PL E December 2014–June 2015 Edition REVISION QUESTION BANK SA M ACCA Paper F8 | AUDIT AND ASSURANCE (INTERNATIONAL) ATC International became a part of Becker Professional Education in 2011 ATC International has 20 years of experience providing lectures and learning tools for ACCA Professional Qualifications Together, Becker Professional Education and ATC International offer ACCA candidates high quality study materials to maximize their chances of success In 2011 Becker Professional Education, a global leader in professional education, acquired ATC International ATC International has been developing study materials for ACCA for 20 years, and thousands of candidates studying for the ACCA Qualification have succeeded in their professional examinations through its Platinum and Gold ALP training centers in Central and Eastern Europe and Central Asia.* Becker Professional Education has also been awarded ACCA Approved Content Provider Status for materials for the Diploma in International Financial Reporting (DipIFR) Nearly half a million professionals have advanced their careers through Becker Professional Education's courses Throughout its more than 50-year history, Becker has earned a strong track record of student success through world-class teaching, curriculum and learning tools PL *Platinum – Moscow, Russia and Kiev, Ukraine Gold – Almaty, Kazakhstan E Together with ATC International, we provide a single destination for individuals and companies in need of global accounting certifications and continuing professional education Becker Professional Education's ACCA Study Materials All of Becker’s materials are authored by experienced ACCA lecturers and are used in the delivery of classroom courses M Study System: Gives complete coverage of the syllabus with a focus on learning outcomes It is designed to be used both as a reference text and as part of integrated study It also includes the ACCA Syllabus and Study Guide, exam advice and commentaries and a Study Question Bank containing practice questions relating to each topic covered Revision Question Bank: Exam style and standard questions together with comprehensive answers to support and prepare students for their exams The Revision Question Bank also includes past examination questions (updated where relevant), model answers and alternative solutions and tutorial notes SA Revision Essentials*: A condensed, easy-to-use aid to revision containing essential technical content and exam guidance *Revision Essentials are substantially derived from content reviewed by ACCA’s examining team ® E PL ACCA PAPER F8 SA M AUDIT AND ASSURANCE REVISION QUESTION BANK For Examinations to June 2015 ® ©2014 DeVry/Becker Educational Development Corp. 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All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) As shown by the Specimen Examination provided, the examination will have two sections: Section A: two mark and one mark multiple choice questions (MCQs); Section B: four 10 mark and two 20 mark questions The 20 mark questions will predominantly examine one or more aspects of audit and assurance from planning and risk assessment, internal control or audit evidence, although topics from other syllabus areas may also be included CONTENTS Question MULTIPLE CHOICE QUESTIONS (Section A) Page Answer 10 11 13 14 15 17 18 19 21 22 23 24 26 27 28 29 30 31 32 33 35 36 37 38 40 41 1001 1001 1002 1003 1003 1004 1004 1005 1005 1006 1006 1007 1007 1008 1008 1009 1009 1010 1010 1011 1011 1012 1012 1013 1013 1013 1014 1014 1015 1015 1016 1016 1017 Marks Date worked 13 10 11 8 10 8 11 8 13 10 8 8 8 10 9 8 PL Audit and other assurance engagements External audit Corporate governance Professional codes of ethics and conduct Auditor appointment Documentation Audit planning Understanding the entity Internal control Audit materiality Fraud, law and regulations Tests of control Communication on internal control Service organisations Audit evidence Analytical procedures Accounting estimates Using the work of an expert Audit sampling Written representations Computer-assisted audit techniques Non-current assets Inventory External confirmations, receivables and sales Share capital, reserves and directors’ remuneration Loans, bank and cash Liabilities, provisions and contingencies Small business and not-for-profit organisations Audit finalisation The auditor’s report on financial statements Going concern Internal audit Using the work of internal audit SA M 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 E Questions indicated ** are not exam style but provided for further revision of areas of the syllabus ©2014 DeVry/Becker Educational Development Corp. All rights reserved (iii) AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK Question Page Answer Marks Date worked 43 1018 10 43 43 1018 1020 10 10 44 44 45 46 1022 1023 1024 1025 10 10 10 10 46 46 1026 1028 10 20 47 48 1029 1030 10 10 49 1031 20 49 50 51 52 1034 1036 1038 1041 20 20 20 10 53 53 1042 1044 10 20 54 54 1046 1048 10 10 (Section B) AUDIT AND OTHER ASSURANCE ENGAGEMENTS Non-audit engagements and true and fair (ACCA J10 adapted) Conoy (ACCA J09 adapted) Serena VDW (ACCA D11 adapted) PROFESSIONAL CODES OF ETHICS AND CONDUCT Client confidentiality (ACCA D03 adapted) Stark (ACCA D08 adapted) LV Phones (ACCA J10 adapted) Goofy I (ACCA J11 adapted) AUDIT APPOINTMENT Melton Manufacturing (ACCA J95 adapted) Bondi (ACCA J99) DOCUMENTATION Specs4You I (ACCA J07 adapted) Specs4You II (ACCA J07 adapted) SA M 10 11 PL E CORPORATE GOVERNANCE AUDIT PLANNING 12 Bridgford Products (ACCA D98) UNDERSTANDING THE ENTITY 13 14 15 16 EuKaRe Charity (ACCA D08) Redsmith (ACCA D10) Abrahams (ACCA D11) Donald Co (ACCA J11 adapted) INTERNAL CONTROL 17 18 Internal control Bestwood Engineering (ACCA D98) AUDIT MATERIALITY 19 20 (iv) Mistiread I (ACCA J07 adapted) Documentation and materiality (ACCA D10 adapted) ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) Question Page Answer Marks Date worked 54 55 56 1049 1051 1052 20 10 10 57 1054 20 FRAUD, LAW AND REGULATIONS 21** 22 23 Tye (ACCA J09) Tinkerbell I (ACCA J11 adapted) Bestwood Trading (ACCA J98 adapted) TESTS OF CONTROL Tinkerbell II (ACCA J11 adapted) COMMUNICATION ON INTERNAL CONTROL 25 26 Blake (ACCA D08 adapted) Greystone (ACCA D10 adapted) 27 28 57 59 1056 1058 20 20 PL AUDIT EVIDENCE E 24 Boulder (ACCA D04) Obtaining Evidence (ACCA J11 adapted) 60 61 1062 1063 20 10 61 61 1065 1066 10 10 62 1067 10 63 1069 10 63 63 64 1070 1071 1072 10 20 10 64 65 65 66 1073 1074 1075 1076 10 10 10 20 67 67 1078 1080 20 20 ANALYTICAL PROCEDURES 29 30 Analytical procedures Planning analytical procedures (ACCA J02 adapted) ACCOUNTING ESTIMATES Newthorpe Engineering I (ACCA J97 adapted) SA M 31 USING THE WORK OF AN EXPERT 32** Expert, rights and assertions (ACCA D08) AUDIT SAMPLING 33 34 35 Audit sampling (ACCA J03) Tam (ACCA D06) Sample selection and assertions (ACCA J09 adapted) WRITTEN REPRESENTATIONS 36 37 38** 39** Written representation letter (ACCA J05 adapted) Crighton-Ward (ACCA J05 adapted) Sufficent evident (ACCA J08) Greenfields (ACCA D10) COMPUTER-ASSISTED AUDIT TECHNIQUES 40 41 Walsh (ACCA D06) Delphic (ACCA D07) ©2014 DeVry/Becker Educational Development Corp. All rights reserved (v) AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK Question Page Answer Marks Date worked 68 69 1081 1083 20 10 70 70 72 1084 1087 1089 20 20 10 NON-CURRENT ASSETS 42 43 WW (ACCA J06) JonArc I (ACCA D07 adapted) INVENTORY Trent Textiles (ACCA Pilot 1997) Smoothbrush (ACCA J10 adapted) MistiRead II (ACCA J07 adapted) E 44 45 46 EXTERNAL CONFIRMATIONS, RECEIVABLES AND SALES Lidcombe (ACCA D00) Alternative Procedures (ACCA D02 adapted) External confirmations (ACCA D06 adapted) 72 74 74 1090 1093 1094 20 10 10 PL 47** 48 49 LOANS, BANK AND CASH 50 51 Bank & Cash (ACCA J02) Jayne (ACCA D06 adapted) 74 75 1095 1097 20 10 75 76 76 1098 1099 1101 10 20 20 77 77 78 1104 1104 1106 10 20 20 79 80 81 82 82 1109 1110 1112 1113 1114 10 20 10 10 10 83 84 84 1116 1117 1118 10 10 20 85 85 86 86 1120 1121 1122 1123 10 10 10 10 LIABILITIES, PROVISIONS AND CONTINGENCIES 52 53** 54 Newthorpe Engineering II (ACCA J97 adapted) Tourex and Pudco (ACCA J03) Metcalf (ACCA J07) SA M SMALL BUSINESS AND NOT-FOR PROFIT ORGANISATIONS 55 56 57 Small firm internal controls (ACCA J03) Firefly Tennis Club (ACCA D06) Bluesberry Hospital (ACCA D10) AUDIT FINALISATION 58 59** 60 61 62 Dylan Sharp ZeeDiem (ACCA D08 adapted) Humphries I (ACCA D11 adapted) Humphries II (ACCA D11 adapted) THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS 63 64 65** Cremorne (ACCA J99 adapted) JonArc II (ACCA D07 adapted) Daffy (ACCA J11) GOING CONCERN 66 67 68 69 (vi) Going concern status (ACCA D03 adapted) Corsco (ACCA D03 adapted) Medimade I (ACCA J10 adapted) Medimade II (ACCA J10 adapted) ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) Question Page Answer Marks Date worked 87 88 88 1124 1125 1126 10 10 10 89 1128 20 INTERNAL AUDIT 70 71 72 Octball I (ACCA D05 adapted) Octball II (ACCA D05 adapted) Goofy II (ACCA J11 adapted) USING THE WORK OF INTERNAL AUDIT ZPM (ACCA J06) RECENT EXAMINATIONS E 73 June 2012 1A Pear International I (adapted) [internal control, substantive procedures] 1B Pear International II (adapted) [external audit, internal audit) 2** Planning and sampling Orange Financials (adapted) [ethics] Pineapple Beach Hotel [evidence, substantive procedures, documentation] 5A Strawberry Kitchen Designs (adapted) [going concern] 5B** Serious concerns (adapted) [going concern] 1131 20 91 91 92 1134 1136 1137 10 10 10 92 1138 20 93 1141 10 94 1143 December 2012 1A Lily Window Glass I (adapted) [inventory] 1B Lily Window Glass II (adapted) [CAATs] 2** External audits [external audit, internal control] Sunflower Stores [evidence, risks, internal audit] Rose Leisure Club [ethics, substantive procedures] 5A Written and oral representations (adapted) 5B Violet & Co (adapted) [audit finalisation] 95 96 96 97 98 98 99 1144 1146 1147 1149 1152 1154 1155 20 10 10 20 20 10 10 June 2013 Fox Industries (adapted) [internal control, deficiences, substantive procedures] 2** Independence and objectivity [ethics, going concern] Kangaroo Construction [materiality, audit risks] Bush-Baby Hotels (adapted) [fraud, internal audit] Panda (adapted) [subsequent events] 100 101 101 102 103 1157 1161 1163 1166 1168 20 10 20 10 10 104 1170 20 105 105 106 106 107 1173 1174 1177 1180 1181 10 20 10 10 10 SA M PL 90 December 2013 Minty Cola (adapted) [audit risks, substantive procedures] 2** Audit procedures [tests of controls, substantive procedures, audit evidence] Oregano [internal control] 4A Salt & Pepper I (adapted) [audit report] 4B Salt & Pepper II (adapted) [ethics] Paprika (adapted) [audit report] ©2014 DeVry/Becker Educational Development Corp. All rights reserved (vii) AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK Question Page Answer 6 7 13 14 15 15 16 16 17 19 Marks Date worked SPECIMEN EXAM Multiple Choice Questions Hazard Balotelli Beach Hotel Savage & Co Torres Leisure Club Walters Garcia International Marking Scheme 20 10 10 10 10 20 20 SA M PL E (viii) ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) Audit planning (i) Ratios to assist in planning 2014 Gross margin Operating margin Inventory days Receivable days Payable days Current ratio Quick ratio (ii) 12 /23 /23 2·1 /11 × 365 4·5 /23 × 365 1·6 /11 × 365 6·6 /2·5 (6·6 – 2·1)/2·5 4·5 2013 52·2% 19·6% 70 days 71 days 53 days 2·6 1·8 Audit risk /18 /18 1·6 /10 × 365 3·0 /18 × 365 1·2 /10 × 365 6·9 /1·2 (6·9 – 1·6)/1·2 44·4% 22·2% 58 days 61 days 44 days 5·8 4·4 E (c) Response to risk Throughout the audit the team will need to be alert to this risk They will need to carefully review judgemental decisions and compare treatment against prior years A generous sales-related bonus scheme has been introduced in the year, this may lead to sales cut-off errors with employees aiming to maximise their current year bonus Increased sales cut-off testing will be performed along with a review of post yearend sales returns as they may indicate cut-off errors Revenue has grown by 28% in the year; however, cost of sales has only increased by 10% This increase in sales may be due to the bonus scheme and the advertising however, this does not explain the increase in gross margin There is a risk that sales may be overstated During the audit a detailed breakdown of sales will be obtained, discussed with management and tested in order to understand the sales increase Gross margin has increased from 44·4% to 52·2% Operating margin has decreased from 22·2% to 19·6% This movement in gross margin is significant and there is a risk that costs may have been omitted or included in operating expenses rather than cost of sales There has been a significant increase in operating expenses which may be due to the bonus and the advertising campaign but could be related to the misclassification of costs The classification of costs between cost of sales and operating expenses will be compared with the prior year to ensure consistency SA M PL Management was disappointed with 2013 results and hence undertook strategies to improve the 2014 trading results There is a risk that management might feel under pressure to manipulate the results through the judgements taken or through the use of provisions ©2014 DeVry/Becker Educational Development Corp. All rights reserved 1037 AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK Audit risk Response to risk The finance director has made a change to the inventory valuation in the year with additional overheads being included In addition inventory days have increased from 58 to 70 days There is a risk that inventory is overvalued The change in the inventory policy will be discussed with management and a review of the additional overheads included performed to ensure that these are of a production nature Receivable days have increased from 61 to 71 days and management have extended the credit period given to customers This leads to an increased risk of recoverability of receivables Extended post year-end cash receipts testing and a review of the aged receivables ledger to be performed to assess valuation The current and quick ratios have decreased from 5·8 to 2·6 and 4·4 to 1·8 respectively In addition the cash balances have decreased significantly over the year Although all ratios are above the minimum levels, this is still a significant decrease and along with the increase of sales could be evidence of overtrading which could result in going concern difficulties Detailed going concern testing to be performed during the audit and discussed with management to ensure that the going concern basis is reasonable E PL SA M Answer 15 ABRAHAMS Detailed cost and net realisable value testing to be performed and the aged inventory report to be reviewed to assess whether inventory requires writing down (a) Components of audit risk Tutorial note: The requirement to this part is general The scenario of Abrahams is only relevant from part (b) which starts “Using the information provided ” Inherent risk The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls Inherent risk is affected by the nature of an entity Factors which can result in an increase include: 1038 Changes in the industry it operates in Operations that are subject to a high degree of regulation Going concern and liquidity issues including loss of significant customers Developing or offering new products or services or moving into new lines of business Expanding into new locations Application of new accounting standards Accounting measurements that involve complex processes Events or transactions that involve significant accounting estimates Pending litigation and contingent liabilities ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) Control risk The risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control Factors that can result in an increase in control risk include: Lack of personnel with appropriate accounting and financial reporting skills Changes in key personnel including departure of key management Deficiencies in internal control, especially those not addressed by management Changes in the information technology (IT) environment Installation of significant new IT systems related to financial reporting E Detection risk PL The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements Detection risk is affected by sampling and non-sampling risk Factors which can result in an increase include: Inadequate planning Inappropriate assignment of personnel to the engagement team Failing to apply professional scepticism Inadequate supervision and review of the audit work performed Incorrect sampling techniques performed Incorrect sample sizes Tutorial note: Only one example for each component of risk was required for full marks Audit risks and responses SA M (b) Audit risk Audit response The finance director is planning to capitalise, as an asset, the full $2·2 million of development expenditure incurred However, in order to this all the criteria of IAS 38 Intangible Assets must be met A breakdown of the development expenditure should be reviewed and tested in detail to ensure that only projects which meet the capitalisation criteria are included as an intangible asset, with the balance being expensed Some projects may not reach final development stage and hence should be expensed rather than capitalised The risk of overstating intangible assets is increased due to the loan covenant requirements to maintain a minimum level of assets The inventory valuation method used is standard costing This is acceptable under IAS Inventories if standard cost is a close approximation to actual cost Abrahams has not updated the standard costs from when the product was first developed and hence there is a risk that the standard costs could be out of date, resulting in over or undervalued inventory ©2014 DeVry/Becker Educational Development Corp. All rights reserved The standard costs used for the inventory valuation should be tested in detail and compared to actual cost If there are significant variations this should be discussed with management, to ensure that the valuation is appropriate 1039 AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK Audit response The work in progress balance at the year end is likely to be material; however there is a risk that due to the nature of the production process the audit team may not be sufficiently qualified to assess the quantity and value of work in progress leading to misstated work in progress Consideration should be given to whether an independent expert is required to value the work in progress If so this will need to be arranged with consent from management and in time for the year-end count Over one-third of the warehouses of Abrahams belong to third parties Sufficient and appropriate evidence will need to be obtained to confirm the quantities of inventory held in these locations in order to verify completeness and existence Additional procedures will be required to ensure that inventory quantities have been confirmed for both third party and company owned locations In September Abrahams introduced a new accounting system This is a critical system for the accounts preparation and if there were any errors that occurred during the changeover process, these could affect the final amounts in the trial balance The new system will need to be documented in full and testing should be performed over the transfer of data from the old to the new system The new accounting system is bespoke and the IT manager who developed it has left the company already and his replacement is not due to start until just before the year end The accounting personnel who are using the system may have encountered problems and without the IT manager’s support, errors could be occurring in the system due to a lack of knowledge and experience This could result in significant errors arising in the financial statements This issue should be discussed with the finance director to understand how he is addressing this risk of misstatement In addition, the team should remain alert throughout the audit for evidence of such errors Significant finance has been obtained in the year, $1 million of equity finance and $2·5 million of long-term loans This finance needs to be accounted for correctly, with adequate disclosure made The equity finance needs to be allocated correctly between share capital and share premium, and the loan should be presented as a noncurrent liability Check that the split of the equity finance is correct and that total financing proceeds of $3·5 million were received In addition, the disclosures for this finance should be reviewed in detail to ensure compliance with relevant accounting standards The loan has a number of covenants attached to it If these are breached then the loan would be instantly repayable and would be classified as a current liability This could result in the company being in a net current liability position If the company did not have sufficient cash flow to meet this loan repayment then there could be going concern implications Review the covenant calculations prepared by Abrahams and identify whether any defaults have occurred; if so then determine the effect on the company SA M PL E Audit risk 1040 The team should maintain their professional scepticism and be alert to the risk that assets have been overstated to ensure compliance with covenants ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) The land and buildings are to be revalued at the year end; it is likely that the revaluation surplus/deficit will be material The revaluation needs to be carried out and recorded in accordance with IAS 16 Property, Plant and Equipment; otherwise non-current assets may be incorrectly valued Review the reasonableness of the valuation and recalculate the revaluation surplus/deficit to ensure that land and buildings are correctly valued The reporting timetable for Abrahams is likely to be reduced The previous timetable was already quite short and any further reductions will increase detection risk and place additional pressure on the team in obtaining sufficient and appropriate evidence The timetable should be confirmed with the finance director If it is to be reduced then consideration should be given to performing an interim audit in late December or early January, this would then reduce the pressure on the final audit PL Substantive procedures E Audit response (i) Inventory held at third party warehouses Send a letter requesting direct confirmation of inventory balances held at year end from the third party warehouse providers used by Abrahams regarding quantities and condition Attend the inventory count (if one is to be performed) at the third party warehouses to review the controls in operation to ensure the completeness and existence of inventory Inspect any reports produced by the auditors of the warehouses in relation to the adequacy of controls over inventory Inspect any documentation in respect of third party inventory (ii) Use of standard costs for inventory valuation Discuss with management the basis of the standard costs applied to the inventory valuation, and how often these are reviewed and updated Review the level of variances between standard and actual costs and discuss with management how these are treated Obtain a breakdown of the standard costs and agree a sample of these costs to actual invoices or wage records to assess their reasonableness SA M (c) Audit risk Answer 16 DONALD Audit risk Audit response Donald has ordered six planes which may not have been received by the year end Only assets which physically exist at the year end should be included in property, plant and equipment Discuss with management whether the planes have arrived If so then physically verify a sample to ensure existence ©2014 DeVry/Becker Educational Development Corp. All rights reserved 1041 AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK Audit risk Audit response The existing planes have been refurbished at a cost of $15m This expenditure needs to be reviewed to assess whether it is of a capital nature and should be included within assets or expensed as repairs Review a breakdown of the costs and agree to invoices to assess the nature of the expenditure and if capital agree to inclusion within the asset register and if repairs agree to the income statement Donald has applied for a loan of $25m It has not received this loan yet, but it has already ordered the planes and if it does not receive the money in time then it may struggle to pay for the planes ordered and this could result in going concern difficulties Discuss with management the status of the loan application and if still outstanding whether any other banks have been approached for the loan The travel agents who sell tickets on behalf of the airline are struggling to pay their outstanding balances to Donald This could result in an increase in irrecoverable debts and receivables being overvalued Extended post year-end cash receipts testing and a review of the aged receivables ledger to be performed to assess valuation PL E Perform a detailed going concern review An allowance for receivables to be discussed with management Donald’s website has encountered difficulties Extended controls testing to be performed over with recording sales, this could lead to errors in the sales cycle to assess the extent of the errors Detailed testing to be performed over relation to completeness of income completeness of income Review the cut-off of customer refunds around the year end to ensure that sales are complete and accurate SA M Due to the website errors tickets have been sold twice, therefore some customers will require refunds At the year end there is a risk that the tickets to be refunded have not been removed from sales Donald is closing its call centre and making the Discuss with management the status of the workforce redundant; as it has announced this to redundancy programme and review and the staff then under IAS 37 Provisions, recalculate the redundancy provision Contingent Liabilities and Contingent Assets a redundancy provision will be required for any staff not yet paid at the year end Tutorial note: Only five audit risks and responses were required Answer 17 INTERNAL CONTROL (a) 1042 Understanding internal control ISA 315 requires the auditor to understand internal control by considering the design and implementation of relevant controls to assess the potential risk of material misstatements As an objective of internal control is to prevent, detect and correct material errors, if controls are poorly designed or are not implemented, there is potentially a greater risk of material misstatement in the financial statements The auditor must then consider whether the risks are of the type and magnitude that could result in a material misstatement of the financial statements ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) Use of questionnaires As well as flowcharting systems and compiling narrative notes, auditors will use questionnaires (e.g ICQs – internal control questionnaires – and ICEQs – internal control evaluation questionnaires) as a framework for understanding the design of internal controls ICQs comprise a series of questions for each control cycle (e.g sales, purchases, wages) that are designed to identify if particular internal controls exist (and if they not, then a possible area of weakness) for example: E Is the customer credit limit checked before an order is accepted? Are goods received agreed to the authorised purchase order? PL (b) Professional judgement has to be used to identify those controls that relate to the entity’s objective of preparing financial statements that give a true and fair view and the management of risk that may result in a material misstatement in the financial statements Is the price charged by the supplier on the purchase invoice agreed to an authorised price list? Is each amendment to the standing payroll database reviewed to original input and authorisation and approved by an independent official? Questions are framed such that a “No” answer indicates a weakness and would highlight potential problems in segregation of duties, controls or management supervision ICEQs go further than ICQs in that they are designed to assess whether errors or fraud are possible The questions asked are more open and principles-based than the closed form (rules-based) of ICQs They are also closely related with control objectives, for example: SA M How does the client ensure that goods are only sent to customers who can pay? How does the client ensure that goods are only accepted if the correct ordering procedures have been followed? How does the client ensure that payments are only made for goods and services received and required by the company? How does the client ensure that amendments to the standing payroll data are relevant and accurate? The questions in an ICEQ can be concentrated (targeted) on the possibility of error and fraud in each cycle and therefore specifically designed to cover such possibilities, reducing the number of questions needed to be asked and increasing their relevance Each question can relate to more than one client as they are open and each client may have different relevant controls that meet the question requirement Alternatively, an ICEQ can be specifically tailored to each client ©2014 DeVry/Becker Educational Development Corp. All rights reserved 1043 AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK The answers will describe the nature and extent of the controls in operation The auditor can then assess the control design and whether or not to rely on them (i.e they can form the basis of the control testing programme) Answer 18 BESTWOOD ENGINEERING (a) Purchase and receipt of goods Tutorial note: The question specifically refers to controls to be exercised in the purchasing department E For all goods ordered, there should be a purchase requisition from a user department The purchasing department should not be permitted to raise purchase requisitions as this would create a weakness in the division of duties PL The purchasing department should check the purchase requisition is for goods the user department is authorised to buy or consume If the value of the order is substantial, the purchasing department should ensure there is a need for such a large order by checking current inventory levels and future orders to determine whether so large a quantity or value is required The purchase requisition should use a standard form and be signed by an authorised signatory The purchasing department should order the goods from an authorised vendor Where there is a choice of vendor or a new vendor is required, the purchasing department should obtain the product from the vendor who provides the product or service at the best price, quality and delivery SA M The purchasing department should raise the purchase order which should be signed by the purchasing manager For large value purchases, a director may be required to sign the purchase order The purchase order should be sent to the vendor, the goods received department, the user department and the accounts department The purchasing department should ensure the goods are received on time This may require them to contact the vendor a week before the expected delivery date to ensure they are received on time, and allow action to be taken if the delivery date is later than specified on the purchase order When the goods are received the purchasing department should receive a copy of the goods received note (GRN) from the goods received department They should record the goods received against the order The purchasing department may be part of the system which authorises purchase invoices They should check the goods on the invoice are consistent with the purchase order/GRN and the price per unit is correct The purchasing department should be informed about short deliveries (i.e the quantity of goods received is less than on the purchase order or advice note) and when there are quality problems From this information, they can contact the vendor so that corrective action is taken Also, such details may be helpful in determining whether the vendor should be used for future orders The purchasing department should be informed of situations when goods or services are received but no purchase order has been raised With this information, the purchasing department should contact the “offending” department and ensure that in future a purchase order is raised for all the goods they order 1044 ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) (b) Authorisation of purchase invoices Tutorial note: The question calls for control procedures in the accounts department before the purchase invoice is processed The accounts department will receive the purchase invoice, which they should record in a register The expense code will be entered on the invoice (for posting to the general ledger) E The accounts department will either match the purchase invoice to the goods received note and delivery note or ask the goods received department to check and authorise the purchase invoice The purchasing department will be asked to confirm the goods are as described on the purchase order and the price per unit is correct The user department may be asked to authorise the purchase invoice PL An appropriate responsible official will be asked to finally approve the purchase invoice Provided these checks are satisfactory, the accounts department should input the invoice details into the computer which will post it to the accounts payable ledger and the general ledger An independent person should check monthly supplier statements against the balances on the accounts payable ledger Differences between these two balances should be investigated for correction of possible error or omission (c) Controls over purchase of services SA M Procedures over receiving services are inherently different to those over receiving goods For some types of service there may be no system for raising purchase orders (e.g electricity, gas, water and telephone charges) However there should be a system for reviewing these costs, by comparing them with the previous year (or period), with budget and with amounts charged by alternative vendors In this way, the company can ensure these services are received at the most economical cost For receipt of all other services, before the service is obtained, a purchase requisition could be raised by the user department, and the purchasing department should raise a purchase order In emergency situations, it may be acceptable to raise a purchase requisition and order after the service has been received (e.g the repair of a vehicle which has broken down) There should be a system whereby action is taken when no purchase order has been raised for a service which has been received The major controls over validity and cost of services (e.g advertising, training, etc) will be monitoring and control over cost: Budgets set for major activities, suitably analysed; Monitoring of actual cost against budget; Informing cost centres of charges allocated to them from incoming invoices; Cost centre approval of invoices; Management review of performance including efficiency and effectiveness of the services received ©2014 DeVry/Becker Educational Development Corp. All rights reserved 1045 AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK Answer 19 MISTIREAD I (b) Engagement letter Discuss the matter again with the directors in an attempt to reach a suitable compromise Remind the directors that statutory audits require the directors to make all the necessary information and explanations available to the auditor Explain that lack of information on the website will result in a limitation in scope of the audit work Further explain that because the lack of evidence appears to relate to a material amount that the auditor’s report will have to be modified with an “except for” qualification due to the lack of information and the possibility of misstatement of non-current assets Finally note that auditor may have to decline to continue to act for MistiRead unless suitable terms of engagement can be agreed E PL (a) Concept of materiality Financial statements are materially misstated when they contain errors or irregularities whose effect, individually or in the aggregate, is important enough to prevent the statements from being fairly presented In this context, misstatements may result from misapplication of applicable accounting standards, departures from fact, or omissions of necessary information SA M ISA 320, Materiality in Planning and Performing an Audit, requires auditors to consider materiality when determining the nature, timing and extent of audit procedures In complying with this requirement ISA 320 recommends that auditors make preliminary judgements about materiality levels in planning the audit at the following levels: the financial statement level, because the auditors’ opinion on fair presentation extends to the financial statements taken as a whole; the account balance (assertion) level, because the auditors verify account balances in reaching an overall conclusion that the financial statements are fairly presented; cumulative impact of aggregated undetected immaterial misstatements exceeding the materiality level (performance materiality) The overall level of materiality and the nature of account balances enable auditors to determine which account balances to audit and how to evaluate the effects of misstatements in financial information as a whole Materiality at the account balance level assists auditors in determining what items in a balance (or transactions class) to audit and what audit procedures to undertake (e.g whether to use sampling or analytical procedures) Performance materiality determines a level of materiality above which all items should be tested Overall financial statement level There may be more than one level of materiality relating to the financial statements For the statement of comprehensive income, materiality could be related to revenue or to profit (usually before tax) For the statement of financial position, materiality could be based on shareholders’ equity, assets or liability class totals 1046 ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) In making a preliminary judgement about materiality, auditors initially determine the aggregate level of materiality for each financial statement For example, it may be estimated that errors totalling $100,000 for the statement of comprehensive income and $200,000 for the statement of financial position would be material For planning purposes, the auditors should use the smallest aggregate level of misstatement considered to be material to any one of the financial statements This decision rule is appropriate because the financial statements are interrelated and many audit procedures pertain to more than one statement For instance, the audit procedure to determine whether year-end credit sales are recorded in the proper period provides evidence about both accounts receivable (statement of financial position) and sales (statement of comprehensive income) an amount equal to or greater than 10% of the base is presumed to be material; an amount equal to or less than 5% of the base may be presumed not to be material; to determine whether an amount between 5% and 10% is material is a matter of judgement PL E ISA 320 offers no guidance for determining this relationship but, where an item has an effect on profit, widely used parameters are: Other commonly used bases, and materiality thresholds expressed as a percentage of that base, are as follows Base Sales Net profit Total assets Equity (net assets) Materiality threshold (%) ½ - 1% - 10% ½ - 1% - 2% SA M Qualitative considerations The emphasis in planning materiality is on quantitative considerations ISA 320 acknowledges that in designing the audit plan, the auditor establishes an acceptable materiality level so as to detect quantitatively material misstatements Since the errors are not yet known, their qualitative effect can be considered only during the testing phase of the audit, as evidence becomes available Qualitative considerations relate to the causes of misstatements or to misstatements that not have a quantifiable effect A misstatement that is quantitatively immaterial may be qualitatively material This may occur, for instance, when the misstatement is attributable to an irregularity or an illegal act by the entity Discovery of either occurrence might cause the auditors to conclude there is a significant risk of additional similar misstatements Although it is suggested that the auditors should be alert for misstatements that could be qualitatively material, it is ordinarily not practical to design procedures to detect them – hence the importance of fully understanding the entity and its environment (including the economic decisions of users) and the use of professional judgement and scepticism Account balance/class of transactions level Account balance materiality is the minimum misstatement that can exist in an account balance for it to be considered materially misstated In making judgements about materiality at the account balance level, the auditors must consider the relationship between it and financial statement materiality This consideration should lead the auditors to plan the audit to detect misstatements that may be immaterial individually but that may be material to the financial statements taken as a whole when aggregated with misstatements in other account balances ©2014 DeVry/Becker Educational Development Corp. All rights reserved 1047 AUDIT AND ASSURANCE (F8) – REVISION QUESTION BANK When the auditors’ preliminary judgements about financial statement materiality are quantified, a preliminary estimate of materiality for each account may be obtained by allocating financial statement materiality to the individual accounts The allocation may be made to both statement of financial position and statement of comprehensive income accounts Performance materiality The determination of performance materiality is not a simple mechanical calculation, but draws upon the auditor’s past experience, the use of professional judgement and the expectation of misstatements within the current period E It may be the overall financial statement materiality, the individual materiality for specific classes of transactions, balances and disclosures that are key to the users or a separate lower level calculated to take into account the possibility of undetected material misstatements Answer 20 DOCUMENTATION AND MATERIALITY PL Documenting audit work Provides evidence of the auditor’s basis for a conclusion about the achievement of the overall objective of the audit Provides evidence that the audit was planned and performed in accordance with ISAs and applicable legal and regulatory requirements Assists the engagement team to plan and perform the audit Assists members of the engagement team responsible for supervision to direct, supervise and review the audit work SA M (a) (b) Enables the engagement team to be accountable for its work Retains a record of matters of continuing significance to future audits Materiality Materiality is defined as “misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements” In assessing the level of materiality there are a number of areas that should be considered Firstly the auditor must consider both the amount (quantity) and the nature (quality) of any misstatements, or a combination of both The quantity of the misstatement refers to the relative size of it and the quality refers to an amount that might be low in value but due to its prominence could influence the user’s decision (e.g directors’ transactions) In assessing materiality the auditor must consider that a number of errors each with a low value may when aggregated amount to a material misstatement The assessment of what is material is ultimately a matter of the auditors’ professional judgement, and it is affected by the auditor’s perception of the financial information needs of users of the financial statements 1048 ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) In calculating materiality the auditor should also consider setting the performance materiality level This is the amount set by the auditor, it is below materiality, and is used for particular transactions, account balances and disclosures As per ISA 320 materiality is often calculated using benchmarks such as 5% of profit before tax or 1% of gross revenue These values are useful as a starting point for assessing materiality Answer 21 TYE Valuation of aviation inventory Review GAAP to ensure that there are no exceptions for aviation fuel or inventory held for emergency purposes which would suggest a market valuation should be used Calculate the difference in valuation The error in inventory valuation is $105 * 6,000 barrels or $630k, which is a material amount compared to profit Review prior year working papers to determine whether a similar situation occurred last year and ascertain the outcome at that stage Discuss the matter with the directors to obtain reasons why they believe that market value should be used for the inventory this year Warn the directors that in your opinion, aviation fuel should be valued at the lower of cost or net realisable value (that is $15/barrel) and that using market value will result in a modification to the audit report If the directors now amend the financial statements to show inventory valued at cost, then consider mentioning the issue in the weakness letter and not modify the audit report in respect of this matter If the directors will not amend the financial statements, quantify the effect of the disagreement in the valuation method – the sum of $630,000 is material to the financial statements as Tye’s loss is decreased from a small loss to a loss of $130,000 although net assets decrease by only about 0·3% Obtain written representations from the directors of Tye confirming that market value is to be used for the emergency inventory of aviation fuel If the directors will not amend the financial statements, draft the relevant sections of the audit report, showing a qualification on the grounds of disagreement with the accounting policy for valuation of inventory PL E SA M (a) (b) Audit procedures and actions (i) External auditor responsibilities regarding detection of fraud Overall responsibility of auditor The external auditor is primarily responsible for the audit opinion on the financial statements following the international auditing standards (ISAs) ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements is relevant to audit work regarding fraud ©2014 DeVry/Becker Educational Development Corp. All rights reserved 1049 E PL ABOUT BECKER PROFESSIONAL EDUCATION Together with ATC International, Becker Professional Education provides a single destination for candidates and professionals looking to advance their careers and achieve success in: Accounting • International Financial Reporting • Project Management • Continuing Professional Education • Healthcare SA M • For more information on how Becker Professional Education can support you in your career, visit www.becker.com ® E This ACCA Revision Question Bank has been reviewed by ACCA's examining team and includes: The most recent ACCA examinations with suggested answers t Past examination questions, updated where relevant t Model answers and suggested solutions t Tutorial notes SA M PL t www.becker.com/ACCA | acca@becker.com ©2014 DeVry/Becker Educational Development Corp All rights reserved ... and what level of assurance to a review of financial statements? A B C D and and and and ©2014 DeVry/Becker Educational Development Corp. All rights reserved (2 marks) AUDIT AND ASSURANCE (F8) ... systems? A B C D 10 1, and 3, and 1, and 1, and (2 marks) ©2014 DeVry/Becker Educational Development Corp. All rights reserved REVISION QUESTION BANK – AUDIT AND ASSURANCE (F8) 8.4 What is detection... its profitability Managing its assets and liabilities Cutting down the time needed for the audit Complying with laws and regulations A B C D and and and and SA M (1) (2) (3) (4) (5) 9.2 (2 marks)