CAF 9 Audit and Assurance Question bank ICAP

Multiple choice questions CHAPTER 1 – CONCEPT AND NEED FOR ASSURANCE 1 1 The fundamental objective of the audit of a company is to A Protect the interests of the minority shareholders

AUDIT AND ASSURANCE

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Audit and Assurance

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Section A Multiple choice questions 1

Section B Objective test and long-form questions 17 Answers

Section C Multiple choice answers 71 Section D Objective test and long-form answers 77

I

Index to Objective test and long-form

questions and answers

Question page

Answer page

Audit framework, regulation and ethics

Planning and risk assessment

Question page

Answer page

Question page

Answer page

Question page

Answer page

87 Situations have arisen on different

89 An ‘emphasis of matter’ paragraph and

Multiple choice questions

CHAPTER 1 – CONCEPT AND NEED FOR ASSURANCE

1

1 The fundamental objective of the audit of a company is to

A Protect the interests of the minority shareholders

B Detect and prevent errors and fraud

C Assess the effectiveness of the company’s performance

D Attest to the credibility of the company’s accounts

2 The concept of stewardship means that a company’s directors

A Are responsible for ensuring that the company complies with the law

B Are responsible for ensuring that the company pays its tax by the due date

C Safeguard the company’s assets and manage them on behalf of the

shareholders

D Report suspected fraud and money laundering to the authorities

3 Why do auditors concentrate their efforts on material items in accounts?

A Because they are easier to audit

B Because it reduces the audit time

C Because the risk to the accounts of their being incorrectly stated is greater

D Because the directors have asked for it

4 Which of the following is NOT the responsibility of a company’s directors?

A Reporting to the shareholders on the accuracy of the accounts

B Establishment of internal controls

C Keeping proper accounting records

D Supplying information and explanations to the auditor

5 International auditing standards are issued by the:

A International Accounting Standards Board

B Financial Accounting Standards Board

C International Audit and Assurance Standards Board

D Auditing Practices Board

CHAPTER 2 – OBTAINING AN ENGAGEMENT

6 When an auditor is proposed for removal from office, which one of the following is he NOT permitted to do?

A Circulate representations to members

B Apply to the court to have the proposal removed

C Speak at the AGM/EGM where the removal is proposed

D Receive notification of the AGM/EGM where the removal is proposed

7 Which one of the following is NOT a duty of the auditor?

A Duty to report to the company’s bankers

B Duty to report to the members

C Duty to sign the audit report

D Duty to report on any violation of law

8 Assuming that it is not the first appointment of the auditor, who is responsible for the appointment of the auditor?

A The shareholders in a general meeting

B The managing director

C The board of directors in a board meeting

D The audit committee

9 The independent auditor's primary responsibility is to:

A the directors

B the company's creditors (payables)

C the company's bank

D the shareholders

10 How long is the auditor’s term of office?

A Until the audit is complete

B Until the financial statements are complete

C Until the next AGM

D Until the directors remove them

CHAPTER 3 – PLANNING AND RISK ASSESSMENT

11 Which of the following is correct in relation to materiality?

A A matter is material only if it changes the audit report

B A matter is material if the auditor and the directors both decide that further work needs to be done in the area under question

C A matter is material only if it affects directors’ emoluments

D A matter is material if its omission or misstatement would reasonably influence the decisions of an addressee of the auditors’ report

12 Which one of the following is NOT considered to be part of planning?

A Background i.e industry

B Previous year’s audit i.e any qualifications in the report

C Considering the work to be done by the client staff e.g internal audit

D Considering whether the financial statements show a true and fair view

13 Audit risk is composed of 3 factors Which of the following is NOT one of those factors?

A Compliance risk

B Detection risk

C Control risk

D Inherent risk

14 Which of the following should NOT be considered at the planning stage?

A The timing of the audit

B Analytical review

C Last year’s written representation letter

D Obtaining written representations

15 At the planning stage you would NOT consider:

A the timing of the audit

B whether corrections from the inventory count have been implemented

C last year's audit

D the potential use of internal audit

CHAPTER 4 – EVIDENCE AND SAMPLING

1

16 Which of the following describes sampling risk?

A The risk of the auditor carrying out a test the wrong way round

B The risk of reliance on unsuitable audit evidence

C The risk that the sample does not reflect the population

D The risk of the auditor reaching the wrong conclusions from testing

17 Which of the following is NOT an accepted method of selection in sampling?

A Memorandum & articles of association

B Audit planning memorandum

C Summary of unadjusted errors

D Details of the work done on the inventory count

19 According to ISA 500, the strength of audit evidence is determined by which two

qualities?

A Appropriateness & competence

B Sufficiency & appropriateness

C Reliability & extensiveness

D Objectivity & independence

20 Which of the following is normally the most reliable source of audit evidence?

A Internal audit

B Suppliers’ statements

C Board minutes

D Analytical review

CHAPTER 5 – INTERNAL CONTROL

2

21 The degree of effectiveness of an internal control system depends on:

A The design of the internal control system and the implementation of the controls

B The design of the internal controls and the implementation of the control system

C The implementation of the controls and the correctness of the accounting records

D The design of the internal control system and the correctness of the accounting records

22 According to ISA 315, which of the following is NOT an element of the control

environment?

A Participation of management

B Information processing

C Commitment to competence

D Human resource policies and practices

23 According to ISA 315, which of the following is NOT a control activity?

A Performance reviews

B Physical controls

C Organisational structure

D Segregation of duties

24 Which of the following is NOT an internal control?

A Authorising purchase orders

B Ensuring cash is locked away

C Performing external confirmation of receivables

D The opening of the post should not be the same person who banks the cheques

25 A walk-through test is designed to do what?

A To check that materiality levels are acceptable

B As a checklist to see if all substantive tests have been performed

C To provide assurance within a letter of representation

D To confirm that the auditor’s understanding of the internal control system is correct

CHAPTER 6 – FLOWCHARTS AND IT CONCEPTS

2

26 Which of the following descriptions is correct?

A An internal control evaluation questionnaire is circulated to staff within the

internal control function of an organisation to ask for feedback about their job satisfaction and targets for the coming year

B Narrative notes are a list of questions about controls in a particular aspect of operations or accounting They are designed to establish whether appropriate controls exist that meet specific control objectives

C An internal control questionnaire is sent from the internal auditors to the external auditors during the audit to request ideas for improving the internal control

system

D A systems flowchart provides a logical representation of an accounting system (or part of a system) in the form of a diagram representing documents generated, processes applied and the flow of documents between departments

27 Which of the following are levels within a systems flowchart?

A Top, middle, lower

B Mini, micro, macro

C Executive, managerial, operational

D Strategic, tactical, factory

28 Which of the following descriptions for flowchart symbols is correct?

A A circle is used to indicate the starting and ending points of the process

B An oval represents an individual activity or step in the process

C Triangles are used to show decision points Each path emerging from the triangle must be labelled with one of the potential answers

D A pentagon is used to link a particular step of the process to another page or part

of the flowchart Letters are placed in the pentagon to clarify continuation

29 Which of the following is not a type of physical access control?

A Taking a weekly backup of data

B Surveillance video

C Fingerprint readers for system log-in

D Fences, doors and door-locks

30 Which of the following descriptions of ciphers is correct?

A Asymmetric key ciphers – these use related (often identical) keys to both encrypt and decrypt information This is sometimes called ‘shared secret’ between two or more parties

B Block ciphers – data is encrypted one ’data unit’ (typically 1 byte) at a time in the same order it was received The simplest method is to use translation tables which offset the input blocks across an array of the table Enhanced encryption can be achieved by combining two or more tables

C Symmetric key ciphers – these use related (often identical) keys to both encrypt and decrypt information This is sometimes called ‘shared secret’ between two or more parties

D Stream ciphers – this is where fixed length blocks are encrypted and streamed across the network with a high speed connection

CHAPTER 7 – TESTS OF CONTROLS

31 Which one of the following is NOT an internal control you would expect to see in a sales system?

A All goods received notes are authorised by the customer

B All orders are checked against credit limits

C All invoices are recorded on pre-numbered sequential documents

D All cash is banked on the same day as it was received

32 Which one of the following is NOT an internal control you would expect to see in a purchases system?

A Preferred suppliers are used

B All invoices are grid-stamped to create the company’s own invoice system

C Employees are only paid for work done

D There is a list of authorised cheque signatories

33 Which of the following is NOT a main element of a sales system?

A Receiving orders from customers

B Marketing

C Despatching the goods and invoicing customers

D Recording sales and debtors in the accounts

34 Which of the following is NOT a test of control?

A Checking that all purchase invoice are authorised by the proper people

B Test checking from purchase invoices to goods received notes

C Where a list of approved suppliers exists, checking that orders are placed only with suppliers on such a list

D Checking for sequential numbering by the client of purchase invoices received

D Decisions at board level on whether to incur capital expenditure

CHAPTER 8 – INTRODUCTION TO SUBSTANTIVE PROCEDURES

36 Which of the following is NOT a financial statement assertion?

38 Which one of the following types of evidence is the most reliable?

A The client's sales invoices

B Report obtained from a client’s bank confirming balances

C The written representation letter

D Confirmation during a telephone call with the Managing Director that there are no loans outstanding

39 At what stage of the audit do ISAs 315 and 520 require the auditor to use analytical procedures?

A When tendering for the audit of a new client

B During the planning stage and the review stage

C At the report writing stage

D When deciding whether to rely on the evidence of an expert

40 Which of the following is not an accounting estimate?

A Depreciation

B Provision for claims under a law suit

C Price paid for a new non-current asset

D Accrued revenue

CHAPTER 9 – SUBSTANTIVE PROCEDURES: NON-CURRENT ASSETS

4

41 Which tangible non-current assets are normally not depreciated?

A Land and buildings

B Land only

C Buildings only

D All tangible non-current assets are depreciated

42 Which of the following should not be shown as an intangible non-current asset?

A Purchased goodwill

B Non-purchased goodwill

C Development costs meeting the criteria in IAS 38

D Other intangible assets having a readily ascertainable market value

43 A non-current asset register holds details of non-current assets

These details will include:

A Cost, depreciation, service details, location, disposal proceeds

B Service details, serial number, capital allowances, net book value

C Capital allowances, disposal proceeds, supplier, location

D Cost, depreciation, asset number, serial number, location

44 Which of the following is NOT a substantive test for the audit of non-current assets?

A Reconcile the non-current assets register to the receivables ledger control

account

B Consider the reasonableness of any revaluations

C Physically check a sample of non-current asset additions

D Vouch disposal proceeds to the bank statement

45 Which term would you NOT associate with non-current assets?

A Net realisable value

B Goodwill

C Investments

D Net book value

CHAPTER 10 – SUBSTANTIVE PROCEDURES: CURRENT ASSETS

47 Which of the following is NOT a substantive test for the audit of inventories?

A Test the updating of all inventory count differences to inventory records

B Test the accuracy of net realisable value through the review of post year-end sales

C Have satisfactory explanations been explained for all material inventory count differences

D Check that all administrative overheads have been correctly accrued for in the valuation of inventories

48 Which of the following are acceptable valuation methods under IAS 2?

A LIFO and weighted average

B FIFO and base

C LIFO and base

D FIFO and weighted average

49 Which of the following is NOT a substantive test for the audit of receivables?

A Test cash received after the end of the reporting period

B Check adequate provision for doubtful debts

C Check reasons for debit balances (and ensure they are disclosed under

payables)

D Check brought forward balance

50 What is NOT true about bank reconciliations?

A Reconciling items must be followed through to the bank statement

B An error, if below materiality, is acceptable

C If the client has performed the reconciliation, the auditor must cast the whole reconciliation

D It is the primary substantive test for cash

CHAPTER 11 – SUBSTANTIVE PROCEDURES: OTHER AREAS

5

51 A good way to authenticate sales is to view the authorisation of?

A Goods received notes

A Matching sales invoices to goods despatch notes

B Casting the sales ledger

C Confirming receivables balances with customers

D Checking the dating of outstanding cheques

53 Which of the following is NOT normally a non-current liability?

A Corporation tax payable

B Debentures

C Bank loans

D Finance lease obligations

54 Which of the following does not appear in IAS 37?

A Deferred income

B Contingent assets

C Provisions

D Contingent liabilities

55 Suppliers’ statements are reconciled in order to:

A verify the completeness of payables

B ensure cut-off is correct

C vouch the authorisation of purchase orders

D verify the existence of payables

CHAPTER 12 – RELATED PARTY TRANSACTIONS

56 An example of an external business risk is:

A The existence of related parties

B Having a small customer database

C A customer's insolvency

D Process of dealing with customer relations

57 Which of the following statements about the audit of related parties is correct?

A The materiality of related parties is judged by reference to the company being audited, not the individual related party

B The main audit concern in relation to related parties is the adequacy of the

disclosures of the related parties that have been identified

C It is usually considered unnecessary to obtain written representations from

management about related parties

D A company should disclose both the nature of related party relationships and the amount of related party transactions

58 Which of the following statements are correct?

1 With related party transactions, there is some risk of collusion and fraud

2 A focus of audit attention with regard to related party transactions should be on significant non-routine transactions

A Statement 1 only is correct

B Statement 2 only is correct

C Both statements are correct

D Neither statement is correct

CHAPTER 13 – RELIANCE ON OTHERS

59 The auditor may work with a specialist What effect does this have on the auditor’s responsibilities?

A The client must take full responsibility for the specialist

B The auditor’s responsibilities are not diminished in any way

C The auditor and client have joint responsibility for the specialist

D All 3 are equally responsible

60 Which of the following statements is correct?

A Responsibility for a group audit is shared by the group auditor and any

component auditors

B An audit firm may accept an engagement as group auditor even if it is

insufficiently involved in the audit of significant components to obtain audit

evidence about them

C A group auditor may rely on the work done by a component auditor without the need to assess its quality

D The group auditor sets the group materiality level for the financial statements as

a whole and component materiality levels for components audited by component auditors

D The principal auditor can demand co-terminus year-ends for all group companies

62 Which of the following statements is correct?

A A component auditor should provide the group auditor with access to its relevant auditing documentation

B A component auditor should provide the group auditor with a report of work

performed unless the group auditor specifically states that this is not necessary

C When there is a joint audit, one of the firms must act as the senior firm in the audit

D When a component within a group is significant, the audit of the component

should use group materiality

63 Which of the following items should be communicated by a group auditor to the group management?

1 material weaknesses in group-wide controls

2 material weaknesses discovered by the group auditor in any component of the group

3 material weaknesses discovered by any component auditor in any component of the group

4 Any fraud or suspected fraud

A 1, 2, 3 and 4

B 1 only

C 1 and 4 only

D 1, 2 and 4 only

CHAPTER 14 – PROFESSIONAL ETHICS AND CODES OF CONDUCT

64 You have been proposed as auditor of a company What is the first step that you

should take?

A Obtain the client’s permission to communicate with the existing auditor

B Obtain the existing auditor’s working papers

C Obtain a copy of the company’s most recent board minutes

D Obtain a copy of the existing auditor’s letter of engagement

65 Which one of the following may auditors NOT perform for their client?

A Taking management decisions

B Preparation of accounting records

C Preparing tax computations

D Advising on weaknesses in the internal control systems

66 Which of the following are fundamental ethical principles for professional accountants?

68 Which of the following statements is INCORRECT?

A An auditor may serve on the board of directors of an audit client

B An auditor who is an immediate family member of the director of an audit client must not be assigned to the audit team

C Purchasing goods from an audit client on normal commercial terms does not create a threat to the auditor’s independence

D An auditor who was recently a director of an audit client must not be assigned to the audit team for that client

CHAPTER 15 – AUDIT FINALISATION AND REPORTING

69 Which of the following is true about written representations?

A They are the best source of audit evidence

B They should be used only when there is a lack of other substantive audit

evidence

C They should be used only when there is other substantive audit evidence to complement it

70 Which of the following would you not use as a benchmark for comparison when

undertaking analytical procedures?

A Other audit clients

B Previous years

C Other companies in the same industry

D Budget

71 What is meant by the expression ‘expectation gap’?

A The gap between how the directors of a company perform their duties and how the shareholders expect them to perform

B The gap between how the directors of a company perform their duties and how the general public expects them to perform

C The gap between the public perception of the role of company auditors and their statutory role and responsibilities

D The gap between the auditors’ own perception of their duties and how they are set out in the Companies Act

72 Which of the following does NOT belong in the auditors’ report?

A Introductory paragraph specifying the pages to which the report relates and the accounting convention adopted

B Basis of the opinion

C Involvement of any specialist

D Statement of responsibilities of directors and auditors

73 Which one of the following is part of the auditor’s function?

A Conducting the inventory count

B Obtaining and evaluating audit evidence on the financial statements

C Calculating the year-end accruals figure for inclusion in the accounts

D Providing representations to management

CHAPTER 16 – INTERNATIONAL STANDARDS ON REVIEW ENGAGEMENTS

74 What sort of assurance is provided in a review engagement?

A Positive assurance

B Negative assurance

C High level of assurance

D No assurance

75 Which of the following statements is correct?

A When a company negotiates a ‘friendly’ takeover, it usually appoints a firm of accountants to carry out due diligence on the takeover target

B In an attestation engagement, the accountant is required to report on the quality

76 For companies required to produce interim financial statements (IFI):

A one audit firm should audit the IFI and a different firm should audit the financial statements for the year as a whole

B one accountancy firm should review the IFI and a different firm should audit the financial statements for the year as a whole

C the same firm should audit the IFI and the financial statements for the year as a whole

D the same firm should review the IFI and the financial statements for the year as a whole

77 What is meant by negative assurance?

A The auditor cannot give an opinion due to lack of evidence

B The client's financial statements were found to be materially misstated

C The auditor could not conduct any tests due to lack of controls

D The auditor did not find anything to indicate that a material misstatement exists

(a) ICAP’s code of ethics has specified five principles of professional ethics for

chartered accountants The circumstances in which a chartered accountant

operates may give rise to specific threats to compliance with these principles

Required:

(i) Briefly describe each of the fundamental principles of professional ethics

(7)

(ii) Briefly describe different categories of the threats to compliance with

(b) Mustansar is the audit manager of a team engaged on the audit of a listed

company During his initial discussion with the chief executive officer (CEO) of

the company, he was informed that depressed economic conditions have badly affected the company and its liquidity Due to uncertainty about the future of the company, certain key employees have left including several staff members of

accounting and finance department Consequently, the accounting records are in

a bad shape and the management is making efforts to complete the draft

accounts quickly He therefore requested Mustansir to carry out necessary

accounting work and to help prepare the annual financial statements at a fee to

be agreed mutually

Required:

Briefly describe the guidelines contained in the ICAP’s Code of Ethics and the

extent of support that can be offered by the auditors, in the above situation (6)

(Total: 18 marks)

Distinguish between absolute and reasonable assurance Identify the type of

assurance that is expected in an audit of the financial statements, clearly outlining the

Shamsuddin a newly qualified chartered accountant has recently established his

practice in the name of Shamsuddin & Co., Chartered Accountants He is continuously trying to expand his practice and in this process he came across the following

situations:

(i) One of his friends, who is the owner of an advertising agency, has offered to provide significant discount for publicity of his new practice

(ii) Fashion Limited, a private limited company, which has suffered heavily on

account of recent financial turmoil, has informed him that it is willing to appoint him in the forthcoming annual general meeting (AGM) of the company in place of the existing auditors, if he can quote a fee below the existing audit fee

(iii) Design Limited has contacted Shamsuddin and informed him that they are willing

to appoint him as their external auditor in the next AGM at a fee of Rs 200,000 if

he completes the audit in a month However, in case of delay in the audit work the audit fee will be reduced to Rs.150,000

(iv) Shamsuddin receives an offer of appointment as auditors from Style Enterprises,

a sole proprietorship, who wants to remove the existing auditors before

completion of their term of office

Required:

Shamsuddin is inclined to accept the above offers Discuss the options available with

management integrity or risk of fraud in the Company The audit manager responded that the auditor should always maintain an attitude of professional scepticism throughout the audit

Required:

Briefly describe ‘Audit Scepticism’ and elaborate on the response of the audit

(Total: 15 marks)

A chartered accountant is required to comply with five fundamental principles

specified by ICAP’s Code of Ethics However, compliance with the fundamental principles may potentially be threatened by a broad range of circumstances

Required:

Briefly describe the categories of threats that may potentially affect

compliance with the fundamental principles Give two examples for each category

(10)

Discuss the categories of threats that may be involved in each of the following independent situations and advise the partners of the concerned firm with regard to the possible course of action that may be followed, in each case

(a) Burewala Bank Limited (BBL) is a listed audit client of Umer and Company, Chartered Accountants (UCC) BBL has granted a house loan of Rs 5 million to a

(b) Kamal was the audit manager during the last year’s annual audit of Faisalabad Textile Mills Limited (FTML) He has joined FTML as their Manager Finance, prior to the commencement of the current year’s audit (8)

(Total: 12 marks)

Comment on each of the following independent situations with reference to the applicable rules and regulations

(a) Zaman is a partner in a firm of Chartered Accountants and holds 5,000 shares

in Mardan Limited (ML) His firm has received an offer for appointment as

auditors of Khanewal Limited (KL) ML and KL are subsidiaries of Dera Khan

(b) Bilal and Company has received an offer for appointment as auditors of IJK Limited The total paid up capital of the company is Rs 990 million whereas its ordinary share capital is Rs 130 million

Faryal, the wife of a partner in Bilal and Company, is a director in LMN Limited which holds 50 million non-voting preference shares and 2 million

ordinary shares in IJK Limited Faryal also holds 10,000 shares in LMN Limited The par value of both types of shares is Rs 10 each (4)

(Total: 7 marks)

The purpose of an external audit and its role are not well understood You have been asked to write some material for inclusion in your firm’s training materials dealing with these issues in the audit of large companies

Required:

(a) Draft an explanation dealing with the purpose of an external audit and its role in the audit of large companies, for the inclusion in your firm’s training materials

(7)

(b) The external audit process for the audit of large entities generally involves two or more recognisable stages One stage involves understanding the business and risk assessment, determining the response to assessed risk, testing of controls and a limited amount of substantive procedures This stage is sometimes known

as the interim audit Another stage involves further tests of controls and substantive procedures and audit finalisation procedures This stage is sometimes known as the final audit

Describe and explain the main audit procedures and processes that take place during the interim and final audit of a large entity (7)

(Total: 14 marks)

9

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

Auditing standards

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

Fraud

Auditing firms should have a duty to detect and report fraud

Non audit services

Non auditing services supplied to an audit client should be stopped

The duration of the appointment of auditors

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

Required:

(a) Describe the current regulatory and professional requirements relating to each of

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

The responsibilities of external auditors are not always well understood When external auditors provide non-audit services to their audit clients, it is essential that the auditors make a clear distinction between their audit and non-audit responsibilities

Required:

Explain why it is essential for external auditors to be independent of their clients (5)

Your firm is the external auditor to two companies One is a hotel, Tahira, the other is a

food wholesaler, Parvez, which supplies the hotel Both companies have the same

year-end Just before the year end, a large number of guests became ill at a wedding

reception at the hotel, possibly as a result of food poisoning

The guests have taken legal action against the hotel and the hotel has taken action

against the food wholesaler Neither the hotel nor the food wholesaler has admitted

liability The hotel is negotiating out-of-court settlements with the ill guests, the food

wholesaler is negotiating an out-of-court settlement with the hotel At the year end, the

public health authorities have not completed their investigations

Lawyers for both the hotel and the food wholesaler say informally that negotiations are

‘going well’ but refuse to confirm this in writing The amounts involved are material to

the financial statements of both companies

Required:

Assuming that your firm continues with the audit of both companies, for each company,

describe the difficulties you foresee in obtaining sufficient audit evidence for potential

provisions, contingent liabilities and contingent assets (4)

PLANNING AND RISK ASSESSMENT

You are a manager in the audit firm of Ajmal & Co; and this is your first time you have

worked on one of the firm’s established clients, Saad Co The main activity of Saad Co

is providing investment advice to individuals regarding saving for retirement, purchase

of shares and securities and investing in tax efficient savings schemes Saad is

regulated by the relevant financial services authority

You have been asked to start the audit planning for Saad Co, by Mr Sher, a partner in

Ajmal & Co Mr Sher has been the engagement partner for Saad Co, for the previous

nine years and so has excellent knowledge of the client Mr Sher has informed you that

he would like his daughter Zhura to be part of the audit team this year; Zhura is

currently studying for her first set of exams for her ICAP qualification Mr Sher also

informs you that Mr Faisal, the audit senior, received investment advice from Saad Co

during the year and intends to do the same next year

Required:

(a) Explain the ethical threats which may affect the auditor of Saad Co (3)

(b) For each ethical threat, discuss how the effect of the threat can be mitigated (3)

(Total: 6 marks)

The following three entities have approached Alpha & Company, Chartered

Accountants (the firm) for appointment as their statutory auditors In each case there

are following issues which need to be considered before the firm decides to accept the

assignments

(i) Client: Safe Bank Limited

Issue: the firm has acquired office equipment from the bank under finance lease

arrangements In addition, some partners of the firm are also using the bank’s

credit card facility

(ii) Client: Pride Communication Limited (PCL):

Issue: One of the firm’s partners had remained the director of PCL for many years, as a nominee of Federal Government

(iii) Client: Gama Limited

Issue: A partner of the firm holds shares in Beta Limited which is an associated company of Gama Limited

R

Required:

In each case specify the minimum conditions specified by Companies Ordinance,

1984, which should be fulfilled in order to accept the audit engagement (9)

(a) List down the principal contents of an audit engagement letter (7)

(b) Audit documentation facilitates understanding of the nature, timing and extent of audit procedures; the results of audit procedures and significant matters arising during the audit

(i) Briefly explain what you understand by the risk of material misstatement at

(ii) List down the risk assessment procedures as referred above (2)

(b) “The auditor’s assessment of materiality and audit risk may be different at the time of initially planning the engagement from at the time of evaluating the results

of audit procedures.”

Briefly describe the reasons which may lead to such a change in the

(c) Briefly describe the assertions used by the auditors in respect of the following: (i) account balances

(ii) classes of transactions; and

(a) Farrukh & Co., Chartered Accountants, has received an offer to be appointed as the external auditor of Ebrahim Gas Company The firm is indebted to the

company as it has not paid the last two months’ bills amounting to Rs 4,860 (b) After seventy days of incorporation, the directors of Rahman Limited (RL)

decided to appoint Mr Shahid as the company’s statutory auditor Mr Shahid was employed by RL before he started his own practice

(c) The directors of Fazal Limited (FL) have decided to appoint Syed & Company, Chartered Accountants, as external auditor of the company One of the partner’s spouse holds 1,000 shares in the subsidiary of FL

(d) The directors of Najam (Pvt.) Limited having paid-up capital of Rs 4.5 million have appointed Mr Dawood to act as the external auditor of the company Mr Dawood has been awarded a diploma in International Financial Reporting

Standards by the Institute of Chartered Accountants of Pakistan and has

completed the mandatory period of training from a leading firm of chartered accountants

(e) All directors of Hussain Associates (Pvt.) Limited are chartered accountants The company has recently received an offer for appointment as the external auditor of Masood (Pvt.) Limited which has a paid-up share capital of Rs 1,000,000 (10)

You are the Audit Manager on the audit of Al-Salam Pakistan Limited (ASPL) for the year ended June 30, 20X3 ASPL is engaged in the manufacture of a wide range of plastic products While reviewing the initial work performed by the audit team, the following matters have come to your notice:

(i) The quantity of material scrapped during the year is materially different from the quantity of scrap sold The company’s records show nil balance both at the beginning and at the close of the year No reconciliation for the difference has been provided by the company

(ii) Sales for the year have increased by 7% over the previous year However, it has been noted that sales in the last two weeks of June 2010 have been

exceptionally high and represent 15% of the annual sales The audit working papers carry the following observations in respect of the above:

‰ 70% of the sales in the last two weeks of June were made to two new customers whose credit assessment has not been formally documented;

‰ a significant portion of the goods sold to the above referred customers were returned in the first week of July 2010; and

‰ management bonuses are linked to the operating performance of the

company

(iii) During the year, ASPL purchased a machine for Rs 25 million The payment voucher is duly supported by the invoice from the supplier However, the fixed assets schedule provided by the client shows the amount capitalized as Rs 2.5 million Depreciation has been charged on this amount The difference of Rs 22.5 million is appearing in the Bank Reconciliation Statement

The donations are received from the following sources:

(i) Cash collected from the general public through charity boxes placed at key points in hospitals, airports, superstores etc.,

(ii) cash and cheques received from individuals and institutions at AMF’s office; and (iii) cash from generous individuals who prefer to remain anonymous

Donations received in case of (ii) and (iii) above, often contain specific instructions for utilisation of the donated amount for specific purposes e.g for education of orphan children

Required:

(a) Identify the inherent risks in the operations of AMF (3)

(b) Briefly discuss the effect of each of these risks on the audit of AMF (3)

(Total: 6 marks)

(a) What is the difference between audit strategy and audit plan? (4)

(b) You have been appointed as the auditor of a company which was previously audited by another auditor Being a new client, what additional considerations would you take into account while performing the preliminary engagement activities prior to commencement of the audit? (5)

(Total: 9 marks)

Strawberry Pakistan Limited (SPL) was incorporated on March 1, 20X3 The directors

of SPL are in the process of appointing the first statutory auditor of the company They have requested your firm to submit a proposal for the statutory audit assignment A partner of your firm has asked you to draft the proposal after assessing whether the preconditions for the audit exist

Required:

(a) Briefly discuss the term ‘preconditions for an audit’

(b) What are the steps that you would perform in order to ensure that preconditions for the audit exist?

(c) Discuss whether your firm may or may not accept the assignment if one of the preconditions for the audit is not present

(Total: 15 marks)

Comment on each of the following independent situations in respect of appointment of auditors, with reference to the applicable rules and regulations:

(a) Guava and Company, Chartered Accountants, have received a request for appointment as auditor of Orange Bank Limited (OBL) Most of the partners of Guava and Company maintain their accounts with OBL and are enjoying credit card facilities from them The maximum outstanding balance on the credit card facility, due from any partner is Rs.399,000

(b) Apricot and Company, Chartered Accountants, have received an offer for appointment as auditor of Banana Limited Mr Pumpkin who is a nominee

director of the Government on the Board of Directors of Banana Limited holds 25% shares in Water Melon Limited The spouse of a partner also holds shares in Water Melon Limited

(c) Mr Zaheer, a legal practitioner, has received an offer for appointment as external auditor of Lychee (Private) Limited (LPL) The paid up capital of LPL is Rs 1,500,000 of which 40% is owned by Blue Black Limited, a listed company

(d) Walnut and Company, Chartered Accountants, have received an offer for

appointment as external auditors of Wasim (Private) Limited (WPL), in place of the previous auditors, who were removed before the completion of their term You may assume that WPL has completed all the legal formalities before

removing the previous auditors

(e) Mr Sadiq has recently joined your firm as a partner He has served on the Board of Directors of Strawberry Limited (SL) until 30 June 20X0, as a

Government nominee In the Annual General Meeting of SL held on 31 August 20X2, a shareholder has proposed the name of your firm for appointment as the external auditors for the year ending 30 June 20X3

(Total: 11 marks)

(a) List the benefits associated with holding timely discussion among the team members in respect of matters susceptible to material misstatements (5)

(b) Quite often, the risk of material misstatement is greater in case of non-routine transactions and judgmental matters

Eight months period ended

(c) List the steps that the auditor should consider, if he is unable to agree to a

change in the terms of engagement

(Total: 9 marks)

ISA 315 Identifying and Assessing the Risks of Material Misstatement Through

Understanding the Entity and its Environment deals with the auditor’s responsibility to

identify and assess the risks of material misstatement in the financial statements, through understanding the entity and its environment, including the entity’s internal control

Required:

(i) Explain the purpose of risk assessment procedures (3)

(ii) Outline the sources of audit evidence the auditor can use as part of risk

Charity income consists of cash collections at fund raising events, telephone appeals, and bequests (money left to the charity by deceased persons) The charity is small and the trustees do not consider that the charity can afford to employ a qualified accountant The charity employs a part time book-keeper and relies on volunteers for fund raising

Your firm has been appointed as accountants and auditors to this charity because of the new regulations Accounts have been prepared (but not audited) in the past by a volunteer who is a recently retired Chartered Accountant

Required:

(a) Describe the risks associated with the audit of Azam under the headings inherent and control risks and detection risk and explain the implications of these risks for

(b) List and explain the audit tests to be performed on income and expenditure from

Note: In part (a) you may deal with inherent risk and control risk together You are not

required to deal with the detail of accounting for charities in either part of the question

(Total: 20 marks)

You are the audit manager in charge of the audit of Hurricane, a limited liability company The company’s year-end is 31 December, and Hurricane has been a client for seven years The company purchases and resells fittings for ships including anchors, compasses, rudders, sails etc Clients vary in size from small businesses making yachts to large companies maintaining large luxury cruise ships No manufacturing takes place in Hurricane

It is now early in 20X4 Information on the company’s financial performance is available

as follows:

20X4 20X3 Forecast Actual

„ One of the directors purchased a yacht during the year

„ Inventory is stored in ten different locations across the country, with your firm again having offices close to seven of those locations

„ A computerised inventory control system was introduced in August Year

„ Inventory balances are now obtainable directly from the computer system The client does not intend to count inventory at the year end but rely instead on the computerised inventory control system

R

Required:

(a) ISA 300 Planning an Audit of Financial Statements, states that an auditor must

plan the audit

Explain why it is important to plan an audit (5)

(b) Using the information provided above, prepare the audit strategy for Hurricane for

(Total: 20 marks)

(a) With reference to ISA 520 Analytical Procedures explain

(i) what is meant by the term ‘analytical procedures’; (2)

(ii) the different types of analytical procedures available to the auditor; and (3)

(iii) the situations in the audit when analytical procedures can be used (3)

Zakir Co sells garden sheds and furniture from 15 retail outlets Sales are made to individuals, with income being in the form of cash and debit cards All items purchased are delivered to the customer using Zak’s own delivery vans; most sheds are too big for individuals to transport in their own motor vehicles The directors of Zak indicate that the company has had a difficult year, but are pleased to present some acceptable results to the members

The income statements for the last two financial years are shown below:

Income statement

31 March 20X4

31 March 20X3

Hajira has a detailed constitution which explains how the charity’s income can be spent The constitution also notes that administration expenditure cannot exceed 10% of income in any year

The charity’s income is derived wholly from voluntary donations Sources of donations include:

(i) Cash collected by volunteers asking the public for donations in shopping areas,

(ii) Cheques sent to the charity’s head office,

(iii) Donations from generous individuals Some of these donations have specific clauses attached to them indicating that the initial amount donated (capital) cannot be spent and that the income (interest) from the donation must be spent on specific activities, for example, provision of sports equipment

The rules regarding the taxation of charities in the country Hajira is based are complicated, with only certain expenditure being allowable for taxation purposes and donations of capital being treated as income in some situations

Required:

(b) Identify areas of inherent risk in the Hajira charity and explain the effect of each

(c) Explain why the control environment may be weak at the charity Hajira (4)

(Total: 20 marks)

One of your audit clients is Tahir Co a company providing petrol, aviation fuel and similar oil based products to the government of the country it is based in Although the company is not listed on any stock exchange, it does follow best practice regarding corporate governance regulations The audit work for this year is complete, apart from the matter referred to below

As part of Tahir Co.’s service contract with the government, it is required to hold an emergency inventory reserve of 6,000 barrels of aviation fuel The inventory is to be used if the supply of aviation fuel is interrupted due to unforeseen events such as

natural disaster or terrorist activity

This fuel has in the past been valued at its cost price of Rs.150 a barrel The current value of aviation fuel is Rs.1,200 a barrel Although the audit work is complete, as noted above, the directors of Tahir Co have now decided to show the ‘real’ value of this closing inventory in the financial statements by valuing closing inventory of fuel at

market value, which does not comply with relevant accounting standards The draft financial statements of Tahir Co currently show a profit of approximately Rs.5m with net assets of Rs.1.7 billion