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For Examinations to June 2017
REVISION QUESTION BANK
ACCA
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Paper P7 | ADVANCED AUDIT AND
ASSURANCE
(INTERNATIONAL)
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ACCA
PAPER P7
SA
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ADVANCED AUDIT AND ASSURANCE
(INTERNATIONAL)
REVISION QUESTION BANK
For Examinations to June 2017
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REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
CONTENTS
Question
Page
Answer
Marks Date worked
The current exam format is indicated by the examinations from June 2013 in the Recent
Exams section. Questions with different mark allocations and those that are not identified as
ACCA are provided for further revision question practice on certain syllabus area.
REGULATORY ENVIRONMENT
Flight Investment
1
MONEY LAUNDERING
2
3
Banana Co (ACCA D09 adapted)
Dedza & Co (ACCA J07 Pilot Paper)
1
3
4
5
6
7
Kloser (ACCA D02)
Becker & Co (ACCA D08)
Carter & Co (ACCA J10)
Neeson & Co (ACCA D10)
20
1005
1011
35
20
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CODES OF ETHICS FOR PROFESSIONAL ACCOUNTANTS
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1
3
4
5
6
1014
1016
1020
1022
15
20
20
20
7
8
9
1026
1029
1031
20
20
20
10
1034
20
10
11
1038
1040
15
25
12
14
16
1044
1050
1055
35
35
35
18
19
21
24
1061
1066
1072
1078
35
35
35
35
26
27
28
1084
1088
1091
20
20
20
PROFESSIONAL RESPONSIBILITY AND LIABILITY
8
9
10
Rapid Travel Co (ACCA J98)
Blod Co (ACCA J08 adapted)
Grimes Co (ACCA J10)
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QUALITY CONTROL
11
Guidance on quality control
PROFESSIONAL APPOINTMENTS
12
13
Sepia (ACCA D03)
Wexford (ACCA J11 adapted)
BUSINESS RISK
14
15
16
Champers (ACCA J09 adapted)
Jolie Co (ACCA D10 adapted)
Grohl Co (ACCA D12 adapted)
PLANNING, MATERIALITY AND RISK
17
18
19
20
Shire Oil (ACCA D05 adapted)
Island Co (ACCA D07 adapted)
Bluebell (ACCA D08 adapted)
Oak (ACCA D11 adapted)
EVALUATION AND REVIEW
21
22
23
Seymour Co (ACCA D06)
Lamont Co (ACCA J07)
Clooney Co (ACCA D10)
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
(iii)
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
Question
Page
Answer
Marks Date worked
29
29
30
1094
1097
1100
20
20
20
31
33
35
36
1103
1108
1114
1117
35
35
20
35
1123
1129
1133
35
28
20
44
1137
20
45
46
1140
1144
25
35
49
50
51
1150
1154
1157
26
20
35
52
53
1163
1166
20
24
55
56
56
58
1170
1172
1175
1178
20
20
20
20
59
59
59
60
61
61
1180
1182
1185
1187
1188
1192
15
20
20
15
15
15
AUDIT OF FINANCIAL STATEMENTS
24
25
26
Pulp Co (ACCA J08)
Robster Co (ACCA J09)
Beech & Co (ACCA D11 adapted)
27
28
29
30
Murray Co (ACCA J07 adapted)
Rosie Co (ACCA J08 adapted)
Nassau Group (ACCA J11 adapted)
CS Group (ACCA J12 adapted)
ASSURANCE SERVICES
Sci-Tech Co (ACCA J07 adapted)
Eastwood Co (ACCA D10 adapted)
Bradrye City Council
39
41
43
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31
32
33
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GROUP AUDITS
REVIEWS AND RELATED SERVICES
34
Plaza Co (ACCA J05 adapted)
PROSPECTIVE FINANCIAL INFORMATION
35
36
Cusiter Co (ACCA J07)
Hawk Co (ACCA J12 adapted)
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FORENSIC AUDITS
37
38
39
Crocus (ACCA D08 adapted)
Chestnut (ACCA D11 adapted)
Efex Engineering (ACCA J07 Pilot Paper adapted)
OUTSOURCING
40
41
RBG (ACCA D06)
Mac Co (ACCA J10 adapted)
AUDITOR’S REPORTS
42
43
44
45
Bertie Co (ACCA D07)
Pluto Co (ACCA J09 adapted)
Willis and Moore (ACCA D10)
Yew (ACCA D11 adapted)
CURRENT ISSUES AND DEVELOPMENTS
46
47
48
49
50
51
(iv)
Serious fraud
Greater limitations
Audit risk alert (non-exam style)
Corporate business risk (ACCA D00)
IFAC (ACCA J06)
Practices (ACCA D06)
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REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
Question
Page
Answer
June 2013
1
Parker Co
2
Retriever Group
3
Setter Stores Co
4
Groom & Co
5
Poodle Group
62
65
66
67
68
1195
1201
1205
1208
1210
December 2013
1
Stow Group
2
Baltimore Co
3
Dasset Co
4
Chester & Co
5
Burford Co
69
71
73
74
74
Marks Date worked
RECENT EXAMS
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December 2014
1
Connolly Co
2
Francis Group
3
Faster Jets Co
4
Weston & Co
5
Bradley Co
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1214
1221
1225
1228
1231
35
25
20
20
20
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June 2014
1
Adams Group
2
Waters Co
3
Cooper Co
4
Ryder & Co
5
Marr Co
35
25
20
20
20
June 2015
1
Ted Co
2
Adder Group
3
Tony Group
4
Wire Co
5
Darren Co
September/December 20151
1
Dali Co
2
Kandinsky Co and Rothko University
3
Sanzio Co
4
Monet & Co
5
Hopper Group
Marking scheme
76
79
80
81
82
1235
1240
1243
1246
1250
35
25
20
20
20
84
85
87
88
89
1253
1258
1262
1264
1268
35
25
20
20
20
91
93
94
95
96
1271
1276
1280
1283
1286
35
25
20
20
20
2
4
6
7
8
11
14
16
18
20
23
35
25
20
20
20
Note: References to the IESBA (International Ethics Standards Board for Accountants) Code of Ethics
and the IFAC Code of Ethics relate to the same document, the IESBA being an independent standard
setting body established by the IFAC.
1
Since the introduction of four exam sessions a year ACCA now publishes a “hybrid” of the September and
December examinations.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
(v)
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ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
(vi)
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REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
Question 1 FLIGHT INVESTMENT
Required:
Draft for inclusion in a letter to Mr Row:
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Arnie Row, managing director of Flight Investment, has contacted you, as his auditor, for advice
regarding the establishment of an audit committee. The company operates a group of investment and
property management companies with interests overseas and has a small internal audit department.
Some companies are audited by other firms and some by other offices of your own firm. The board of
Flight Investment comprises Arnie Row, the heads of three departments of the main activities
undertaken by the group (property, investment and marketing) and a non-executive director (Arnie’s
brother-in-law, Dan Ackroyd) who rarely attends. Arnie himself is the driving force behind the
business. When the idea of an audit committee was raised by an insurance company with a significant
shareholding in Flight Investment, Arnie, with his usual enthusiasm, was keen that he should head the
committee but was not too sure of its role. He has turned to you for guidance.
an explanation of the purposes of an audit committee;
(b)
suggestions for the composition of the committee; and
(c)
a description of the specific responsibilities an audit committee should have with
internal audit and external audit.
(10 marks)
Question 2 BANANA CO
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(a)
(7 marks)
(3 marks)
(20 marks)
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You are a manager in Grape & Co, a firm of Chartered Certified Accountants. You have been
temporarily assigned as audit manager to the audit of Banana Co, because the engagement manager has
been taken ill. The final audit of Banana Co for the year ended 30 September 2016 is nearing
completion and you are now reviewing the audit files and discussing the audit with the junior members
of the audit team. Banana Co designs and manufactures equipment such as cranes and scaffolding,
which are used in the construction industry. The equipment usually follows a standard design, but
sometimes Banana Co designs specific items for customers according to contractually agreed
specifications. The draft financial statements show revenue of $12·5 million, net profit of $400,000
and total assets of $78 million.
The following information has come to your attention during your review of the audit files:
During the year, a new range of manufacturing plant was introduced to the factories operated by
Banana Co. All factory employees received training from an external training firm on how to safely
operate the machinery, at a total cost of $500,000. The training costs have been capitalised into the cost
of the new machinery, as the finance director argues that the training is necessary in order for the
machinery to generate an economic benefit.
After the year end, Cherry Co, a major customer with whom Banana Co has several significant
contracts, announced its insolvency and that procedures to shut down the company had commenced.
The administrators of Cherry Co have suggested that the company may be able to pay approximately
25% of the amounts owed to its trade payables. A trade receivable of $300,000 is recognised on
Banana Co’s statement of financial position in respect of this customer.
In addition, one of the junior members of the audit team voiced concerns over how the audit had been
managed. The junior said the following:
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ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
“I have only worked on two audits prior to being assigned to the audit team of Banana Co. I was
expecting to attend a meeting at the start of the audit, where the partner and other senior members of the
audit team discussed the audit, but no meeting was held. In addition, the audit manager has been away
on holiday for three weeks and left a senior in charge. However, the senior was busy with other
assignments, so was not always available.
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I was given the task of auditing the goodwill which arose on an acquisition made during the year. I also
worked on the audit of inventory and attended the inventory count, which was quite complicated as
Banana Co has a lot of work-in-progress. I tried to be as useful as possible during the count and helped
the client’s staff count some of the raw materials. As I had been to the inventory count, I was asked by
the audit senior to challenge the finance director regarding the adequacy of the provision against
inventory, which the senior felt was significantly understated.
Lastly, we found that we were running out of time to complete our audit procedures. The audit senior
advised that we should reduce the sample sizes used in our tests as a way of saving time. He also
suggested that if we picked an item as part of our sample for which it would be time consuming to find
the relevant evidence, then we should pick a different item which would be quicker to audit.”
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Required:
In respect of the specific information provided:
(a)
Comment on the matters to be considered and explain the audit evidence you should
expect to find during your file review in respect of:
(i)
The training costs that have been capitalised into the cost of the new
machinery; and
(ii)
The trade receivable recognised in relation to Cherry Co.
(12 marks)
Evaluate the audit junior’s concerns regarding the management of the audit of Banana
Co.
(9 marks)
(c)
There are specific regulatory obligations imposed on accountants and auditors in relation to
detecting and reporting money laundering activities. You have been asked to provide a
training session to the new audit juniors on auditors’ responsibilities in relation to money
laundering.
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(b)
Required:
Prepare briefing notes to be used at your training session in which you:
(i)
Explain the term “money laundering”. Illustrate your explanation with
examples of money laundering offences, including those which could be
committed by the accountant; and
(ii)
Explain the policies and procedures that a firm of Chartered Certified
Accountants should establish in order to meet its responsibilities in relation to
money laundering.
(10 marks)
Professional marks will be awarded in part (c) for the format of the answer and the quality of
the explanations provided.
(4 marks)
(35 marks)
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©2016 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
Question 3 DEDZA & CO
(a)
Comment on the need for ethical guidance for accountants on money laundering.
(5 marks)
(b)
You are senior manager in Dedza & Co, a firm of Chartered Certified Accountants. Recently,
you have been assigned specific responsibility for undertaking annual reviews of existing
clients. The following situations have arisen in connection with three clients:
Dedza was appointed auditor and tax advisor to Kora Co last year and has recently
issued an unmodified opinion on the financial statements for the year ended 31
March 2016. To your surprise, the tax authority has just launched an investigation
into the affairs of Kora on suspicion of under-declaring income.
(7 marks)
(ii)
The chief executive of Xalam Co, an exporter of specialist equipment, has asked for
advice on the accounting treatment and disclosure of payments being made for
security consultancy services.
The payments, which aim to ensure that
consignments are not impounded in the destination country of a major customer,
may be material to the financial statements for the year ending 31 December 2016.
Xalam does not treat these payments as tax deductible.
(4 marks)
(iii)
Your firm has provided financial advice to the Pholey family for many years and
this has sometimes involved your firm in carrying out transactions on their behalf.
The eldest son, Esau, is to take up a position as a senior government official to a
foreign country next month.
(4 marks)
Required:
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Identify and comment on the ethical and other professional issues raised by each of these
matters and state what action, if any, Dedza & Co should now take.
(15 marks)
Note: The mark allocation is shown against each of the three situations.
(20 marks)
Question 4 KLOSER
You are an audit manager of Kloser, a firm of Chartered Certified Accountants. You are assigning staff
to the final audit of Isthmus, a company listed on a stock exchange, for the year to 31 December 2016.
You are aware of the following matters:
(1)
Isthmus has recently issued a profits warning. The company has announced that the
significant synergies expected from the acquisition of Vanaka, a former competitor company,
have not materialised. Moreover, it has emerged that certain of Vanaka’s assets are
significantly impaired. Your firm’s corporate finance department, assisted by two audit
trainees, carried out due diligence work on behalf of Isthmus before the purchase of Vanaka
was completed in December 2015.
(2)
Mercedes, the assistant manager assigned to the interim audit of Isthmus, has since inherited
5,000 $1 shares in Isthmus. Mercedes has told you that she has no intention of selling the
shares until the share price recovers from the fall to $1·95 which followed the profit warning.
(3)
Anthony, an audit senior, has been assigned to the audits of Isthmus since joining the firm
nearly three years ago. He has confided to you that his father owned 1,001 shares in Isthmus
but sold them only days before the profits warning at a share price of $7·95. You are assured
that Anthony did not previously know that his father had the shares.
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ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
Required:
Comment on the ethical and other professional issues raised by the above matters and their
implications, if any, for staffing the final audit of Isthmus for the year to 31 December 2016.
(15 marks)
Question 5 BECKER & CO
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You are a senior manager in Becker & Co, a firm of Chartered Certified Accountants offering audit and
assurance services mainly to large, privately owned companies. The firm has suffered from increased
competition, due to two new firms of accountants setting up in the same town. Several audit clients
have moved to the new firms, leading to loss of revenue and an over-staffed audit department. Bob
McEnroe, one of the partners of Becker & Co, has asked you to consider how the firm could react to
this situation. Several possibilities have been raised for your consideration:
Murray Co, a manufacturer of electronic equipment, is one of Becker & Co’s audit clients.
You are aware that the company has recently designed a new product, which market research
indicates is likely to be very successful. The development of the product has been a huge
drain on cash resources. The managing director of Murray Co has written to the audit
engagement partner to see if Becker & Co would be interested in making an investment in the
new product. It has been suggested that Becker & Co could provide finance for the
completion of the development and the marketing of the product. The finance would be in the
form of convertible debentures. Alternatively, a joint venture company in which control is
shared between Murray Co and Becker & Co could be established to manufacture, market and
distribute the new product.
(2)
Becker & Co is considering expanding the provision of non-audit services. Ingrid Sharapova,
a senior manager in Becker & Co, has suggested that the firm could offer a recruitment
advisory service to clients, specialising in the recruitment of finance professionals. Becker &
Co would charge a fee for this service based on the salary of the employee recruited. Ingrid
Sharapova worked as a recruitment consultant for a year before deciding to train as an
accountant.
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(1)
(3)
Several audit clients are experiencing staff shortages and it has been suggested that temporary
staff assignments could be offered. It is envisaged that a number of audit managers or seniors
could be seconded to clients for periods not exceeding six months, after which time they
would return to Becker & Co.
Required:
Identify and explain the ethical and practice management implications in respect of:
(a)
(b)
(c)
4
A business arrangement with Murray Co;
A recruitment service offered to clients;
Temporary staff assignments.
(7 marks)
(7 marks)
(6 marks)
(20 marks)
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
Answer 1 FLIGHT INVESTMENT
(a)
Purposes of an audit committee
The basis for establishing an audit committee primarily concerns corporate governance (i.e.
the ethical corporate behaviour of directors or others charged with governance in the creation
of wealth for all stakeholders). Such committees have been mandatory for domestic
companies listed on the New York Stock Exchange for many years and are also a requirement
of the London Stock Exchange for UK listed companies.
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An audit committee is the sub-committee of the board, established by the board, which
provides an independent oversight of the organisation’s systems of internal control and
financial reporting process. This separate committee:
enables the board to delegate a thorough and detailed review of audit matters;

enables non-executive directors to contribute an independent judgement and play a
positive role in an area for which they are particularly fitted;

offers the external auditors a direct link with non-executive directors.
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
Taking, for example, the UK Corporate Governance Code, the main role and responsibilities
of the committee members must be set out in written terms of reference and include:
monitoring the integrity of the financial statements (and any formal announcements
relating to the company’s financial performance) and reviewing significant financial
reporting judgements contained therein;

reviewing related information presented with the financial statements, including the
business review (or equivalent) and corporate governance statements relating to the
audit and to risk management;
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

reviewing the content of the annual report and accounts and advise the board on
whether, taken as a whole, it is fair, balanced and understandable and provides the
information necessary for shareholders to assess the company’s performance,
business model and strategy;

reviewing internal financial controls and internal control and risk management
systems (unless reviewed by a separate risk committee of independent directors or
by the board itself);

monitoring and review of the effectiveness of the internal audit function or, if there
is no internal audit, consideration (annually) of the need for internal audit and
making that recommendation to the board;

reviewing and approving the internal audit function’s remit, having regard to the
complementary roles of the internal and external audit functions;

ensuring that the internal audit function has access to information to fulfil its
mandate and the necessary resources to meet the requirements of professional
standards for internal auditors (e.g. IIA);

recommending that the board put certain matters to the shareholders for their
approval in general meeting (e.g. regarding the appointment, re-appointment,
removal and remuneration of the external auditor);
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1001
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
reviewing and monitoring the external auditor’s independence and objectivity and
the effectiveness of the audit process, taking into consideration relevant UK
professional and regulatory requirements;

developing and implementing policy on the engagement of the external auditor to
supply non-audit services, taking into account ethical guidance for the provision of
non-audit services by the external audit firm;

reporting to the board any matters for action or improvement including
recommendations on the steps to be taken;

reviewing arrangements by which staff may, in confidence, raise concerns about
possible improprieties in matters of financial reporting or other matters and ensuring
that arrangements are in place for independent investigation of such matters and for
appropriate follow-up action.
Composition of the committee
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(b)

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Since the primary purpose of an audit committee is to carry out an independent review its
members should be independent of the company’s main executives. This will mean that
Arnie should not be a member of the audit committee.
In a large company there should be a minimum of three members of the audit committee. All
must be independent, non-executive directors. At the present time Flight Investments has
currently four executive directors plus Mr Ackroyd. As his relationship with the executive
(brother-in-law) will mean that he will not be perceived to be independent, new non-executive
directors (NEDs) should be appointed. Good corporate governance practice requires at least
50% of the board be independent NEDs. It is not unusual for the NEDs in major listed
companies to be in the majority (e.g. 60 to 70% of the board).
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At least one of the NEDs on the audit committee must be experienced in financial accounting
(i.e. IFRS) and the others should have sufficient business experience. Because of the
specialist business nature of Flight Investment, it would be advisable that one should have
experience of the investment and property management business.
(c)
Specific responsibilities with internal audit and external auditors
Internal audit
1002

Approve the appointment or termination of the head of internal audit.

Ensure that the internal auditor has direct access to the board chairman and to the
Audit Committee and is accountable to the Audit Committee.

Review and assess the annual internal audit work plan, ensuring that it covers all
group companies.

Receive a report on the results of the internal auditors’ work on a periodic basis
including reports all group companies and locations visited.

Review and monitor group and local management’s responsiveness to the internal
auditor’s findings and recommendations.

Meet with the head of internal audit at least once a year without the presence of
management.

Monitor and assess the role and effectiveness of the internal audit function in the
overall context of the group’s and individual companies risk management systems.
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REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
External audit

Approve the terms of engagement and the remuneration to be paid in respect of
audit services provided for all of the auditors of the group.

Ensure that all external auditors (group and other auditors) are independent of the
group and group companies, for example:



discussion with the auditors;
review of their policies and processes to maintain independence; and
compliance with appropriate ethical guidelines.
At the start of each annual audit cycle, ensure that appropriate plans are in place for
the group audit (e.g. the overall strategy, risk assessment, materiality, resources,
work plans and group accounting instructions).

Review and discuss, with the group auditors, the findings of their work, for
example:






PL
E

the outcome of the audit of each subsidiary;
major issues arising during the audit (resolved and unresolved);
key accounting and audit judgements;
levels of error identified during the audit; and
why certain errors remain unchanged.
Review with the group auditors the draft financial statements of each subsidiary
company, with particular attention to significant elements, for example:
compliance with legislation;
compliance with the applicable financial reporting framework (e.g. IFRS);
disclosure of all items and accounting policies;
large or unusual items;
foreign currency translation;
valuations of properties and investments;
consistency of treatment of like items within the group; and
all other financial information included in the annual report.
SA
M









Review the audit representation letters (before signing by management).

Review the reports to management and monitor management’s actions taken on its
recommendations.

Consider any modifications made by the group and subsidiary auditors in their
reports and in particular the impact of any subsidiary qualification on the group
auditor’s report.

Consider the planning of subsequent audits, with particular reference to:




timing;
use of internal auditors;
use of computer-assisted auditing techniques; and
location visits by rotation.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
1003
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
Annually, assess and report to the board on the qualification, expertise and
resources, and independence of the external auditors and the effectiveness of the
audit process. Include in the report a recommendation whether or not the external
auditor’s reappointed should be proposed to the shareholders. The assessment
should cover all aspects of the audit service provided by the audit firm and include
obtaining a report on the audit firm’s own internal quality control procedures and
consideration of audit firms’ annual transparency reports, where available. It might
also be appropriate for the audit committee to consider whether any benefit might
be derived from using firms from more than one audit network.

Ensure that the audit services contract is put out to tender at least once every 10
years, to enable the audit committee to compare the quality and effectiveness of the
services provided by the incumbent auditor with those of other audit firms. So that
there is time to undertake an effective tendering process, and to allow shareholders
to provide input to the process should they wish, the company should announce its
intention in advance of the commencement of the tendering process.

Evaluate the risks to the quality and effectiveness of the financial reporting process
and consider the need to include the risk of the auditor’s withdrawal from the
market in that evaluation.

If the external auditor resigns, the audit committee should investigate the issues
giving rise to the resignation and consider whether any action is required.

Assess the effectiveness of the audit process for the group and for each subsidiary.
Consider, for example:
whether the agreed audit plan was adhered to and, where changes were
made, understand the reasons for such changes (including changes in
perceived audit risks and the work undertaken address those risks);
SA
M

PL
E


1004

the robustness and perceptiveness of the group auditors in handling the
key accounting and audit judgements identified, in responding to
questions from the audit committees, and in commenting, where
appropriate, on the systems of internal control;

feedback obtained about the conduct of the audit from the key people
involved (e.g. finance directors and the head of internal audit).
The audit committee should develop and recommend to the board the company’s
policy in relation to the provision of non-audit services by the auditor. The audit
committee’s objective should be to ensure that the provision of such services does
not impair the external auditor’s independence or objectivity. In this context, the
audit committee should consider:

whether the skills and experience of the audit firm make it a suitable
supplier of the non-audit service;

whether there are safeguards in place to ensure that there is no threat to
objectivity and independence in the conduct of the audit resulting from the
provision of such services by the external auditor;

the nature of the non-audit services, the related fee levels and the fee
levels individually and in aggregate relative to the audit fee; and the
criteria which govern the compensation of the individuals performing the
audit.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)

The audit committee section of the annual report should include an explanation of
how the committee has assessed the effectiveness of the external audit process and
its approach to the appointment or reappointment of the external auditor, so that
shareholders can understand the recommended reappointment or change in auditors.
It should also include information on the length of tenure of the current audit firm,
when a tender was last conducted and any contractual obligations that restricted the
audit committee’s choice of external auditors.
Tutorial note: It is a higher level skill to be able to distinguish between the requirements of
parts (a) and (c) without repeating detail between the two parts.
(a)
E
Answer 2 BANANA CO
File review
(i)
Training costs
PL
Matters to consider
Materiality – the relevant materiality calculations are:
Based on revenue: 500,000 ÷ 12·5 million × 100 = 4%
Based on net profit: 500,000 ÷ 400,000 × 100 = 125%
Based on total assets: 500,000 ÷ 78 million × 100 = <1%
SA
M
Based on the above, the training costs are immaterial to the statement of financial position,
but material to the statement of comprehensive income and therefore to revenue and profit. It
is important to note that any adjustment made to recognise the costs as an expense will have
the effect of turning the profit of $400,000 currently recognised into a loss of $100,000.
Accounting treatment
The finance director’s argument is based on the idea that the training costs are directly related
to the assets concerned and therefore should be capitalised. IAS 16 Property, Plant and
Equipment does not permit the capitalisation of these costs as they are operating costs rather
than costs directly attributable to the item of plant. The concept behind this is that assets
should only be recognised if they are controlled by the entity. It is unlikely that Banana can
exercise control over the skills of its staff which have been developed by the training
programme, as staff may decide to leave employment with the company. Further, IAS 38
Intangible Assets also argues against the recognition of training costs as an intangible asset.
Therefore there are no grounds for recognising the training costs as a non-current asset and
the $500,000 cost of the training programme should be expensed to profit or loss.
Audit opinion
If the financial statements are not amended, the audit opinion should be modified due to a
disagreement in accounting treatment. This would most likely be a qualified “except for”
opinion due to the material nature of the disagreement.
Evidence

A schedule detailing the major categories of expenses which make up the total
$500,000 costs of the training programme.

Agreement of a sample of the costs per the schedule to supporting documentation
such as invoices provided from the external training firm.
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1005
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
Agreement of a sample of the costs to the cash book and/or the bank statement.

Confirmation that the training programme was completed before the year end (i.e.
that none of the $500,000 represents a prepayment of costs).

Confirmation that the $500,000 is the total and that no further invoices received
after the year end for training carried out before the year end should have been
accrued.

Clarification that Banana does not exercise specific control over the skills of its
staff, by a review of standard terms of employment.

Confirmation that the amount spent on the training programme agrees to an
authorised budget or an approved expenditure programme relating to the new
machinery and that the amount incurred is in line with expectations.
(ii)
Trade receivable
PL
Matters to consider
E

Materiality – the relevant calculations for the total value of the trade receivable are as
follows:
Based on revenue: 300,000 ÷ 12·5 million × 100 = 2·4%
Based on net profit: 300,000 ÷ 400,000 × 100 = 75%
Based on total assets: 300,000 ÷ 78 million × 100 = <1%
SA
M
Therefore the total receivable is not material to the statement of financial position; however, it
is material to the profit and loss account and therefore to profit for the year, which is relevant
given that it appears that an impairment loss should be recognised in respect of this amount.
Accounting treatment
IFRS 9 Financial Instruments requires trade receivables to be measured at amortised cost.
Any expected impairment should be recognised at the earliest opportunity, with the receivable
being written down to the expected cash receivable from the customer; that amount should be
discounted if the time value of money has a significant effect. According to the information
provided by Cherry’s administrators, it is likely that 25% of the amount outstanding will be
paid. It seems, therefore, that 75% of the $300,000 trade receivable is irrecoverable and so an
impairment loss of $225,000 should be recognised. This is material to the statement of profit
or loss as follows:
Based on revenue: 225,000 ÷ 12·5 million × 100 = 1·8%
Based on net profit: 225,000 ÷ 400,000 × 100 = 56%
The potential expense to be recognised is highly material to net profit.
A further issue is that there may be inventory relating to Cherry in current assets. As Banana
has several contracts with Cherry there may be raw materials purchased specifically for use in
a contract agreed with Cherry or items of work-in-progress. As Cherry is in insolvency, all
activity on such contracts will cease with immediate effect. Any such inventory should be
reviewed to see if it can be re-allocated to different contracts or back into general inventory.
If not, the inventory should be written down to the lower of cost and fair value less costs to
sell, with the associated loss recognised in profit or loss for the year.
1006
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REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
Audit opinion
If the impairment loss on the trade receivable is not recognised the audit opinion should be
modified due to a disagreement in accounting treatment. This would most likely be a
qualified “except for” opinion due to the material nature of the disagreement.
Looking at the two issues together, it appears that with the adjustments needed for the training
costs and the impairment of the receivable, the statement of profit or loss should show a loss
for the year of $325,000 (400 – 500 – 225). If the adjustments are not made the auditor may
be of the opinion that the statement of comprehensive income is rendered meaningless. This
may results in an adverse opinion stating that the financial statements are not fairly presented.
E
Tutorial note: Credit would be awarded for discussion of going concern issues arising from
the loss of a major customer.
Audit evidence
The initial correspondence from the administrators of Cherry confirming that the
company is insolvent and that only 25% of amounts outstanding is likely to be paid.

A written confirmation from the administrators of Cherry stating the amount that is
likely to be paid and an anticipated payment date.

Agreement of the amount owed by Cherry to the receivables ledger and to written
confirmation from the administrator.

Recalculations of the impairment losses.

A review of inventory documentation for the value of inventory relating to contracts
with Cherry.
SA
M
PL

(b)
Evaluation of the management of the audit of Banana
The comments made by the junior indicate that the audit has not been properly planned or
supervised. Both ISQC1 Quality Control for Firms that Perform Audits and Reviews of
Historical Financial Information and Other Assurance and Related Services Engagements
and ISA 220 Quality Control for Audits of Historical Financial Information provide guidance
in this area. There are many indicators of poor quality control which are evaluated below.
No audit planning meeting at the start of the audit
A meeting is important as this is where the audit partner should direct the audit assignment by
explaining to the members of the audit team their responsibilities, the nature of the client’s
business and significant risk or fraud indicators identified, and the detailed approach to the
audit.
If no meeting is held at the start of the audit, then it is unlikely that members of the audit team
will understand the audit strategy, the objectives of the work they have been asked to perform
or how tasks have been allocated amongst members of the team.
The audit partner should lead the meeting, as it is his responsibility to ensure that the audit is
directed, supervised and performed in accordance with professional and regulatory standards.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
1007
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
Audit manager and supervisor are not always available
All audit assignments should be properly supervised. In the absence of a manager and
supervisor, the more junior members of the audit team will not be able to resolve problems
which arise. The longer there is a lack of supervision, the more problems will accumulate.
Without supervision, the audit plan may not be properly followed and inappropriate
modifications may be made to audit programmes.
Junior was given the tasks of auditing goodwill and inventory
It seems that audit work has not been properly delegated amongst members of the audit team.
E
An inexperienced audit junior should not be given relatively complex procedures to perform.
Both goodwill and work-in-progress can be challenging to audit and involve the use of
judgement (e.g. the evaluation of the stage of completion of work-in-progress) and it is
unlikely that a junior who has only been on two audits will have enough knowledge and
experience to fully understand the complexities of the accounting and audit issues involved.
PL
Tasks associated with goodwill and work-in-progress should be allocated to a more
experienced member of the team, leaving more straightforward tasks for the junior.
Junior helped with inventory count procedures
The junior did not understand the objectives of the inventory count. Test counts should have
been performed by the junior, in order to gather audit evidence for the completeness and
existence of inventory items, but members of the audit team should not “help out” the client’s
staff with counting. Instead, the junior should have observed the client’s staff and assessed
whether the count was being performed in accordance with count instructions.
SA
M
Junior was asked to challenge the finance director
It is inappropriate for an inexperienced junior to challenge a senior member of client’s
management. Contentious issues should be discussed with the client by the audit manager or
partner, as they have a more appropriate level of authority and will be in a better position to
explain why the provision is considered to be inadequate. This is an inappropriate delegation
of tasks within the audit team.
Inadequate time to complete necessary audit procedures
It seems that either not enough time has been allowed to complete the necessary audit
procedures or that, in the absence of much direction and supervision, the audit procedures
have been performed inefficiently.
One of the key aspects of supervision is to keep track on the progress of the audit
engagement. The audit plan should initially determine appropriate timescales and deadlines;
if it transpires that more time is needed, this should be discussed with the client.
Modification to planned audit procedures
The audit procedures have been changed in response to lack of time. It is not acceptable to
cut corners by reducing sample sizes or changing the items selected for the sample.
Modifications should be discussed by senior members of the audit team and should only
occur for genuine reasons. The danger is that reduced sample sizes or changing the items
selected for testing will not provide sufficient, reliable audit evidence as the sample selected
may no longer be representative of the population as a whole.
1008
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REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
Conclusion
Poor quality control means that this audit engagement has not had appropriate direction and
supervision. The evidence gathered may be inappropriate and inadequate for the purposes of
issuing an audit opinion. This could result in an incorrect opinion being issued. A detailed
hot and cold review should be performed to determine if any areas need extra audit work
performed and to consider what measures the firm should take to improve its quality control
monitoring procedures.
(c)
Briefing notes to be used at training session
(i)
E
Subject: Money laundering policies and procedures
Introduction
PL
In recent years accountants and auditors have become subject to anti-money laundering
regulations. This is largely due to the work of the inter-governmental body the Financial Task
Force on Money-Laundering (FATF).
A firm of Chartered Certified Accountants must establish sound policies and procedures to
ensure that the firm meets its responsibilities under the relevant regulation in which the firm is
operating. It is important that all members of an audit engagement team are aware of the
regulations, the firm’s policies and procedures and their own responsibilities regarding money
laundering activities.
Definition of money laundering
SA
M
Money laundering is a process by which criminals attempt to conceal the true origin and
ownership of the proceeds of criminal activities. It is a way in which money earned from
criminal activities (“dirty money”) is transferred and transformed so it appears to have come
from a legitimate source (“clean money”). Money laundering includes a wide range of
potential crimes including possessing, dealing with, or concealing the proceeds of crime.
Illustrations
Money laundering activities could include:

Acquiring, using or possessing the proceeds of criminal activities such as drug
trafficking and terrorist activities, or retaining control over the proceeds of tax
evasion;

Benefits obtained through bribery or corruption; and

Inciting, aiding, counselling or concealing such activities.
The three stages of the money laundering process are placement, layering and integration:
(1)
Placement is putting money into financial products or instruments, including life
policies, pension arrangements, unit trusts, travellers’ cheques and bank deposits.
(2)
Layering is creating a series of transactions so that the original source of funds is
obscured and difficult to trace.
(3)
Integration is converting the proceeds of money laundering into a legitimate form.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
1009
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
For accountants there are specific ways that they could commit offences relating to money
laundering. These could include:
Handling the proceeds of criminal activity, or advising on the use of such proceeds.

Failure to report knowledge or suspicion of money laundering activities to the
appropriate authority.

Making a disclosure which is likely to prejudice an investigation into money
laundering (known as “tipping off”).

Failure to comply with the specific regulatory requirements in relation to money
laundering in the jurisdiction in which the accountant is operating.
(ii)
Policies and procedures
E

Appointment of a Money Laundering Reporting Officer (MLRO)
PL
The MLRO is a nominated officer who is responsible for receiving and evaluating reports of
suspected money laundering from colleagues, deciding whether further enquiry is required
and, if necessary, making reports to the appropriate external body. The MLRO should have
an appropriate level of seniority and experience and would usually be a senior partner.
Customer identification procedures
SA
M
This is often referred to as customer due diligence or “know your client” procedures. The
point of these procedures is to ensure that the firm knows the identity of clients (whether the
client is an individual or an entity) and has obtained evidence of that identity. For an
individual, typical evidence of identity would be a passport or driving licence and evidence of
home address (e.g. a utility bill). For an entity, evidence may include a certificate of
incorporation.
The identification process for an entity would also involve identification of key management
personnel and those people in control of the entity, and an assessment whether any connected
individuals are politically exposed people.
Enhanced record keeping
Records must be kept of clients’ identity, the firm’s business relationship with them and
details of transactions with the client. All records should be kept for five years after the end
of the business relationship or completion of the transactions. Internal and external reports
made in connection to money laundering should also be securely kept for five years.
Communication and training
All relevant employees should receive training so that they are aware of the main provisions
of money laundering regulations and know how to recognise and deal with activities which
may be money laundering.
The training programme should be offered to all members of the firm with an involvement in
audit engagements. Training should also be provided on the firm’s internal policies and
procedures with relation to money laundering. In particular, all staff should be aware of
appropriate lines of communication and who they should report suspicions of money
laundering activities to. Training should be considered for all staff, including support staff
who do not carry out an advisory role.
1010
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
Internal controls, risk assessment, management and monitoring
The firm should establish systems and controls to effectively manage the risk that the firm is
exposed to in terms of money laundering activities. This could include:
Client screening procedures to minimise the risk of taking on a new client with a
high risk of money laundering activities;

Systems and controls to ensure that training is attended and understood by all
relevant employees;

Systems that allow periodic testing that the firms’ policies and procedures comply
with legislative and regulatory requirements.
E

All of the above contribute to the acceptance and following of firm-wide practices by all
relevant individuals and can be seen as quality control measures.
Conclusion
Answer 3 DEDZA & CO
(a)
Need for ethical guidance
Accountants (firms and individuals) working in a country that criminalises money
laundering are required to comply with anti-money laundering legislation and
failure to do so can lead to severe penalties. Guidance is needed because:
SA
M

PL
It can be seen that the firm needs to have in place appropriate measures to ensure that
complex anti-money laundering regulation is adhered to. It is the responsibility of all relevant
staff to be alert for suspicious activities and to understand their own responsibility to report
the activity. Failing to do so puts the individual and the firm at risk of a breach of regulation.





legal requirements are onerous;
money laundering is widely defined; and
accountants may otherwise be used, unwittingly, to launder criminal funds.
Accountants need ethical guidance on matters where there is conflict between legal
responsibilities and professional responsibilities. In particular, professional
accountants are bound by a duty of confidentiality to their clients. Guidance is
needed to explain:

how statutory provisions give protection against criminal action for
members in respect of their confidentiality requirements;

when client confidentiality over-ride provisions are available.
Further guidance is needed to explain the interaction between accountants
responsibilities to report money laundering offences and other reporting
responsibilities, for example:




reporting to regulators;
auditor’s reports on financial statements (ISA 700);
reports to those charged with governance (ISA 260);
reporting misconduct by members of the same body.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
1011
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK

Professional accountants are required to communicate with each other when there is
a change in professional appointment (i.e. “professional etiquette”). Further ethical
guidance is needed on how to respond to a “clearance” letter where a report of
suspicion has been made (or is contemplated) in respect of the client in question.
Tutorial note: Although the term “professional clearance” is widely used, remember that
there is no “clearance” that the incumbent accountant can give or withhold.
Annual reviews of existing clients
(i)
Tax investigation

Kora is a relatively new client. Before accepting the assignment(s) Dedza should
have carried out customer due diligence (CDD). Dedza should therefore have a
sufficient knowledge and understanding of Kora to be aware of any suspicions that
the tax authority might have.

As the investigation has come as a surprise it is possible that, for example:


PL
(b)
Ethical guidance is needed to make accountants working in countries that do not
criminalise money laundering aware of how anti-money laundering legislation may
nevertheless affect them. Such accountants may commit an offence if, for example,
they conduct limited assignments or have meetings in a country having anti-money
laundering legislation (e.g. UK, Ireland, Singapore, Australia and the United States).
E

the tax authorities suspicions are unfounded;
Dedza has failed to recognise suspicious circumstances.
SA
M
Tutorial note: In either case, Dedza should now review relevant procedures.
1012

Dedza should review any communication from the predecessor auditor obtained in
response to its “professional inquiry” (for any professional reasons why the
appointment should not be accepted).

A quality control for new audits is that the audit opinion should be subject to a
second partner review before it is issued. It should be considered now whether or
not such a review took place. If it did, then it should be sufficiently well
documented to evidence that the review was thorough and not a mere formality.

Criminal property includes the proceeds of tax evasion. If Kora is found to be
guilty of under-declaring income that is a money laundering offence.

Dedza’s reputational risk will be increased if implicated because it knew (or ought
to have known) about Kora’s activities. (Dedza may also be liable if found to have
been negligent in failing to detect any material misstatement arising in the 31 March
2016 financial statements.)

Kora’s audit working paper files and tax returns should be reviewed for any
suspicion of fraud being committed by Kora or error overlooked by Dedza. Tax
advisory work should have been undertaken and/or reviewed by a manager/partner
not involved in the audit work.

As tax advisor, Dedza could soon be making disclosures of misstatements to the tax
authorities on behalf of Kora. Dedza should encourage Kora to make necessary
disclosure voluntarily.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)

If Dedza finds reasonable grounds to know or suspect that potential disclosures to
the tax authorities relate to criminal conduct, then a suspicious transaction report
(STR) should be made to the financial intelligence unit (FIU) also.
Tutorial note: Though not the main issue credit would be given for other ethical issues such
as the potential self-interest/self-review threat arising from the provision of other services.
Advice on payments

As compared with (i) there is no obvious tax issue. Xalam is not overstating
expenditure for tax purposes.

Dedza should consider its knowledge of import duties, etc in the destination country
before recommending a course of action to Xalam.

The payments being made for security consultancy services may amount to a bribe.
Corruption and bribery (and extortion) are designated categories of money
laundering offence under The Forty Recommendations of the Financial Action Task
Force on Money Laundering (FATF).
PL
E
(ii)
If this is a bribe:
Xalam clearly benefits from the payments as it receives income from the contract
with the major customer. This is criminal property and possession of it is a money
laundering offence.

Dedza should consider the seriousness of the disclosure made by the chief executive
in the context of domestic law.

Dedza may be guilty of a money laundering offence if the matter is not reported. If
a report to the FIU is considered necessary Dedza should encourage Xalam to make
voluntary disclosure. If Xalam does not, Dedza will not be in breach of client
confidentiality for reporting knowledge of a suspicious transaction.
SA
M

Tutorial note: Making a report takes precedence over client confidentiality.
(iii)
Financial advisor

Customer due diligence (CDD) and record-keeping measures apply to designated
non-financial businesses and professions (such as Dedza) who prepare for or carry
out certain transactions on behalf of their clients.

Esau is a “politically exposed person” (“PEP” i.e. an individual who is to be
entrusted with prominent public functions in a foreign country).

Dedza’s business relationships with Pholey therefore involve reputational risks
similar to those with Esau. In addition to performing normal due diligence
measures Dedza should:

have risk management systems to have determined that Esau is a PEP;

obtain senior partner approval for maintaining business relationships with
such customers;

take reasonable measures to establish the sources of wealth and funds;

conduct enhanced ongoing monitoring of the business relationship.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
1013
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK

Dedza can choose to decline to act for Pholey and/or Esau (if asked).

If the business relationship is to be continued senior partner approval should be
obtained for any transactions carried out on Pholey’s behalf in future.
Tutorial note: The Pholey family is not described as an audit client therefore no familiarity
threat arises in relation to an audit (the family may not have any involvement in entities
requiring an audit).
Answer 4 KLOSER
Profits warning
PL
(1)
E
Tutorial note: This answer is expressed in the terms used in IESBA’s “Code of Ethics for Professional
Accountants”. However, an answer expressed in terms of the ACCA’s “Code of Ethics and Conduct”
is equally acceptable. Remember that there is more to “ethics” than “independence” (e.g. competence,
confidentiality) and more to “professional” issues than “ethics” (e.g. quality control and risk
assessments).
Ethical and professional issues
The profit warning increases the inherent risk of this assignment. As more work
may be needed than for the prior year (e.g. on Vanaka’s impaired assets), additional
staff may need to be assigned to the audit.

An “advocacy threat” may occur if a dispute (potential legal action) arises between
Isthmus and Kloser. For example, if the due diligence work should have recognised
the significant impairments.

Kloser should undertake a review of the due diligence work and audit for the yearended 31 December 2015 to ensure there were no findings which should have
alerted them to the problems in Vanaka which precipitated the profit warning.

A “self-review threat” may arise in that the prior year-end audit, which followed the
purchase, may have lacked objectivity. For example, the involvement of the
corporate finance department in due diligence may have resulted in less audit work
being carried out on Vanaka’s assets and operating results than would otherwise
have been performed.

If Kloser was negligent in undertaking the due diligence work (e.g. because assets
were impaired at the time of acquisition and/or the assumptions underlying the
expected synergies were unrealistic or hypothetical), to whom will Kloser be liable?
To whom was the due diligence work reported? (Isthmus, Isthmus’s shareholders,
providers of finance for the acquisition?)
SA
M

Tutorial note: To illustrate that these “model” answers are not exhaustive consider, for
example, that credit was given to candidates who argued that the trainees’ involvement in the
audit would be beneficial (to Kloser and/or Isthmus).
1014
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
Implications for staffing
As a safeguard for the provision of the other service (due diligence) the audit personnel
seconded to the corporate finance department should not have participated in the audit for the
year ended 31 December 2016. Any such “bar” should continue.
If the secondees are involved in the audit, appropriate safeguards would include not assigning
them to the audit areas most closely associated with due diligence and close monitoring and
review of their work.
(2)
Shares inherited
Ethical and professional issues
E
More senior or experienced staff should be assigned to the audit (than would have been
necessary had the profit warning not been issued).
A “self-interest threat” has arisen as Mercedes has a direct financial interest in
Isthmus (i.e. she controls the shares). In particular, in wishing the share price to
increase Mercedes might be in a position to overlook unrecorded liabilities and
losses discovered during the conduct of the audit (say).

Even though Mercedes may have independence of mind and be known to act with
the utmost integrity, she cannot have independence in appearance.

This inadvertent violation (i.e. through inheritance) of an independence principle
does not impair the independence of Kloser or the audit team providing:
Kloser’s established policies and procedures have resulted in Mercedes
having reported promptly her inheritance of the shares;
SA
M

PL


Kloser promptly advises Mercedes that the shares should be disposed of;
and

the disposal occurs at the earliest practical date, or she is removed.

Mercedes does not intend to dispose of the shares quickly as she is waiting for the
share price to recover.

It is unlikely that Kloser would consider offering her adequate compensation for an
earlier disposal (the loss in share value since the fall is 5,000 × ($7·95 – $1·95) =
$30,000).

Although IESBA’s independence statement requires Mercedes’ removal from the
audit team, Kloser may require stricter safeguards and prohibit all professional staff
from holding direct financial interests. Mercedes may therefore be asked to choose
either to stay with the firm or dispose of the shares at the earliest practical date.

If any work has been done by Mercedes on the audit of Isthmus since she inherited
the shares (e.g. in reviewing interim audit work or planning the year-end or final
audit visits) that work should be re-reviewed by another professional accountant.
Implications for staffing
This threat is so significant that Mercedes should be removed from the audit team unless she
disposes of the shares before she undertakes any further tasks relating to the audit of Isthmus.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
1015
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
(3)
Dealing in shares
Ethical and professional issues

A self-interest threat would have arisen only if Anthony had known that a close
family member (a parent) had shares in Isthmus (but he did not). A self-interest
threat cannot now arise as his father has disposed of the shares.

Providing Anthony did not knowingly prompt his father to sell the shares, he has
not committed a criminal act (e.g. of insider dealing).
E
Tutorial note: If he committed such an act he should be instantly dismissed by the firm and
any professional body under which he is registered (e.g. ACCA) notified for disciplinary
action.
However, if he in some way communicated (e.g. in a careless remark) something
that prompted his father to sell the shares, he may be in breach of his duty of
confidentiality. This should be investigated and appropriate action taken (e.g. he
may be cautioned or given a written warning).

If he unknowingly gave his father price sensitive information, then his father may
be guilty of insider dealing (or similar) for having acted on it.
Implications for staffing
PL

Unless there is any reason to suppose that Anthony has acted improperly (e.g. if he has
delayed disclosing the matter) there is no reason why he should not continue his position in
the audit team.
SA
M
However, if his father were to come under suspicion of insider dealing then Anthony should
be withdrawn from this assignment.
Overall
Given the high profile attaching to this listed client it would be timely to have all members
assigned to the audit team renew their written declarations of independence and
confidentiality.
Answer 5 BECKER & CO
(a)
Joint business arrangement
The business opportunity of Murray could be lucrative if the market research is to be
believed.
However, IESBA’s Code of Ethics for Professional Accountants states that a mutual business
arrangement is likely to give rise to self-interest and intimidation threats to independence and
objectivity. The audit firm must be and be seen to be independent of the audit client, which
clearly cannot be the case if the audit firm and the client are seen to be working together for a
mutual financial gain.
In the scenario, two options are available:
(1)
(2)
1016
provision of finance by Becker & Co;
establishing a joint venture.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
(1)
Provision of finance
Becker & Co could provide the audit client with finance to complete the development and
take the product to market. There is a general prohibition on audit firms providing finance to
their audit clients. This would create a clear financial self-interest threat as the audit firm
would be receiving a return on investment from a client. The Code states that if a firm makes
a loan (or guarantees a loan) to a client, the self-interest threat created would be so significant
that no safeguard could reduce the threat to an acceptable level.
E
The provision of finance using convertible debentures raises a further ethical problem; if the
debentures are ultimately converted to equity the audit firm would then hold equity shares in
an audit client. This is a severe financial self-interest; safeguards are unlikely to be available
to reduce the risk to an acceptable level.
The finance should not be advanced to Murray while the company remains an audit client of
Becker & Co.
Establishing a joint venture
PL
(2)
This would be perceived as a significant mutual business interest as Becker & Co and Murray
would be investing together, sharing control and sharing a return on investment in the form of
dividends. IESBA’s Code of Ethics states that unless the relationship between the two parties
is clearly insignificant, the financial interest is immaterial and the audit firm is unable to
exercise significant influence, then no safeguards could reduce the threat to an acceptable
level. In this case Becker & Co may not enter into the joint venture arrangement while
Murray is still an audit client.
SA
M
The audit practice may consider that investing in the new electronic product is a commercial
strategy that it wishes to pursue, either through loan finance or using a joint venture
arrangement. In this case the firm should resign as auditor with immediate effect in order to
eliminate any ethical problem with the business arrangement. The partners should carefully
consider if the potential return on investment will more than compensate for the lost audit fee
from Murray.
The partners should also reflect on whether they want to diversify to such an extent – this
investment is unlikely to be in an area where any of the audit partners have much knowledge
or expertise. A thorough commercial evaluation and business risk analysis must be performed
on the new product to ensure that it is a sound business decision for the firm to invest.
The audit partners should also consider how much time they would need to spend on this
business development if they decided to resign as auditors and proceed with the investment.
Such a new and important project could mean that they take their focus off the key business
(i.e. the audit practice). They should consider if it would be better to spend their time trying
to compete effectively with the two new firms of accountants; trying to retain key clients and
to attract new accounting and audit clients rather than diversify into something completely
different.
(b)
Recruitment service
IESBA’s Code of Ethics for Professional Accountants does not prohibit firms from offering a
recruitment service to client companies. However several ethical problems could arise if the
service were offered. The severity of these problems would depend on the exact nature of the
service provided and the role of the person recruited into the client’s organisation.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
1017
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
Specific ethical threats could include:

Self-interest – clearly the motive for Becker & Co to offer this service is to generate
income from audit clients, thereby creating a financial self-interest threat. The
amount received for the recruitment service depends on the magnitude of the salary
of the person employed. The more senior the person recruited, the higher his salary
is likely to be, and the higher the fee to be paid to Becker & Co.
In addition, the firm could be tempted to advise positively on the recruitment of an
individual merely to receive the relevant recruitment fee, without properly
considering the suitability of the person for the role.
Familiarity – when performing the audit, the auditors may be less likely to criticise
or challenge the work performed by a person they helped to recruit, as any
significant problems discovered may make the recruitment appear ill-advised.

Management involvement – there is also a threat that the audit firm could be
perceived to be making management decisions by selecting employees. The firm
could offer services such as reviewing the professional qualifications of a number of
applicants and providing advice on the applicant’s suitability for the post. In
addition the firm could draw up a shortlist of candidates for interview, using criteria
specified by the client. However in all cases, the final decision on whom to hire
must be made by the client, as the audit firm should not make, or be perceived to be
making, management decisions.
PL
E

SA
M
The threats discussed above would increase in significance if the recruitee took on a role in
key management pertaining to the finance function, such as finance director or financial
controller. The threats would be less severe if the audit firm advised on the recruitment of a
junior member of the client’s finance function.
If these threats could not be reduced to a level less than clearly insignificant, then the
recruitment service should not be offered.
Commercial evaluation
The firm should consider whether there is likely to be much demand for the potential service
before developing such a resource. Some form of market research is essential.
Offering this type of service represents a significant departure from normal audit services.
The firm should consider whether there is sufficient knowledge and expertise to offer a
recruitment service. Ingrid Sharapova seems to have some experience but her skills may be
out of date and not specifically relevant to the recruitment of finance professionals. It may be
that considerable training and possibly the attainment of a new professional qualification
relevant to recruitment may be necessary for a credible service to be offered to clients.
If the recruitment service proved successful Ingrid could be faced with too much work (as she
is the only person with relevant experience and has no one to delegate to). If the firm decides
to offer this service, then one other person should receive appropriate training (to cover for
Ingrid’s holidays and any sick leave and provide someone for Ingrid to delegate to). The
financial cost of such training should be considered.
Finally, Becker & Co should consider the potential damage to the firm’s reputation if the
service offered is not of a high quality. If the partners decide to pursue this business
opportunity, they may wish to consider setting it up as a separate entity, so that if the business
fails or its reputation is questioned, the damage to Becker & Co would be minimised.
1018
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
REVISION QUESTION BANK – ADVANCED AUDIT AND ASSURANCE (P7)
(c)
Temporary staff assignments
Lending staff on a temporary basis to an audit client will create the following ethical threats:
Management involvement – assuming that the manager or senior is seconded to the
finance function of the audit client, it is likely that the individual would be in some
way involved in decision making in relation to the accounting systems, management
accounts or financial statements.

Self-review – on returning to the audit firm a seconded individual could be a
member of the audit team for the client to which he was seconded. This would
create a self- review threat as he would be unlikely to criticise his own work
performed or decisions made. Even if the individual was not assigned to the client
where he performed a temporary assignment, the audit team assigned may tend to
over rely on areas worked on by a colleague during the period of his temporary
assignment.

Familiarity – if the individual is working at the client at any time during the audit,
there will be a familiarity threat; audit team members will be unlikely to sufficiently
challenge the work performed by the seconded individual (and professional
skepticism may be lacking).
PL
E

In addition, due to the over-staffing problem of Becker & Co, the seconded individuals may
feel that if they were not on the secondment, they could be made redundant. This may cause
them to act in such a way as not to jeopardise the secondment, even if the action were not in
the best interests of the firm.
SA
M
The threats discussed above are increased where a senior person likely to make significant
decisions is involved with the temporary assignment, as in this case where audit managers or
seniors will be the subjects of the proposed secondment.
In practice, assistance can be provided to clients, especially in emergency situations, but only
on the understanding that the firm’s personnel will not be involved with:



making management decisions;
approving or signing agreements or similar documents; and
having the authority to enter into commitments on behalf of the company.
In addition, the individual seconded to a client should not then be involved in any way with
the audit of that client when he returns to the audit firm. This may be a difficult area, as
presumably the client would prefer that such an individual has knowledge and experience of
the business (i.e. a member of the audit team) and, most likely in this scenario, is the audit
manager. If this were the case the manager would then have to be reassigned to a different
client, causing internal problems for the audit firm. This problem is likely to outweigh any
benefits, financial or otherwise, to Becker & Co.
If the temporary staff assignment were to a non-finance department of the client then the
threats would be reduced.
If Becker & Co decides to go ahead with the secondment programme, the firm must ensure
that the staff are suitably experienced and qualified to carry out the work given to them by the
client. There could be a risk to the reputation of Becker & Co if the seconded staff are not
competent or do not perform as well as expected by the client.
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
1019
ADVANCED AUDIT AND ASSURANCE (P7) – REVISION QUESTION BANK
One advantage of a secondment is that the individual concerned can benefit from exposure to
a different type of work and work environment. This will provide some valuable insights into
accounting within a business and the individual may bring some new skills and ideas back
into the audit firm.
However, the staff seconded could be offered a permanent position at the client. This would
lead to the loss of key members of staff and be detrimental for Becker & Co in the long run.
The other benefit for the audit firm is that a programme of secondments will ease the problem
of an over-staffed audit department and should have cash flow benefits.
E
Tutorial note: In answering this question it is relevant to briefly mention corporate
governance implications (e.g. the client may not be able to accept the services offered by the
auditor for ethical, particularly objectivity, reasons).
Answer 6 CARTER & CO
Fernwood Co
PL
(a)
The provision of a valuation service is an example of providing a non-audit service. The key
issue is that if an audit firm provides a valuation service for an item which will be included in
the financial statements, a self-review threat arises. The self-review threat exists because the
audit firm will be auditing a balance on which they have themselves placed a valuation.
SA
M
The significance of the risk depends on the level of materiality of the item in the financial
statements. According to IESBA’s Code of Ethics for Professional Accountants (the Code), if
the valuation service involves the valuation of matters material to the financial statements,
and the valuation involves a significant degree of subjectivity, the self-review threat created
could not be reduced to an acceptable level by the application of any safeguards. If this were
the case, the audit firm should not provide the valuation service. Alternatively, if the
valuation service were provided, the firm should resign from providing the audit service.
Carter & Co must assess the degree of risk in valuing Fernwood’s pension liability. If the
amount is immaterial to the financial statements, or does not involve a significant degree of
subjectivity, the valuation service can be provided, as long as safeguards are put in place, for
example:



Using separate personnel for the valuation service and the audit;
Performing a second partner review;
Confirming that the client understands the valuation method and the assumptions
used.
The valuation of the pension balance recognised is likely to involve many judgments and
assumptions, and so is likely to be a subjective exercise. It is, therefore, most likely that
Carter & Co will assess the situation as creating a significant self-review threat which
safeguards cannot reduce to an acceptable level, in which case the valuation service should
not be provided as well as carrying out the audit.
If Carter & Co were to provide the valuation service, either because the self-review threat is
assessed as low, or if they were to resign as auditor, then the firm should carefully consider
whether it possesses sufficient skills and expertise to perform the valuation. This is a
specialist area, and the firm would have to ensure that it could perform the work competently.
1020
©2016 DeVry/Becker Educational Development Corp. All rights reserved.
PL
Paper P7E(INT)
Professional Level – Options Module
Advanced Audit and
Assurance
(International)
M
September/December 2015
Time allowed
Reading and planning:
Writing:
15 minutes
3 hours
SA
This question 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 question 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.
This question paper must not be removed from the examination hall.
The Association of Chartered Certified Accountants
Section A – BOTH questions are compulsory and MUST be attempted
You are a manager in the audit department of Mondrian & Co, a firm of Chartered Certified Accountants. You are
responsible for the audit of Dali Co, a listed company specialising in the design and manufacture of equipment and
machinery used in the quarrying industry. You are planning the audit of the financial statements for the year ending
31 December 2015. The projected financial statements for the 2015 year end recognise revenue of $138 million
(2014 – $135 million), profit before tax of $9·8 million (2014 – $9·2 million) and total assets of $90 million (2014
– $85 million). Dali Co became listed in its home jurisdiction on 1 March 2015, and is hoping to achieve a listing
on a foreign stock exchange in June 2016.
You have just received the following email from the audit engagement partner.
To: Audit manager
Regarding: Audit planning – Dali Co
Hello
PL
E
From: Audit engagement partner, Sam Hockney
I need you to start planning the audit of Dali Co. I know you are new to this audit client, so I have provided you
with some background information, the results of some preliminary analytical review performed by one of the audit
team members, and notes from a discussion I had with the company’s audit committee yesterday. I require you to
prepare briefing notes for use in the audit planning meeting which will be held next week. In these notes you are
required to:
(a) (i)
Evaluate the audit risks to be considered in planning the audit of Dali Co; and
(18 marks)
(ii) Recommend the additional information which would be relevant in the evaluation of audit risk.
(5 marks)
(b) Explain the principal audit procedures to be performed in respect of:
The valuation of work in progress and;
(4 marks)
M
(i)
(ii) The recognition and measurement of the government grant.
Thank you.
(4 marks)
Company background
Dali Co was established 20 years ago and has become known as a leading supplier of machinery used in the
quarrying industry, with its customers operating quarries which extract stone used mainly for construction. Its
customer base is located solely in its country of incorporation but most of the components used in Dali Co’s
manufacturing process are imported from foreign suppliers.
SA
1
The machines and equipment made by Dali Co are mostly made to order in the company’s three manufacturing sites.
Customers approach Dali Co to design and develop a machine or piece of equipment specific to their needs. Where
management considers that the design work will be significant, the customer is required to pay a 30% payment in
advance, which is used to fund the design work. The remaining 70% is paid on delivery of the machine to the
customer. Typically, a machine takes three months to build, and a smaller piece of equipment takes on average
six weeks. The design and manufacture of bespoke machinery involving payments in advance has increased during
the year. Dali Co also manufactures a range of generic products which are offered for sale to all customers, including
drills, conveyors and crushing equipment.
Notes from meeting with Dali Co audit committee
This year has been successful from a strategic point of view in that Dali Co achieved its stock exchange listing in
March 2015, and in doing so raised a significant amount of equity finance. The company’s corporate governance was
reviewed as part of the flotation process, resulting in the recruitment of three new non-executive directors and a new
finance director.
In March 2015, a cash-settled share-based payment plan was introduced for senior executives, who will receive a
bonus on 31 December 2017. The amount of the bonus will be based on the increase in Dali Co’s share price from
2
that at the date of the flotation, when it was $2·90, to the share price at 31 December 2017. On the advice of the
newly appointed finance director, no accounting entries have been made in respect of the plan, but the details relating
to the cash-settled share-based payment plan will be disclosed in the notes to the financial statements.
The finance director recommended that the company’s manufacturing sites should be revalued. An external valuation
was performed in June 2015, resulting in a revaluation surplus of $3·5 million being recognised in equity. The
finance director has informed the audit committee that no deferred tax needs to be provided in respect of the valuation
because the property is part of continuing operations and there is no plan for disposal.
PL
E
In July 2015, a government grant of $10 million was received as part of a government scheme to subsidise
companies which operate in deprived areas. Specifically $2 million of the grant compensates the company for wages
and salaries incurred in the year to 31 December 2015. The remaining grant relates to the continued operations in
the deprived area, with a condition of the grant being that the manufacturing site in that area will remain operational
until July 2020.
All of the company’s manufacturing sites will be closed at the year end to allow the inventory counts to take place.
According to the most recent management accounts which are available, at 30 November 2015 work in progress is
valued at $12 million (2014 – $9·5 million) and the majority of these orders will not be complete until after the year
end. In recent weeks several customers have returned equipment due to faults, and Dali Co offers a warranty to
guarantee that defective items will be replaced free of charge.
Preliminary analytical review (extract) and other financial information
Operating margin
Inventory days
Receivables collection period
Trade payables payment period
Required:
75 cents per share
$3·50
M
Earnings per share
Share price
Based on
projected figures to
31 December 2015
15%
175 days
90 days
60 days
Respond to the instructions in the audit partner’s email.
Based on
audited figures to
31 December 2014
13%
150 days
70 days
55 days
–
–
(31 marks)
Note: The split of the mark allocation is shown in the email.
SA
Professional marks will be awarded for the presentation of the briefing notes and for the clarity of explanations
provided.
(4 marks)
(35 marks)
3
[P.T.O.
The audit work in respect of the year ended 31 July 2015 is almost complete, but the audit senior has not yet
completed the audit work in respect of performance information which is being published with the annual
financial statements for the first time this year. It is a requirement in the jurisdiction in which the Rothko
University is located that the performance information is audited as part of the external audit.
Details on the performance information are given below.
Performance area
Graduation rate
Academic performance
Employability
2015 result
85%
20%
65%
70%
PL
E
Course satisfaction
Performance measure
% of students who complete their degree programme
% of students achieving a distinction
% of students who on graduation obtain graduate level
employment
% of students who rate their university experience as
excellent or very good
Required:
(i) Discuss the relevance and measurability of the reported performance information; and
(ii) Recommend the examination procedures to be used in auditing the performance information.
Note: The total marks will be split equally between each part.
(10 marks)
SA
M
(25 marks)
5
[P.T.O.
Section B – TWO questions ONLY to be attempted
You are a manager in the assurance department at Raphael & Co, a firm of Chartered Certified Accountants. Your firm
has been appointed by Sanzio Co to perform a due diligence review of a potential acquisition target, Titian Tyres Co.
As part of the due diligence review and to allow for consideration of an appropriate offer price, Sanzio Co has
requested that you identify and value all the assets and liabilities of Titian Tyres Co, including items which may not
currently be reported in the statement of financial position.
Sanzio Co is a large, privately owned company operating only in this country, which sells spare parts and accessories
for cars, vans and bicycles. Titian Tyres Co is a national chain of vehicle service centres, specialising in the repair and
replacement of tyres, although the company also offers a complete range of engine and bodywork services as well. If
the acquisition is successful, the management of Sanzio Co intends to open a Titian Tyres service centre in each of
its stores.
PL
E
One of the reasons for Titian Tyres Co’s success is their internally generated customer database, which records all
customer service details. Using the information contained on the database software, the company’s operating system
automatically informs previous customers when their vehicle is due for its next service via email, mobile phone text
or automated letter. It also informs a customer service team to telephone the customer if they fail to book a service
within two weeks of receiving the notification. According to the management of Titian Tyres Co, repeat business makes
up over 60% of annual sales and management believes that this is a distinct competitive advantage over other service
centres.
Titian Tyres Co also recently purchased a licence to distribute a new, innovative tyre which was designed and patented
in the United States. The tyre is made of 100% recycled materials and, due to a new manufacturing process, is more
hardwearing and therefore needs replacing less often. Titian Tyres Co paid $5 million for the licence in January 2015
and the company is currently the sole, licenced distributor in this country.
Required:
M
During a brief review of Titian Tyres Co’s financial statements for the year ended 30 June 2015, you notice a
contingent liability disclosure in the notes relating to compensation claims made after the fitting of faulty engine parts
during 2014. The management of Titian Tyres Co has stated that the fault lies with the manufacturer of the part and
that they have made a claim against the manufacturer for the total amount sought by the affected customers.
(a) Describe the purpose of a due diligence assignment and compare the scope of a due diligence assignment
with that of an audit of historical financial statements.
(6 marks)
(b) (i)
Recommend, with reasons, the principal additional information which should be made available to assist
with your valuation of Titian Tyres Co’s intangible assets.
(ii) Explain the specific enquiries you should make of Titian Tyres Co’s management relevant to the
contingent liability disclosed in the financial statements.
SA
3
Note: The total marks will be split equally between each part.
(14 marks)
(20 marks)
6
You are an audit manager at Rockwell & Co, a firm of Chartered Certified Accountants. You are responsible for the
audit of the Hopper Group, a listed audit client which supplies ingredients to the food and beverage industry
worldwide.
The audit work for the year ended 30 June 2015 is nearly complete, and you are reviewing the draft audit report
which has been prepared by the audit senior. During the year the Hopper Group purchased a new subsidiary
company, Seurat Sweeteners Co, which has expertise in the research and design of sugar alternatives. The draft
financial statements of the Hopper Group for the year ended 30 June 2015 recognise profit before tax of $495 million
(2014 – $462 million) and total assets of $4,617 million (2014: $4,751 million). An extract from the draft audit
report is shown below:
Basis of modified opinion (extract)
PL
E
In their calculation of goodwill on the acquisition of the new subsidiary, the directors have failed to recognise
consideration which is contingent upon meeting certain development targets. The directors believe that it is unlikely
that these targets will be met by the subsidiary company and, therefore, have not recorded the contingent
consideration in the cost of the acquisition. They have disclosed this contingent liability fully in the notes to the
financial statements. We do not feel that the directors’ treatment of the contingent consideration is correct and,
therefore, do not believe that the criteria of the relevant standard have been met. If this is the case, it would be
appropriate to adjust the goodwill balance in the statement of financial position.
We believe that any required adjustment may materially affect the goodwill balance in the statement of financial
position. Therefore, in our opinion, the financial statements do not give a true and fair view of the financial position
of the Hopper Group and of the Hopper Group’s financial performance and cash flows for the year then ended in
accordance with International Financial Reporting Standards.
Emphasis of Matter Paragraph
We draw attention to the note to the financial statements which describes the uncertainty relating to the contingent
consideration described above. The note provides further information necessary to understand the potential
implications of the contingency.
M
Required:
(a) Critically appraise the draft audit report of the Hopper Group for the year ended 30 June 2015, prepared by
the audit senior.
Note: You are NOT required to re-draft the extracts from the audit report.
(10 marks)
(b) The audit of the new subsidiary, Seurat Sweeteners Co, was performed by a different firm of auditors, Fish
Associates. During your review of the communication from Fish Associates, you note that they were unable to
obtain sufficient appropriate evidence with regard to the breakdown of research expenses. The total of research
costs expensed by Seurat Sweeteners Co during the year was $1·2 million. Fish Associates has issued a qualified
audit opinion on the financial statements of Seurat Sweeteners Co due to this inability to obtain sufficient
appropriate evidence.
SA
5
Required:
Comment on the actions which Rockwell & Co should take as the auditor of the Hopper Group, and the
implications for the auditor’s report on the Hopper Group financial statements.
(6 marks)
(c) Discuss the quality control procedures which should be carried out by Rockwell & Co prior to the audit report
on the Hopper Group being issued.
(4 marks)
(20 marks)
End of Question Paper
8
Professional Level – Options Module, Paper P7 (INT)
Advanced Audit and Assurance (International)
Briefing notes
To: Audit partner
From: Audit manager
Subject: Audit planning in respect of Dali Co
Introduction
(i)
Audit risk evaluation
Stock exchange listing and pressure on results
The listing obtained during the year can create inherent risk at the financial statement level because management may
feel under pressure to achieve good results in this financial year. The flotation raised equity capital, so there will be new
shareholders who will want to see strong performance in the expectation of a dividend pay-out. In addition, the
introduction of the cash-settled share-based payment plan motivates management to produce financial statements which
show a favourable performance and position which is likely to lead to an increase in the company’s share price. There
is a risk that revenue and profits may be overstated. Revenue has increased by 2·2% and profit before tax by 6·5%,
which may indicate overstatement.
Disclosure for listed companies
This is the first set of financial statements produced since Dali Co became listed. There is a risk that the new finance
director will not be familiar with the requirements specific to listed companies, for example, the company now falls under
the scope of IAS 33 Earnings per Share and IFRS 8 Operating Segments for the first time. There is a risk of incomplete
or inaccurate disclosures in respect of these standards and also in respect of any listing rules in the jurisdiction in which
the company is listed.
Foreign exchange transactions
Dali Co purchases many components from foreign suppliers and is therefore likely to be transacting and making
payments in foreign currencies. According to IAS 21 The Effects of Changes in Foreign Exchange Rates, transactions
should be initially recorded using the spot rate, and monetary items such as trade payables should be retranslated at
the year end using the closing rate. Exchange gains and losses should be recognised within profit for the year. The risk
is that the incorrect exchange rate is used for the translation and retranslation, or that the retranslation does not happen
at the year end, in which case trade payables and profit could be over or understated, depending on the movement in
the exchange rate. The company may have entered into hedging arrangements as a way to reduce exposure to foreign
exchange fluctuations. There is a risk that hedging arrangements are not identified and accounted for as derivatives
according to IFRS 9 Financial Instruments which could mean incomplete recognition of derivative financial assets or
liabilities and associated gains or losses.
M
(a)
PL
E
These briefing notes are prepared to assist in the audit planning meeting for Dali Co, our manufacturing client supplying machinery
and equipment to the quarrying industry. The notes contain an evaluation of audit risk along with recommendations of the
additional information which is relevant to audit risk evaluation. The notes also explain the principal audit procedures to be
performed in respect of the valuation of work in progress, and the government grant received during the year.
SA
1
September/December 2015 Answers
Payment in advance and revenue recognition under contract with customers
For items where significant design work is needed, Dali Co receives a payment in advance. This gives rise to risk in
terms of when that part of the revenue generated from a sale of goods is recognised. There is a risk that revenue is
recognised too early, especially given the risk of management bias and the incentive to overstate revenue and profit as
discussed above. According to IFRS 15 Revenue from Contracts with Customers, revenue should only be recognised as
control is passed, either over time or at a point in time. The timing of revenue recognition will depend on the contractual
terms with the customer, with factors which may indicate the point in time at which control passes including the
transference of the physical asset, transference of legal title, and the customer accepting the significant risks and rewards
related to the ownership of the asset. It is likely that the payments in advance should be treated as deferred revenue at
the point when the payment is received as the conditions for recognition of revenue are unlikely to have been met at
this point in time.
There is additional audit risk created if a customer were to cancel a contract part way through its completion, the
bespoke work in progress may be worthless and would need to be written off according to IAS 2 Inventories. There is
therefore a risk of overstated work in progress.
New directors
During the year several new non-executive directors were appointed, as well as a new finance director. While this may
serve to strengthen the corporate governance structure including the control environment, equally the introduction of
new personnel could mean inexperience and a control risk, particularly if the finance director is lacking in experience.
Some of the suggestions and accounting treatments made by the finance director indicate that their knowledge of the
applicable financial reporting framework is weak, signalling that errors may occur in the preparation of the financial
statements.
11
Cash-settled share-based payment scheme
This falls under the scope of IFRS 2 Share-based Payment which states that the liability in respect of the plan should
be measured at fair value at the year end. The increase in the share price from $2·90 at flotation to $3·50 (projected)
at the year end indicates that a liability should be recognised at 31 December 2015 based on the fair value of the liability
which has accrued up to that date, with the expense recognised in the statement of profit or loss. This accounting
treatment has not been followed leading to understated liabilities and overstated profit, and the disclosure in respect of
the plan may not be sufficient to meet the requirements of IFRS 2 which requires extensive disclosures including the
effect of share-based payment transactions on the entity’s profit or loss for the period and on its financial position.
Revaluation of property
Deferred tax recognition
PL
E
The decision to revalue the company’s manufacturing sites creates several risks. First, revaluation involves establishing
a current market price or fair value for each property included in the revaluation, which can be a subjective exercise,
leading to inherent risk that the valuations may not be appropriate. A risk also arises in that IAS 16 Property, Plant and
Equipment requires all assets in the same class to be revalued, so if any properties which are manufacturing sites have
not been included in the revaluation exercise, the amounts recognised will not be correct. There is also a risk that
depreciation has not been recalculated on the new, higher value of the properties, leading to overstatement of
non-current assets and understatement of operating expenses. IAS 16 also requires a significant level of disclosure in
relation to a policy of revaluation, so there is a risk that the necessary disclosures are incomplete. The revaluation gain
recognised in equity represents 3·9% of total assets and is therefore material to the financial statements.
IAS 12 Income Taxes requires deferred tax to be recognised in respect of taxable temporary differences which arise
between the carrying amount and tax base of assets and liabilities, including the differences which arise on the
revaluation of non-current assets, regardless of whether the assets are likely to be disposed of in the foreseeable future.
The finance director’s suggestion that deferred tax should not be provided for is therefore incorrect, and at present
liabilities are understated, representing an error in the statement of financial position. There is no profit impact, however,
as the deferred tax would be recognised in equity. Depending on the rate of tax which would be used to determine the
necessary provision, it may not be material to the financial statements.
Government grant recognition
M
The government grant represents 11·1% of total assets and is material to the financial statements. A risk arises in
relation to the recognition of the grant. IAS 20 Accounting for Government Grants and Disclosure of Government
Assistance requires that a grant is recognised as income over the period necessary to match the grant received with the
related costs for which they are intended to compensate. Therefore, the $2 million relating to costs incurred this year
should be recognised as income, but the remainder should be released to profit on a systematic basis; in this case it
would seem appropriate to release on a straight line basis until July 2020. The risk is that the grant has been recognised
on an inappropriate basis leading to over or understated profit for the year. The part of the grant not recognised in profit
should be recognised in the statement of financial position. IAS 20 allows classification as deferred income, or
alternatively the amount can be netted against the assets to which the grant relates. There is therefore also a risk that
the amount is recognised elsewhere in the statement of financial position, leading to incorrect presentation and
disclosure.
SA
If the terms of the grant have been breached, the grant or an element of it may need to be repaid. There is therefore a
risk that if there is any breach, the associated provision for repayment is not recognised, understating liabilities.
Inventory valuation
Work in progress is material at 13·3% of total assets and has increased by 26·3% in the current year. The valuation of
work in progress is likely to be complex as many different jobs for different customers are ongoing at the year end, and
each will have a different stage of completion and cost base at the year end. There are also issues more generally with
the valuation of inventory, due to the customer returns of items which have recently occurred showing that there are
problems with the quality of the goods supplied. For items which have been returned, the net realisable value is likely
to be less than the cost of the item indicating that a write-off may be necessary to reduce the value of the inventory
according to IAS 2. The increase in the inventory holding period, as demonstrated by the increase in inventory days,
shows that inventory has become more slow-moving during the year also indicating that inventory may be overstated.
Provision in respect of returned goods
A provision should be recognised where a reliable estimate can be made in relation to a probable outflow of economic
resources and an obligating event has taken place. The fact that Dali Co replaces faulty products free of charge indicates
that a provision should be recognised based on the best estimate of the future economic outflow. The risk is that no
provision or an insufficient provision in relation to the warranty has been recognised, leading to understated liabilities
and operating expenses.
Working capital
The preliminary analytical review reveals that Dali Co is struggling to manage its working capital. The liquidity ratios
provided show that the operating cycle has increased from 165 days in 2014 to 205 days in 2015. The company may
be finding it difficult to collect cash from customers, as the receivables period has increased by 20 days, and in turn the
12
payment period to suppliers has increased by five days. If there is doubt over the collectability of receivables, then certain
balances may need to be written off, and there is a risk of overstatement of receivables and understatement of operating
expenses if bad debts are not recognised.
Tutorial note: Credit will be awarded for other relevant audit risks.
Recommended additional information
–
Details of the stock exchange listing during the year including the terms of the flotation, number of equity shares
issued and amount of equity capital raised.
–
Any information available in relation to the flotation, for example, investor prospectus, pre- and post-flotation press
releases, communications with the stock exchange registrar.
–
Information on the specific listing rules relevant to the stock exchange, for example, the corporate governance code
and disclosures necessary in company annual reports and financial statements.
–
Details on the planned foreign stock exchange listing in 2016 including the jurisdiction, the strategic rationale for
seeking the listing and proposed timescales.
–
Information on the background and experience of the new non-executive directors and the new finance director, for
example, their professional qualifications and previous employment or directorships held.
–
A full set of forecast financial statements including a statement of cash flows to assess the working capital issues
faced by the company.
–
Details on the valuation of properties including the date of the revaluation and information on the valuer such as
their professional qualification and relationship with the company and a copy of the valuation report.
–
Documentation on the cash-settled share-based payment scheme to gauge the number of members of the scheme
and its potential materiality to the financial statements.
PL
E
(ii)
Tutorial note: Credit will be awarded for other relevant information which would be available at this stage of the audit
to help in the evaluation of audit risk.
Audit procedures in respect of the valuation of work in progress
–
Obtain a schedule itemising the jobs included in work in progress at the year end, cast it and agree the total to the
general ledger and draft financial statements.
–
Agree a sample of items from the schedule to the inventory count records.
–
For a sample of jobs included on the schedule:
o
o
o
o
o
M
(i)
Agree costs to supporting documentation such as supplier’s invoice and payroll records;
For any overheads absorbed into the work in progress valuation, review the basis of the absorption and assess
its reasonableness;
Assess how the degree of completion of the job has been determined at the year end and agree the stage of
completion of the job to records taken at the inventory count;
Agree the details of the job specification to customer order; and
Confirm that net realisable value is greater than cost by agreeing the contract price and cash received from
the customer post year end.
SA
(b)
–
(ii)
To assess the completeness of work in progress, select a sample of customer orders and trace through to the list
of jobs included in work in progress.
Audit procedures in respect of the recognition and measurement of the government grant
–
Obtain the documentation relating to the grant to confirm the amount, the date the cash was received, and the
terms on which the grant was awarded.
–
Review the documentation for any conditions attached to the grant, for example, is there a requirement that a
certain number of people are employed at the manufacturing plant?
–
Discuss with management the method of recognition of the amount received, in particular how much of the grant
has been recognised in profit and the treatment of the amount deferred in the statement of financial position.
–
For the part of the grant relating to wages and salaries, confirm that the grant criteria have been complied with by
examining payroll records and timesheets to verify that $2m has been spent on wages in the deprived area.
–
For the part of the grant relating to continued operation of the manufacturing site, determine the basis on which
this is being released into profit and recalculate to confirm accuracy of management’s calculations.
–
Review forecasts and budgets in relation to the manufacturing site to assess the likelihood of its continued
operations until 2020.
13
–
Using the draft financial statements, confirm the accounting treatment outlined by discussion with management
has been applied and recalculate the amounts recognised.
–
Confirm the cash received to bank statement and cash book.
Conclusion
These briefing notes indicate that there are many areas of potential audit risk to be considered when developing the audit strategy
for Dali Co, and that additional information should be requested from the client to be obtained as soon as possible to facilitate a
more in-depth evaluation of certain audit risks identified. The audit procedures recommended in respect of work in progress and
the government grant received will provide assurance on these significant issues.
(i)
Going concern matters
Revenue and profitability
PL
E
The extract financial statements show that revenue has fallen by 38·2%. Based on the information provided, operating
profit was $1,150,000 in 2014 but is only $340,000 in 2015. Operating margins have fallen from 29·1% to 13·9%
during the year and the fall in revenue and margin has caused the company to become loss-making this year.
These changes are highly significant and most likely due to the economic recession which will impact particularly on
the sale of luxury, non-essential products such as those sold by Kandinsky Co. The loss-making position does not in
itself mean that the company is not a going concern, however, the trend is extremely worrying and if the company does
not return to profit in the 2016 financial year, then this would be a major concern. Few companies can sustain many
consecutive loss-making periods.
Bank loan
The bank loan is significant, amounting to 33·7% of total assets this year end, and it has increased by $500,000 during
the year. The company appears to be supporting operations using long-term finance, which may be strategically
unsound. The loan is secured on the company’s properties, so if the company defaults on the payment due in June
2016, the bank has the right to seize the assets in order to recoup their funds. If this were to happen, Kandinsky Co
would be left without operational facilities and it is difficult to see how the company could survive. There is also a risk
that there is insufficient cash to meet interest payments due on the loan.
Trade payables
The trade payables balance has increased by 38·5%, probably due in part to the change in terms of trade with its major
supplier of raw materials. An extension to the payable payment period indicates that the company is struggling to
manage its operating cycle, with the cash being generated from sales being insufficient to meet working capital
requirements. Relations with suppliers could be damaged if Kandinsky Co cannot make payments to them within agreed
credit terms, with the result that suppliers could stop supplying the company or withdraw credit which would severely
damage the company’s operations. There is also a risk that suppliers could bring legal action against the company in
an attempt to recover the amounts owed.
M
(a)
Borrowing facility
Kandinsky Co has $500,000 available in an undrawn borrowing facility, which does provide a buffer as there is a source
of cash which is available, somewhat easing the going concern pressures which the company is facing. However, the
availability of the borrowing facility depends on certain covenants being maintained. The calculations below show that
the covenants have now been breached, so the bank is within its right to withdraw the facility, leaving Kandinsky Co
exposed to cash shortages and possibly unable to make payments as they fall due.
SA
2
Interest cover
Borrowings to operating profit
Covenant
2
4:1
2015
340/520 = 0·65
3,500/340 = 10·3:1
2014
1150/500 = 2·3
3,000/1,150 = 2·6:1
Contingent liability
The letter of support offered to a supplier of raw materials exposes Kandinsky Co to a possible cash outflow of
$120,000, the timing of which cannot be predicted. Given the company’s precarious trading position and lack of cash,
satisfying the terms of the letter would result in the company utilising 80% of their current cash reserve. Providing such
support seems unwise, though it may have been done for a strategic reason, i.e. to secure the supply of a particular
ingredient. If the financial support is called upon, it is not certain that Kandinsky Co would have the means to make the
cash available to its supplier, which may create going concern issues for that company and would affect the supply of
cane sugar to Kandinsky Co. There may also be legal implications for Kandinsky Co if the cash could not be made
available if or when requested by the supplier.
(ii)
Audit procedures in relation to going concern matters identified
–
Obtain and review management accounts for the period after the reporting date and any interim financial accounts
which have been prepared. Perform analytical review to ascertain the trends in profitability and cash flows since
the year end.
14
Discuss with management the strategy which is being developed to halt the trend in declining sales and evaluate
the reasonableness of the strategy in light of the economic recession and auditor’s knowledge of the business.
–
Review the company’s current order book and assess the level of future turnover required to break even/make a
profit.
–
Analyse and discuss the cash flow, profit and other relevant forecasts with management and review assumptions
to ensure they are in line with management’s strategy and auditor’s knowledge of the business.
–
Perform sensitivity analysis on the forecast financial information to evaluate the impact of changes in key variables
such as interest rates, predictions of sales patterns and the timing of cash receipts from customers.
–
Calculate the average payment period for trade payables and consider whether any increase is due to lack of cash
or changes in the terms of trade.
–
Obtain the contract in relation to the borrowing facility to confirm the covenant measures and to see if any further
covenants are included in the agreement.
–
Review correspondence with the bank in relation to the loan and the borrowing facility to gauge the bank’s level of
support for Kandinsky Co and for evidence of deteriorating relationships between the bank and the company’s
management.
–
Obtain the bank loan agreement to confirm the amount of the loan, the interest rate and repayment dates and
whether the charge over assets is specific or general in nature.
–
Review the bank loan agreement for any clauses or covenants to determine whether there are any breaches.
–
Obtain the letter of support in relation to the supplier to confirm the conditions under which Kandinsky Co would
become liable for payment of the $120,000.
–
Discuss with management the reason for the letter of support being given to the supplier to understand the business
rationale and its implications, including why the supplier approached Kandinsky Co for the letter of support.
–
Inspect minutes of management meetings where those charged with governance discussed the letter of support
and authorised its issuance.
–
Obtain any further documentation available in relation to the letter of support, for example, legal documentation
and correspondence with the supplier, to confirm the extent of Kandinsky Co’s involvement with the supplier and
that no further amounts could become payable.
PL
E
–
M
(i)
Read the minutes of the meetings of shareholders, those charged with governance and relevant committees for
reference to trading and financing difficulties.
The relevance and measurability of the reported performance information
Performance information should be relevant to the users of that information. In the case of Rothko University, there is
likely to be a wide range of interested parties including current and potential students who will be interested in the quality
of the teaching provided and the likelihood of securing employment on completion of the university course. Other
interested parties will include the government body which provides funding to the University, regulatory bodies which
oversee higher education and any organisations which support the University’s work, for example, graduate employers.
For current and potential students, performance measures such as the graduation rate and employability rate will be
relevant as this will provide information on the success of students in completing their degree programmes and
subsequently obtaining a job. This is important because students pay tuition fees to attend Rothko University and they
will want to know if the investment in education is likely to result in employment. However, some students may be more
interested in further study after graduation, so employability measures would be less relevant to them.
SA
(b)
–
Students will be interested in the proportion of graduates who achieve a distinction as this may lead to better job
prospects and a better return on the investment (of time and money) in their education. Finally, students will find the
performance measure on course satisfaction relevant because it indicates that the majority of students rated the quality
of the course as high, an important factor in deciding whether to enrol onto a degree programme. Stakeholders other
than current and potential students may find other performance information more relevant to them, for example,
potential graduate employers may be interested in the amount of work experience which is provided on the University’s
degree programme.
The performance measures are most relevant where they can be compared to the measures of other universities.
Currently, the University has not provided comparative information and this is likely to make it difficult to assess the
performance of the University over time and also makes the current year measures harder to gauge.
In terms of measurability, as with many key performance indicators, it is sometimes difficult to precisely define or
measure the performance information. Some of the measures are quite subjective, for example, the rating which a
student gives to a course is down to personal opinion and it is difficult to substantiate, for example, the difference
between a course rating of excellent and very good. Similarly, defining ‘graduate level employment’ could be subjective.
Some measures will be easier to quantify, for example, the degree completion percentage, which will be based on fact
rather than opinion.
15
There may also be problems in how the information is gathered, affecting the validity of the information. For example,
only a sample of students may have completed a course evaluation, and possibly the most satisfied students were
selected which will improve the measure.
Obtain a list detailing all of the University’s performance objectives and the basis of measurement for each
objective.
–
Enquire of the University whether comparative information is available and if this information needs to be verified
as part of the disclosure in the current year.
–
For the graduation rate, obtain a list of students awarded degrees in 2015, and a list of all students who registered
on the degree programme and use this information to recalculate the %.
–
For academic performance, review minutes of meetings where degree results were discussed and approval given
for the award of distinction to a number of students.
–
For a sample of students awarded a distinction, confirm each student’s exam results to supporting documentation,
e.g. information in their student files, notices of exam results sent to the student and confirm that the grades
achieved qualify for a distinction being awarded.
–
Inspect any documentation issued at events such as degree award ceremonies to confirm the number of students
being awarded a distinction.
–
Obtain supporting documentation from the University for the employability rate and discuss with appropriate
personnel, for example, the careers centre, the basis of the determination of the rate.
–
For the employability rate, a confirmation could be sent to a sample of students asking for the details of their
post-graduation employment.
–
If the University supplies references for students seeking employment, inspect the references issued in 2015 and
contact the relevant company to see if the student was offered employment.
–
For course satisfaction, inspect the questionnaires or surveys completed by students from which the % was derived,
and recalculate.
–
Enquire if there is any other supporting documentation on course satisfaction, for example, minutes of student and
lecturer meetings about the quality of courses.
The purpose of due diligence
M
(a)
–
Information gathering
Due diligence is the process of fact finding to help reduce the risk involved in investment decisions. It is used when gathering
information about a target company, for the purpose of ensuring that the acquirer has full knowledge of the operations,
financial performance and position, legal and tax situation, as well as the general commercial background of the target. In
particular, due diligence helps to uncover potential problems before a decision regarding the acquisition is made.
Verification of management representations
During a sale, the vendor may make representations to the potential acquirer which it is essential to verify. As an example,
the vendor may state that the company has recently had a health and safety or fire safety investigation or that since their last
year end they have replaced ageing property, plant and equipment. Due diligence can be used to substantiate such claims.
SA
3
Examination procedures
PL
E
(ii)
Identification of assets and liabilities
One of the key reasons for performing due diligence is to identify the assets and liabilities of the target company, which is
vital when trying to value the target company. It is particularly important to attempt to identify and value the intangible assets
of the target company, including their brands, customer databases and development costs. Internally generated intangibles
will not be included on the statement of financial position and are particularly difficult to assess.
The valuation of liabilities is also critical because the acquirer will have to settle these in the future. This must be appropriately
planned for and considered during the negotiation of the acquisition price. Contingent liabilities are particularly significant
because, by their nature, the amount required to settle them and the likelihood of settlement are uncertain.
Operational issues
As well as the risk associated with the valuation of a business, the acquirer must also consider operational implications which
could jeopardise a proposed acquisition, such as high staff turnover, the need to renegotiate supplier or customer contracts
or contracts with lenders, and future changes in the product mix of the target company. Any of these could lead to operational
problems in the future and could be considered potential ‘deal breakers’ or, at the very least, be used to negotiate the
acquisition price.
Acquisition planning
Due diligence will also assess the potential commercial benefits and drawbacks of the acquisition. For example, it could be
used to calculate the potential economies of scale from aligning the supply chains of the buyer and the target company. On
16
the other hand, there are post-acquisition costs to consider, such as the costs of reorganisation and the potential staff turnover
which may be experienced.
Scope of a due diligence assignment compared to an audit
With due diligence, the scope is focused primarily on fact finding, which means that the investigation will draw on a much
wider range of sources than those connected with the current financial statements. These include:
Several years’ worth of historical financial statements
–
Management accounts
–
Profit and cash flow forecasts
–
Recent business plans and internal strategies/objectives
–
Employee contracts, particularly those of management
–
All binding contracts, such as supply contracts, lease agreements and loan agreement
–
Discussions with management, employees and third parties.
PL
E
–
While many of these items may be reviewed during an audit of historical financial statements, it is likely that due diligence
will require a much wider range of information.
The objective of an audit is to provide reasonable assurance that the financial statements are free from material misstatement.
In contrast, the aim of due diligence is to provide the acquirer with a set of information which has been collated and, most
likely, reviewed by the practitioner. Unless requested by the client, the practitioner will not express any opinion with regard
to the accuracy of the information provided. In this case, due diligence is performed as an ‘agreed upon procedures’
assignment.
If the practitioner is requested to provide assurance regarding the accuracy of the information provided, the due diligence
service would be performed as a limited assurance review engagement. This is a lower level of assurance than that provided
in an audit due to the reduced procedures performed during due diligence.
The type of work performed during due diligence is quite different to an audit, as a due diligence investigation uses, primarily,
analytical procedures and enquiry as a means of gathering information. Very few, if any, substantive procedures are carried
out, unless they are specifically requested by the client or there are specific issues which cause concern and therefore need
more detailed investigation. This is in contrast to an audit, where a comprehensive range of tests of control and substantive
tests are performed.
M
Due diligence is much more ‘forward looking’ than an audit. Much of the time during a due diligence investigation will be
spent assessing forecasts and predictions. This is in contrast to an audit, where procedures only tend to consider future events
if they are directly relevant to the year-end financial statements, for example, contingencies, or going concern problems.
In contrast to an audit, when it is essential to evaluate systems and controls, the due diligence investigation will not conduct
detailed testing of the accounting and internal control systems, unless specifically requested to do so.
(i)
Intangible assets
Customer database
–
A copy of the financial statements for the year ended 30 June 2015 to identify the current carrying value of any
purchased intangibles relating to the database, such as computer software.
SA
(b)
–
A copy of the original purchase agreement for the software to identify the age of the software and when any product
licences expire.
–
A copy of the original purchase/ongoing maintenance contracts for the software to identify the continuing costs of
maintaining the system at its current level of efficiency.
–
Historic records of sales by customer to verify management’s statement that repeat customers make up over 60%
of annual sales.
–
Copies of a sample of recent automated customer communications; these can be traced to customer bookings/sales
records to confirm the current efficacy of the system.
–
Sales forecasts for the foreseeable future to assess the potential future cash flows attributable to the customer
database system to assess its value when determining the potential purchase price.
–
Confirmation of the current price of similar database software to assess the market value/fair value of the asset.
Licence
–
A copy of the original purchase agreement for the licence to confirm the $5 million cost and the exclusivity of the
agreement.
–
The original purchase agreement can also be used to identify whether any further incremental/contingent
considerations or royalties are due in the future.
–
A copy of the licence agreement to confirm whether the licence is for a fixed period of time or not and to confirm
the exclusivity of the licence.
17
Professional Level – Options Module, Paper P7 (INT)
Advanced Audit and Assurance (International)
September/December 2015 Marking Scheme
Marks
(a)
(i)
Evaluation of audit risks
Up to 2 marks for each audit risk evaluated, and 1 mark for relevant calculations (e.g. materiality,
trends):
Stock exchange listing and pressure on results
Disclosure for listed companies
Foreign exchange transactions and potential derivatives (up to 3 marks)
Payment in advance and revenue recognition
Potential for cancelled contracts and implication for valuation of work in progress
New directors
Cash-settled share-based payment scheme
Revaluation of property
Deferred tax recognition
Government grant recognition and potential for repayment if terms are breached
Inventory valuation
Provision in respect of returned goods
Working capital
Maximum marks
(ii)
Additional information
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–
–
–
–
–
–
–
–
–
–
–
–
–
18
1 mark for each relevant piece of relevant information recommended. The list below is indicative, and
credit should be given for other relevant recommendations:
–
–
–
Details of the stock exchange listing during the year
Information on the specific listing rules relevant to the stock exchange
Details on the planned foreign stock exchange listing
Information on the background and experience of the new non-executive directors and the new
finance director
A full set of draft financial statements including a statement of cash flows
Details on the valuation of properties such as date of valuation and name of the valuer
Documentation on the cash-settled share-based payment scheme
M
–
–
–
–
Maximum marks
(b)
(i)
5
Audit procedures on the valuation of work in progress
1 mark for each well explained audit procedure:
–
–
–
Obtain a schedule itemising the jobs included in work in progress at the year end, cast it and
agree the total to the general ledger and draft financial statements
Agree a sample of items from the schedule to the inventory count records
For a sample of jobs included on the schedule:
o
Agree costs to supporting documentation such as supplier’s invoice and payroll records
o
For any overheads absorbed into the work in progress valuation, review the basis of the
absorption and assess its reasonableness
o
Assess how the degree of completion of the job has been determined at the year end and
agree the stage of completion of the job to records taken at the inventory count
o
Agree the details of the job specification to customer order and
o
Confirm that net realisable value is greater than cost by agreeing the contract price and
cash received from the customer post year end
To assess the completeness of work in progress, select a sample of customer orders and trace
through to the list of jobs included in work in progress
SA
1
–
Maximum marks
4
23
Marks
(ii)
Audit procedures in respect of the government grant
1 mark for each well explained audit procedure:
–
–
–
–
–
–
Obtain the documentation relating to the grant to confirm the amount, the date the cash was
received, and the terms on which the grant was awarded
Review the documentation for any conditions attached to the grant, for example, is there a
requirement that a certain number of people are employed at the manufacturing plant?
Discuss with management the method of recognition of the amount received, in particular how
much of the grant has been recognised in profit and the treatment of the amount deferred in the
statement of financial position
For the part of the grant relating to continued operation of the manufacturing plant, determine
the basis on which this is being released into profit, assess its reasonableness and recalculate
to confirm accuracy of management’s calculations
Review forecasts and budgets in relation to the manufacturing plant to assess the likelihood of
its continued operations until 2020
Using the draft financial statements, confirm the accounting treatment outlined by discussion
with management has been applied and recalculate the amounts recognised
Confirm the cash received to bank statement and cash book
Maximum marks
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–
4
Professional marks for headings, introduction, conclusion and quality of explanations provided
SA
M
Maximum
24
4
–––
35
–––
Marks
(i)
Identify and explain going concern matters
Up to 2½ marks for matter identified and explained, to include 1 mark for relevant calculations:
–
–
–
–
–
Revenue, operating margins and profitability
Bank loan
Trade payables
Borrowing facility
Contingent liability
Maximum marks
Audit procedures in respect of going concern matters
Up to 1 mark for each well explained procedure:
–
–
–
–
–
–
–
–
–
–
–
Obtain and review management accounts, perform analytical review to ascertain the trends in
profitability and cash flows since the year end
Read the minutes of the meetings for reference to trading and financing difficulties
Discuss with management the strategy which is being developed to halt the trend in declining
sales and evaluate the reasonableness of the strategies in light of the economic recession and
auditor’s knowledge of the business
Review the company’s current order book and assess the level of future turnover to level required
to break even/make a profit
Analyse and discuss the cash flow, profit and other relevant forecasts with management and
review assumptions are in line with management strategy and auditor’s knowledge of the
business
Obtain the bank loan agreement to confirm the amount of the loan, the interest rate and
repayment dates and whether the charge over assets is specific or general in nature
Review the bank loan agreement for any clauses or covenants to determine whether there are
any breaches
Calculate the average payment period for trade payables and consider whether any increase is
due to lack of cash or changes in the terms of trade
Obtain the contract in relation to the borrowing facility to confirm the covenant measures and to
see if any further covenants are included in the agreement
Discuss correspondence with the bank in relation to the loan and the borrowing facility to gauge
the bank’s level of support for Kandinsky Co and for evidence of deteriorating relationships
between the bank and the company’s management. Inspect minutes of management meetings
where those charged with governance discussed the letter of support and authorised its issuance
Obtain any further documentation available in relation to the letter of support, for example, legal
documentation and correspondence with the supplier, to confirm the extent of Kandinsky Co’s
involvement with the supplier and that no further amounts could become payable
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(ii)
9
M
(a)
Maximum marks
6
SA
2
25
Marks
(i)
The relevance and measurability of the reported performance information
Generally up to 1 mark for each point explained:
–
–
–
–
–
Examination procedures
Up to 1 mark for well described procedures:
–
–
–
–
–
–
–
–
–
–
Obtain a list detailing all of the University’s performance objectives and the basis of
measurement for each objective
Discuss with University the availability of comparative information and requirement to include
in current year report
For the graduation rate, obtain a list of students awarded degrees in 2015, and a list of all
students who registered on the degree programme and use this information to recalculate the %
For academic performance, review minutes of meetings where degree results were discussed
and approval given for the award of distinction to a number of students
Agree a sample of students’ exam results to supporting documentation, e.g. information in their
student files, notices of exam results sent to the students
Inspect any documentation issued at events such as degree award ceremonies to confirm the
number of students being awarded a distinction
Obtain supporting documentation from the University for the employability rate and discuss with
appropriate personnel, for example, the careers centre, the basis of the determination of the rate
For the employability rate, a confirmation could be sent to a sample of students asking for the
details of their post-graduation employment
If the University supplies references for students seeking employment, inspect the references
issued in 2015 and contact the relevant company to see if the student was offered employment
For course satisfaction, inspect the questionnaires or surveys completed by students from which
the % was derived, and recalculate
Enquire if there is any other supporting documentation on course satisfaction, for example,
minutes of student and lecturer meetings about the quality of courses
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E
–
M
(ii)
1 mark for explaining why each measure would be relevant to an existing or potential student
(4 measures in total, so maximum 4 marks)
Problems in defining the measures
Problems in quantifying the measures – some are subjective
Issues in validity of the reported information
Lack of comparative information
Maximum marks
10
–––
25
–––
Maximum
SA
(b)
26
Marks
(a)
Purpose and scope of due diligence
Generally up to 1 mark for each description of the purpose of due diligence and up to 1 mark for each
point of comparison with an audit.
Purpose:
–
Gathering information to reduce risk of investment decisions
–
Verification on management representations
–
Identification and valuation of assets and liabilities
–
Identification of operational concerns and synergies
–
Assistance with acquisition planning
Maximum marks
(i)
Additional Information
6
Up to 1 mark for each piece of information recommended and adequately explained.
Database:
–
30 June 2015 financial statements (carrying value)
–
Original software purchase agreement
–
Software maintenance contract
–
Historic records of sales by customer
–
Sample customer communications
–
Sales forecasts
Licence:
–
Original purchase agreement (cost)
–
Original purchase agreement (incremental/contingent consideration)
–
Licence terms and conditions
–
Sales figures for new brand
–
Forecast sales for new brand
(ii)
Enquiries
M
(b)
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Scope:
–
Range of sources used
–
Level of assurance/type of engagement
–
Types of procedure performed
–
Forward looking v mainly historical
–
No controls testing
Up to 1 mark for enquiry recommended and adequately explained.
–
–
–
–
–
–
–
–
Legal advice regarding who bears the liability
Legal advice regarding likelihood of settlement
Basis of estimation of liability
Settlement of claims since year end
How long faulty parts used for
New claims since year end
Risk of further claims
Quality problems with other parts
SA
3
Maximum marks
14
–––
20
–––
Maximum
27
E
PL
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This ACCA Revision Question Bank has been reviewed
by ACCA's examining team and includes:
The most recent ACCA examinations with suggested answers
•
Past examination questions, updated where relevant
•
Model answers and suggested solutions
•
Tutorial notes
SA
M
•
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