acca p7 audit questions

26
KAPLAN PUBLISHING 1 QUESTIONS

Upload: john-paul-muranda

Post on 10-Oct-2014

989 views

Category:

Documents


26 download

TRANSCRIPT

Page 1: ACCA P7 Audit Questions

KAPLAN PU BL ISHING 1

QUESTIONS

Page 2: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

2 KAPLAN PU BL ISH ING

PROFESSIONAL AND ETHICAL CONSIDERATIONS

BIGG BIKES

Bigg Bikes, a privately-owned company manufactures bicycles and supplies them internationally and through a network of sales outlets throughout the country of Europia. They traditionally manufactured race bikes but have latterly moved into a broad range of bikes to take advantage of the latest trends in the marketplace. In particular, mountain bikes now make up 40% of their sales. They have expanded rapidly over the last two years and are now the major European manufacturer.

You are the auditor of Bigg Bikes and have been approached by the directors for advice on corporate governance and internal controls. They are aware that with their rapid growth, their obligations as directors have increased and that they should be taking much more interest in the level of controls within the company. They are also considering establishing an audit committee and would like your advice in this area.

You have recently completed the annual audit of Bigg Bikes and are aware that very little has been done to promote sound governance within the company.

Required:

(a) Explain the role of the directors in relation to corporate governance and controls. (5 marks)

(b) Describe the types of controls that should be operated by Bigg Bikes to provide sound governance. (6 marks)

(c) Explain the potential role of the audit committee and the factors that Bigg Bikes should consider in making a decision on whether to go ahead with the formation of the committee. (5 marks)

(d) Explain how, as part of the normal audit process, the external auditor may assist in the promotion of effective corporate governance within the company. Identify how the auditor would communicate any relevant recommendations. (4 marks)

(Total: 20 marks)

Page 3: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 3

SEASUN YACHTING AND MARINA (SYM)

SYM have a marina on the South Coast and a large sales operation dealing in yachts and speedboats. You are responsible for the audit of SYM and have found some potential causes of concern that could indicate fraudulent activity or financial misconduct within the company. In particular:

• 30% of the yachts on sale by SYM are supplied through one of the major international boating companies with a special finance arrangement deal. However, SYM have also obtained separate finance on these yachts, which are therefore in effect being ‘double financed’.

• Ten yachts shown as assets by SYM cannot be located, with no explanation other than that they have not been sold. These yachts together are worth approximately $5m.

• Long delays have occurred in performing reconciliations with the last four months of reconciliations still not completed. At the time of the last reconciliation, material differences had been identified upon which no action appears to have been undertaken.

• Sales have been overstated by $10m in the current financial statements.

The finance director has been off sick with stress for the last five months and therefore has not been available to discuss any of the issues identified.

Required:

(a) Explain whether the issues referred to above should be categorised as fraud or error.(5 marks)

(b) Discuss the role of management and the role of the auditor in the prevention and detection of fraud and error. (5 marks)

(c) Describe what steps you would take to further investigate and then report on the matters referred to above. (10 marks)

(Total: 20 marks)

Page 4: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

4 KAPLAN PU BL ISH ING

ETHICS

The ACCA’s Rulebook contains a Code of Ethics and Conduct. The Code is applicable to all members and students. If the Code is not complied with then disciplinary action may be taken, which could result in reprimand, fine or exclusion from the Association.

Required:

(a) Explain why you think the ACCA’s five principles of professional conduct are so fundamental to auditing. (5 marks)

(b) Explain how a member can demonstrate that he is truly independent in carrying out the work he performs, and why it is important that he should do so. (5 marks)

(c) In what circumstances is it permissible to disclose confidential client information? (5 marks)

(Total: 15 marks)

Page 5: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 5

ETHICS AND OF PROFESSIONAL CONDUCT

(a) It can be argued that integrity, objectivity and independence are important at both the individual practitioner level and also at the national professional body level. At the practitioner level, one is concerned with the conduct and attitudes of the individual accountant whilst at the national level, the image and integrity of the profession are of paramount importance.

Required:

Explain the role that practitioners play in the maintenance of professional integrity, objectivity and independence. (7 marks)

(b) The following notes relate to the personal files of two student accountants undertaking training in an accounting firm:

File Note 1

The student was asked by an audit senior whether she had taken her ACCA final stage professional examinations in June 1998. She replied that she had not taken the examinations but was planning to take the examinations in December 1998. The student in fact did take the examinations in June 1998 but did not wish to disclose the fact in case she failed the examinations and lost her reputation as having passed the examinations at the first attempt. The audit senior has formally complained about the conduct of the student. The student subsequently passed the June examinations. (7 marks)

File Note 2

The student has consistently completed his assigned tasks below the budgeted hours allocated to those audit tasks. The audit senior has no tangible proof that the tasks have not been carried out but suspects that this may be the case or alternatively time spent on the audit work is not being recorded. The audit senior has reported his suspicions to the audit partner. (6 marks)

Required:

Discuss the implications of the above file notes and how each of the matters should be dealt with by the audit partner.

Please note that the mark allocation is shown after File Notes 1 and 2 above.

(Total: 20 marks)

Page 6: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

6 KAPLAN PU BL ISH ING

POLITICAL COMMENTATORS

Political commentators have pointed out in recent years instances of where the auditor may appear not to be independent. An example of this lack of independence could be deemed to be the situation where the accounting firm provides audit services and other services such as consultancy advice to a client. In these circumstances objectivity may be threatened by undue dependence on a client. However, an issue which may well gain in prominence is that of the hiring by audit clients of personnel who were formerly employed by their independent auditors.

Where an audit partner or other senior audit staff member is employed by a client on leaving the audit firm, there is an element of risk that the objectivity of future audits may be impaired. There may be a public perception that the auditor of a company cannot be independent, where former employees of the audit firm are employed in senior positions.

Required:

(a) Discuss the advantages to a client of their auditor moving to undertake employment as a senior executive in their company. (6 marks)

(b) Discuss the ethical problems associated with a former audit partner becoming the financial director of the audit firms principal client. (6 marks)

(c) Describe the current ethical guidance designed to deal with the problems associated with the auditor accepting a senior position with the firm’s principal client, discussing any additional safeguards which could be introduced. (8 marks)

(Total: 20 marks)

Page 7: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 7

STYLUS

Stylus is a medium-sized engineering company with sales revenues of $12 million and a workforce of 150 employees. Frazer and Company have been the auditors of Stylus for four years. Stylus is one of a number of clients that have been referred to Frazer and Company by Coultard bank. The bank receives a commission from Frazer and Company of 10% of the first year's audit fees for these referrals.

During the early stages of the final audit for the year ended 30 September 1999 the following issues arose:

Taylor, a publicly listed company, is a major customer of Stylus. At 30th September 1999 the work-in-progress and trade receivables of Stylus contain $1.2 million and $800,000 respectively relating to contracts with Taylor. Frazer and company are also the auditors of Taylor and, acting in this capacity, they are aware that Taylor is in severe financial difficulties and will be unable to carry on trading much longer. As a consequence it is likely that Taylor will not be able to pay the amount it owes Stylus nor be able to accept the work that it has on order and currently in progress with them. The materiality of the above amounts is such that the losses that Stylus would sustain may put its going concern status in doubt.

Until very recently Stylus had not paid the audit fee and expenses for the year ended 30th September 1998. An associated company to the practice, ‘Frazer Consulting’, provides most of the staff of the internal audit department at Stylus in a consultancy capacity. Again a considerable amount of fees for this work were unpaid. In view of the possibility that Stylus may itself soon be in financial difficulties, the partners of Frazer and Company had insisted that before any further work was taken all amounts due to the practice must be paid together with a payment on account for the current year. A similar action was taken by the directors of Frazer Consulting. Bankers drafts were obtained from the directors of Stylus and these were presented to the bank for ‘special clearance’.

Due to its special knowledge, Frazer and Company have a number of clients in the property letting sector. The fee income from one particular client is a significant proportion of the local practice income. Frazer and Company is in exploratory merger talks with Bradley and Company, a similar-sized audit firm. Unfortunately another of Frazer and Company's clients, Toddy's Property Management, recently went into receivership after speculative investments made by the directors, using clients' money, resulted in huge losses. The receiver of Toddy’s Property Management has appointed Bradley and Company to investigate the collapse, and in particular the role of the auditor, Frazer and Company.

Required:

(a) Describe the ethical issues and problems in relation to:

(i) the audit of Stylus; and (8 marks)

(ii) the proposed merger of Frazer and Company with Bradley and Company (5 marks)

(b) As auditor of Stylus, describe the work you would perform and the action you would take in regard to the work-in-progress and accounts receivable of Stylus which relate to Taylor.

(7 marks)

(Total: 20 marks)

Page 8: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

8 KAPLAN PU BL ISH ING

BOLEYN & CO

(a) IFAC’s Code of Ethics for Professional Accountants is divided into three parts:

Part A – Applicable to All Professional Accountants

Part B – Applicable to Professional Accountants in Public Practice

Part C – Applicable to Employed Professional Accountants

Required:

Distinguish between ‘Professional Accountants’, ‘Professional Accountants in Public Practice’ and ‘Employed Professional Accountants’. (3 marks)

(b) As a newly-qualified Chartered Certified Accountant in Boleyn & Co, you have been assigned to assist the ethics partner in developing ethical guidance for the firm. In particular, you have been asked to draft guidance on the following frequently asked questions (‘FAQs’) that will be circulated to all staff through Boleyn & Co’s intranet:

(i) What Information Technology services can we offer to audit clients? (5 marks)

(ii) Can we entertain our clients as a gesture of goodwill or is corporate hospitality ruled out? (3 marks)

(iii) Can audit teams cross sell services to their clients? (4 marks)

Required:

For EACH of the three FAQs, explain the threats to objectivity that may arise and the safeguards that should be available to manage them to an acceptable level.

Note: The mark allocation is shown against each of the three questions.

(Total: 15 marks)

Page 9: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 9

PRACTICE MANAGEMENT

TOWER ACCOUNTANTS AND PARTNERS

You have just joined the partnership of a small firm of Certified Accountants ‘Tower Accountants and Partners’, and have been asked to prepare a communication brief for distribution to all staff which will then be followed by a presentation with a ‘question and answer’ session. The communication brief required is regarding ‘quality control procedures’ and ‘audit working papers’. Together ISQC 1 and ISA 220 requires that quality control policies and procedures are to be implemented at the level of the audit firm, and on individual audits. The partners are concerned that the firm’s quality control procedures may not be satisfactory, as they have never been reviewed since they were first implemented five years ago. In addition, although staff are able to read the policies and procedures in the staff manual, there are currently no other ways in which the information is communicated to them.

Required:

(a) Prepare a communication brief for distribution to all staff which states:

(i) why quality control policies and procedures are necessary

(ii) the areas that should be covered by quality control policies

(iii) outline procedures that would be required to ensure that the policies are met.

(10 marks)

(b) Answer the following queries that were asked at the ‘question and answer’ session held with the firm’s staff.

(i) What is the difference between a hot review and a cold review and why are both necessary?

(ii) Why is it so important that all audit reasons and justifications are documented in the working papers when it should be obvious from test results what the key issues are?

(iii) Why do audit working papers have to be standardised; surely this inhibits auditors exercising their skills and experience in the most effective way? (10 marks)

(Total: 20 marks)

Page 10: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

10 KAPLAN PU BL ISH ING

LANCASTER

You are the Senior Audit Manager for a medium-sized firm of accountants which has just lost two clients which have gone into receivership and has now been invited to tender for the audit of a company called ‘Lancaster’. The audit fees have been initially estimated at $20k.

Lancaster is a medium-sized manufacturing organisation which has existed for 45 years and has generally made consistent profits since then; however, in the last two years profits have fallen by approximately 10% in each year although the market sector in which Lancaster operates is expanding. They have also stated that they would like some consultancy support regarding business strategy and planning to try and reverse the current profit downturn, and have set aside $100k for this. You have ascertained the following from a brief discussion with the managing director:

• There has been no investment in non-current assets in the last ten years; they were intending to start a programme of investment two years ago but this was cancelled due to the reduced profits, and maintenance and repair costs have increased significantly over the last year.

• Staff wages have been frozen, and there has been some discussion with unions as staff morale is very low and several staff have already left; industrial action has so far been avoided.

• The Financial Director was dismissed three thre months ago, and hasn’t been replaced; he is currently suing Lancaster for unfair dismissal.

• The Managing Director is due to retire next year; a replacement has not yet been considered.

• There is an outstanding litigation case as an employee is suing Lancaster due to an accident whilst in the workplace. Health and Safety Officers have written a detailed report about the case

The audit firm’s total fee income last year was $700k (this includes $50k from the lost clients).

Required:

Prepare a document for discussion with the partners stating the following:

(a) The advantages and disadvantages of tendering for the audit of Lancaster; highlighting any key risks to the audit firm. (10 marks)

(b) Although the initial estimate of audit fee was $20k, further work needs to be completed before a figure should be included in the tender document. What factors should be taken into account when calculating the fee? (5 marks)

(c) An outline of what should be included in the tender document if the audit firm decides to tender. (5 marks)

(Total: 20 marks)

Page 11: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 11

BG

BG is a multinational firm of accountants. Their managing partner has been requested to appear in court in connection with one of their largest clients, BV, a public limited company. BG carry out the audit and tax work for BV. BV is being investigated for a possible tax fraud, which was linked to the establishment of a secret fund designed to make political contributions. The funds were maintained in a foreign bank, TBL, which was also a client of the audit firm. The existence of the fund had been discovered by the managing partner during the audit of the overseas bank.

The judge had ordered that the audit and tax working papers of BV be submitted to the court. However, the managing partner of BG had refused to submit the tax working papers of BV and copies of letters between BV and their solicitors on the grounds that they contained confidential information that would be damaging to their client.

The BG manager in charge of the tax affairs of BV was disturbed by the managing partner's actions and felt that they were ethically wrong as the tax working papers proved that BV was guilty of fraud and he refused to carry on acting for BV. He decided that he was going to submit the tax working papers to the court without the managing partner's due authority.

Required:

(a) Explain how the audit firm should have dealt with the discovery of the existence of the 'secret fund'. (5 marks)

(b) Discuss whether the managing partner of BG was justified on the grounds of confidentiality in not providing the court with all the working papers of BV. (5 marks)

(c) Discuss the position of the tax manager if he submits the tax working papers to the court against the partner's wishes. (5 marks)

(Total: 15 marks)

Page 12: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

12 KAPLAN PU BL ISH ING

ASSIGNMENTS

CERTIFIED ACCOUNTANTS

You are the training partner in a medium-sized firm of Certified Accountants who have a wide range of audit clients. The firm has recently recruited ten graduates as trainees. The trainees will attend an intensive induction course next month which will cover the firm’s audit philosophy and standard auditing procedures.

The managing partner has asked you to deliver a presentation on the role of the materiality concept in auditing. He believes that if this guidance is provided to staff at an early stage in their training it will allow them to carry out audit work more effectively.

Required:

Prepare a draft of the text of your presentation which will include:

(a) a definition of the term ‘material’ and an explanation as to why the concept of materiality is important to auditors; (5 marks)

(b) guidance on assessing materiality. Your answer should consider:

(i) errors in tests of control on accounting systems

(ii) errors in the statement of comprehensive income

(iii) errors in statement of financial position items

(iv) compliance with relevant company law and Accounting Standards

(v) aggregation of errors and uncertainties. (20 marks)

(Total: 25 marks)

Page 13: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 13

PERSEPHONE PUBLISHING

You are the audit manager in charge of the audit of Persephone Publishing Limited, a new client for your firm with a year-end of 31 December 20X3.

The company publishes a series of lifestyle magazines. The company’s major titles are Balinese Interiors, Better Housekeeping, and Budget Style. The typical readership of these titles is female, married, aged 35-45, and has a household income of $45,000 – $60,000 per annum.

A new Chief Executive, Daniel Jones, was appointed a year ago. Daniel sees his mission being the modernisation of the company. As a result of this, the company’s printing department was closed down and the staff made redundant. Printing is now outsourced.

Daniel is keen to widen the demographics of the company’s readership. A new magazine, Young Professional, aimed at 18–25 year olds, is scheduled to be launched on 1 January 20X4. Daniel has also entered into negotiations for the purchase of E-solutions, an electronic publishing company, with the intention of launching an electronic magazine, E-retiree. E-solutions is based in a country where your firm does not have an affiliated office.

Required:

(a) Identify and explain the business risks facing Persephone Publishing. (8 marks)

(b) Identify and explain two additional audit risks associated with this audit. (2 marks)

(c) Describe the effect the acquisition of E-solutions would have on your audit of Persephone Publishing. (10 marks)

(d) Explain the effect on the group audit report if the auditors of E-solutions qualify their audit report on the grounds of a limitation of scope. (5 marks)

(Total: 25 marks)

Page 14: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

14 KAPLAN PU BL ISH ING

GROUP AUDITING

The Pepper Group is an international business, comprising 10 subsidiaries with a head office in a central European country. You are undertaking the Group audit, but there are separate auditors for the Cayenne subsidiary in the US, Habenaro in Mexico and Hybrid in Columbia. You are aware of the following information:

(a) Hybrid is a loss-making subsidiary, with losses at the current year end totalling $2.7m. There are significant control problems, high levels of bad debts and 25% staff turnover. The local auditors have already stated their intention to provide a qualified report for the year just ended because of the material issues found.

(b) Cayenne is operating to a different financial year to that of the Group as a whole, being October 20X1 rather than December 20X1.

(c) Shortly after year-end, in January 20X2, the Pepper Group announced the sale of Habenaro for $25m and this disposal is currently under way.

(d) The Pepper Group is guaranteeing loans of approximately $10m for four of its stores.

Required:

(a) Explain how you would approach the audit of the Pepper Group, in particular how you would plan and control the audit. (5 marks)

(b) Describe the impact of each of the issues shown on the audit of the Group, explaining any further checks required and how the issues should be reflected in the financial statements.

(10 marks)

(c) Explain the nature of the relationship between your firm and the auditors of the subsidiaries, making particular reference to the extent to which your firm may rely on the other auditors’ work and to the considerations involved where joint audits are conducted. (5 marks)

(Total: 20 marks)

Page 15: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 15

EXTERNAL AUDITOR

Audit practitioners have recently initiated substantive changes in the audit approach. It appears to be the strategy that audit firms are moving away from the audit of financial statements and more to the provision of assurances on financial data, systems and controls in those systems. Auditors are focusing on providing ‘business assurance’ and ‘business risk’ which gives clients wider assurance than the traditional audit has offered. Auditors are reviewing the business from a process standpoint utilising benchmarking, performance measurements and best control practices as the key criteria. It seems that the audit is moving more to the analysis of business risk, and the alignment of the audit much more to the management perspective.

A wide range of risk assessment services is now part of the audit service which clients can subscribe to. The provision of internal audit services is becoming an increasingly larger part of the ‘business assurance’ service offered by auditors. It seems that the audit is becoming a management consultancy exercise with internal audit, external audit and consultancy assignments being seen as complementary services.

Required:

(a) Discuss the implications of the external auditor providing an internal audit service to a client, explaining the current ethical guidance on the provision of other services to clients.(10 marks)

(b) Explain the principal effects of the external auditor providing wider assurance to the client. (5 marks)

(c) Critically evaluate the move by large auditing firms to providing ‘business risk and assurance’ services rather than the traditional audit assurance for investors and creditors. (5 marks)

(Total: 20 marks)

Page 16: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

16 KAPLAN PU BL ISH ING

HILL

Hill is a small company incorporated in a country which has a division of its stock market which provides finance for small companies. Hill has recently achieved a listing on this 'Small Companies Market'. Hill's management are ambitious and intend to expand rapidly. On 1 April 20X7 the company acquired all of the equity share capital of a private limited company, Glen, by way of a share exchange. Hill issued four of its own shares for every three shares in Glen. The value of Hill's shares on the 'Small Companies Market' at 1 April 20X7 was $5 each. The share issue has not yet been recorded in Hill’s books because the directors of Hill did not know how the investment should be treated when preparing the group financial statements.

Valley and Company are the newly appointed auditors of Hill plc for the year to 30 September 20X7. The accounts of Glen have been audited for the year to 30 September 20X7 by another firm of auditors.

Required:

In relation to the audit of Hill, describe the audit procedures that Valley and Company would perform in relation to:

(a) opening balances and comparatives (5 marks)

(b) determining the appropriate accounting treatment for the acquisition of Glen. (5 marks)

(c) the financial statements of Glen being audited by another firm of auditors. (5 marks)

(Total: 15 marks)

Page 17: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 17

SIGHTHILL SUPERMARKETS

ISA 610 has been issued Considering the Work of Internal Audit.

Your firm is the external auditor of Sighthill Supermarkets, a listed company. The company has a head office, central warehouse, and a large number of supermarkets which sell food to the general public. The company's chief financial officer has suggested the audit fee could be reduced if your firm was prepared to place greater reliance on the work of the internal audit department.

The chief financial officer has explained that the duties of the internal audit department include:

(i) testing and reporting on the effectiveness of internal controls by maintaining up-to-date descriptions of the company's accounting systems and evaluating the effectiveness of controls in those systems. Recommendations are made of improvements in controls, and proposed changes in controls are assessed.

(ii) checking the operation and reliability of the computer systems. The department uses the computer-assisted audit techniques of test data and audit software (computer audit programs). Particular attention is paid to controls over access to the computer and checking payment of vendors and wages, and receipt of cash at supermarkets.

(iii) visiting the central warehouse to check operation of the systems and the effectiveness of controls. Procedures are checked at the periodic inventory counts.

(iv) visits to supermarkets. All supermarkets are visited at least once a year with more frequent visits to larger supermarkets and those where serious weaknesses have been detected. At the supermarkets, the internal auditors check the effectiveness of controls and carry out cash counts and test counts of the inventory. Visits are made to supermarkets to attend the periodic inventory counts and check procedures.

The chief financial officer says the internal audit department would be willing to amend the timing of its work, so as to fit in with the external auditor's work. The results of the internal auditor's work can be reported directly to the external auditor.

In part (a) of the question, in considering the effectiveness of the internal audit department, you should consider factors which indicate the independence and competence of the internal audit staff, reporting arrangements and the extent to which their recommendations are implemented.

In part (b) of the question, you should consider the extent to which you can rely on the internal auditors' work and either reduce or eliminate certain aspects of the audit work carried out by your firm. The reduction in audit work will result in a reduction in the cost of carrying out the audit and thus allow a reduction in the audit fee.

Required:

(a) Describe the matters you should consider at the planning stage to assess the effectiveness of the internal audit department. (6 marks)

(b) Consider the chief financial officer's proposals, namely the extent to which you can rely on the work of the internal auditors and thus reduce your audit work in:

(i) recording accounting systems and evaluating the effectiveness of the recorded controls

(ii) performing tests of controls

(iii) carrying out substantive procedures to verify assets and liabilities in the statement of financial position

(iv) auditing the computer systems, including using computer-assisted audit techniques

(v) visiting supermarkets. (14 marks)

(Total: 20 marks)

Page 18: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

18 KAPLAN PU BL ISH ING

EXCEPTIONAL EVENTS

Exceptional Events (known as Double E) are a concert hall and events company, with their own venue in a large town close to London. They organise around three events a week in their own venue during the main season (closing for the summer months). They have a restaurant and two bars, which are open to the general public as well as those attending events. They also arrange events for other organisations, in particular conferences and outdoor concerts. Double E have a telephone booking system for events, using a computerised booking and seat allocation system, which automatically produces information on seat availability and capacity for each event. A separate finance system is in place for capturing significant expenditure – the prime costs being the booking of acts.

Double E has a finance department but no internal audit team. The chief executive is concerned about the level of risk exposure of the company and in particular the deteriorating financial position in a time when events have been their most successful ever. You have been asked to conduct an internal review of Double E and in particular to provide guidance on risk assessment and recommendations on effective management of risk.

Required:

(a) Explain how you would approach the review of Double E, in particular the key steps required. (5 marks)

(b) Provide guidance on risk assessment and describe examples of the types of key risks facing Double E. (6 marks)

(c) Describe how Double E might manage their risks, with specific examples of appropriate controls. (6 marks)

(d) List appropriate means of reviewing the performance of Double E to help identify why there is a deteriorating position at the time of their best performance ever. (3 marks)

(Total: 20 marks)

Page 19: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 19

BELLE VISAGE

You are the manager in charge of the audit of Belle Visage Limited, a company operating in the cosmetics industry. The audit for the year ended 30 September 20X3 is nearing completion. Due to a worldwide recession, the company’s revenue has fallen substantially, and the company is being forced to restructure its operations. The financial statements show a profit before tax of $3.2m.

The audit senior has produced a schedule of ‘Points for the Attention of the Audit Manager’ as follows:

(1) The company produces a line of cosmetics for older women called 'Like Fine Wine'. Falling sales revenues led the company to perform an impairment review of the assets in the cash-generating unit on 28 September 20X3. The directors concluded that the assets were not impaired, and so the assets remained in the financial statements at their carrying value of $900,000. On 15 October 20X3, the line of cosmetics was sold to a competitor for $640,000. (8 marks)

(2) On 26 September 20X03, the company announced that it was closing down production of its men’s cosmetics division, 'Metrosexual'. The closure is to take effect from 1 March 20X4, and all staff are to be made redundant and to receive redundancy based on their service and salary. The expected cost is $620,000, but no provision has been made in the financial statements as the closure will not take place until next year. (7 marks)

(3) The company has changed the period over which it depreciates plant and machinery. A review of the average lives of plant, performed on 15 August 20X3, showed that plant was lasting for five years when previously depreciation had been charged over three years. The directors have performed a prior year adjustment, and increased opening reserves by $240,000, representing the depreciation that would not have been charged on the company’s current plant if it had always been depreciated over a five year period rather than three. (5 marks)

Required:

For each of the above points:

(i) comment on the matters that you should consider; and

(ii) state the audit evidence that you should expect to find,

in undertaking your review of the audit working papers and financial statements of Belle Visage.

(Total: 20 marks)

Page 20: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

20 KAPLAN PU BL ISH ING

PACIFIC GROUP

Pacific Group (PG), a limited liability company, is a publisher of a monthly magazine ‘Sea Discovery’. Approximately 70% of the magazine’s revenue is derived from advertising, the remainder being subscription income.

Individual advertisements, which may be quarter, half or whole page, are priced at $750, $1,250 and $2,000, respectively. Discounts of 10% to 25% are given for repeat advertisements and to major advertising customers.

PG’s management has identified the following risks relating to its advertising revenues:

(i) Loss of revenue through failure to invest in developments which keep the presentation of advertisements up to date with competitor publications (such as ‘The Deep’);

(ii) Due to unsuitable credit limits being set, business is accepted from a small proportion of advertising customers who are uncreditworthy;

(iii) Published advertisements may not be invoiced due to incomplete data transfer between the editorial and invoicing departments;

(iv) Individual advertisements are not charged for at approved rates – either in error or due to arrangements with the advertisers. In particular, the editorial department does not notify the invoicing department of reciprocal advertisement arrangements, whereby advertising customers provide PG with other forms of advertising (such as website banners).

(v) Individual advertisers refuse to pay for the inaccurate production of their advertisement;

(vi) Cash received at a front desk, which is significant, may not be passed to cashiers, or be misappropriated;

(vii) The risk of error arising from unauthorized access to the editorial and invoicing systems;

(viii) The risk that the editorial and invoicing systems are not available;

(ix) The computerized transfer of accounting information from the invoicing system to the general ledger may be incomplete or inaccurate;

(x) The risk that PG may be sued for advertizements which do not meet the National Standards Authority’s ‘Code of Advertising’.

Risks are to be screened out, as ‘non-applicable’, if they meet any of the following criteria:

(1) the effect of the risk can be quantified and is less than $5,000;

(2) the risk is mitigated by an effective risk strategy e.g. insurance;

(3) the risk is likely to be low or its effect insignificant.

Those risks not screened out, called ‘applicable risks’, will require further consideration and are to be actively managed.

Page 21: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 21

Required:

(a) For each of the above risks identified by management, state, with a reason, whether it should be considered an ‘applicable risk’. (14 marks)

(b) Describe suitable internal controls to manage any FOUR of the applicable risks identified in (a). (6 marks)

PG’s management has decided to set up an internal audit function to improve the company’s systems and risk management process.

Required:

(c) Discuss the advantages and disadvantages of outsourcing the internal audit function to an audit firm rather than setting up a department in-house. (10 marks)

(Total: 30 marks)

Page 22: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

22 KAPLAN PU BL ISH ING

VEMA

You are the manager responsible for the audit of Vema, an established limited liability company. Vema offers a national network for the distribution of wholesale goods through a fleet of heavy goods vehicles (HGVs) and has one wholly-owned subsidiary, Weddell. The draft consolidated financial statements for the year ended 30 September 2003 show revenue of $125 million (2002 – $114 million), profit before taxation of $12.4 million (2002 – $10.9 million) and total assets of $110 million (2002 – $93 million).

The following issues arising during the final audit have been noted on a schedule of points for your attention:

(a) Historically, fleet vehicles have been depreciated at 33⅓% on a straight-line basis as it was Vema’s operational policy to replace them every three years. During the year, Vema decided to change the basis of calculation to 25% reducing balance to reflect the fact that HGVs are only replaced ‘as and when necessary’, usually every four to seven years. Management has calculated the current year charge on the new basis as $2.9 million (former basis; $4.2 million) and $4.7 million of accumulated depreciation has been written back in the restatement of opening reserves. (8 marks)

(b) A payment of $592,000 selected in a substantive procedure has been traced to the following general ledger journal in December 2002: Debit Administrative expenses $786,000

Credit Other liabilities $194,000

Credit Bank $592,000

The accompanying narrative reads ‘Termination payment for Mr Z – not processed on any payroll’. The audit senior has documented that ‘Mr Z, a former director of Vema, was made redundant in July 2002 in a regional re-organization’. (6 marks)

(c) The financial statements of the subsidiary company, Weddell, for the year ended 30 September 2003, are audited by another firm. Profit before taxation of $0.4 million and total assets of $34.1 million have been included in the draft consolidated financial statements of Vema. The notes to Weddell’s financial statements as at 30 September 2003 disclose a contingent liability for a pending legal matter estimated at $0.2 million. In November 2003, the courts found Weddell to be liable for costs and damages amounting to $1.1 million. However, Weddell’s directors have refused to make a provision, for any amount, as they have lodged an appeal against the judgement. (6 marks)

Required:

For each of the above issues:

(i) comment on the matters that you should consider; and

(ii) state the audit evidence that you should expect to find,

in undertaking your review of the audit working papers and financial statements of Vema for the year ended 30 September 2003.

Note: The mark allocation is shown against each of the three issues.

(Total: 20 marks)

Page 23: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 23

REPORTING

CREMORNE

Cremorne is a listed construction company with annual sales of $350 million and its draft statement of comprehensive income shows profit from operations for the year ended 31 December 1998 of $40 million. This is the first audit by your audit firm. Inquiry of the previous auditor revealed no reasons for concern. On completing audit work at the company's premises, the audit senior drafts a memo, extracts from which are reproduced below.

Inventory valuation

Inventories include $7 million, at cost, of scrap rubber: This material is widely used as a road surface in other countries. Currently, the land Transport Authority (LTA) does not permit the use of this material for road building. However, the matter was known to be under review by the LTA and, on being offered a special purchase of this material, Cremorne speculated on a favourable outcome of the review and purchased the material. In February 1999, shortly before the financial statements were approved by the directors, the LTA reported that it would not, currently accept the use of this material. If used on overseas contracts the material's net realisable value would not exceed $2 million. The chief financial officer maintains that, as the LTA report was issued after the statement of financial position date, the write down of the inventory should be reflected in the next period's financial statements. (6 marks)

Depreciation

In 1994 the company purchased two computer controlled earth movers at a cost of $2,500,000 each and a further two at the same price in 1995. Depreciation has been provided at 10% straight line, the same basis as it previously depreciated conventional earthmovers. This year, 1998, the company decided that improvements in technology made it worthwhile scrapping their first two computer controlled movers and replacing them with the latest model at a cost of $4,000,000 each. The company's chief engineer tells you that technology is developing so rapidly it appears likely they will continue to replace these machines every five years. The chief financial officer claims that the depreciation rate of 10% is in line with industry standard and reflects the physical life of the machines. He argues that continued improvements in technology cannot be foreseen and that there is no justification for increasing depreciation to 20% because of the possibility of technological obsolescence. (7 marks)

Contingent liability

The company is being sued for $50 million by the Land Transport Authority (LTA) for defective work on a recently completed road. The company maintains that it met LTA's specification and that it is the LTA's engineers who are at fault in drawing up the specification. Cremorne maintains that it has no case to answer; that the possibility of loss is remote and that the claim need not be disclosed as a contingent liability. An investigative journalist has recently published an article suggesting that other roads constructed by the company exhibit similar faults. The chief executive officer has admitted that the company's road building techniques are under investigation by the LTA. If the company were to lose the case its future as a going concern would be threatened.

(7 marks)

Required:

Explain the effect of each matter (i) on the financial statements and, (ii) if the company were to refuse to amend the financial statements, on the auditor's report. Your answer should consider materiality where appropriate.

(Total: 20 marks)

Page 24: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

24 KAPLAN PU BL ISH ING

JESPERE

(a) The performance of non-audit work by auditors for their audit clients can lead to ethical problems.

Required:

Describe the potential problems associated with auditors performing non-audit work. (5 marks)

(b) You are an audit manager with Goh & Co. One of your clients, Jespere Limited, has recently asked your firm to perform a review of the financial statements.

During your review, you discovered a cash payment of $50,000. You have asked the company for details of this payment, and the directors have told you that it was an agency fee, and they cannot tell you any more details as the company would lose its competitive advantage. Profit before tax is $2m.

Your audit supervisor is happy with this explanation, and has proposed a draft review report with the following opinion paragraph:

'Based on our review nothing has come to our attention which indicates that the financial statements do not give a true and fair view'.

Required:

Discuss the validity or otherwise of the suggested opinion, and discuss the appropriateness of alternative opinions. Suggest suitable wording for the opinion you consider to be most appropriate. (10 marks)

(Total: 15 marks)

Page 25: ACCA P7 Audit Questions

LECTURER RESOURCE PACK – QUESTIO NS

KAPLAN PU BL ISHING 25

FRAZIL

(a) Explain the auditor’s responsibilities for reporting on compliance with International Financial Reporting Standards (IFRSs) when the financial statements state that they are prepared in accordance with:

(i) only IFRSs;

(ii) both IFRSs and relevant national standards or practices; and

(iii) relevant national standards or practices, but which disclose in the notes to the financial statements the extent of compliance with IFRSs. (5 marks)

(b) You are the engagement partner to Frazil, a private limited liability company. Frazil’s financial statements for the year ended 30 September 2003, show total assets $107 million and profit before tax $8.2 million. The following matters require your consideration:

(i) The basis of accounting note states that the financial statements have been prepared in compliance with International Financial Reporting Standards. However, the accounting policy note for development costs states that all development costs are expensed as incurred. Results of audit tests showed that of the $3.7 million development costs expensed during the year, $1.4 million should have been recognized as an asset in accordance with IAS 38 Intangible Assets.

(ii) The management of Frazil has just informed you that, for the first time, the annual report is to be published on the company’s website.

Required:

Identify and comment on the implications of the above matters for your auditor’s report on the financial statements of Frazil for the year ended 30 September 2003. (10 marks)

(Total: 15 marks)

Page 26: ACCA P7 Audit Questions

PAPER P7 ( INT ) : AD VANCED AUDIT AND ASSURANCE

26 KAPLAN PU BL ISH ING

CURRENT ISSUES AND DEVELOPMENTS

REGULATION AND PROFESSIONALISM

The auditing profession has been criticised recently by politicians for its role in monitoring potential corporate failure. Radical reforms have been called for in the way the audit is regulated. For example, politicians have stated that there should be a change of legislation in the following ways:

(i) Auditing standards

Auditing standards should be set and enforced independently from the accounting profession.

(ii) Fraud

Auditing firms should have a duty to detect and report fraud.

(iii) Non-audit services

Non-auditing services supplied to an audit client should be stopped.

(iv) The duration of the appointment of auditors

The appointment of auditors should be for a maximum period of seven years.

Required:

(a) Describe the current regulatory and professional requirements relating to each of the main headings listed above. (12 marks)

(b) Discuss the reasons why you feel that the audit profession has been criticised over the current regulations in the above areas. (8 marks)

(Total: 20 marks)