the wages programme, all of the monthly summaries produced should be made available to the company’s accountant. The accountant should review the summaries and enquire into any abnormal or irregular payments to be made. Queries and apparent discrepancies should be resolved, and updated summaries produced before closure of the wages programme. All final summaries should be signed as checked by the accountant prior to filing. (Full marks will be awarded for identifying and commenting on any four of the above or other weaknesses in the wages system)

2

(a)

The following categories of application controls should be incorporated: Format Checks

ensure that data is entered in the correct form. For example, where a date entry in numeric format is required, alphabetical character input would be rejected.

Compatibility/Dependence Checks

ensure that input entered on documents with more than one data field is compatible. For example, an expense invoice with an appropriate general ledger code would be rejected if it was also coded with a trade receivables ledger account code.

Range/Reasonable Checks

ensure that input data is rejected or highlighted if it is outside pre-set parameters. For example, weekly hours worked in excess of 60 by an employee may be outside of such parameters.

Sequence Checks

ensure that sequential input of documentation/data is maintained. For example, if input of trade payables invoices are input out of sequence, this will be highlighted at the input stage.


Control Totals

ensures completeness of input, where data from common documents is input in quick succession. For example, ‘hash’ totals can be used as a means of control when inputting batches of trade receivable invoices.

(Full marks will be awarded for describing any three of the above or other appropriate controls and for providing an example) (b)

An implementation date of 1 September 2008 for the new accounting system would have major impact on my firm’s audit of Plum Co’s financial statements for the year ending 31 October 2008. Our procedures would be governed by the extent to which we were able to rely on the company’s system of internal controls. These would include the general and application controls over the company’s computer-based accounting system. As Plum Co is a new audit client the audit resource required and cost of ascertaining, recording and evaluating the company’s system of internal control would be quite extensive. Any problems encountered in this regard would simply be exacerbated by an implementation date prior to 31 October 2008. Given that the updated system will result in staff redundancies and a change in responsibilities for retained employees, it is apparent that there will be wholesale changes to the company’s internal control system. My firm will need to fulfil its obligation to evaluate the new system. Similarly the change from ‘old’ to ‘new’ will entail the transfer of master file and data file information to the replacement system. The planning and execution of this task by the company and checking (by my firm) of the transferred data, is likely to take up some considerable time and the associated financial costs are likely to be high. Finally, given that my firm’s audit software will not be compatible with the new system, my firm will need to invest in new software resulting in higher projected 2008 audit costs for Plum Co. In summary any implementation date prior to 31 October 2008 would have a negative impact on our audit of Plum Co’s financial statements for the year ending on that date. It is apparent that an implementation date prior to 31 October 2008 would be problematic. However it should also be apparent that any implementation date other than 1 November 2008 would only postpone the problems detailed above, such that they would need to be considered when planning the work in connection with the audit of the company’s subsequent (2009) annual financial statements. (Full marks will be awarded for covering any ten points mentioned above or other relevant points)

(c)

The following inherent risks are associated with ascertaining the quantity and the value of inventory (including work in progress): Quantifying Inventory Broadly there are three categories of inventory being, plants, shrubs and flowers (including fertilisers and seeds), other sales ranges and café inventory. Whilst it may be relatively easy to quantify the levels of the other inventories, it may prove more challenging to quantify the amount of fertilisers, seeds, plants, shrubs and flowers owned by the company. The company may rely on a perpetual inventory recording system as a means of monitoring inventory levels. Such a system could be updated at the point of delivery and (automatically) at the point of sale. However the fact that the public do have open access to inventory lines inevitably increases the inherent risk associated with quantifying inventory. Similarly the movement of inventory between centres introduces added problems in the control and monitoring of inventory quantities. Valuing Inventory The nature of inventory held by the centres is such that at any point in time a proportion of the inventory held (including café inventory), will include ‘perishable’ inventory lines. Similarly general inventory lines held may have become tarnished because of exposure to inclement weather conditions, whilst others may have become obsolete due to lack of demand from customers. The directors of Plum Co should recognise the risk in being able to identify such inventory lines and the requirement to place a value on them at the lower of cost and net realisable value. With regard to seeded, unpicked plants, shrubs and flowers, these should be similarly valued at the lower of cost and net realisable value. In the determination of cost, the company would need to take account of all costs directly attributable to the plants, including the cost of employing the gardening assistants and other associated overheads. Quantifying and Valuing Work in Progress Engaging 40 full-time employees and numerous subcontractors, the company’s landscape garden contracting operations are apparently quite sizeable. Consequently there are likely to be various contracts in operation at any point in time, involving numerous financial transactions. The combination of large contracts, simultaneous operations and numerous financial transactions, represent a large inherent risk for the company in trying to ensure that they are able to record and monitor and ascertain the amount of work they have carried out on specified contracts. Irrespective of the cost structures of the landscape gardening activity, there is a high level of inherent risk in the valuation of work in progress. The company will need to recognise its obligations to value work in progress in accordance with IAS2 Inventories, as appropriate.


3

(a)

Audit tests that should be carried out include the following: Irrecoverable Debts (i) (ii) (iii) (iv) (v) (vi) (vii) (viii)

Agree reported irrecoverable debts value to underlying working paper schedules. Review customer correspondence files, solicitors/legal correspondence and results of trade receivables circularisation – if carried out – for evidence of irrecoverable debts. Confirm accuracy of aged trade receivables balance by test checking known cash receipts paid against earlier invoices raised. Review aged trade receivables schedule and compare recognised irrecoverable debts to this, enquire into any longstanding unpaid receivables balances. Examine customer receipts after the reporting period and check to schedule of irrecoverable debts schedule. Examine credit notes raised after the reporting period to identify any balances erroneously omitted from irrecoverable debts schedule. Enquire into reasons for exceptional balances included in irrecoverable debts value. Use CAATs as appropriate to interrogate system for long outstanding receivable balances and unusual credit entries posted to accounts.

Trade Payables (i) (ii) (iii) (iv) (v) (vi) (vii)

Agree reported trade payables values to trade payables control account reconciliation and underlying working papers/schedules. Carry out analytical procedures and make enquiries as appropriate, ensuring that 54% increase on previous year balance makes sense taking all matters into account. Check reconciliation of supplier account statements to trade payable ledger balances, prepared by Pear Co staff. Enquire into any abnormalities and carry out further reconciliations as required. Review cut-off procedures for goods received and recognition of amounts payable at 30 April 2008. Test to ensure accuracy. Review unmatched goods received notes (goods received but associated invoice not received at 30 April 2008), and ensure inclusion in trade payables value. Review trade payables control account postings immediately, prior to and post 30 April 2008 and enquire into veracity of unusual items. Use CAATs as appropriate to identify for further investigation, long outstanding balances including those with no recent activity and accounts containing unusual debit entries.

Accruals (i) (ii)

Agree reported accruals value to underlying working papers/schedules. Carry out analytical analysis procedures and raise enquiries as appropriate ensuring that 40% decrease or previous year balance makes sense taking all matters into account. (iii) Compare budget expenditure with actual reported expenditure in income statement and enquire into whether any reported under-spend(s) could be represented by omitted/erroneous accruals. (iv) Review expenditures and postings to the general ledger, after the reporting period, paying particular attention to known accrual expense accounts, to identify possibly omitted/erroneous accruals. (v) Use CAATs and manual procedures as appropriate, to compare expense heading relationships to sales or other appropriate measures for current year to those of previous year to identify possible omitted/erroneous accruals. (vi) Identify any round sum amount accruals and make appropriate enquiries to test veracity of them. Provision (i)

Read relevant correspondence (including legal correspondence) relating to the damages claim and compare the value of the claim as reported in the company income statement to underlying estimates and opinions available. (ii) Discuss the nature and amount of the claim with senior responsible officials of the company, and enquire as to underlying rationale of the sum provided. If appropriate, with permission of the company, seek confirmation of value of claim from an independent expert. (iii) Examine the minutes of board or management meetings to obtain substantiating evidence as to the existence and nature of the claim. (iv) Scrutinise appropriate expense accounts to identify expenditures already incurred in connection with the claim and costs possibly duplicated in the final provision. (v) Obtain permission from the directors of Pear Co and write to the company legal advisers to confirm the likelihood of Pear Co having to settle the claim and the likely value of the claim. (vi) Check disclosure of provision in financial statements in accordance with relevant international financial reporting standards. (For each financial statement item above, full marks will be awarded for stating any five of the above or other appropriate procedures. Marks will be awarded for detailing manual and/or computer-assisted auditing techniques) (b)

(i)

An auditor must achieve a balance between the requirement to obtain sufficient appropriate audit evidence and the requirement to complete the audit on a timely basis at a realistic cost. Consequently, in the normal course of events, provided there is sufficient appropriate audit evidence available from other sources, the auditor may decide that there is little useful purpose in carrying out a trade payables circularisation.


Third party evidence is a good source of audit evidence and a large proportion of the documentation available when auditing trade payables is produced by third parties, for example, suppliers’ invoices, statements and correspondence. Provided the auditor has sufficient confidence in the evidence otherwise available, then (s)he may consider it unnecessary to carry out a trade payables circularisation. (ii)

A trade payables circularisation may however be deemed appropriate where: 1 2 3 4

4

(a)

(i)

The purpose of an audit review is to consider whether: 1. 2. 3. 4. 5.

(ii)

supplier statements are, for whatever reason, unavailable. only faxed or photocopied supplier statements are available and there is some doubt as to their authenticity. the auditor or the company, suspect that fraudulent manipulation with regard to supplier payments is taking place within the company. the auditor is of the opinion that (s)he cannot rely on the internal controls of the company when verifying trade payable balances.

the audit work has been performed in accordance with the audit programme. the work performed and the results obtained have been adequately documented. all significant matters have been resolved or are reflected in audit conclusions. the objectives of the audit procedures have been achieved and the conclusion expressed are consistent with the results of the work performed and support the audit opinion.

‘Hot’ Review This type of review involves any review of audit work carried out, prior to the signing of the audit report. Work may be reviewed as and when it is being carried out by audit staff, during the course of the audit, by a more experienced member of staff. In such circumstances a good review should ensure that adequate feedback is given to the individual(s) carrying out the work thus enabling them to make good any omissions in the procedures they have carried out. In any event all work carried out should be reviewed at the final stage of the audit, by the partner responsible for the audit assignment. A thorough review at this stage should ensure that the audit work is reviewed alongside the financial statements, that any risk areas identified during the audit process have been adequately covered by the audit work carried out, and that all conclusions have been properly stated and are adequately supported. ‘Cold’ Review This type of review involves any type of review carried out after the audit has been completed, by persons who are independent of it. Such a review may be carried out either internally or externally. An internal review may be carried out by suitably qualified staff, from the same office or perhaps from another office of the same firm. Alternatively, it may be carried out by another audit firm (a ‘peer review’). In either case a good review should ensure that adequate feedback is given so that perceived weaknesses in procedures, may be discussed and improved where deemed appropriate.

(b)

(1) Materiality Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements. An auditor should conclude that financial statements do not show a true and fair review if there is a material misstatement in, or an omission from those financial statements. (2) Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards There is a universal acceptance that financial statements will not normally show a true and fair view, unless they have been prepared in accordance with GAAP and appropriate International Financial Reporting Standards (IFRS). In very exceptional circumstances there may be occasions when non-compliance with GAAP or IFRS, will result in financial statements showing a true and fair view. However, auditors need to be aware that when financial statements do not comply then they will not normally show a true and fair view. (3) Objectivity Information reflected in financial statements is normally a mixture of information sourced from verifiable facts and management opinion. To the extent that information is based on management opinion (for example, management estimates) auditors have to make a judgement on the objectivity of management in forming their opinion. Auditors need to be aware that the materiality of information, based on management opinion and included in the financial statements will affect the extent to which the auditor is able to comment on the truth and fairness of those financial statements. (4) Disclosure In order that financial statements may show a true and fair view, they should provide full disclosure of all required information in a clear and unambiguous manner. In this way readers of the financial statements should not be misled. Consequently, auditors need to be aware, that if financial statements do not fulfil all legislative and regulatory disclosure requirements – they are unlikely to show a true and fair view.


(c)

(i)

A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management is not so material and pervasive as to require an adverse opinion or a disclaimer of opinion. A qualified opinion should be expressed as being 'except for’ the effects of the matter to which the qualification relates.

(ii)

An adverse opinion should be expressed when the effect of a disagreement is so material and pervasive to the financial statements that the auditor concludes that an ‘except for’ qualification of the report is not adequate to disclose the misleading or incomplete nature of the financial statements.




The marking scheme generally indicates that up to 11/2 marks may be awarded for relevant points. Consideration should be given to the depth and relevance given by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 mark whilst a detailed discussion could be worth up to a maximum of 11/2 marks. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answers is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%. 1

PEACH CO (a)

Stating five objectives of the internal controls that should be exercised over a wages system. Generally 1 mark per objective up to a maximum of

(b)

(5 marks)

Stating four controls that should be exercised over the data contained in the wages master file of a company. Generally 1 mark per point, up to a maximum of

(c)

(4 marks)

Identifying four weaknesses in the wages system of Peach Co, describing implications arising from the weaknesses and recommending improvements to address the weaknesses. Generally up to 1 mark for identifying a weakness up to a maximum of (1 x 4)

(4 marks)

Generally up to 11/2 marks for describing the implication arising from the weakness up to a maximum of (11/2 x 4) Generally up to

11/2

marks for recommending improvements to address the weaknesses

(11/2

x 4)

(6 marks) (6 marks) (Total 25 marks)

2

PLUM CO (a)

Listing and describing three categories of application controls over the input and processing of data and providing an example of its use. (i)

(ii)

(b)

Generally up to 1 mark for listing an application control up to a maximum of (1 x 3)

(3 marks)

Generally up to 1 mark for describing the application control up to a maximum of (1 x 3)

(3 marks)

Generally up to 1 mark for providing an example of use for each application control up to a maximum of (1 x 3)

(3 marks)

Explanation of the effect that an implementation date of 1 September 2008 would have on firm’s audit of Plum Co’s financial statements for the year ending 31 October 2008. Generally up to 1 mark per point up to a maximum of

(c)

(5 marks)

Identifying the inherent risks associated with ascertaining the quantity and value of inventory (including work in progress) of Plum Co for the year ending 31 October 2008. Generally up to 1 mark per point up to a maximum of



3

PEAR CO (a)

(b)

Listing five substantive procedures to verify the completeness and valuation assertions contained in the financial statements of Pear Co for the year ended 30 April 2008. Irrecoverable Debts Generally 1 mark per procedure up to a maximum of (1 x 5)

(5 marks)

Trade Payables Generally 1 mark per procedure up to a maximum of (1 x 5)

(5 marks)

Accruals Generally 1 mark per procedure up to a maximum of (1 x 5)

(5 marks)

Provision Generally 1 mark per procedure up to a maximum of (1 x 5)

(5 marks)

(i)

Explaining why an auditor may decide not to carry out a circularisation of trade payables. Generally up to 1 mark per point up to a maximum of (1 x 3)

(ii)

(3 marks)

Identifying two situations when such a circularisation may be deemed appropriate. Generally up to 1 mark per each example up to a maximum of (1 x 2)


4

REVIEW AND REPORTING (a)

(i)

Explaining the purpose of audit review. Generally up to 1 mark per point up to a maximum of (1 x 5)

(ii)

(5 marks)

Stating when and by whom relevant review should be carried out for the two review types. Generally up to 1 mark per point up to a maximum of (1 x 2 x 2)

(4 marks)

Stating what should be gained from a thorough review. Generally up to 1 mark per point up to a maximum of (1 x 2) (b)

Explaining relevance of three factors to the auditor when determining true and fair view. Generally up to 1 mark for each point for each factor with maximum of 3 marks for each factor up to a maximum of (3 x 3)

(c)

(2 marks)

(9 marks)

Describing the circumstances when (due to disagreement) an audit firm should express: (i)

A qualified opinion – up to 1/2 mark per point up to a maximum of (1/2 x 5)

(21/2 marks)

(ii)

An adverse opinion – up to 1/2 mark per point up to maximum of (1/2 x 5)

(21/2 marks) (Total 25 marks)


Implementing Audit Procedures (International Stream) Monday 8 December 2008


15 minutes 3 hours


Do NOT open this paper until instructed by the supervisor.

Paper T8 (INT)


During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.




Ruby Co produces kitchen units from factory premises, and prepares annual financial statements to 31 December. Its board comprises four directors, there being a managing director and directors of sales, production and finance & administration. The company employs only one buyer who reports directly to the managing director. Ruby Co exercises the following controls over the acquisition of tangible non-current assets: 1.

In October the directors and the buyer meet to discuss the tangible non-current asset requirements of each functional area. At the end of the meeting an agreed list of acquisitions is approved and a copy is retained by all attendees.

2.

The buyer is then required to contact potential suppliers of the approved acquisitions to obtain confirmation of availability, and the lowest price for inclusion in the company’s tangible non-current assets expenditure budget for the forthcoming year.

3.

In December the directors and the buyer meet again to formalise and approve the tangible non-current asset expenditure budget. Following the meeting, a schedule is produced detailing approved acquisitions by category, expected month of purchase and budgeted cost as obtained by the buyer. The schedule then forms the basis of the tangible non-current assets expenditure budget of Ruby Co for the forthcoming year.

4.

Throughout the new year, on a monthly basis, without prior consultation the buyer places orders with suppliers ensuring that assets are acquired in the month as budgeted. As part of his remuneration package, the buyer is entitled to bonus payments equating to 10% of any saving he can negotiate on budgeted costs. Consequently assets may not necessarily be purchased from the suppliers contacted by the buyer for budgeting purposes.

5.

The buyer normally places orders to purchase by a simple e-mail message. However where required by suppliers he provides orders by way of a letter, which he signs.

6.

Having placed an order, the buyer calculates his bonus entitlement and forwards a copy of the calculation together with a copy of the order documentation to the managing director. He reviews this against his copy of the budget, prior to authorising as appropriate and forwarding to the accounts department for payment of the bonus as part of the buyer’s monthly salary.

Required: (a) State FOUR objectives of the internal controls that should be exercised over the acquisition of tangible non-current assets. (4 marks) (b) With regard to the tangible non-current assets acquisition system of Ruby Co: (i)


(4 marks)

(ii) Describe the implications of each weakness identified; and

(6 marks)

(iii) Recommend improvements to address the weaknesses.

(6 marks)

(c) Explain the purpose of a tangible non-current assets register, describe its contents and state how it should be used by a company. (5 marks) (25 marks)


2

Emerald Co builds luxury yachts on a ‘made to order’ basis for a worldwide client base. Typically, it builds four fully equipped and furnished yachts annually, with annual sales exceeding $80 million. The company’s operations are based in a large dockside yard, which houses ancillary production and administration buildings. Although it maintains inventory records throughout the year, Emerald Co relies on a physical count as a basis for the inclusion of an inventory value in its annual financial statements. As the company’s auditors, your firm is now planning for attendance at the year-end inventory count on 31 January 2009. Consequently the manager responsible for the audit has reviewed the adequacy of the inventory count instructions and is satisfied with them. Required: (a) Identify and explain FOUR inherent risks associated with the inventory and work-in-progress of Emerald Co. (10 marks) (b) List THREE audit objectives of your firm’s attendance at the physical inventory count of Emerald Co on 31 January 2009. (3 marks) (c) State EIGHT key procedures that members of your firm should carry out when attending the inventory count of Emerald Co on 31 January 2009. (12 marks) (25 marks)

3

Your firm Penn & Company has assigned you to the audit of the trade receivables of Opal Co for its financial year ended 30 November 2008. Your tasks include the organisation of a trade receivables circularisation in respect of balances as at that date. Opal Co, is a book publishing company and there are in excess of 300 accounts in its trade receivables ledger, with total balances outstanding of $960,000 as at 30 November 2008. Your audit senior has selected the customer account balances for inclusion in the circularisation. Your first task is to prepare a draft positive circularisation letter for review, approval and subsequent forwarding together with customer statements. Required: (a) Explain how your audit senior should have selected the sample of account balances for inclusion in the circularisation. (5 marks) (b) Explain the difference between a negative circularisation and a positive circularisation.

(3 marks)

(c) Comment on the extent to which results from a negative circularisation may be relied upon to verify the existence of year-end receivable balances and contrast this to the reliability of the results received from a positive circularisation. (8 marks) (d) State with reasons who should forward the circularisation letters to the customers of Opal Co.

(3 marks)

(e) Prepare a draft positive circularisation letter to be forwarded with customer statements to the selected customers of Opal Co. (6 marks) (25 marks)


[P.T.O.

4

The board of directors of Topaz Co met recently to discuss the company’s audited annual financial statements, in readiness for the company’s forthcoming annual general meeting. At the board meeting, the following statements were made by the various directors: 1.

Noting that the company’s auditors had recommended that the company should have an internal audit department, the sales director enquired, ‘What are the differences between external auditors and internal auditors?’

2.

Whilst reading the auditors’ report, the production director commented, ‘The term true and fair is meaningless audit jargon. For the fee they charge us, it would be reasonable for us to expect the auditors to confirm whether the accounts are correct and error free.’

3.

Recalling that the managing director and financial director had signed a letter of representation in connection with the audited financial statements, the technical director stated, ‘I still don’t understand the purpose of that letter.’

Required: (a) Explain the differences between external and internal auditors.

(8 marks)

(b) Explain why the production director’s comments about ‘true and fair’ and his expectation of the auditors are unreasonable. (9 marks) (c) (i)

Explain the purpose of a letter of representation and describe the circumstances in which auditors should seek such a letter from the management of an audit client. (5 marks)

(ii) Describe the actions auditors should take if management refuses to provide them with written representations. (3 marks) (25 marks)



Answers



(a)


Objectives of the internal controls that should be exercised over the acquisition of tangible non-current assets are to ensure that: –

assets are acquired only when required by the entity.

–

assets are only acquired for use by the entity.

–

assets are acquired only if there is a secure and safe environment for their subsequent use and/or storage.

–

assets are acquired only with proper authority.

–

assets are acquired on the best possible terms.

–

transactions pertaining to asset acquisitions are properly accounted for and recorded.

(Full marks will be awarded for stating any FOUR of the above points or other appropriate objectives) (b)

1.

(i)

Weakness Overall, there is insufficient segregation of duties and control exercised with regard to the tasks carried out by the buyer.

(ii)

Implications The buyer could easily perpetrate fraud against the company and it is probable that the objectives of the system for acquiring tangible non-current assets will not be met.

(iii) Recommendations The current system should be changed to ensure that the buyer is not in a position to easily perpetrate fraud and to ensure that all systems objectives are met. (See points 2 to 7 below) 2.

(i)

Weakness There is no control exercised over the buyer to ensure that best prices are obtained for inclusion in the tangible non-current assets acquisitions budget.

(ii)

Implications Inflated acquisition costs could be included in the company’s budget in breach of the company’s policy to include only lowest confirmed prices. This could lead to a false impression of the buyer’s subsequent efficiency in acquiring assets at favourable prices.

(iii) Recommendations The work carried out by the buyer in obtaining costs for inclusion in the budget should be closely scrutinised by the managing director to ensure that only bona fide lowest cost confirmations from a range of approved suppliers are considered for inclusion in the budget. 3.

(i)

Weakness Tangible non-current assets are acquired in months as budgeted irrespective of actual requirements.

(ii)

Implications Tangible non-current assets will probably be acquired without need by the company, causing an unnecessary drain on cash flow, non-utilisation of acquisitions and losses due simply to an inefficient acquisition policy.

(iii) Recommendations Tangible non-current assets should be acquired only on the specific request of the relevant functional director. The request should be submitted to the managing director only on an ‘as required basis’. Submissions made on appropriate approval documentation should state the reason for the request (e.g., as budgeted – old asset beyond economical repair). For both budgeted and non-budgeted requests, the managing director should make appropriate checks and enquiries to ensure the purchase will be in the best interest of Ruby Co. 4.

(i)

Weakness The buyer has unfettered authority to order tangible non-current asset purchases.

(ii)

Implications Unauthorised purchases could be made.

(iii) Recommendations The buyer should place orders to purchase tangible non-current assets only after having received specific authority from the managing director. Robust documentary procedures should be put in place to ensure there is an adequate audit trail of authority documentation to support orders placed. 5.

(i)

Weakness The buyer’s remuneration package from the company includes entitlement to bonus payment which he can easily influence by making fraudulent representations for inclusion in the company’s budget.

(ii)

Implications Fraud could easily be perpetrated against the company.


(iii) Recommendations The current system is fraught with difficulty and there is a high risk that if the buyer’s bonus continues to be based on savings against costs obtained by her/him, the buyer will not act in the interest of the company. Therefore an alternative method of motivating the buyer should be introduced. If however the directors wish to motivate the buyer by offering a bonus payment for savings made on budget, rigorous procedures should be introduced to ensure that budgeted cost figures are bona fide and that the buyer makes genuine endeavours to obtain the lowest available costs for inclusion in the budget. In these circumstances, the buyer’s bonus should only be authorised after the acquisition of the specified assets. 6.

(i)

Weakness The company does not use formal sequentially numbered purchase order (capital expenditure) stationery.

(ii)

Implication There is an increased risk of unauthorised deliveries of tangible non-current assets being accepted by the company leading to problems with suppliers, and the possibility of erroneous payments. The absence of sequential numbered purchase orders increases the likelihood of duplicated purchase orders. This is because when checking orders raised under the current systems, the buyer cannot ensure that he has a copy of all orders.

(iii) Recommendations The company should use multi-part sequentially numbered purchase orders. Orders should be raised by the buyer only after having received authority to do so from the managing director (see (4) above). Copies of purchase orders raised should be forwarded to the company’s goods received area and to the company’s accounts department for checking against subsequent goods received and supplier documentation. 7.

(i)

Weakness Purchase orders raised by the buyer are not subject to review or scrutiny by an appropriate responsible official of the company.

(ii)

Implication Unauthorised orders could be placed on behalf of the company resulting in unauthorised payments to suppliers.

(iii) Recommendation All purchase orders raised by the buyer should be subject to frequent random review and scrutiny by either the managing director or the finance and administration director, to ensure that all authorised ordering procedures are being adhered to. (Full marks will be given for identifying any FOUR of the above or other weaknesses) (c)

The purpose of a tangible non-current assets register is to list details of all the non-current assets owned by an entity, in order to facilitate control over those assets. Typically, the register should record cost, depreciation and net book value information of each asset along with identifying details. For example in the case of plant and machinery – gross cost, annual depreciation rate, depreciation provision, net book value, date of acquisition, serial number and description and location of asset. The register should be updated by individuals who are separated from the acquisition, custody and disposal of assets. Company management should ensure that there is independent checking of assets recorded for existence and condition. Similarly to ensure completeness of recording, checks should be made to ensure that assets in existence are properly recorded in the register. Any discrepancies should be investigated with appropriate follow up action by management.

2

(a)

Inherent risks associated with the inventory and work-in-progress of Emerald Co: (1) The value of inventory and work-in-progress presented in the company’s financial statements is a function of quantity and value. The nature of the inventory and work-in-progress is such that there are numerous product lines/inventory items with a range of values including many high value items. There is therefore a risk of error in quantifying and valuing these. (2) The value of work-in-progress is likely to be material and the valuation process is likely to be complex. It will involve the allocation of direct costs, the absorption of appropriate overheads and ensuring that these are correctly reflected in the closing valuation. There is a risk of error in the valuation in this regard. (3) As a consequence of the company’s ‘made to order’ policy, there is a strong probability that parts and equipment purchases being surplus to requirement for specified yacht completion, will be of ‘nil value’ or ‘scrap value’ to Emerald Co. There is a risk that these could be included erroneously at full cost value in the inventory valuation. (4) Many of the product lines/inventory items, for example satellite navigation systems and exquisite luxury furnishings, will be of high value, portable and desirable to employees and third parties. There is therefore a risk of loss due to the misappropriation of such items. (5) Many product lines/inventory items will be common to the building of all yachts, however technological advances may render some lines obsolete. There is a risk that such items could be over valued.


(6) The delicate and fragile nature of various high value inventory items means that there is a strong possibility of them being damaged prior to the building and fitting out of yachts. There is therefore a risk that damaged inventory lines could be over valued. (Full marks will be awarded for stating any FOUR of the above or other relevant inherent risks) (b)

The audit objectives of attending the physical inventory count are to: (1) Ensure that the inventory count instructions are followed. (2) Ensure that the inventory exists. (3) Confirm the condition of inventory. (4) Provide corroborative evidence that inventory is owned by Emerald Co. (5) Obtain information to verify that cut-off procedures are correctly applied. (Full marks will be awarded for stating any THREE of the above or other relevant objectives)

(c)

The following key procedures should be carried out by members of my firm when attending the inventory count of Emerald Co on 31 January 2009: (1) Observe the procedures carried out by the company employees to ensure compliance with the inventory count instructions. (2) Obtain completed inventory sheets and carry out test counts on a sample basis to ensure that inventory lines are accurately described and that counts are accurately recorded. Highlight inventory lines counted and results. (3) Note any inventory that is set aside or specially marked, providing possible indicators that inventory is not owned by the company. (4) Record details of inventory not owned by the company. (5) Enquire as to the possibility of consignment or third party inventories being held by the company and record appropriate notes for subsequent follow up. (6) Observe and record inventory movements during the count. (7) For subsequent use in cut-off tests, record the number of the last goods received note and stores issue note. (8) Check that the items listed on the notes in (7) above have been correctly included/excluded in/from the closing inventory quantities. (9) Observe goods received quantities in the goods received area and check to ensure that these have been correctly included in closing inventory quantities. (10) Record the number of inventory sheets issued to inventory checkers and returned to the count supervisor, for subsequent follow-up when verifying completeness of inventory reflected in the company’s financial statements. (Full marks will be awarded for stating any EIGHT of the above or other key procedures)

3

(a)

When selecting a sample of account balances for inclusion in the trade receivables circularisation, the audit senior should have ensured that: (i)

The sample was based on the total population of the trade receivables accounts.

(ii)

In order to ensure testing of a sufficient proportion of the total value of receivables, the sample should have been selected after the stratification of account balances.

(iii) Due consideration was applied to the following categories of account for inclusion in the sample: (i) (ii) (iii) (iv) (v) (vi) (vii)

long standing unpaid accounts. dormant accounts. nil balance accounts. credit balance accounts. accounts containing round sum payments. accounts to which credit notes/journals have been posted close to the year-end. accounts containing unusual transactions.

(b)

A negative circularisation is one in which letters are forwarded to customers with the request that they respond to the company auditors only if they do not agree with the stated balance. A positive circularisation letter asks customers to respond to the company auditors to either confirm the stated balance or, if not in agreement, to provide full details of the balance as per their own records.

(c)

Response rates to negative circularisation letters are often very low. However the reason for the low response rate does not necessarily indicate agreement of balances by customers. For example, the response may not be received due to non-delivery


of letter to customers, because customers do not wish to divulge that balances stated are lower than those shown in their own records, or simply because customers do not have the time to respond. For these reasons, the results of a negative circularisation should not be solely relied on to confirm the existence of receivable balances. Response rates to positive circularisations are normally higher than those for negative circularisations, however whilst written confirmation by customers does provide good audit evidence of the existence of receivable balances, auditors should exercise caution in assuming that no further evidence should be sought in this regard. For example, some customers will confirm agreement irrespective of the balance outstanding per their own records, whilst others will confirm on the basis that they would not wish to divulge a higher level of debt per their own records. Additionally cut-off differences may lead to misleading confirmation from customers, whilst some customers will simply refrain from providing any response to the circularisation. In summary whilst both positive and negative circularisation methods carry a degree of sampling risk (risk that the results obtained from the sample selected are not representative of the total population of receivables balances), the results from a positive circularisation tend to be more reliable than those received from a negative circularisation. However, as indicated above, caution should be exercised in interpreting the results of the circularisation. (d)

A member of my own audit team should forward the circularisation letters to the customers of Opal Co. This is to prevent the possibility of letters being intercepted by a dishonest employee of the company who would intend confirming the incorrect balances in order to hide earlier misappropriations. For example, where an employee has diverted monies forwarded for banking by Opal Co to a bank account in which they have a personal interest.

(e)

Opal Co Address

Customer’s Name Customer’s Address Date

Dear Sirs As part of their normal audit procedures, we have been requested by our auditors Penn & Company to ask you to confirm direct to them your indebtedness to us as shown on the enclosed statement as at 30 November 2008. If the statement is in agreement with your records, please sign in the space provided below and return this letter directly to our auditors. If the statement is not in agreement with your records, then please notify our auditors directly of the amount shown by your records and if possible send them full particulars of the difference. It will be of assistance to us if you will give this request your urgent attention. We enclose a reply-paid envelope for your convenience. Your faithfully XXXXXX For Opal Co ……………………………………………………………………………….......................................................................... Please do not detach Name of Trade Receivable The balance shown on the statement as at 30/11/08 of $…………due from us is in agreement with our records at 30/11/08 ………………………..Signature ………………………...Position (Full marks will be awarded to answers presented in alternative format but containing all relevant points)

4

(a)

The differences between external and internal auditors may be summarised as follows: External

Internal

Appointment Process

Determined by statute appointed by members. Formal auditing qualifications are required.

Determined by management appointed by management. Qualification requirements are determined by management.

Report To

Members – formally in an auditor’s report on the truth and fairness of the financial statements of the company.

Management – formally or informally by verbal/written communication on any matter deemed appropriate by management.

Responsibilities

Determined by statute.

Determined by management, will often encompass responsibilities focusing on business risk assessment/evaluation and evaluation and effectiveness of internal control.

Scope of Work

To express an opinion on whether financial statements show a true and fair view.

Determined by management, governed by the extent of responsibilities (above).


(b)

When reporting to members on a set of financial statements, auditors are required by statute to report whether those financial statements show a true and fair view. Thus, the term ‘true and fair’ is a legal term and the production director is wrong in asserting that it is ‘meaningless audit jargon’. There is however no statutory definition of the term ‘true and fair’. Consequently the content of the concept is subject to continuous change and development as commentators in academia, the professions, industry and commerce continue to debate its meaning. There is a general consensus by all of the above that ‘true and fair’ does not mean ‘correct and error free’. ‘Correct’ is an absolute term, whereas ‘true and fair’ is an abstract term with both words incorporating subjective notions. Certainly the term does not mean ‘error free’. There is however consensus that it means, ‘based on fact and reality, objective and free from bias’. In arriving at a conclusion as to whether financial statements do show a true and fair view, auditors use subjective judgement and should carry out procedures in accordance with International Standards on Auditing in arriving at that conclusion. Procedures are often extensive in terms of time taken, resources and cost. It is generally accepted that if financial statements have not been prepared in accordance with generally accepted accounting principles and International Accounting Standards, then they will not show a true and fair view. Similarly, if they contain a material error, or there is a material omission from them, the financial statements will not show a true and fair view. Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements. In summary, when carrying out their work, auditors seek only to assure readers that the financial statements confirm with reality and factual information and that they have been prepared objectively and without bias in accordance with relevant statute(s) and standards. They also seek to assure readers that the financial statements are free from material error or omission. On the basis of the foregoing, I believe that both the comment made and expectation of the auditors by the production director of Topaz Co are unreasonable.

(c)

(i)

If an auditor has been unable to obtain written evidence (for example from board minutes) that the management of an entity accepts its responsibility for the preparation and fair presentation of the financial statements, and that it approves them, then the auditor may receive written management representation in this regard by way of inclusion in a letter of representation addressed to the auditor. Similarly, where an auditor requires audit evidence (in the form of written representations from management) pertaining to the financial statements on which insufficient evidence has been obtained from other sources, such representation may be included in a letter of representation. Auditors should however not substitute this type of evidence for audit evidence that could reasonably be expected to be available. By necessity, during the course of an audit, audit staff will discuss issues relating to the financial statements with management and will often receive verbal clarification, confirmation and assurances in connection with various material matters. Whilst many of these will be corroborated by sufficient evidence from other sources (with varying degrees of reliability), some will not. In such instances, the auditor with overall responsibility for the audit should ensure that written representations are received from management, as audit evidence, usually in the form of a letter of representation. There may be instances when representations from management is the only form of audit evidence available. Where for example discretionary bonuses payable to employees have been accrued in the financial statements, the auditors would be relying on management’s genuine intention to pay the bonuses at some future date. In such an instance the auditors should seek a written representation, normally in the letter of representation. Similarly, a letter containing appropriate representations should be sought when the matter or issue under review is principally one of subjective opinion or judgement on the part of management.

(ii)

If management refuses to provide a written representation, then the auditor should again review the possibility of obtaining sufficient audit evidence from alternative sources in connection with the matter or issue under review. If evidence is unobtainable then the auditor should express a qualified opinion or a disclaimer of opinion on the basis of scope limitation.




The marking scheme generally indicates that up to 11/2 marks may be awarded for relevant points. Consideration should be given to the depth and relevance given by each candidate when answering the question; for example if only a brief explanation is given then it may only be worth 1/2 mark whilst a detailed discussion could be worth up to a maximum of 11/2 marks. Marks are not allocated to specific points as the candidate may include a valid point within their answer which is not included in the model answer; the candidate should be given full credit for such points. The majority of the questions require several points to be included within the answer, so if a candidate concentrates on a few points then they should not be given as much recognition, and their overall mark should be lower than a candidate who provides a range of points. In conclusion, it is important that the overall standard of the candidate’s answers is considered in terms of whether it is above or below a pass grade. After marking each question, the total mark awarded should be evaluated to assess whether it is fair. If it is decided that the total mark is not a proper reflection of the standard of the candidate’s answer then the answer should be reviewed again, and the marks adjusted to ensure that the total awarded is fair. If the answer is of a pass standard then it should be awarded a minimum of 40%; if it is below a pass standard then it should be awarded less than 40%. 1

(a)

Stating four objectives of the internal control that should be exercised over the acquisition of tangible non-current assets. Generally 1 mark per objective up to a maximum of

(b)

(4 marks)

(i)

Identifying four weaknesses in the non-current tangible assets acquisition system of Ruby Co.

(ii)

Describing the implications of the weakness identified.

(iii) Recommending improvements to address the weakness. Generally 1 mark for each weakness identified, up to 11/2 marks for describing the implications arising and up to 11/2 marks for recommending improvements to address the weakness 4 x (1 + 11/2 + 11/2) up to a maximum of (16 marks) (c)

Explaining the purpose of a tangible non-current assets register, describing its contents and stating how it should be used by a company. Generally 1/2 mark per point up to a maximum of


2

(a)

Identifying and explaining four inherent risks associated with the inventory and work-in-progress of Emerald Co. Generally 21/2 marks for each risk identified (1) and explained (11/2) up to a maximum of 4 x 21/2

(b)

Stating three audit objectives of firm’s attendance at the physical inventory count of Emerald Co on 31 January 2009. Generally up to 1 mark per objective up to a maximum of

(c)

(10 marks)

(3 marks)

Listing eight key procedures that members of audit firm should carry out when attending the inventory count of Emerald Co on 31 January 2009. Generally up to 11/2 marks per procedure up to a maximum of 8 x 11/2



3

(a)

Explaining the strategy that should have been adopted when selecting a sample of balances for inclusion in the trade receivables circularisation. Generally up to 1 mark per point, including 1/2 mark for each category of account to be included in sample up to a maximum of (5 marks)

(b)

Explaining the difference between a positive circularisation and a negative circularisation. Up to 1/2 mark per point up to a maximum of

(c)

(3 marks)

Comment on the extent to which results from a negative circularisation may be relied upon to verify the existence of year end receivable balances and contrasting this to the results received from a positive circularisation. Generally up to 1 mark per point up to a maximum of

(d)

(8 marks)

Stating with reasons who should forward the circularisation letters to the customers of Opal Co. Generally up to 1 mark per point up to a maximum of

(e)

(3 marks)

Format of letter up to Points included in letter, generally

(1 mark) 1/ 2

per point up to a maximum of


4

(a)

Explaining the difference between external and internal auditors. Generally up to 1 mark per point up to a maximum of

(b)

(8 marks)

Explaining why the production director’s comment about ‘true and fair’ and his expectations of the auditors are unreasonable. Generally up to 1 mark per point up to a maximum of

(c)

(i)

(9 marks)

Explaining the purpose of a letter of representation and describing the circumstances in which auditors should seek such a letter from the management of an audit client. Generally 1/2 mark per point up to a maximum of

(ii)

(5 marks)

Describing the action auditors should take if management refuses to provide them with representations. Generally 1/2 mark per point up to a maximum of



15112557 ACCA CAT Paper T8 Implementing Audit Procedures Solved Past Papers

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