audit practice & assurance services

NOTES: SECTION A: Answer Question 1, and SECTION B: Answer any two from Questions 2, 3 and 4. Should you provide answers to more questions than required in Section B, only answers to Questions 2 and 3 will be marked.

Time Allowed 3.5 hours, plus 20 minutes to read the paper. Examination Format This is an open book examination. Hard copy material may be consulted during this examination, subject to the limitations advised on the Institute’s website. Reading Format During the reading time you may highlight text and write notes on the examination paper, however, you may not commence writing on the answer field until your Supervisor tells you to do so. Please read each Question carefully. Marks Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Answers You are reminded to pay particular attention to your communication skills, and care must be taken regarding the format and literacy of your solutions. The marking system will take into account the content of your answers and the extent to which answers are supported with relevant legislation, case law or examples, where appropriate.

The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

AUDIT PRACTICE & ASSURANCE SERVICES

PROFESSIONAL 2 EXAMINATION - AUGUST 2020

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND AUDIT PRACTICE & ASSURANCE SERVICES


Section A: Question 1 is compulsory.

Case study: Glamour Fashions Limited (GFL)

1. You are an audit manager in C&G Certified Public Accountants and have just returned from holiday. Upon your return, your director has informed you that you will be working on the audit of Glamour Fashions Limited (GFL) for the year ended 31 December 2019. You are very excited about this opportunity as you have a great interest in fashion. The audit engagement partner is Paul Lynch.

Background Laura Flynn owns 60% of the ordinary shares in GFL and her husband, John, owns the remaining shares. GFL designs, manufactures and sells designer clothing in Ireland and the UK. The company sells its clothing online and through its own store, which opened in June 2019. In addition, GFL has a three-year contract to sell its designer clothing to Abbey’s Department Store Ltd (ADS), a major retailer in Dublin

GFL’s website enables customers to order clothing online from the comfort of their own home, as well as join the company’s VIP membership club. The VIP membership club members pay an annual subscription, for which they receive exclusive offers and discounts throughout the year.

Revenue The contract provides ADS with exclusivity, which prohibits GFL from supplying the designer clothing ranges to any other retailer. The income generated from the contract accounts for approximately 20% of GFL’s total revenue, and GFL achieves a 25% gross profit margin on these sales. The contract is due for renewal on 30 June 2020. ADS has written to GFL stating that it believes the opening of GFL’s new store is in breach of the exclusivity agreement.

New Premises The purchase of the premises and fixtures for the new store was financed by a five-year loan from the company’s bank which requires GFL to meet loan covenants set out in the loan agreement. Any breach of the loan covenants would result in the loan becoming repayable immediately.

Government Grant GFL received €350,000 in grant aid from a government agency in June 2019 towards new equipment purchased during the year (with an expected useful life of 10 years). This grant was contingent on 10 new positions being created in GFL by 31 December 2019. At 31 December 2019, GFL was able to employ only 5 new staff members. GFL has had no correspondence with the government agency since the grant was received in June 2019.

Inventory As stated above, GFL designs and manufactures all its own clothing at the factory in Dublin, using high-quality materials. To avoid the disruption of a year-end inventory count, GFL, has this year, introduced a continuous/perpetual inventory counting system. The warehouse has been divided into 12 areas and each of these will be counted once a year. The counting team includes a member of the audit team and a warehouse staff member. The following procedures have been adopted:

(1) The team prints the inventory quantities and descriptions from the system and these records are then

compared to the inventory physically present. (2) Any discrepancies in relation to quantities are noted on the inventory sheets, including any items not

listed on the sheets but present in the warehouse area. (3) Any damaged or old items are noted and are removed from the inventory sheets by the finance

department.

(4) When the count has finished, the sheets are then passed to the finance department to make adjustments to the records.

(5) During the counts, there will continue to be inventory movements with goods arriving and leaving the warehouse.

At the year end, it is proposed that the inventory will be based on the underlying records.

See Appendix 1, for details of the notes taken at the planning meeting with Laura and John Flynn, Paul Lynch and the audit manager.

Appendix 1: Planning meeting: On 10 February 2020, as part of audit planning, you met with Laura and John who highlighted the following: (1) GFL is being sued by a competitor who claims that one of GFL’s new clothing ranges, ‘DESIGNFX’, has

infringed the trademark owned by the competitor for that brand name. The outcome of the claim will not be known until after the audit report is signed.

(2) GFL sources its luxury materials internationally; however, its main supplier, BMK, is located in New York. All

purchases from BMK are invoiced and payable in US Dollars (US$). Due to fluctuations in the foreign exchange rate between the Euro€ and US$, the cost of the materials from New York has significantly increased. Laura is therefore trying to source the materials in Ireland; however, she is concerned about the quality of the materials and believes that it may be compromised

(3) During November 2019, GFL was the subject of adverse publicity regarding the quality of the latest clothing

range, ‘LM LUXE’. As a result, GFL has decided to sell this particular clothing range at a discount of 50% in the January sale.

(4) The directors prepared the financial statements for the full year ending 31 December 2019 and have

provided the summary below. Laura explained that the difference between actual and budgeted performance was due to higher than expected interest costs on the bank loan and unbudgeted administrative costs associated with operating the new store.

Actual Original Budget Actual

31 December 2019 31 December 2019 31 December 2018 €’000 €’000 €’000

Revenue 9,600 11,700 10,800 Profit 345 702 1,200

(5) Dividends of €180,000 were declared in January 2019 and dividends of €220,000 were declared in January

2020 relating to the 2018 and 2019 financial reporting years, respectively. These have been accounted for in retained earnings for the respective years. See below the reconciliation of retained earnings for both the year ended 31 December 2018 and the year ended 31 December 2019.

Retained earnings 2019 2018

€’000 €’000 Opening balance 7,390 5,250 Dividends (220) (180) Profit after tax 345 1,200 Closing balance 7,515 6,580

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REQUIREMENT: (a) Draft a memo to the audit partner which:

(i) Critically evaluates SIX key audit risks arising from all of the information provided; and

(12 marks) (ii) For each risk, outlines the procedures which should be included in the audit plan to address that risk.

(12 marks)

NOTE: Please ignore dividends and retained earnings, as these have been included in requirement part (b) below.

(b) Prepare the audit plan for the audit work required to gain comfort over the retained earnings and dividends declared at 31 December 2019.

(10 marks)

(c) Identify and explain suitable controls that should operate over the continuous/perpetual inventory counting

system to ensure the completeness and accuracy of the existing inventory records at GFL.(10 marks)

(d) According to ISA 240 (Ireland) The auditor’s responsibilities relating to fraud in an audit of financial

statements:

“When Identifying and assessing the risks of material misstatement due to fraud, the auditor shall, based on a presumption that there are risks of fraud in revenue recognition, evaluate which types of revenue, revenue transactions or assertions give rise to such risks.’

Discuss why the auditor should presume that there are risks of fraud in revenue recognition and why ISA 240 requires specific auditor responses in relation to the risks identified.

(6 marks)

[Total: 50 Marks]

SECTION B - ANSWER TWO QUESTIONS ONLY 2. (a) The situations outlined below have arisen in three audit clients of your firm. The financial reporting year end in

each case is 30 September 2019:

Morgan Plc Morgan Plc, a supplier of retail display equipment, has included in its Statement of Profit or Loss immediately below profit after tax, an exceptional loss of €3.7 million on the sale of a trade investment. This accounting treatment is not in accordance with financial reporting standards, which require the loss to be taken into account in arriving at the profit or loss before taxation.

The pre-tax profit of Morgan Plc for the year ended 30 September 2019 is €694,000.

Aiken Plc Aiken Plc manufactures light fittings. The directors of Aiken Plc are of the view that some of its finished inventory lines are currently out of fashion and have a net realisable value €35,000 lower than their original cost. However, the directors argue that, overall, the net realisable values of the entire inventories exceeds original cost. They also maintain that fashions may well change over the next few years such that the company may ultimately sell these lines above their current net realisable value.

The pre-tax profits of Aiken Plc for the year ended 30 September 2019 are €900,000. Net assets and inventories on 30 September 2019 totalled €10 million and €4 million, respectively.

Medic Plc Medic Plc, a company engaged in the manufacture of pharmaceutical products, has extensive interests in an overseas country which requires pharmaceutical products to be registered. The regulatory situation in that country is undergoing considerable change and the company does not expect to obtain drug registration as quickly as originally anticipated. However, after carrying out the appropriate review, the directors have decided that Medic Plc has enough resources to continue for the next 12 months. Additional funding will be required from that point, and the directors believe that this can be achieved by a further issue of shares within the next 12 months.

The directors have included a note to the financial statements explaining this matter.

REQUIREMENT: In respect of the audit engagements outlined above, discuss the pertinent matters and explain a conclusion on whether or not each audit report should be modified? Give reasons for your conclusions and describe the potential effects on each audit report.

(b) ISA (Ireland) 701 Communicating Key Audit Matters in the Independent Auditor’s Report states: ‘The purpose of

communicating key audit matters is to enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed.’

REQUIREMENT: Critically discuss the above statement in relation to the benefits and difficulties of communicating key audit matters to users of the auditor’s report and assess the contribution of ISA (Ireland) 701 in addressing the audit expectations gap.

(10 marks)

[Total: 25 Marks]

3. Johnston & Co. (Johnston) operates a chain of retail outlets across the country. The company employs 260

permanent staff and its financial reporting year end is 30 November 2019. You are the audit senior of RMK & Co., Certified Public Accountants, which has audited Johnston for a number of years. You are currently looking at the areas of payroll and trade payables.

Payroll At Johnston, permanent staff work a standard number of hours per week, as specified in their employment contract. However, when the retail outlets are busy, staff can be requested by management to work additional shifts as overtime. This can either be paid on a monthly basis or taken as time in lieu.

The overtime is recorded manually, and the resulting gross and net pay of each employee is then calculated automatically by the payroll system. Wages are increased by the rate of inflation each year and the payroll clerks are responsible for updating the standing data in the payroll system.

Employees are paid on a monthly basis by bank transfer for their contracted weekly hours and for any overtime worked in the previous month where applicable. The payroll package produces a list of payments per employee; this interfaces with the bank system to produce a list of automatic payments.

Johnston deducts employment taxes from wages on a monthly basis and pays these to the taxation authorities in the following month. At the year end, the financial statements will include an accrual for income tax payable on employment income.

Additional Information: Johnston employs 25 retail and office managers, 200 retail staff and 35 office staff. The pay range for each category is shown below:

- Retail and office managers: €35,000 - €50,000 per annum - Retail and office staff: €18,000 - €25,000 per annum

All staff were given a 4% pay rise during the year, backdated to the start of the financial year.

One manager left halfway through the financial year and 15 new retail and office staff joined halfway through the year.

The payroll expense in the draft financial statements for the year ended 30 November 2019 is €6,795,400.

Trade payables Trade payables on Johnston’s draft Statement of Financial Position are as follows:

€ €

2019 2018 Trade payables 884,824 816,817

REQUIREMENT:

(a) Outline and explain the substantive audit procedures that should be performed during the final audit to confirm

the completeness and accuracy of Johnston’s payroll expenses.

Please ignore tax payable on employment income as this is included in part (b) below. (6 marks) (b) Identify the audit procedures required in respect of the year-end accrual for tax payable on employment income.

(4 marks) (c) Perform a substantive analytical procedure to gain comfort over the total payroll expense and explain the audit

procedures required to place reliance on the calculation. (7 marks)

(d) Describe the substantive audit procedures that should be performed in the audit of trade payables for the year

ended 30 November 2019. For each procedure, explain the purpose of that procedure, including the relevant assertions.

(8 marks)

[Total: 25 Marks] 4.

(a) Dalton Plc (Dalton) has been trading for over 20 years and obtained a listing on the Irish stock exchange five years ago. The company provides specialist training in accounting and finance.

The listing rules of the stock exchange require compliance with corporate governance principles and the directors are fairly confident that they are following best practice in relation to this. However, they have recently received an email from a significant shareholder who is concerned that Dalton does not comply with corporate governance principles.

Dalton’s board comprises six directors: four executives who originally established the company and two non-executive directors who joined Dalton just prior to the listing. Each director has a specific area of responsibility and only the finance director reviews the financial statements and budgets.

The chief executive officer, Paul O’Brien, set up the audit committee and he sits on this sub-committee along with the finance director and the non-executive directors. As the board is relatively small and to save costs, Paul O’Brien has recently taken on the role of chairman of the board. The finance director and the chairman make decisions on the appointment and remuneration of the external auditors. Again, for economic reasons, no internal audit function has been set up to monitor internal controls.

The executive directors’ remuneration is proposed by the finance director and approved by the chairman. They are paid an annual salary, as well as a general annual revenue-related bonus.

Since the company listed, the directors have remained unchanged and have not been subject to re-election by shareholders.

REQUIREMENT: Evaluate five corporate governance weaknesses faced by Dalton Plc and provide recommendations to address each weakness in order to ensure compliance with corporate governance principles.

(10 marks) (b) You are the audit manager of Farrell & Co. Certified Public Accountants and Registered Auditors (Farrell & Co.)

and are planning the audit of AQ Direct Limited (AQ Direct), who specialise in the provision of loans and financial advice to individuals and companies. Farrell & Co. has audited AQ Direct for many years.

The directors are planning to list AQ Direct on a stock exchange within the next few months and have asked if the engagement partner can attend meetings with potential investors. In addition, as the finance director of AQ Direct is likely to be quite busy with the listing, he has asked if Farrell & Co. can produce the financial statements for the current year.

During the year, the assistant finance director of AQ Direct left and joined Farrell & Co. as a partner. It has been suggested that due to familiarity with AQ Direct, he should be appointed to provide an independent partner review for the audit.

The AQ Direct finance director has indicated that once the stock exchange listing has been completed, he would like the audit engagement team to attend a weekend away at a luxury hotel with his team, as a thank you for all of their hard work. In addition, he as offered a senior member of the audit engagement team a short-term loan at a significantly reduced interest rate.

REQUIREMENT: Discuss three ethical concerns which may affect the independence of Farrell & Co’s audit of AQ Direct Limited and explain appropriate safeguards which may be implemented in respect of this concerns.

(9 marks) (c) The Proceeds of Crime Act and Money Laundering Regulations identify accountants as having special

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responsibilities with respect to reporting suspicions of money laundering. REQUIREMENT: Appraise the responsibilities contained in the above legislation that apply to accountants and comment on how these reporting responsibilities potentially conflict with Ethical Guidance, and International Standards on Auditing relating to auditors.

(6 marks)

[Total: 25 Marks]

END OF PAPER

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THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

AUDIT PRACTICE & ASSURANCE SERVICES


SOLUTION 1 (a) Memo – Audit risks and testing approach

Client: Glamour Fashions Limited Year end: 31 December 2019 To: Paul Lynch, Audit Engagement Partner From: Audit Manager Date: April 2020 Subject: Audit risks and testing approach The following audit risks and proposed tests have been identified for the current year audit: Dividends and retained earnings:

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SUGGESTED SOLUTIONS

(b) The dividend amounts have been accounted for in the incorrect year in accordance with IAS 10 which states dividends should be recognised in the year they are declared as opposed to the year they relate to. Due to the error noted above there is a risk that similar accounting errors have occurred in other areas of the financial statements.

[3 marks for identifying the concerns]

The reconciliations of retained earnings for both years are incorrect. See recalculation below:

Re-performance of reconciliation:

Retained earnings 2019 2018 €’000 €’000

Opening balance 6,270 5,250 Dividends (220) (180) Profit after tax 345 1,200 Closing balance 6,395 6,270 Per reconciliation prepared by GFL: Closing balance 7,515 6,580 Material difference 1,120 310

[3 marks for re-performing the calculation]

Dividends: Audit work required:

- Obtain board minutes as evidence of the dividend declaration and to verify date of declaration. - Review bank statements for evidence of payment - Explain to management that this is the incorrect accounting treatment and that disclosure may be required

instead. - Propose the adjusting journals required to be made to the financial statements and demonstrate to

management the impact of the adjustment required. - Discuss the need for a prior year adjustment in accordance with IAS 8 - Review accounting treatments for all other areas of the financial statements to ensure compliance with

accounting standards.

[0.5 marks for each valid point] = Maximum 2 marks

Retained earnings: Audit work required:

- Agree the opening retained earnings figure of €5,250,000 at 1 January 2018 to 2017’s signed financial statements.

- Agree the profit for the year ended 31 December 2018 and 31 December 2019 to the respective Statement of Profit or Loss.

- Inquire with management as to any other adjustments made to Retained Earnings. - Review retained earnings nominal ledger for the year ended 31 December 2018 and the year ended 31

December 2019 for evidence of adjustments being posted directly to this nominal account. - Inquire with management as to why the closing balance for the year ended 31 December 2018 is not the

same as the opening balance in the year ended 31 December 2019.

[0.5 marks for each valid point] = Maximum 2 marks

[3 marks for identifying the concerns, 3 marks for re-performing the calculation, 2 marks for identifying the correct audit procedures to be performed over dividends, 2 marks for identifying the correct audit procedures to be

performed over retained earnings] = Maximum 10 marks

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(c)

[1 mark for each suitable control identified x 5 to a maximum of 5 marks]

[1 mark for explaining the control identified x 5 to a maximum of 5 marks] (d) There are a number of reasons why there should be a presumption that there are risks of fraud in revenue

recognition. One reason is that managers of companies are often under pressure, particularly in listed companies, to achieve certain performance targets. The achievement of those targets often impacts their job security and their compensation. These performance targets often include measures of revenue growth, providing an incentive for management to use earnings management techniques.

In other companies there may be incentives to understate revenues, for example, to reduce reported profits and, therefore, company taxation charges. This may be more relevant to private limited companies where management may not be under such pressure to achieve revenue based targets.

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There is also usually a high volume of revenue transactions during a financial period. As the volume of transactions increases, the risk of failing to detect fraud and error using traditional, sample based auditing techniques also increases. This means that it is potentially easier for management to successfully manipulate these balances than other balances which are subject to a lower volume of transactions. Material misstatement through the manipulation of revenue recognition can be readily achieved by recording revenue in an earlier or later accounting period than is proper or by creating fictitious revenues.

Revenue recognition can also be a judgemental area. Examples include the recognition of revenues on long-term contracts, such as the construction of buildings, and from the provision of services. These require the estimation of the percentage of completion at the period end, increasing the scope for management to manipulate reported results.

As well as requiring judgement, revenue recognition can also be a complex issue. For example, some sales have multiple elements, such as the sale of goods and the separate sale of related maintenance contracts and warranties. This added complexity increases the risk of manipulation.

In some companies, for example, those in the retail industry, a high proportion of revenue may be earned through cash sales. This increases the risk of the theft of cash and the consequent manipulation of recorded revenues to conceal this crime.

Methods of revenue manipulation have also featured prominently in cases of accounting fraud, such as Enron and Worldcom.

The prevalence of these methods in modern accounting frauds and the failure of auditors to detect this in these cases suggests that it is one of the more common methods of earnings management and one which auditors should rightly consider as high risk.

While revenue recognition in general may be considered a high risk area, it is not always the case; companies with simple revenue streams or a low volume of transactions may be considered at low risk of fraud through revenue manipulations. Accordingly ISA 240 (Ireland) The auditor’s responsibility relating to fraud in an audit of financial statements permits the rebuttable of the fraud risk presumption for revenue recognition. One example of simple revenue streams would be where a company leases properties for fixed annual amounts over a fixed period of time. If this is the case, the reasons for not treating revenue as a high fraud risk area must be fully documented by the auditor.

[1 mark for each valid, detailed explanation] x 6 to a maximum of 6 marks

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SOLUTION 2 (a) Morgan Plc

- Modify opinion on the grounds of a material disagreement. - The matter is material as the amount of the loss exceeds the pre-tax profit. - Give an ‘except for’ qualification if the matter is not considered pervasive/misleading. Give an adverse

opinion if considered material and pervasive, if the financial statements do not show a true and fair view. - A paragraph immediately before the opinion paragraph, should include details of the reason for the

modification and the impact on the financial statements. - In this case, the matter would considered as material and pervasive, as this would result in the pre-tax profit

being significantly reduced from €694,000 to a loss of €3,006,000 therefore an adverse opinion would be the most appropriate.

Aiken Plc - Give an unmodified opinion. The write down of inventory to its NRV would reduce profit by 4% and reduce

net assets and inventory by less than 1% each. - It is therefore unlikely that the misstatement would be considered material. - The auditor might, however, be put on guard to ensure that €35,000 is the maximum misstatement and

that all other categories of inventory are correctly valued. - Significant departures from accounting standards are required to be disclosed in the financial statements. - Because the impact on the financial statements of this accounting departure is limited, the auditor is

unlikely to consider it to be significant. Medic Plc - Give an unmodified opinion if disclosure is adequate. - Constitutes a material matter in relation to going concern which should be highlighted as the matter is likely

to have a significant impact on the business. - An emphasis of matter paragraph is required to explain the matter and stating that the opinion is not

qualified in this respect. - If the note to the accounts is inadequate, modify opinion on the grounds of disagreement. - If the uncertainty is material but not pervasive, a qualified opinion, except for would be recommended.

[1 mark for each valid point to a maximum of 5 marks] x 3 = 15 marks (b) Key audit matters are the matters which, in the auditor’s judgement, were of most significant in the audit of the

financial statements. They were introduced by ISA (Ireland) 701 Communicating Key Audit Matters in the Independent Auditor’s Report, to enhance the auditor’s report issued in respect of listed entities by providing more relevant information to the users of those reports.

Benefits The principle reason for the disclosure of key audit matters in the auditor’s report was to provide increased transparency in response to requests from users of the financial statements for more information in relation to significant judgments made by both management and the auditor. This should lead to increased focus on the uncertainties created by judgement in the reporting process and help to improve users’ understanding of the financial statements. This in turn will serve to increase confidence in the audit process and the perception of audit quality.

The audit expectation gap is the difference between the actual role of the external auditor and the role which the public believes the auditor performs. In this context, the inclusion of key audit matters within the auditor’s report represents an important step in the process of informing and educating the public about the auditor’s role in evaluating areas of high risk, judgements and significant events or transactions which occurred during the period. Furthermore, auditors are expected to discuss how they addressed key audit matters during the course of the audit and the provision of detail in relation to the procedures performed will also go some way to provide greater transparency on how the audit is performed.

Difficulties The determination of which audit matters to report as ‘key’ is subjective and requires auditor judgement. As a result, this may reduce the consistency and comparability of auditor reporting. In order to assist with this, ISA

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(Ireland) 701 provides a decision making framework to help auditors determine which matters are key audit matters. This should help reduce ambiguity and promote consistency across audits.

The inclusion of key audit matters in the auditor’s report may lead to significant increase in the volume of detail contained in the report thereby obscuring which of the matters are of the greatest significance. This increase in volume may deter users from reading the auditor’s report in full and therefore undermine its role in closing the audit expectation gap. There are also concerns that the lack of specific guidance may lead to standardised ‘boilerplate’ disclosures which add little value to the auditor’s report.

[1 mark for each valid point] x 10 = 10 marks

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SOLUTION 3 (a) Payroll substantive procedures:

- Cast a sample of payroll records to confirm that the payroll expense has been correctly calculated. - Agree the total salaries and wages expense recorded in the payroll system to the trial balance, and

investigate any differences. - Compare the total salaries and wages expense to the prior year figure; make inquiries of management as

to the reasons for any significant differences. - Compare the monthly payroll expenses, and compare these with the budget and with the corresponding

month’s expense in the prior year. Make inquiries of management regarding the reasons for any significant differences.

- Perform a proof in total of payroll costs, taking into account new joiners and leavers and pay increases. - For a sample of employees, recalculate the gross and net pay, and compare this with the payroll records. - For a sample of employees, recalculate the benefit and statutory deduction calculations; agree the tax

deducted to the taxation records. - For a sample of new joiners and leavers, agree their start date or leaving date per the payroll records to

the HR records to ensure that salaries have been calculated for the correct periods. Agree a sample of new joiners on the HR records to payroll, to check for completeness.

- For a sample of employees, agree the payroll expense to the HR records to ensure that the correct pay grade has been applied.

- For a sample of new joiners and leavers, recalculate their pay for the first/last month to confirm accuracy. - Compare the total payments made per the bank transfer list with the total net pay per the payroll records

to ensure that all employees paid have been recorded via payroll. - For a sample of overtime payments, agree the overtime paid from the weekly overtime sheets to the payroll

records to confirm completeness.

[1 mark for each valid point] x 6 = Maximum 6 marks (b) Audit procedures in respect of tax payable on employment income:

- Inspect correspondence with the tax authorities to confirm the amount of outstanding payments due. (The balance at the year end would normally represent one month’s deductions). Verify the amount outstanding to the payroll records.

- Trace the tax payments from the cash book to the bank statements. - Agree the year end income tax payable accrual to the payroll records to confirm accuracy. - For a sample of employees, reperform the calculation of the tax deduction to confirm accuracy. - Review the disclosures made of the income tax accrual and determine whether they comply with

accounting standards and legislation.

[1 mark for each valid point] x 4 = Maximum 4 marks (c) Payroll expense: Substantive Analytical Procedure

€ Managers: Average salary based on range 42,500 (0.5 marks) Applying 4% rise for the year 44,200 (1 mark) Total Average salary (25 – 0.5 = 24.5 managers) 1,082,900 (0.5 mark)

Staff: Average salary based on range 21,500 (0.5 marks) Applying 4% rise for the year 22,360 (1 mark) Total Average salary (235 + 7.5 = 242.5 staff) 5,422,300 (0.5 marks)

Expected total expense for wages and salaries 6,505,200 (0.5 marks) Payroll expense per draft financial statements 6,795,400 Difference 290,200 (0.5 marks)

4.27%

As the difference is less than 4.27% it is therefore deemed to not be a material difference. However in order to rely on the substantive analytical procedure, it is important we are comfortable with the data we are using in the calculation.

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We would need to get comfort over the following: - Agree the staff salaries to employment contracts. - Agree the staff numbers to payroll reports. Select a sample of employees from the payroll reports and agree

them to the employment contracts to ensure they exist. - Agree the 4% pay rise to written correspondence to the employees. - Ensure we are comfortable with the joiners and leavers during the year.

[2 marks for explaining further audit evidence required to rely on the substantive analytical procedure]

[See mark breakdown above, maximum 7 marks]

(d)

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SOLUTION 4 (a) Corporate governance weaknesses and related recommendations

[1 mark for each weakness x 5] – Maximum 5 marks [1 mark for each recommendation x 5] – Maximum 5 marks

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(b)

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[1 mark for identifying each ethical concern x 3 = Maximum 3 marks] [0.5 marks for identifying appropriate ethical threat x 3 = Maximum 1.5 marks]

[0.5 marks for identifying appropriate ethical standard x 3 = Maximum 1.5 marks] [1 mark for identifying an appropriate safeguard x 3 = Maximum 3 marks]

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(c) If an accountant has grounds for suspicion that money laundering is taking place they must report it. Failure to do so is a criminal offence. Suspicions should be reported to the assurance firms officially nominated Money Laundering Reporting Office (MLRO). The MLRO will then decide if the matter should be reported to the Serious Organised Crime Agency. The firm must not “tip off” the client.

Conflicts with Ethical Guidance and ISAs:

A conflict exists with ethical guidance on confidentiality – the responsibility to report overrides any duty of confidentiality to a client in these circumstances.

In addition, tipping-off could result from:

- Requirements in ISA 260 ‘Communication with Those Charged With Governance’ – where auditors are

required to report issues arising during the course of the audit to those charged with governance. - The auditor’s responsibility to form an opinion on the financial statements. If the opinion were modified as

a consequence of the impact on the financial statements of money laundering, inclusion in the auditor’s report would alert the client.

- If the firm concludes that it is unethical to continue to act for a client as a result of suspicion of money laundering, they may choose to resign. However, procedures around resignation would require the firm to:

o Deposit a statement of circumstances at companies register office; and o Communicate with any successor auditor regarding circumstances affecting their appointment.

[1 mark for each valid point] x 6 = 6 marks

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audit practice & assurance services

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