Mock 1 Questions

Mock One

Advanced Audit Audit and Assurance (International) P7AAA-MK1-Z16-Q

Time allowed:

3 hours 15 minutes

This paper is divided into two sections Section A – BOTH questions are compulsory and MUST be attempted Section B – TWO questions ONLY to be attempted Do NOT open this paper until instructed by the supervisor.

©2016 DeVry/Becker Educational Development Corp. ®

Section A – BOTH questions are compulsory and MUST be attempted 1

You are the manager responsible for the audit of Pavia Co. The company’s core business is the manufacture of eight models of sports cars. The company is organised on a divisional basis with factories selling parts to assembly plants. You have just received the following e-mail from Albret Plage, the lead partner of the audit: To: You, Audit Manager From: Albret Plage Re: Pavia Co planning

Hi, During your holiday I had a couple of meetings with Paris Mercedes, the finance director of Pavia Co, and attach to this e-mail a summary of the information I obtained from her. In respect of the financial statement audit of Pavia Co for the year ending 30 September 2016, please complete the following before our meeting next week: (a)

Prepare briefing notes that identify and explain the financial statement risks on the basis of the draft financial statements for us to discuss as part of our planning meeting. (12 marks)

(b)

Suggest how we might be able use analytical procedures to provide audit evidence and reduce the level of detailed substantive procedures. (7 marks)

(c)

Recommend the principal audit work to be performed in respect of the carrying amount of the following items in the statement of financial position: (i) (ii) (ii)

development expenditure on the Fox model; consignment inventory; and the warranty provision.

(4 marks) (4 marks) (4 marks)

Many thanks. PAVIA Co: Notes of meetings with Paris Mercedes for the year ending 30 September 2016 Statement of profit or loss for the year to 30 September 2016 Draft $m Note 645.5 Revenue (1) Other income 15.6 (2) Changes in inventories 3.8 Cost of materials (334.1) Employee benefits expense (91.0) (3) Depreciation and amortisation (29.8) Other expenses (116.3) (4) Interest income, net 12.3 (5) –––––– 106.0 Profit before tax Income tax expense (44.4) –––––– 61.6 Profit for the period –––––– ©2016 DeVry/Becker Educational Development Corp. All rights reserved.

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2015 Actual $m 606.5 14.4 (16.4) (286.8) (83.9) (23.6) (100.6) 20.9 –––––– 130.5 (47.7) –––––– 82.8 ––––––

Statement of financial position at 30 September

ASSETS Non-current assets Intangible assets Property, plant and equipment Current assets Inventories Trade receivables Cash and cash equivalents

(6) (7) (8)

Total assets EQUITY AND LIABILITIES Equity Share capital Share premium Retained earnings

Non-current liabilities Provisions

(9)

Current liabilities Trade payables Tax Other liabilities Total equity and liabilities

2016 Draft $m 47.8 124.5

2015 Actual $m 40.5 102.5

30.3 73.1 111.4 –––––– 387.1 ––––––

27.9 50.3 86.0 –––––– 307.2 ––––––

5.8 15.3 112.1 –––––– 133.2

5.8 15.3 80.1 –––––– 101.2

160.1

121.4

33.5 50.4 9.9 –––––– 387.1 ––––––

31.8 44.3 8.5 –––––– 307.2 ––––––

Notes:

(1)

Revenue from business activities: 2016 Draft $m 588.0 39.6 17.9 –––––– 645.5 ––––––

Vehicles Parts and accessories Other

2015 Actual $m 526.0 36.8 43.7 –––––– 606.5 ––––––

(2)

Other income includes gains on the disposals of tangible assets and income from the reversal of provisions.

(3)

Average number of employees: 2016 Draft 484 483 36 –––––– 1,003 ––––––

Wage earners Salaried employees Apprentices and trainees

©2016 DeVry/Becker Educational Development Corp. All rights reserved.

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2015 Actual 499 477 37 –––––– 1,013 ––––––

(4)

Other expenses include costs for warranties, administration and distribution, maintenance and insurance.

(5)

Interest income, net: 2016 Draft $m 16.8 (4.5) –––––– 12.3 ––––––

Interest and similar income Interest and similar expenses

2015 Actual $m 25.1 (4.2) –––––– 20.9 ––––––

(6)

Intangible assets include development costs, also franchises and industrial rights and licences. During the year $12.7 million (prior year – $6.3 million) was spent on developing a new sports model, the Fox.

(7)

Property, plant and equipment:

Cost 1 October 2015 Additions Disposals Reclassification

Land and buildings $m 61.8 5.0

3.0 ––––– 69.8 –––––

30 September 2016 Depreciation Current year

Accumulated Carrying amount 30 September 2016

30 September 2015 (8)

(11.9) ––––– 16.5 –––––

Total $m 292.9 43.3 (4.5) 0.0 –––––– 331.7 ––––––

1.9 ––––– 28.7 –––––

18.4 ––––– 178.5 –––––

– ––––– – –––––

20.3 –––––– 207.2 ––––––

41.1 ––––– 34.9 –––––

66.9 ––––– 48.6 –––––

16.5 ––––– 19.0 –––––

124.5 –––––– 102.5 ––––––

Inventories comprise:

Raw materials, consumables and supplies Work-in process Finished goods

(9)

Equipment $m 212.1 28.9 (4.5) 8.9 ––––– 245.4 –––––

Assets under construction $m 19.0 9.4

2016 Draft $m 8.3 6.8 15.2 ––––– 30.3 –––––

2015 Actual $m 7.3 4.8 15.8 ––––– 27.9 –––––

Provisions cover mainly manufacturing warranty, product liability and litigation risks. Also, provisions have been established for deferred maintenance and IT reorganisation.


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The following additional information is available: (i)

Pavia Co has achieved record sales in 2016 with the delivery of 10,153 vehicles (prior year – 7,642 vehicles).

(ii)

Although some sales are direct to individual customers the majority are ordered through dealers who take new vehicles on consignment.

(iii)

Since 1 October 2015 (i.e. from the beginning of the current financial year) Pavia Co has offered 0% finance for three years on new vehicle sales in its most competitive markets.

(iv)

The launch of the Fox range was expected to be made before the end of the current financial year (September 2016) but has been postponed by six months as internal trials have revealed that the doors are not sufficiently secure at high speeds.

(v)

A car part required for the Cipeta model is bought-in exclusively from an overseas manufacturer. Deliveries of supplies have been unpredictable since last year causing disruption to the Cipeta model assembly schedules.

Required:

(31 marks)

Respond to Albret Plage’s e-mail.

Note: The mark allocation is shown against each of the three requirements in the e-mail. Professional marks will be awarded for the presentation, structure, logical flow and (4 marks) clarity of your answer. (35 marks)


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2

(a)

You have just attended a meeting with the senior audit partner (SAP) in which you were informed that your firm, York & Co, has been invited to tender for the provision of internal audit services to the Retail and Business Group (RBG) for the next three years. If successful, this will be the first time York & Co have acted as internal auditors. He has asked you to prepare preparatory notes in relation to the tender that: (i)

Briefly describes the potential advantages and disadvantages to RBG of outsourcing its internal audit services. (6 marks)

(ii)

Describes the principal matters that should be included in the submission to provide internal audit services to RBG. (9 marks)

(iii)

Considers the potential impact of York & Co acting as the internal auditor on the external audit performed by Grey & Co (RBG’s auditors). (3 marks)

You made the following notes during your meeting with SAP together with extracts from RBG’s tender document: NOTES OF MEETING WITH SAP ON THE RETAIL & BUSINESS GROUP (RBG)

The invitation to tender indicates that written submissions will be used as a means of shortlisting candidates to make a detailed presentation to the Group’s Audit and Risk Management Committee. The activities of RBG comprise retailing of general merchandise and luxury goods. They have developed an internal audit function over many years but recently employee turnover in the internal audit department has risen, with high performing employees moving to other departments and less successful ones moving out. This has acted as a spur for them to consider outsourcing their internal audit function. The CEO of RBG is adamant that to enhance the independence of their external auditors (currently Grey & Co) the internal audit function should be outsourced to a different professional firm The appointment will include an evaluation of organisational risk, financial compliance, information technology control and systems audits, and fraud investigation.

EXTRACTS FROM RBG’S TENDER DOCUMENT

The Audit and Risk Management Committee receives annual reports from the head of internal audit on the controls over operational, financial and compliance risks RBG has a comprehensive system of budgetary control including monthly performance reviews of both financial and non-financial indicators Financial extracts ($m): Six months to 30 June 2016 Actual 387 46

Revenue Profit before tax

Year to 31 Dec 2016 Draft 751 83

A substantial proportion of RBG’s revenue is generated through retail outlets in department stores and shopping centres. Many of the rents payable for these premises are contingent on revenues earned.


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Required: Prepare the briefing notes as requested by the senior audit partner. (18 marks) Note: You should assume that York & Co has the necessary expertise and available staff to carry out the engagement, if they are successful in the tender. Note: The mark allocation is shown against each of the three requirements detailed above. (b)

One particular criticism of the audit profession is that auditors reduce their fees for the external audit (lowballing) when tendering in order to obtain the appointment. They then hope that more lucrative work (e.g. consultancy) will be awarded to them by the audit client. Required: Explain the practice of “lowballing” and the associated ethical risks and discuss whether current ethical guidance concerning lowballing is sufficient. (7 marks) (25 marks)


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Section B – TWO questions ONLY to be attempted 3

You are the manager of the audit of Tyrex Co, a large private company which operates as a retailer and fitter of electronic security equipment from fifteen locations throughout the country. Each location is treated as a cost centre for management accounting purposes. The chief accountant, Nick Jones, who was appointed in April 2016, qualified two years ago. He is responsible for the central accounts department of eight staff and reports to the managing director. The managing director, Graham Philips, is not an accountant. He has just telephoned the senior partner to complain about the conduct of the audit for the year ended 30 June 2016 which is nearing completion. Specifically: (1)

The audit senior-in-charge, Stephen, has had no previous involvement with Tyrex Co and Graham has had to spend valuable time recounting matters which he had previously explained to last year’s senior.

(2)

Stephen was seen to spend time explaining to two of the audit assistants the reasons for performing specific audit tests and ways to improve the presentation of the working papers. Graham has expressed concern that such inexperienced trainees are part of the audit team.

(3)

The final audit work commenced before the chief accountant had adjusted the management accounts for a number of substantial trade payables arising from late invoices received from suppliers. The audit team took a long time to verify the subsequent amendments to the first draft management accounts.

(4)

Extensive substantive procedures carried out to verify the inventory allowances and write-downs were clearly unwarranted as they did not disclose any problems of consequence. Graham is annoyed that his offer, to provide a suitable management representation instead, was declined by Stephen.

(5)

Finally, Graham is disputing the proposed increase in the current year audit fee as he believes it is due to the audit having been badly controlled and conducted. Graham had been hoping for a significant reduction in fees.

Required: (a)

Define “quality controls” and list the elements of a firm’s system of quality (4 marks) control.

(b)

Draft, for inclusion in a formal letter to Mr Philips:

(12 marks)

(i)

suitable responses to the issues he has raised; and

(ii)

suggestions for steps which may be taken to resolve these issues in (4 marks) future years. (20 marks)


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4

You are the senior in charge of the audit of the Rhondo Group. Its principal activities are the manufacture and supply of laboratory scientific equipment which is marketed throughout the world. There are five wholly-owned overseas subsidiaries. You have just received an email from the auditors of the African subsidiary in respect of the year ended 30 June 2016. Details are as follows: (a)

A valuable consignment of equipment was detained by customs officials five months ago. The equipment has now been paid for and is included at cost in the financial statements, disclosed as goods-in-transit. It has not been possible to physically verify, or obtain confirmation of, the equipment. (7 marks)

(b)

To reduce the rate of devaluation of the local currency the government has imposed temporary exchange control restrictions, effective 16 July 2016. Since then, the company has only been able to settle half of its liabilities for purchases (i.e. bills of exchange) as they fall due. Bills which cannot be settled are being extended, resulting in additional interest costs and greater exposure to exchange rate fluctuations. (7 marks)

(c)

The auditor’s report has been modified regarding the inventory and the company’s ability to continue in operational existence for the foreseeable future. (6 marks)

Required: For each of the three matters, describe the additional information required from the African auditors, the possible consequences for the group financial statements and for your auditor’s report thereon. (20 marks) Note: The mark allocation is shown against each of the three issues.


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5

(a)

Explain the auditor’s responsibilities in respect of subsequent events. (6 marks)

(b)

You are the audit manager of Jinack Co. You are currently reviewing two matters that have been left for your attention on the audit working paper file for the year ended 30 June 2016: (i)

Jinack holds an extensive range of inventory and keeps perpetual inventory records. There was no full physical inventory count at 30 September 2016 as a system of continuous stock checking is operated by warehouse personnel under the supervision of an internal audit department. A major systems failure in July 2016 caused the perpetual inventory records to be corrupted before the year-end inventory position was determined. As data recovery procedures were found to be inadequate, Jinack is reconstructing the year-end quantities through a physical count and “rollback”. The reconstruction exercise is expected to be completed after the financial statements will have been issued to members. (8 marks)

(ii)

Audit work on after-date bank transactions identified a transfer of cash from Batik Co. The audit senior has documented that the finance director explained that Batik commenced trading on 7 July 2016, after being set up as a wholly-owned foreign subsidiary of Jinack. No other evidence has been obtained. (6 marks)

Required: Identify and comment on the implications of the above matters for the auditor’s report on the financial statements of Jinack Co for the year ended 30 June 2016 and, where (14 marks) appropriate, the year ending 30 June 2017. Note: The mark allocation is shown against each of the matters. (20 marks)

End of Question Paper


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Mock 1 Questions

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