acca p7 study manual june 2013

P7Paper P7

Advanced Audit and Assurance (INT & UK)

Study Manual For Exams in 2013

ACCA

ADVANCED AUDIT AND ASSURANCE

2

shapingsuccessinbusinessandfinance

LondonSchoolofBusiness

Finance

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library

Published by InterActive World Wide Limited Westgate House, 8-9 Holborn London EC1N 2LL

www.iaww.com/publishing

ISBN 978-1-908888-52-5

Fourth Edition 2013 Printed in Bulgaria

2009 InterActive World Wide Limited. London School of Business & Finance and the LSBF logo are trademarks or registered trademarks of London School of Business & Finance (UK) Limited in the UK and in other countries and are used under license. All usedbrand names or typeface names are trademarks or registered trademarks of their respective holders.

All our rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of InterActive World Wide.

P7



Finance

3

ForEWorD

Thank you for choosing to study with the London School of Business and Finance.

A dynamic, quality-oriented and innovative educational institution, the London School of Business and Finance offers specialised programmes, designed with students and employers in mind. We are always at the frontline, driving the latest professional developments and trends.

LSBF attracts the highest-quality candidates from over 140 countries worldwide. We work in partnership with leading accountancy firms, banks and best-practice organisations enabling thousands of students to realise their full potential in accountancy, finance and the business world.

With an international perspective, LSBF has developed a rich portfolio of professional qualifications and executive education programmes. To complement our face-to-face and cutting-edge online learning products, LSBF is now pleased to offer tailored study materials to support students in their preparation for exams.

The exam-focused content in this manual will provide you with a comprehensive and up-to-date understanding of the ACCA syllabus. We have an award-winning team of tutors, who are highly experienced in helping students through their professional exams and have received consistently excellent feedback.

I hope that you will find this manual helpful and wish you the best of luck in your studies.

Aaron Etingen

ACCA, MSI, Founder and CEo

Foreword


4



Finance

P7



Finance

5

Foreword 3

Contents 5

About ACCA Paper P7 7

Syllabus and Study Guide 11

Examinable Documents 27

Pilot Paper 35

Chapter 1 Regulatory Environment 69

Chapter 2 Professional and Ethical Considerations 81

Chapter 3 Practice Management 97

Chapter 4 Planning Risk and Audit Strategy 107

Chapter 5 Audit Evidence 125

Chapter 6 Completion and Review 153

Chapter 7 Audit Reports 163

Chapter 8 Group Audits 175

Chapter 9 Other Assurance 183

Chapter 10 Current Issues and Developments 197

Index 204

Feedback and review Form 207

CoNTENTS

Contents


6



Finance

P7About ACCA

Paper P7 Advanced Audit and Assurance


8



Finance

P7



Finance

9

Aim of the Paper

The aim of the paper is to analyse, evaluate and conclude on the assurance engagement and other audit and assurance issues in the context of best practice and current developments.

In simpler terms, this means a very practical exam, in which students need to look at real situations and identify relevant issues to an auditor (or other assurance provider), and how those issues may be addressed.

Outline of the Syllabus

1. regulatory Environment

2. Professional and Ethical Considerations

3. Practice Management

4. Audit Assignments

5. Non-Audit Assignments

6. Reporting

7. Current Issues and Developments

Format of the Exam Paper

The syllabus is assessed by a three hour paper-based examination, with 15 minutes of reading time.

The examination consists of:

two compulsory questions, totalling 50-70 marks, and covering several areas of the syllabus within a single scenario; and

a choice of two from three questions totalling 30-50 marks, which are each likely to focus mostly on a single syllabus area.

ABoUT ACCA PAPEr P7


10



Finance

P7Syllabus and Study Guide


12



Finance

P7



Finance

13

SYLLABUS AND STUDY GUIDE

Advanced Audit and Assurance (INT) (P7) June & December 2013 This syllabus and study guide is designed to help with planning study and to provide detailed information on what could be assessed in any examination session. THE STRUCTURE OF THE SYLLABUS AND STUDY GUIDE Relational diagram of paper with other papers This diagram shows direct and indirect links between this paper and other papers preceding or following it. Some papers are directly underpinned by other papers such as Advanced Performance Management by Performance Management. These links are shown as solid line arrows. Other papers only have indirect relationships with each other such as links existing between the accounting and auditing papers. The links between these are shown as dotted line arrows. This diagram indicates where you are expected to have underpinning knowledge and where it would be useful to review previous learning before undertaking study. Overall aim of the syllabus This explains briefly the overall objective of the paper and indicates in the broadest sense the capabilities to be developed within the paper. Main capabilities This papers aim is broken down into several main capabilities which divide the syllabus and study guide into discrete sections. Relational diagram of the main capabilities This diagram illustrates the flows and links between the main capabilities (sections) of the syllabus and should be used as an aid to planning teaching and learning in a structured way.

Syllabus rationale This is a narrative explaining how the syllabus is structured and how the main capabilities are linked. The rationale also explains in further detail what the examination intends to assess and why. Detailed syllabus This shows the breakdown of the main capabilities (sections) of the syllabus into subject areas. This is the blueprint for the detailed study guide. Approach to examining the syllabus This section briefly explains the structure of the examination and how it is assessed. Study Guide This is the main document that students, tuition providers and publishers should use as the basis of their studies, instruction and materials. Examinations will be based on the detail of the study guide which comprehensively identifies what could be assessed in any examination session. The study guide is a precise reflection and breakdown of the syllabus. It is divided into sections based on the main capabilities identified in the syllabus. These sections are divided into subject areas which relate to the sub-capabilities included in the detailed syllabus. Subject areas are broken down into sub-headings which describe the detailed outcomes that could be assessed in examinations. These outcomes are described using verbs indicating what exams may require students to demonstrate, and the broad intellectual level at which these may need to be demonstrated (*see intellectual levels below). Learning Materials ACCA's Approved Learning Partner - content (ALP- c) is the programme through which ACCA approves learning materials from high quality content providers designed to support study towards ACCAs qualifications. ACCA has one Platinum Approved Learning Partner content which is BPP Learning Media. In addition, there are a number of Gold Approved Learning Partners - content.

1 ACCA 2013 All rights reserved.


14



Finance

For information about ACCA's Approved Learning Partners - content, please go ACCA's Content Provider Directory. The Directory also lists materials by Subscribers, these materials have not been quality assured by ACCA but may be helpful if used in conjunction with approved learning materials. You will also find details of Examiner suggested Additional Reading which may be a useful supplement to approved learning materials. ACCA's Content Provider Directory can be found here http://www.accaglobal.com/learningproviders/alpc/c

ontent_provider_directory/search/. Relevant articles will also be published in Student Accountant. INTELLECTUAL LEVELS The syllabus is designed to progressively broaden and deepen the knowledge, skills and professional values demonstrated by the student on their way through the qualification. The specific capabilities within the detailed syllabuses and study guides are assessed at one of three intellectual or cognitive levels: Level 1: Knowledge and comprehension Level 2: Application and analysis Level 3: Synthesis and evaluation Very broadly, these intellectual levels relate to the three cognitive levels at which the Knowledge module, the Skills module and the Professional level are assessed. Each subject area in the detailed study guide included in this document is given a 1, 2, or 3 superscript, denoting intellectual level, marked at the end of each relevant line. This gives an indication of the intellectual depth at which an area could be assessed within the examination. However, while level 1 broadly equates with the Knowledge module, level 2 equates to the Skills module and level 3 to the Professional level, some lower level skills can continue to be assessed as the student progresses through each module and level. This reflects that at each stage of study there will be a

requirement to broaden, as well as deepen capabilities. It is also possible that occasionally some higher level capabilities may be assessed at lower levels. LEARNING HOURS AND EDUCATION RECOGNITION The ACCA qualification does not prescribe or recommend any particular number of learning hours for examinations because study and learning patterns and styles vary greatly between people and organisations. This also recognises the wide diversity of personal, professional and educational circumstances in which ACCA students find themselves. As a member of the International Federation of Accountants, ACCA seeks to enhance the education recognition of its qualification on both national and international education frameworks, and with educational authorities and partners globally. In doing so, ACCA aims to ensure that its qualifications are recognized and valued by governments, regulatory authorities and employers across all sectors. To this end, ACCA qualifications are currently recognized on the education frameworks in several countries. Please refer to your national education framework regulator for further information. Each syllabus contains between 23 and 35 main subject area headings depending on the nature of the subject and how these areas have been broken down. GUIDE TO EXAM STRUCTURE The structure of examinations varies within and between modules and levels. The Fundamentals level examinations contain 100% compulsory questions to encourage candidates to study across the breadth of each syllabus. The Knowledge module is assessed by equivalent two-hour paper based and computer based examinations. The Skills module examinations are all paper based three-hour papers. The structure of papers varies from ten questions in the Corporate and Business


P7



Finance

15


Law (F4) paper to four 25 mark questions in Financial Management (F9). Individual questions within all Skills module papers will attract between 10 and 30 marks. The Professional level papers are all three-hour paper based examinations, all containing two sections. Section A is compulsory, but there will be some choice offered in Section B. For all three hour examination papers, ACCA has introduced 15 minutes reading and planning time. This additional time is allowed at the beginning of each three-hour examination to allow candidates to read the questions and to begin planning their answers before they start writing in their answer books. This time should be used to ensure that all the information and exam requirements are properly read and understood. During reading and planning time candidates may only annotate their question paper. They may not write anything in their answer booklets until told to do so by the invigilator. The Essentials module papers all have a Section A containing a major case study question with all requirements totalling 50 marks relating to this case. Section B gives students a choice of two from three 25 mark questions. Section A of both the P4 and P5 Options papers contain one 50 mark compulsory question, and Section B will offer a choice of two from three questions each worth 25 marks each. Section A of each of the P6 and P7 Options papers contains 60 compulsory marks from two questions; question 1 attracting 35 marks, and question 2 attracting 25 marks. Section B of both these Options papers will offer a choice of two from three questions, with each question attracting 20 marks. All Professional level exams contain four professional marks. The pass mark for all ACCA Qualification examination papers is 50%.

GUIDE TO EXAMINATION ASSESSMENT ACCA reserves the right to examine anything contained within the study guide at any examination session. This includes knowledge, techniques, principles, theories, and concepts as specified. For the financial accounting, audit and assurance, law and tax papers except where indicated otherwise, ACCA will publish examinable documents once a year to indicate exactly what regulations and legislation could potentially be assessed within identified examination sessions.. For paper based examinations regulation issued or legislation passed on or before 30th September annually, will be assessed from June 1st of the following year to May 31st of the year after. . Please refer to the examinable documents for the paper (where relevant) for further information.

Regulation issued or legislation passed in accordance with the above dates may be examinable even if the effective date is in the future.

The term issued or passed relates to when regulation or legislation has been formally approved. The term effective relates to when regulation or legislation must be applied to an entity transactions and business practices. The study guide offers more detailed guidance on the depth and level at which the examinable documents will be examined. The study guide should therefore be read in conjunction with the examinable documents list.



16



Finance

ACCA 2013 All rights reserved.

Syllabus MAIN CAPABILITIES On successful completion of this paper candidates

should be able to: AAA (P7)

4

AIM To analyse, evaluate and conclude on the assurance engagement and other audit and assurance issues in the context of best practice and current developments.

A Recognise the legal and regulatory environment and its impact on audit and assurance practice B Demonstrate the ability to work effectively on an assurance or other service engagement within a professional and ethical framework C Assess and recommend appropriate quality control policies and procedures in practice management and recognise the auditors position in relation to the acceptance and retention of professional appointments D Identify and formulate the work required

to meet the objectives of audit assignments and apply the International Standards on Auditing

E Identify and formulate the work required to meet the objectives of non-audit assignments

F Evaluate findings and the results of work performed and draft suitable reports on assignments G Understand the current issues and developments relating to the provision of audit- related and assurance service

RELATIONAL DIAGRAM OF MAIN CAPABILITIES

CR (P2)

AA (F8)

Current issues and development (G)

Practice management (C)

Reporting (F)

Audit of historical financial information (D)

Regulatory environment (A)

Professional and ethical considerations (B)

Other assignments (E)

P7



Finance

17


RATIONALE The Advanced Audit and Assurance syllabus is essentially divided into seven areas. The syllabus starts with the legal and regulatory environment including money laundering, and professional and ethical considerations, including the Code of Ethics and professional liability. This then leads into procedures in practice management, including quality control and the acceptance and retention of professional engagements. The syllabus then covers the audit of financial statements, including planning, evidence and review. It then covers other assignments including prospective financial information, and other assurance assignments, as well as the reporting of these assignments. The final section covers current issues and developments relating to the provision of audit-related and assurance services. DETAILED SYLLABUS A Regulatory Environment 1. International regulatory frameworks for audit and assurance services 2. Money laundering 3. Laws and regulations B Professional and Ethical Considerations 1. Code of Ethics for Professional Accountants 2. Fraud and error 3. Professional liability C Practice Management 1. Quality control 2. Advertising, publicity, obtaining professional work and fees 3. Tendering 4. Professional appointments

D Audit of historical financial information 1. Planning, materiality and assessing the risk of misstatement 2. Evidence 3. Evaluation and review 4. Group audits E Other assignments 1. Audit-related services 2. Assurance services 3. Prospective financial information 4. Forensic audits 5. Internal audit 6. Outsourcing F Reporting 1. Auditors reports 2. Reports to those charged with governance and

management 3. Other reports G Current Issues and Developments 1. Professional and ethical 2. Information technology 3. Transnational audits 4. Social and environmental auditing 5. Other current issues



18



Finance

APPROACH TO EXAMINING THE SYLLABUS The examination is a three hour paper constructed in two sections. Questions in both sections will be largely discursive. However, candidates will be expected, for example, to be able to assess materiality and calculate relevant ratios where appropriate. Section A questions will be based on case study type questions. That is not to say that they will be particularly long, rather that they will provide a setting within a range of topics, issues and requirements can be addressed. Different types of question will be encountered in Section B and will tend to be more focussed on specific topics, for example auditors reports, quality control and topics of ISAs which are not examinable in Paper F8, Audit and Assurance. (This does not preclude these topics from appearing in Section A). Current issues will be examined across a number of questions. Section A: 2 compulsory questions Question 1 35 marks Question 2 25 marks Section B: Choice of 2 from 3 40 marks questions- 20 marks each 100


P7



Finance

19


Study Guide A REGULATORY ENVIRONMENT 1. International regulatory frameworks for audit

and assurance services a) Explain the need for laws, regulations,

standards and other guidance relating to audit, assurance and related services.[2]

b) Outline and explain the need for the legal and

professional framework including:[2] i) public oversight to an audit and assurance

practice ii) the role of audit committees and impact on

audit and assurance practice. 2. Money laundering a) Define money laundering.[1]

b) Explain how international efforts seek to

combat money laundering.[2]

c) Explain the scope of criminal offences of

money laundering and how professional accountants may be protected from criminal and civil liability.[2]

d) Explain the need for ethical guidance in this

area.[2]

e) Describe how accountants meet their

obligations to help prevent and detect money laundering including record keeping and reporting of suspicion to the appropriate regulatory body.[2]

f) Explain the importance of customer due

diligence (CDD).[2]

g) Recognise potentially suspicious transactions

and assess their impact on reporting duties.[2]

h) Describe, with reasons, the basic elements of an anti-money laundering program.[2]

3. Laws and regulations a) Compare and contrast the respective

responsibilities of management and auditors concerning compliance with laws and

regulations in an audit of financial statements.[2]

b) Describe the auditors considerations of

compliance with laws and regulations and plan audit procedures when possible non-compliance is discovered.[2]

c) Discuss how and to whom non-compliance

should be reported.[2]

d) Recognise when withdrawal from an

engagement is necessary.[2]

B PROFESSIONAL AND ETHICAL

CONSIDERATIONS 1. Code of Ethics for Professional Accountants a) Explain the fundamental principles and the

conceptual framework approach.[1]

b) Identify, evaluate and respond to threats to

compliance with the fundamental principles.[3]

c) Discuss and evaluate the effectiveness of

available safeguards.[3]

d) Recognise and advise on conflicts in the

application of fundamental principles.[3]

e) Discuss the importance of professional scepticism in planning and performing an audit.[2]

f) Assess whether an engagement has been planned and performed with an attitude of professional scepticism, and evaluate the implications.[3]

2. Fraud and error a) Define and clearly distinguish between the

terms error, irregularity, fraud and misstatement.[2]

b) Compare and contrast the respective

responsibilities of management and auditors for fraud and error.[2]

c) Describe the matters to be considered and

procedures to be carried out to investigate



20



Finance

actual and/or potential misstatements in a given situation.[2]

d) Explain how, why, when and to whom fraud and error should be reported and the circumstances in which an auditor should withdraw from an engagement.[2]

e) Discuss the current and possible future role of

auditors in preventing, detecting and reporting error and fraud.[2]

3. Professional liability a) Recognise circumstances in which professional

accountants may have legal liability.[2]

b) Describe the factors to determine whether or

not an auditor is negligent in given situations.[2]

c) Explain the other criteria for legal liability to be

recognised (including due professional care and proximity) and apply them to given situations.[2]

d) Compare and contrast liability to client with

liability to third parties.[3]

e) Evaluate the practicability and effectiveness of

ways in which liability may be restricted.[3]

f) Discuss liability limitation agreements.[2]

g) Discuss and appraise the principal causes of

audit failure and other factors that contribute to the expectation gap (e.g. responsibilities for fraud and error).[3]

h) Recommend ways in which the expectation

gap might be bridged.[2] C PRACTICE MANAGEMENT 1. Quality control a) Explain the principles and purpose of quality

control of audit and other assurance engagements.[1]

b) Describe the elements of a system of quality control relevant to a given firm.[2]

c) Select and justify quality control procedures that are applicable to a given audit engagement.[3]

d) Assess whether an engagement has been

planned and performed in accordance with professional standards and whether reports issued are appropriate in the circumstances.[3]

2. Advertising, publicity, obtaining professional

work and fees a) Recognise situations in which specified

advertisements are acceptable.[2]

b) Discuss the restrictions on practice

descriptions, the use of the ACCA logo and the names of practising firms.[2]

c) Discuss the extent to which reference to fees

may be made in promotional material.[2]

d) Outline the determinants of fee-setting and

justify the bases on which fees and commissions may and may not be charged for services.[3]

e) Discuss the ethical and other professional

problems, for example, lowballing, involved in establishing and negotiating fees for a specified assignment.[3]

3. Tendering a) Discuss the reasons why entities change their

auditors/professional accountants.[2]

b) Recognise and explain the matters to be

considered when a firm is invited to submit a proposal or fee quote for an audit or other professional engagement.[2]

c) Identify the information to be included in a proposal.[2]

4. Professional appointments a) Explain the matters to be considered and the

procedures that an audit firm/professional accountant should carry out before accepting a specified new client/engagement including:[3]

i) client acceptance ii) engagement acceptance


P7



Finance

21


iii) establish whether the preconditions for an audit are present

iv) agreeing the terms of engagement. b) Recognise the key issues that underlie the

agreement of the scope and terms of an engagement with a client.[2]

D AUDIT OF HISTORICAL FINANCIAL

INFORMATION 1. Planning, materiality and assessing the risk of

misstatement a) Define materiality and performance materiality

and demonstrate how it should be applied in financial reporting and auditing.[2]

b) Identify and explain business risks for a given

assignment.[3]

c) Identify and explain audit risks for a given assignment.[3]

d) Identify and explain risks of material

misstatement for a given assignment.[3] e) Discuss and demonstrate the use of analytical

procedures in the planning of an assignment.[3]

f) Explain how the result of planning procedures determines the relevant audit strategy.[2]

g) Explain the planning procedures specific to an initial audit engagement.[2]

h) Identify additional information that may be

required in order to effectively plan an assignment.[2]

i) Recognise matters that are not relevant to the

planning of an assignment.[2]

2. Evidence a) Identify and describe audit procedures to

obtain sufficient audit evidence from identified sources.[2]

b) Identify and evaluate the audit evidence expected to be available to

i) support the financial statement assertions and accounting treatments (including fair values)

ii) support disclosures made in the notes to the financial statements. [3]

c) Apply analytical procedures to financial and

non-financial data.[2]

d) Explain the specific audit problems and procedures concerning related parties and related party transactions.[2]

e) Recognise circumstances that may indicate the

existence of unidentified related parties and select appropriate audit procedures.[2]

f) Evaluate the use of written management

representations to support other audit evidence.[2]

g) Recognise when it is justifiable to place

reliance on the work of an expert (e.g. a surveyor employed by the audit client).[2]

h) Assess the appropriateness and sufficiency of

the work of internal auditors and the extent to which reliance can be placed on it. [2]

3. Evaluation and review a) Evaluate the matters (e.g. materiality, risk,

relevant accounting standards, audit evidence) relating to:[3]

i) inventory and construction contracts ii) standard costing systems iii) statement of cash flows iv) changes in accounting policy v) taxation (including deferred tax) vi) segmental reporting vii) non-current assets viii) fair value ix) leases x) revenue recognition xi) employee benefits xii) government grants xiii) related parties xiv) earnings per share xv) impairment xvi) provisions, contingent liabilities and

contingent assets xvii) intangible assets xviii) financial instruments



22



Finance

xix) investment properties xx) share-based payment transactions xxi) business combinations xxii) assets held for sale and discontinued

operations xxiii) events after the end of the reporting

period xxiv) the effects of foreign exchange rates xxv) borrowing costs.

b) Explain the use of analytical procedures in

evaluation and review.[3]

c) Explain how the auditors responsibilities for

corresponding figures, comparative financial statements, and other information, are discharged.[3]

d) Apply the further considerations and audit procedures relevant to initial engagements.[2]

e) Discuss the courses of action available to an

auditor if an inconsistency or misstatement of fact exists in relation to other information.[2]

f) Specify audit procedures designed to identify

subsequent events that may require adjustment to, or disclosure in, the financial statements of a given entity.[2]

g) Identify and explain indicators that the going

concern basis may be in doubt and recognise mitigating factors.[2]

h) Recommend audit procedures, or evaluate the

evidence that might be expected to be available and assess the appropriateness of the going concern basis in given situations.[3]

i) Assess the adequacy of disclosures in financial

statements relating to going concern and explain the implications for the auditors report with regard to the going concern basis.[3]

4. Group audits a) Recognise the specific matters to be

considered before accepting appointment as principal auditor to a group in a given situation.[3]

b) Identify and explain the matters specific to planning an audit of group financial statements

including assessment of group and component materiality, the impact of non-coterminous year ends within a group, and changes in group structure.[2]

c) Justify the situations where a joint audit would

be appropriate.[2]

d) Recognise the audit problems and describe audit procedures specific to a business combination, including goodwill, accounting policies, inter-company trading, the classification of investments, equity accounting for associates, changes in group structure, and accounting for a foreign subsidiary.[3]

e) Identify and explain the audit risks, and necessary audit procedures relevant to the consolidation process.[3]

f) Identify and describe the matters to be

considered and the procedures to be performed at the planning stage, when a principal auditor considers the use of the work of component auditors.[3]

g) Consider how the principal auditor should evaluate the audit work performed by a component auditor.[2]

h) Explain the implications for the auditors report on the financial statements of an entity where the opinion on a component is qualified or otherwise modified in a given situation.[2]

E OTHER ASSIGNMENTS 1. Audit-related services a) Describe the nature of audit-related services,

the circumstances in which they might be required and the comparative levels of assurance provided by professional accountants and distinguish between:[2]

i) audit-related services and an audit of historical financial statements

ii) an attestation engagement and a direct reporting engagement.[2]

b) Plan review engagements, for example: [2] i) a review of interim financial information


P7



Finance

23


ii) a due diligence assignment (when acquiring a company, business or other assets).

c) Explain the importance of enquiry and

analytical procedures in review engagements and apply these procedures.[2]

2. Assurance services a) Describe the main categories of assurance

services that audit firms can provide and assess the benefits of providing these services to management and external users.[3]

b) Justify a level of assurance (reasonable, high,

moderate, limited, negative) for an engagement depending on the subject matter evaluated, the criteria used, the procedures applied and the quality and quantity of evidence obtained.[3]

c) Recognise the ways in which different types of risk (e.g. strategic, operating, information) may be identified and analysed and assess how management should respond to risk.[3]

3. Prospective financial information a) Define prospective financial information (PFI)

and distinguish between a forecast, a projection, a hypothetical illustration and a target.[1]

b) Explain the principles of useful PFI.[1]

c) Identify and describe the matters to be considered before accepting a specified engagement to report on PFI.[2]

d) Discuss the level of assurance that the auditor

may provide and explain the other factors to be considered in determining the nature, timing and extent of examination procedures.[1]

e) Describe examination procedures to verify

forecasts and projections.[2]

f) Compare the content of a report on an examination of PFI with reports made in providing audit-related services.[2]

4. Forensic audits a) Define the terms forensic accounting, forensic

investigation and forensic audit.[1]

b) Describe the major applications of forensic

auditing (e.g. fraud, negligence, insurance claims) and analyse the role of the forensic auditor as an expert witness.[2]

c) Apply the fundamental ethical principles to

professional accountants engaged in forensic audit assignments.[2]

d) Plan a forensic audit engagement.[2]

e) Select investigative procedures and evaluate

evidence appropriate to determining the loss in a given situation.[3]

5. Internal audit a) Evaluate the potential impact of an internal

audit department on the planning and performance of the external audit.[2]

b) Explain the benefits and potential drawbacks of

outsourcing internal audit.[2] c) Consider the ethical implications of the external

auditor providing an internal audit service to a client.[2]

6. Outsourcing a) Explain the different approaches to

outsourcing and compare with insourcing.[2]

b) Discuss and conclude on the advantages and disadvantages of outsourcing finance and accounting functions.[3]

c) Recognise and evaluate the impact of outsourced functions on the conduct of an audit.[3]

F REPORTING 1 Auditors reports a) Critically appraise the form and content of an

auditors report in a given situation.[3]



24



Finance

b) Recognise and evaluate the factors to be taken into account when forming an audit opinion in a given situation and justify audit opinions that are consistent with the results of audit procedures.[3]

c) Assess whether or not a proposed audit opinion

is appropriate.[3]

d) Advise on the actions which may be taken by the auditor in the event that a modified audit report is issued.[3]

e) Recognise when the use of an emphasis of

matter paragraph and other matter paragraph would be appropriate.[3]

2. Reports to those charged with governance and

management a) Critically assess the quality of a report to those

charged with governance and management. [3]

b) Advise on the content of reports to those

charged with governance and management in a given situation.[3]

3. Other reports a) Analyse the form and content of the

professional accountants report for an assurance engagement as compared with an auditors report.[2]

b) Discuss the content of a report on examination

of prospective financial information.[2]

c) Discuss the effectiveness of the negative

assurance form of reporting and evaluate situations in which it may be appropriate to express a reservation or deny a conclusion.[3]

G CURRENT ISSUES AND DEVELOPMENTS Discuss the relative merits and the consequences of different standpoints taken in current debates and express opinions supported by reasoned arguments. 1. Professional and ethical a) Discuss the relative advantages of an ethical

framework and a rulebook.[2]

b) Identify and assess relevant emerging ethical issues and evaluate the safeguards available.[3]

c) Discuss IFAC developments.[2]

2. Information technology a) Describe recent trends in IT and their current

and potential impact on auditors (e.g. the audit implications of cyberincidents and other risks).[2]

b) Explain how IT may be used to assist auditors

and discuss the problems that may be encountered in automating the audit process.[2]

3. Transnational audits a) Define transnational audits and explain the

role of the Transnational Audit Committee (TAC) of IFAC.[1]

b) Discuss how transnational audits may differ

from other audits of historical financial information (e.g. in terms of applicable financial reporting and auditing standards, listing requirements and corporate governance requirements). [2]

4. Social and environmental auditing a) Plan an engagement to provide assurance on

performance measures and sustainability indicators.[2]

b) Describe the difficulties in measuring and reporting on economic, environmental and social performance and give examples of performance measures and sustainability indicators.[2]

c) Explain the auditors main considerations in

respect of social and environmental matters and how they impact on entities and their financial statements (e.g. impairment of assets, provisions and contingent liabilities).[2]

d) Describe substantive procedures to detect

potential misstatements in respect of socio-environmental matters.[2]

e) Discuss the form and content of an independent verification statement (e.g. on an


P7



Finance

25


environmental management system (EMS) and a report to society).[2]

5. Other current issues a) Explain current developments in auditing

standards including the need for new and revised standards and evaluate their impact on the conduct of audits. [3]

b) Discuss other current legal, ethical, other

professional and practical matters that affect accountants, auditors, their employers and the profession. [3]



26



Finance

ACCA 2013 All rights reserved. 14

SUMMARY OF CHANGES TO P7 ACCA periodically reviews its qualification syllabuses so that they fully meet the needs of stakeholders such as employers, students, regulatory and advisory bodies and learning providers. The main areas to be added to the syllabus are shown in Table 1 below:

Table 1 Additions to P7 Section and subject area Syllabus content D1(i)h) Planning, materiality and assessing the risk of material misstatement

Additional information

D1(i)i) Matters not relevant to planning The main areas that have been clarified in the syllabus (all were implicitly included previously) are shown in Table 2 below: Table 2 Amendments to P7 Section and subject area Syllabus content B1e) Code of Ethics for Professional Accountants Professional scepticism B1f) Evaluation of professional scepticism

P7Examinable Documents


28



Finance

P7



Finance

29

ExAMINABLE DoCUMENTS

EXAMINABLE DOCUMENTS JUNE AND DECEMBER 2013

AUDIT

INTERNATIONAL

Knowledge of new examinable regulations issued by 30th September will be examinable inexamination sessions being held in the following calendar year. Documents may be examinableeven if the effective date is in the future. This means that all regulations issued by 30th

September 2012 will be examinable in the June and December 2013 examinations.

The study guide offers more detailed guidance on the depth and level at which the examinabledocuments should be examined. The study guide should therefore be read in conjunction withthe examinable documents list.

Accounting Standards

Paper F8 Audit and Assurance

The accounting knowledge that is assumed for Paper F8 is the same as that examined in PaperF3. Therefore, candidates studying for Paper F8 should refer to the Accounting Standards listedunder Paper F3.


The accounting knowledge that is assumed for Paper P7 is the same as that examined in PaperP2. Therefore, candidates studying for Paper P7 should refer to the Accounting Standards listedunder Paper P2.

N.B. P7 will only expect knowledge of accounting standards and financial reporting standardsfrom Paper P2. Knowledge of exposure drafts and discussion papers will not be expected.

Title F8 P7International Standards on Auditing (ISAs)Glossary of Terms International Framework for Assurance Assignments Preface to the International Standards on Quality Control, Auditing,Review, Other Assurance and Related Services

ISA 200 Overall Objectives of the Independent Auditor and the Conduct ofan Audit in Accordance with ISAs

ISA 210 Agreeing the Terms of Audit Engagements ISA 220 Quality Control for an Audit of Financial Statements ISA 230 Audit Documentation ISA 240 The Auditors Responsibilities Relating to Fraud in an Audit of

Financial Statements

ISA 250 Consideration of Laws and Regulations in an Audit of FinancialStatements

ISA 260 Communication with Those Charged with Governance ISA 265 Communicating Deficiencies in Internal Control to Those Charged

with Governance and Management

ISA 300 Planning an Audit of Financial Statements ISA 315 Identifying and Assessing the Risks of Material Misstatement

through Understanding the Entity and Its Environment

ISA 320 Materiality in Planning and Performing an Audit ISA 330 The Auditors Responses to Assessed Risks


30



Finance

Title F8 P7ISA 402 Audit Considerations Relating to an Entity Using a Service

Organisation

ISA 450 Evaluation of Misstatements Identified During the Audit ISA 500 Audit Evidence ISA 501 Audit Evidence Specific Considerations for Selected Items ISA 505 External Confirmations ISA 510 Initial Audit Engagements Opening Balances ISA 520 Analytical Procedures ISA 530 Audit Sampling ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting

Estimates, and Related Disclosures

ISA 550 Related Parties ISA 560 Subsequent Events ISA 570 Going Concern ISA 580 Written Representations ISA 600 Special Considerations - Audits of Group Financial Statements

(Including the Work of Component Auditors)

ISA 610 Using the Work of Internal Auditors ISA 620 Using the Work of an Auditors Expert ISA 700 Forming an Opinion and Reporting on Financial Statements ISA 705 Modifications to the Opinion in the Independent Auditors Report ISA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in

the Independent Auditors Report

ISA 710 Comparative Information Corresponding Figures and ComparativeFinancial Statements

ISA 720 The Auditors Responsibilities Relating to Other Information inDocuments Containing Audited Financial Statements

International Standards on Assurance Engagements (ISAEs)ISAE 3000 Assurance Engagements other than Audits or Reviews of Historical

Financial Information

ISAE 3400 The Examination of Prospective Financial Information ISAE 3402 Assurance Reports on Controls at a Service Organisation ISAE 3420 Assurance Engagements to Report on the Compilation of Pro Forma

Financial Information Included in a Prospectus

International Standards on Quality Control (ISQCs)ISQC 1 Quality Controls for Firms that Perform Audits and Reviews of

Financial Statements, and Other Assurance and Related ServicesEngagements

International Standards on Related Services (ISRSs)ISRS 4400 Engagements to Perform Agreed-Upon Procedures Regarding

Financial Information

ISRS 4410 Compilation Engagements International Standards on Review Engagements (ISREs)

ISRE 2400 Engagements to Review Historical Financial Statements ISRE 2410 Review of Interim Financial Information Performed by the

Independent Auditor of the Entity

Exposure Drafts (EDs)IAASB Invitation to Comment Improving the Auditors Report IESBA Responding to a Suspected Illegal Act ISAE 3000 (Revised) Assurance Engagements other than Audits orReviews of Historical Financial Information

Other DocumentsACCAs Code of Ethics and Conduct International Ethics Standards Board for Accountants (IESBAs)

P7



Finance

31


Title F8 P7(IFACs) Code of Ethics for Professional AccountantsACCAs Technical Factsheet 145 Anti Money-LaunderingGuidance for the Accountancy Sector

The UK Corporate Governance Code as an example of a code ofbest practice (Revised September 2012)

The UK Corporate Governance Code (Revised September 2012) asan example of a code of best practice in relation to auditcommittees

IAASB Practice Alert Challenges in Auditing Fair Value AccountingEstimates in the Current Market Environment (October 2008)

IAASB Practice Alert Audit Considerations in Respect of GoingConcern in the Current Economic Environment (January 2009)

IAASB Applying ISAs Proportionately with the Size and Complexityof an Entity (August 2009)

IAASB XBRL : The Emerging Landscape (January 2010) IAASB Auditor Considerations Regarding Significant Unusual orHighly Complex Transactions (September 2010)

IAASB Questions and Answers Professional Skepticism in an Auditof Financial Statements (February 2012)

Note:

Topics of exposure drafts are examinable to the extent that relevant articles about them arepublished in student accountant.


32



Finance

EXAMINABLE DOCUMENTS JUNE AND DECEMBER 2013

AUDIT

UK

Knowledge of new examinable regulations issued by 30th September will be examinable inexamination sessions being held in the following calendar year. Documents may be examinableeven if the effective date is in the future. This means that all regulations issued by 30th

September 2012 will be examinable in the June and December 2013 examinations.

The study guide offers more detailed guidance on the depth and level at which the examinabledocuments should be examined. The study guide should therefore be read in conjunction withthe examinable documents list.

Accounting Standards

All questions set will be based on International Financial Reporting Standards.

Paper F8 Audit and Assurance

The accounting knowledge that is assumed for Paper F8 is the same as that examined in PaperF3. Therefore, candidates studying for Paper F8 should refer to the Accounting Standards listedunder Paper F3.


The accounting knowledge that is assumed for Paper P7 is the same as that examined in PaperP2. Therefore, candidates studying for Paper P7 should refer to the Accounting Standards listedunder Paper P2.

N.B. P7 will only expect knowledge of accounting standards and financial reporting standardsfrom Paper P2. Knowledge of exposure drafts and discussion papers will not be expected.

Title F8 P7International Standards on Auditing (ISAs) (UK and Ireland)Summary of changes to the new ISAs (UK and Ireland) Glossary of terms 2009

ISA 200 Overall objectives of the independent auditor and the conduct of anaudit in accordance with ISAs (UK and Ireland)

ISA 210 Agreeing the terms of audit engagements ISA 220 Quality control for an audit of financial statements ISA 230 Audit documentation ISA 240 The auditors responsibilities relating to fraud in an audit of

financial statements

ISA 250A Consideration of laws and regulations in an audit of financialstatements

ISA 260 (Revised September 2012) Communication with those chargedwith governance

ISA 265 Communicating deficiencies in internal control to those chargedwith governance and management

ISA 300 Planning an audit of financial statements ISA 315 Identifying and assessing the risks of material misstatement

through understanding the entity and Its environment

ISA 320 Materiality in planning and performing an audit

P7



Finance

33


Title F8 P7ISA 330 The auditors responses to assessed risks

ISA 402 Audit considerations relating to an entity using a serviceorganisation

ISA 450 Evaluation of misstatements identified during the audit ISA 500 Audit evidence ISA 501 Audit evidence specific considerations for selected items ISA 505 External confirmations ISA 510 Initial audit engagements opening balances ISA 520 Analytical procedures ISA 530 Audit sampling ISA 540 Auditing accounting estimates, including fair value accounting

estimates, and related disclosures

ISA 550 Related parties ISA 560 Subsequent events ISA 570 Going concern ISA 580 Written representations ISA 600 Special considerations - audits of group financial statements

(including the work of component auditors)

ISA 610 Using the work of internal auditors ISA 620 Using the work of an auditors expert ISA 700 (Revised September 2012) The auditors report on financial

statements

ISA 705 (Revised September 2012) Modifications to the opinion in theindependent auditors report

ISA 706 (Revised September 2012) Emphasis of matter paragraphs andother matter paragraphs in the independent auditors report

ISA 710 Comparative information corresponding figures and comparativefinancial statements

ISA 720A (Revised September 2012) The auditors responsibilities relatingto other information in documents containing audited financialstatements

ISA 720B The auditors statutory reporting responsibility in relation todirectors reports

International Standards on Quality Control (ISQC)ISQC 1 Quality control for firms that perform audits and reviews of

financial statements and other assurance and related servicesengagements

Practice Notes (PNs)PN 16 Bank reports for audit purposes in the United Kingdom (Revised

Feb 2011)

PN 25 Attendance at stocktaking (Revised Feb 2011) PN 26 (Revised) Guidance for smaller entity audit documentation

(December 2009)

Ethical Standards (ESs)ES (Revised December 2010) Provisions available for small entities ES1 (Revised December 2011) Integrity, objectivity and

independence

ES2 (Revised December 2010) Financial, business, employment andpersonal relationships

ES3 (Revised October 2009) Long association with the auditengagement

ES4 (Revised December 2010) Fees, remuneration and evaluationpolicies, litigation, gifts and hospitality

ES5 (Revised December 2011) Non-audit services provided to


34



Finance

Title F8 P7Audited entitiesGlossary (Revised December 2010) Bulletins

2008/01 Audit issues when financial market conditions are difficult andcredit facilities may be restricted

2008/06 The senior statutory auditor under the United Kingdom CompaniesAct 2006

2008/10 Going concern issues during the current economic conditions 2009/4 Developments in corporate governance affecting the responsibilities

of auditors of UK companies

2010/1 XBRL tagging of information in audited financial statements guidance for auditors

2010/2 (Revised) Compendium of illustrative reports on United Kingdomprivate sector financial statements for periods ended on or after 15December 2010

Statement of Standards for Reporting Accountants (SSRAs)ISRE (UKandIreland)2410

Review of Interim Financial Information Performed by theIndependent Auditor of the Entity

Exposure Drafts (EDs) (UK and Ireland)Consultation Paper Revision of ISAs (UK and Ireland) 315 and610 re internal audit

Other DocumentsACCAs Code of Ethics and Conduct International Ethics Standards Board for Accountants (IESBAs)(IFACs) Code of Ethics for Professional Accountants

The UK Corporate Governance Code (Revised September 2012) The UK Corporate Governance Code (Revised September 2012) inrelation to audit committees

FRC Going Concern and Liquidity Risk : Guidance for Directors ofUK Companies 2009

Scope and Authority of APB Pronouncements (Revised) October2009

ACCAs Technical Factsheet 145 Anti-Money LaunderingGuidance for the Accountancy Sector

IAASB Practice Alert Challenges in Auditing Fair Value AccountingEstimates in the Current Market Environment (October 2008)

IAASB Applying ISAs Proportionately with the Size and Complexityof an Entity (August 2009)

IAASB Auditor Considerations Regarding Significant Unusual orHighly Complex Transactions (September 2010)

FRC Briefing Paper : Professional Scepticism (March 2012)

Note:

Topics of exposure drafts are examinable to the extent that relevant articles about them arepublished in student accountant.

P7Pilot Paper


36



Finance

Please note that the Pilot Paper is the original ACCA document and is for guidance only. It has not been updated for any subsequent changes in laws and regulations, so some technical details may have changed since the original Pilot Paper was issued. For up-to-date exam questions and answers, please see the relevant Revision Kit.

Advanced Audit and Assurance(International and UK)

Time allowed Reading and planning: 15 minutesWriting: 3 hours

This paper is divided into two sections:

Section A BOTH questions are complusory and MUST be attempted.

Section B TWO questions ONLY to be attempted.

Do NOT open this paper until instructed by the supervisor.

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

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

Professional Pilot Paper Options module

(INT

& U

K)

P7r epaP

The Association of Chartered Certified Accountants


38



Finance

P7



Finance

39

PILoT PAPEr P7

shaping success in business and finance

LondonSchool of Business

Finance

45

Note to attribute past questions and answers to the pilot paper.

A selection of past scenarios, requirements, and parts thereof, have been used in presenting this Pilot Paper. Answers have been rewritten, technically updated or otherwise amended as necessary.

1 (a) and (b) J02 Q1

(c) D02 Q4 (a)

(d) D05 Q6 (c)

3 (a)(d) D01 Q2 (a)(c) and (e)

(e) D04 Q5 (c)

4 (d) D05 Q4 (b) (ii)

5 (a) J05 Q6 (b)

(b)(d) D05 Q5

PILOT PAPER


40



Finance


46



Finance

Section A BOTH questions are compulsory and MUST be attempted.

1 You are an audit manager in Ribi & Co, a firm of Chartered Certified Accountants. One of your audit clients Beeski Co provides satellite broadcasting services in a rapidly growing market.

In November 2005 Beeski purchased Xstatic Co, a competitor group of companies. Significant revenue, cost and capital expenditure synergies are expected as the operations of Beeski and Xstatic are being combined into one group of companies.

The following financial and operating information consolidates the results of the enlarged Beeski group:

Year end 30 September 2006 2005 (Estimated) (Actual) $m $m Revenue 6,827 4,404 Cost of sales (3,109) (1,991) Distribution costs and administrative expenses (2,866) (1,700) Research and development costs (25) (22) Depreciation and amortisation (927) (661) Interest expense (266) (202) Loss before taxation (366) (172) Customers 14.9m 7.6m Average revenue per customer $437 $556

In August 2006 Beeski purchased MTbox Co, a large cable communications provider in India, where your firm has no representation. The financial statements of MTbox for the year ending 30 September 2006 will continue to be audited by a local firm of Chartered Certified Accountants. MTboxs activities have not been reflected in the above estimated results of the group. Beeski is committed to introducing its corporate image into India.

In order to sustain growth, significant costs are expected to be incurred as operations are expanded, networks upgraded and new products and services introduced.

Required:

(a) Identify and describe the principal business risks for the Beeski group. (9 marks)

(b) Explain what effect the acquisitions will have on the planning of Ribi & Cos audit of the consolidated financial statements of Beeski Co for the year ending 30 September 2006. (10 marks)

(c) Explain the role of support letters (also called comfort letters) as evidence in the audit of financial statements. (6 marks)

(d) Discuss how horizontal groups (ie non-consolidated entities under common control) affect the scope of an audit and the audit work undertaken. (5 marks)

(30 marks)

P7



Finance

41

PILoT PAPEr P7



Finance

47

2 You have been asked to carry out an investigation by the management of Xzibit Co. One of the companys subsidiaries, Efex Engineering Co, has been making losses for the past year. Xzibits management is concerned about the accuracy of Efex Engineerings most recent quarters management accounts.

The summarised income statements for the last three quarters are as follows:

Quarter to 30 June 31 March 31 December $000 $000 $000 2006 2006 2005

Revenue 429 334 343Opening inventory 180 163 203Materials 318 251 200Direct wages 62 54 74 560 468 477Less: closing inventory (162) (180) (163)Cost of goods sold 398 288 314Gross profit 31 46 29Less: overheads (63) (75) (82)Net loss (32) (29) (53)Gross profit (%) 7.2% 13.8% 8.5%Materials (% of revenue) 78.3% 70.0% 70.0%Labour (% of revenue) 14.5% 16.2% 21.6%

Xzibits management board believes that the high material consumption as a percentage of revenue for the quarter to 30 June 2006 is due to one or more of the following factors:

(1) under-counting or under-valuation of closing inventory;

(2) excessive consumption or wastage of materials;

(3) material being stolen by employees or other individuals.

Efex Engineering has a small number of large customers and manufactures its products to each customers specification. The selling price of the product is determined by:

(1) estimating the cost of materials;

(2) estimating the labour cost;

(3) adding a mark-up to cover overheads and provide a normal profit.

The estimated costs are not compared with actual costs. Although it is possible to analyse purchase invoices for materials between customers orders this analysis has not been done.

A physical inventory count is carried out at the end of each quarter. Items of inventory are entered on stocksheets and valued manually. The company does not maintain perpetual inventory records and a full physical count is to be carried out at the financial year end, 30 September 2006.

The direct labour cost included in the inventory valuation is small and should be assumed to be constant at the end of each quarter. Historically, the cost of materials consumed has been about 70% of revenue.

The management accounts to 31 March 2006 are to be assumed to be correct.

Required:

(a) Define forensic auditing and describe its application to fraud investigations. (5 marks)

(b) Identify and describe the matters that you should consider and the procedures you should carry out in order to plan an investigation of Efex Engineering Cos losses. (10 marks)

PILOT PAPER


42



Finance


48



Finance

(c) (i) Explain the matters you should consider to determine whether closing inventory at 30 June 2006 is undervalued; and

(ii) Describe the tests you should plan to perform to quantify the amount of any undervaluation. (8 marks)

(d) (i) Identify and explain the possible reasons for the apparent high materials consumption in the quarter ended 30 June 2006; and

(ii) Describe the tests you should plan to perform to determine whether materials consumption, as shown in the management accounts, is correct. (7 marks)

(30 marks)

Section B TWO questions ONLY to be attempted

3 You are a manager in Ingot & Co, a firm of Chartered Certified Accountants, with specific responsibility for the quality of audits. Ingot was appointed auditor of Argenta Co, a provider of waste management services, in July 2006. You have just visited the audit team at Argentas head office. The audit team is comprised of an accountant in charge (AIC), an audit senior and two trainees.

Argentas draft accounts for the year ended 30 June 2006 show revenue of $116 million (2005 $81 million) and total assets of $36 million (2005 $2 5 million). During your visit, a review of the audit working papers revealed the following:

(a) On the audit planning checklist, the audit senior has crossed through the analytical procedures section and written not applicable new client. The audit planning checklist has not been signed off as having been reviewed. (4 marks)

(b) The AIC last visited Argentas office when the final audit commenced two weeks ago on 1 August. The senior has since completed the audit of tangible non-current assets (including property and service equipment) which amount to $0.6 million as at 30 June 2006 (2005 $0 6 million). The AIC spends most of his time working from Ingots office and is currently allocated to three other assignments as well as Argentas audit. (4 marks)

(c) At 30 June 2006 trade receivables amounted to $2 million (2005 $09 million). One of the trainees has just finished sending out first requests for direct confirmation of customers balances as at the balance sheet date. (4 marks)

(d) The other trainee has been assigned to the audit of the consumable supplies that comprise inventory amounting to $88,000 (2005 $53,000). The trainee has carried out tests of controls over the perpetual inventory records and confirmed the roll-back of a sample of current quantities to book quantities as at the year end. (3 marks)

(e) The AIC has noted the following matter for your attention. The financial statements to 30 June 2005 disclosed, as unquantifiable, a contingent liability for pending litigation. However, the AIC has seen a letter confirming that the matter was settled out of court for $0.45 million on 14 September 2005. The auditors report on the financial statements for the year ended 30 June 2005 was unmodified and signed on 19 September 2005. The AIC believes that Argentas management is not aware of the error and has not brought it to their attention. (5 marks)

. .

..1

.

. .

P7



Finance

43

PILoT PAPEr P7



Finance

49

Required:

Identify and comment on the implications of these findings for Ingot & Cos quality control policies and procedures.

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

(20 marks)

4 You are the manager responsible for four audit clients of Axis & Co, a firm of Chartered Certified Accountants. The year end in each case is 30 June 2006.

You are currently reviewing the audit working paper files and the audit seniors recommendations for the auditors reports. Details are as follows:

(a) Mantis Co is a subsidiary of Cube Co. Serious going concern problems have been noted during this years audit. Mantis will be unable to trade for the foreseeable future unless it continues to receive financial support from the parent company. Mantis has received a letter of support (comfort letter) from Cube Co. The audit senior has suggested that, due to the seriousness of the situation, the audit opinion must at least be qualified except for. (5 marks)

(b) Lorenze Co has changed its accounting policy for goodwill during the year from amortisation over its estimated useful life to annual impairment testing. No disclosure of this change has been given in the financial statements. The carrying amount of goodwill in the balance sheet as at 30 June 2006 is the same as at 30 June 2005 as managements impairment test show that it is not impaired.

The audit senior has concluded that a qualification is not required but suggests that attention can be drawn to the change by way of an emphasis of matter paragraph. (6 marks)

(c) The directors report of Abrupt Co states that investment property rental forms a major part of revenue. However, a note to the financial statements shows that property rental represents only 16% of total revenue for the year. The audit senior is satisfied that the revenue figures are correct.

The audit senior has noted that an unqualified opinion should be given as the audit opinion does not extend to the directors report. (4 marks)

(d) Audit work on the after-date bank transactions of Jingle Co has identified a transfer of cash from Bell Co. The audit senior assigned to the audit of Jingle has documented that Jingles finance director explained that Bell commenced trading on 7 July 2006, after being set up as a wholly-owned foreign subsidiary of Jingle.

The audit senior has noted that although no other evidence has been obtained an unmodified opinion is appropriate because the matter does not impact on the current years financial statements. (5 marks)

Required:

For each situation, comment on the suitability or otherwise of the audit seniors proposals for the auditors reports. Where you disagree, indicate what audit modification (if any) should be given instead.

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

(20 marks)

PILOT PAPER


44



Finance


50



Finance

5 (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:

(i) 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 2006. To your surprise, the tax authority has just launched an investigation into the affairs of Kora on suspicion of underdeclaring 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 2006. 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:

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)

End of Question Paper

P7



Finance

45

PILoT PAPEr

Answers

P7



Finance

51

Tutorial note: These model answers are considerably longer and more detailed than would be expected from any candidate in the examination. They should be used as a guide to the form, style and technical standard (but not length) of answer which candidates should aim to achieve. However, these answers may not include all valid points mentioned by a candidate credit will be given to candidates mentioning such points.

1 Beeski Co

(A) PRINCIPAL BUSINESS RISKS

Tutorial note: The requirement to identify and describe suggests that although marks will be awarded for the mere identification of risks from the scenario, those risks must be described (as illustrated below).

Communications Industry

Rapid and new technological developments in the industry, providing faster data transmission and increasingly interactive capabilities, will render certain existing products and services obsolete.

Beeski cannot predict how emerging and future technologies (e.g. Bluetooth) will affect demand for its services.

Competition

Although Beeski may have reduced competition in the short-term (by having acquired a competitor), the communications market is still expanding. Increasing competition from other existing and new competitors offering new technologies could:

o affect Beeskis ability to attract and retain customers;

o reduce Beeskis share of new and existing customers;

o force Beeski to reduce prices.

The cost (and revenue-generating capabilities) of new technologies tends to fall significantly and relatively quickly (e.g. mobile phone technology is available in disposable form).

Integration

Combining two groups which have previously operated independently (and competitively against each other) is likely to result in disruption.

Potential difficulties may be encountered in seeking to retain customers and key personnel.

The anticipated significant synergies (in revenue, cost and capital expenditure) may have been optimistic. If they do not materialise to the extent predicted, Beeskis operational activities, financial condition and future prospects are likely to be adversely affected.

Beeski may have difficulty in adapting its corporate image to the culture of the Indian network.

Operating Losses

Loss before taxation has more than doubled (increased by 113%). If Xstatic was making significant losses before it was acquired by Beeski those losses may have been expected to continue in the short-term. Although the groups operations are being combined and synergies are expected, recurring losses will clearly threaten the new groups operational existence as a going concern.

PILOT PAPER

Answers


46



Finance


52



Finance

Falling ARPC

ARPC, a key performance indicator, has fallen by more than 20% ((437-556/556 = 21.4%). This is likely to reflect falling tariffs in a competitive market.

Although the number of customers has nearly doubled (increased by 96%), revenue has increased by only 55%. It seems unlikely that such a growth in customer base can be maintained, therefore the reduction in tariffs could result in falling revenues.

Some (if not all) of the growth, is due to the acquisition of Xstatic. The fall in ARPC may indicate that Xstatics ARPC (now absorbed into the enlarged Beeski group) is substantially less than that of Beeski. If Xstatics tariffs were lower than Beeskis because it was offering a lower level of service it may be difficult for Beeski to increase them albeit for an enhanced service.

Sustaining Growth

Growth may not be sustainable as further expansion will incur significant costs and investment which must be financed.

The significant costs expected to be incurred in upgrading networks may not be recouped if additional revenues are insufficient. Failure to maintain existing networks is likely to result in a loss of customers and market share.

If Beeskis financial resources are insufficient to meet the operating losses it may need to issue equity and/or increase its debt. Possible adverse consequences of increasing indebtedness include:

o high debt-service costs;

o operating and financial restrictions being imposed by lenders;

o difficulty in obtaining further finance in the future;

o being unable to take advantage of business opportunities;

o reduction in credit ratings.

Tutorial note: Although there are relatively explicit pointers to the above business risks in the scenario, marks will also be awarded for other risks which are perhaps more implicit (as illustrated below).

Countries of Operation

Operations have been expanded from European countries to India. Beeskis inexperience of economic and legal developments in India may impair the investment in MTbox.

Foreign Exchange Rates

Beeski transacts business in several countries and foreign exchange rate fluctuations could have a material adverse affect on operating results.

Highly Regulated Market

Network operations could be adversely affected by changes in the laws, regulations or government policies which regulate the industry.

Difficulties in obtaining approvals for the erection and operation of transmitters could have an adverse effect on the extent, quality and capacity of Beeskis network coverage.

Allegations of health risks (e.g. associated with radio waves from transmitter masts and mobile handsets) could reduce customer demand and increase exposure to potential litigation.

Tutorial note: Candidates are not expected to have knowledge of industry-related complexities (e.g. of licensing, subsidies and network recharging) however, appropriate marks would be awarded for comments on such business risks arising.

P7



Finance

47

PILoT PAPEr P7



Finance

53

(B) IMPACT OF ACQUISITION ON PLANNING

Tutorial note: Note that the context here is that of the principal auditors planning of a group audit.

Group Structure

The new group structure must be ascertained to identify the entities that should be consolidated into the group financial statements of Beeski for the year ending 30 September 2006.

Materiality Assessment

Preliminary materiality will be much higher, in monetary terms, than in the prior year. For example, if a % of revenue is a determinant of preliminary materiality, it will increase by 55% (based on estimate).

Tutorial note: Profit is not a suitable criterion as group is loss-making.

The materiality of each subsidiary should be assessed, in terms of the enlarged group as at the planning stage. For example, any subsidiary contributing more than 10% of the groups assets and revenue (but not result) is material and less than 5% (say) is not. This will identify, for example:

those entities requiring an audit visit by the principal auditor; and

those for which analytical procedures may suffice.

If MTbox is particularly material to the group, Ribi may plan (provisionally) to visit MTboxs auditors to discuss any problems shown to arise in their audit work summary (see group instructions below).

Goodwill Arising

The audit plan should draw attention to the need to audit the amount of goodwill arising on the acquisitions and managements impairment test at the balance sheet date.

The assets and liabilities of Xstatic and MTbox, at fair value to the group, will be combined on a line-by-line basis and any goodwill arising recognised.

The calculation of the amount attributed to goodwill must be agreed to be the excess of the cost of the acquisition over the fair value of the identifiable assets and liabilities existing at the date of acquisition (Xstatic - November 2005, MTbox - August 2006).

Significant non-current assets such as properties are likely to have been independently valued prior to the acquisition. It may be appropriate to plan to place reliance on the work of quantity surveyors or other property valuers.

Group (Related Party) Transactions and Balances

A list of all the companies in the group (including any associated companies) should be included in group audit instructions to ensure that intra-group transactions and balances (and any unrealised profits and losses on transactions with associated companies) are identified for elimination on consolidation.

It should be confirmed at the planning stage that inter-company transactions are identified as such in the accounting systems of all Beeski companies and that inter-company balances are regularly reconciled. (Problems are likely to arise if new inter-company balances are not identified/reconciled. In particular, exchange differences are to be expected.)

On Analytical Procedures

Having brought in the operations of a group of companies (Xstatic) with similar activities may extend the scope of analytical procedures available. This could have the effect of increasing audit efficiency.

MTbox On Income Statement

The effective date of the acquisition of MTbox may be so late in the financial year (only four to eight weeks, say, before the year end) that it is possible that its post-acquisition results are not material to the consolidated income statement.

PILOT PAPER


48



Finance


54



Finance

Other Auditors

Other auditors will include:

any affiliates of Ribi in any of the countries in which Beeski (as combined with Xstatic) operates; and

unrelated auditors (including those of MTbox).

Ribi will plan to use the work of MTboxs auditors who are Chartered Certified Accountants. Their competence and independence should be assessed (e.g. through information obtained from a questionnaire and evidence of their work).

A letter of introduction should be sent to the unrelated auditors, with Beeskis permission, as soon as possible (if not already done) requesting their co-operation in providing specified information within a given timescale.

Group instructions will need to be sent to affiliated and unrelated auditors containing:

proforma statements;

a list of group and associated companies;

a statement of group accounting policies (see below);

the timetable for the preparation of the group accounts (see below);

a request for copies of management letters;

an audit work summary questionnaire or checklist;

contact details (of senior members of Ribis audit team).

Accounting Policies (Xstatic & MTbox)

Whilst it is likely that Xstatic has the same accounting policies as Beeski (because, as a competitor, it operates in the same jurisdictions) MTbox may have material accounting policies which do not comply with the rest of the group. Ribi may request that MTboxs auditors calculate the effect of any non-compliance with a group accounting policy for adjustment on consolidation.

Timetable

The timetable for the preparation of Beeskis consolidated financial statements should be agreed with management as soon as possible. Key dates should be planned for:

agreement of inter-company balances and transactions;

submission of proforma statements to Ribi;

completion of the consolidation package;

tax review of group accounts;

completion of audit fieldwork by other auditors;

subsequent events review;

final clearance on accounts of subsidiaries;

Ribis final clearance of consolidated financial statements.

Tutorial note: The order of dates is illustrative rather than prescriptive.

(C) SUPPORT LETTERS

Tutorial note: Although there are different types and uses of such letters (e.g. for registering a prospectus), the only reference to them in the P7 Syllabus and Study Guide is in the context of group audits.

P7



Finance

49

PILoT PAPEr P7



Finance

55

Consolidated financial statements are prepared on a going concern basis when a group, as a single entity, is considered to be a going concern. However, the going concern basis may only be appropriate for certain separate legal entities (e.g. subsidiaries) because the parent undertaking (or a fellow subsidiary) is able and willing to provide support. Many banks routinely require a letter of reassurance from a parent company stating that the parent would financially or otherwise support a subsidiary with cashflow or other operational problems.

As audit evidence:

Formal confirmation of the support will be sought in the form of a letter of support or comfort letter confirming the parent companys intention to keep the subsidiary in operational existence (or otherwise meet its obligations as they fall due).

The letter of support should normally be approved by a board minute of the parent company (or by an individual with authority granted by a board minute).

The ability of the parent to support the company should also be confirmed, for example, by examining the groups cash flow forecast.

The period of support may be limited (e.g. to one year from the date of the letter or until the date of disposal of the subsidiary). Sufficient other evidence concerning the appropriateness of the going concern assumption must therefore be obtained where a later repayment of material debts is foreseen.

The fact of support and the period to which it is restricted should be noted in the financial statements of the subsidiary.

(D) HORIZONTAL GROUPS

In general, the scope of a statutory audit should be as necessary to form an audit opinion (ie unlimited) and the nature, timing and extent of audit procedures (ie the audit work undertaken) should be as necessary to implement the overall audit plan.

Horizontal groups of entities under common control were a significant feature of the Enron and Parmalat business empires. Such business empires increase audit risk as fraud is often di