Final Assessment ACCA Paper F8 (INT) Audit and Assurance June 2009 Final Assessment – Answers To gain maximum benefit, not refer to these answers until you have completed the final assessment questions and submitted them for marking KAPLAN PUBLISHING Page of 13 ACCA F8 (INT) Audit and Assurance © Kaplan Financial Limited, 2008 All rights reserved No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing Page of 13 KAPLAN PUBLISHING Final Assessment ANSWER (a) Marks Weakness • Management override • Lack of proper consultation or appraisal in respect of acquisition of noncurrent assets Consequences • Weak control environment may encourage breaches of the control system • Assets surplus to requirements/inappropriate assets acquired/assets for personal use • Adverse impact on cash flow • Over-gearing Weakness • No formal policy in respect of obtaining quotes for major items of expenditure Consequences • Assets may not be acquired on the most favourable terms Weakness • No physical checks between assets and register Consequences • Assets may not exist/disposals not recorded • Assets may not be recorded • Assets which need to be written down may not be identified 14 (b) (i) Consequences • Unauthorised/incorrect changes may be made, resulting in late payment and loss of supplier goodwill and/or non-existent suppliers • No evidence of changes which should have been made Recommendations • All amendments should be recorded on standard forms which should be authorised by the financial controller and evidenced by signature The suppliers' details should have high level password protection, and the amendments should not be undertaken by the purchase ledger clerk • Printouts of amendments should be obtained and checked by the financial controller, and evidenced by signature KAPLAN PUBLISHING Page of 13 ACCA F8 (INT) Audit and Assurance Marks • (ii) Supplier details should be checked, periodically, on a one-for-one basis independently of the ledger clerk Consequences • The reconciliation may not be undertaken • Unauthorised payments may not be prevented or detected • Unrecorded liabilities may not be identified on a timely basis/purchases and payments may not be recorded in the correct period Recommendations (iii) • The reconciliation should be performed independently of the purchase ledger clerk • It should be reviewed by a responsible official, and signed as evidence of review • All suppliers' statements should be retained until the completion of the audit Consequences • Claims may be made for excessive amounts or expenses which have not been incurred • Recovery of input VAT could be jeopardised, and excessive disallowance of such expenditure for Corporation Tax purposes Recommendations • All expense claims should be on standard claim forms, and supported by receipts which should be countersigned and cancelled to prevent resubmission • All employees should be informed, in writing, of the breach in company procedure 16 30 Marking guide – mark per point (1/2 mark if not well explained) Page of 13 KAPLAN PUBLISHING Final Assessment ANSWER (a) Marks Internal audit function • The internal audit function in any entity is part of the overall corporate governance function of an entity Corporate governance objectives include the management of the risks to which the entity is subject that would prevent it achieving its overall objectives such as profitability Corporate governance objectives also include the overarching need for the management of an entity to exercise a stewardship function over the entity’s assets • A large part of the management of risks, and the proper exercise of stewardship, involves the maintenance of proper controls over the business Controls over the business as a whole, and in relation to specific areas, include the effective operation of an internal audit function • Internal audit can help management manage risks in relation to fraud and error, and exercise proper stewardship by: − commenting on the process used by management to identify and classify the specific fraud and error risks to which the entity is subject (and in some cases helping management develop and implement that process) − commenting on the appropriateness and effectiveness of actions taken by management to manage the risks identified (and in some cases helping management develop appropriate actions by making recommendations) − periodically auditing or reviewing systems or operations to determine whether the risks of fraud and error are being effectively managed − monitoring the incidence of fraud and error, investigating serious cases and making recommendations for appropriate management responses • In practice, the work of internal audit often focuses on the adequacy and effectiveness of internal control procedures for the prevention, detection and reporting of fraud and error Routine internal controls (such as the controls over computer systems and the production of routine financial information) and non-routine controls (such as controls over year-end adjustments to the financial statements) are relevant • It should be recognised, however, that many significant frauds bypass normal internal control systems and that, in the case of management fraud in particular, much higher level controls (those relating to the high level governance of the entity) need to be reviewed by internal audit in order to establish the nature of the risks and to manage them effectively (b) External auditors: fraud and error in an audit of financial statements • External auditors are required by ISA 240 The Auditor’s Responsibility to Consider Fraud in an Audit of Financial Statements to consider the risks of material misstatements in the financial statements due to fraud Their audit procedures will then be based on a risk assessment Regardless of the risk assessment, auditors are required to be alert to the possibility of fraud throughout the audit and to maintain an attitude of professional scepticism, notwithstanding the auditors’ past experience of the honesty and integrity of management and those charged with governance Members of the engagement team should discuss the susceptibility of the entity’s financial statements to material misstatements due to fraud KAPLAN PUBLISHING Page of 13 ACCA F8 (INT) Audit and Assurance Marks • Auditors should assessment of communications should enquire process • Auditors should also enquire of management and those charged with governance about any suspected or actual instance of fraud • Auditors should consider fraud risk factors, unusual or unexpected relationships, and assess the risk of misstatements due to fraud, identifying any significant risks Auditors should evaluate the design of relevant internal controls and determine whether they have been implemented • Auditors should determine an overall response to the assessed risk of material misstatements due to fraud and develop appropriate audit procedures, including testing certain journal entries, reviewing estimates for bias, and obtaining an understanding of the business rationale of significant transactions outside the normal course of business Appropriate management representations should be obtained • External auditors are only concerned with risks that might cause material error in the financial statements External auditors might therefore pay less attention than internal auditors to small frauds (and errors), although they must always consider whether evidence of single instances of fraud (or error) are indicative of more systematic problems • It is accepted that, because of the hidden nature of fraud, an audit properly conducted in accordance with ISAs might not detect a material misstatement in the financial statements arising from fraud In practice, routine errors are much easier to detect than frauds • Where auditors encounter suspicions or actual instances of fraud (or error), they must consider the effect on the financial statements, which will usually involve further investigations They should also consider the need to report to management and those charged with governance • Where serious frauds (or errors) are encountered, auditors need also to consider the effect on the going concern status of the entity, and the possible need to report externally to third parties, either in the public interest, for national security reasons, or for regulatory reasons Many entities in the financial services sector are subject to this type of regulatory reporting and many countries have legislation relating to the reporting of money laundering activities, for example make enquiries of management regarding management’s fraud risk, its process for dealing with risk, and its with those charged with governance and employees They of those charged with governance about the oversight 10 Marking guide – mark per point (½ mark if not well explained) Page of 13 KAPLAN PUBLISHING Final Assessment ANSWER (a) Audit risk Meaning ‘Audit risk’ is the risk that an auditor forms an inappropriate audit opinion on the financial statements It has three components: inherent risk, control risk and detection risk The following equation represents the relationship: Audit risk = Inherent risk × Control risk × Detection risk Why is it important? If inherent risk is high, there is greater potential for material misstatement in the financial statements This risk of misstatement is reduced if control risk is low, i.e the accounting and internal control systems of the enterprise are effective in detecting and correcting errors arising Detection risk is under the control of the auditor and dependent on the assessment of inherent and control risk In the audit risk model, detection risk is the balancing figure to satisfy the ultimate risk accepted As the auditor is at risk from non-detection of material misstatements, testing should be concentrated on the material/high risk items This results in more efficient use of resources Risk is a principal determinant of the audit approach and materiality For example: • if detection risk is to be rendered low (e.g because inherent and control risk are high), this could mean more substantive procedures (e.g larger samples) to ensure that the financial statements are not materially misstated • if control risk is evaluated as being low (through tests of controls) then, as expected, the level of substantive procedures will be reduced The level of risk affects the nature and timing of audit work as well as its extent For example, when risk is increased more reliable evidence should be sought, e.g more independent/third party evidence KAPLAN PUBLISHING Page of 13 ACCA F8 (INT) Audit and Assurance (b) Potential risk Why a risk • Richard Pine, the new audit manager, is from the property and service client base • Errors in the financial statements may be missed due to Richard’s non-familiarity with the Carnes’s business • The Carnes are expecting ‘another quick audit’ • Richard is likely to need to carry out more work than usual to become familiar with the client This may be interpreted by the Carnes as mistrust, with the consequence that they are reluctant to volunteer assistance • The business is run and managed by a husband and wife team • There is a limited scope for supervisory or authorisation controls • Those controls in place are likely to be unreliable due to the risk of management override There has been a loss of revenue from the original farming operations, which the Carnes are addressing by diversification • The loss of revenue from the original business may threaten the viability of the farm as a going concern • Although the Carnes are addressing this by diversification, the process of change also carries a risk as it involves adapting to new markets and learning new skills The Carnes are raising organically fed geese as an alternative to turkey • This source of revenue assumes that customers of the meat distributors used can be persuaded to change from the traditional turkey There is a significant possibility that this market will not materialise • Organic food supplies for the geese will carry a higher price tag There is no evidence to suggest that John Carnes has evaluated if this cost can be recouped It is possible that, in spite of generating revenue, the sale of geese may realise no overall profit • This is a markedly seasonal business Income will have ceased before the first holidaymakers arrive in May, thereby putting a strain on the servicing of debt • If John Carnes has entered into contracts for the supply of grazing, this could prohibit future expansion of holiday/fishing facilities by restricting the availability of land • As these are the most successful elements of Golden Pond Fisheries, their curtailment could threaten the going concern status of the company • If no such contracts exist, then grazing revenues could cease at any time – there is no evidence that such a prospect has been considered • • • Page of 13 Pastures are being let for sheep grazing KAPLAN PUBLISHING Final Assessment Potential risk Why a risk • • Any such breach of import regulations – when discovered – will result in severe penalties, extending to fines, quarantine of stocks, etc • The consequence would be a loss of revenue and reputation in the core business • The importing of alien species will threaten existing stocks with diseases and parasites to which they are not resistant John Carnes appears to imply that blue carp are to be imported illegally • The holiday cottages are a seasonal business • Cash flow will fluctuate widely over a 12-month period This places strain on debt repayment terms • The development of the holiday cottages was financed by borrowing • Financing a business by way of borrowing always carries the risk that repayment of capital and interest could cease in less successful periods • The provider of finance will want a review of the financial statements, increasing the risk of management bias in preparing the financial statements to show a favourable position • Accounting records are maintained on a PC • The use of a PC, with its associated risks of data corruption and lack of sufficient controls, increases the risks regarding the completeness and accuracy of accounting records • The amount of paperwork has decreased • Audit trail may be lost without hard copies, increasing the risk that insufficient evidence will be available • Data has recently been transferred to the computer system • Increased risk of errors due to inaccurate transfer of data onto the PC • Claire trained as a bookkeeper 30 years ago • Claire’s bookkeeping training may prove to be of limited advantage as there has been a significant amount of change over recent years Again, this reduces confidence in the accuracy of the financial statements • Part-time staff are employed for six months of the year and are paid in cash • It is important to ensure that these individuals appear on the payroll, and that tax and insurance regulations have been complied with • Insufficient records may be available due to the cash nature of transactions KAPLAN PUBLISHING Page of 13 ACCA F8 (INT) Audit and Assurance Potential risk Why a risk • • It will take time to create and adopt a truly uniform audit approach, and this will increase the detection risk associated with all work undertaken • This arises from non-familiarity, and increases the risk of procedures being omitted or conducted inefficiently • Mergers of any type always increase the risk of ‘culture clashes’, and this can reduce the efficiency of audit work undertaken The current audit firm has resulted from a merger of two firms with very different client bases from different parts of the country MARKING GUIDE (a) Audit risk (b) Potential audit risks (1/2 mark for risk, ½ mark for explanation) 14 Total marks available 20 ANSWER (a) It is the directors’ responsibility to assess the company’s ability to continue as a going concern when they are preparing the financial statements If they are aware of any material uncertainties that may affect this assessment, then they are required to disclose such uncertainties in the financial statements The auditor, when performing the going concern review, should determine how well the directors have performed this assessment and whether they have taken all relevant factors into consideration Auditors should generally look ahead at least one year from the date of the directors’ approval of the accounts, in assessing the validity of the going concern basis (b) • The auditors will need to satisfy themselves that the going concern assumption is reasonable • Auditors should not assume that the going concern concept will continue to apply, but need to regularly conduct a specific examination of the relevant factors to reach a decision • This will involve an overall review of financial factors, preferably before the client’s year end, in order to establish whether there are factors which cast doubt on the going concern basis • If there are, further investigation is required (i) Issues to consider (only ten were required) Issues that the audit manager should have considered when assessing whether or not Caffyn is a going concern are as follows: Page 10 of 13 • Has the company been relying heavily on short-term finance? • Does the company’s market share seem to be declining? KAPLAN PUBLISHING Final Assessment (ii) • Does the company have sufficient funds to meet loan and capital repayments due in the next 12 months? • Is the company collecting its debts without problems? • Are there any contingent events or post balance sheet events which affect the company’s going concern status? • Does the company rely heavily on one or two major suppliers who are experiencing difficulties? • Has the company any unauthorised short-term borrowings? • Has the company been denied credit by any suppliers? • Has the company tried to restructure its debts? • Has the company been experiencing significant staffing problems, with loss of key staff? • Has the company lost any key suppliers/customers which has significantly affected its business? Types of evidence Types of evidence that the audit manager should have considered during her going concern review are as follows: • Budget, forecast and actual information for the period in question and whether or not the budgeting/forecasting details were accurate Clearly, if the information provided were very inaccurate, then future information produced by the same system is unlikely to be reliable The auditor would also review the systems to assess how well these are kept up to date • The systems that exist to provide the directors with warnings of future risk areas and potential problems and whether these are satisfactory • The directors’ plans to address the current borrowing problems • Discussions with the company’s lawyers to assess whether there are any legal issues surrounding the company’s viability/ability to continue • Discussions with the company’s bank to determine whether the directors’ plans for addressing the financial problems are viable and realistic • The existence of obligations and guarantees to any other organisations which could result in Caffyn’s bankruptcy MARKING GUIDE (a) Auditors responsibility – going concern (b) (i) Issues to consider – mark each 10 (ii) Evidence – mark each Total marks available KAPLAN PUBLISHING 20 Page 11 of 13 ACCA F8 (INT) Audit and Assurance ANSWER (a) For an audit, the auditor will provide a positive assurance about the truth and fairness of the accounts Although auditors cannot give absolute assurance on audited financial statements, the work carried out and the level of evidence obtained during the audit work should be sufficient to allow them to provide a high level of assurance that the financial statements are free from material misstatements In contrast, the negative assurance will provide limited assurance but provide some comfort to the intended user In most cases, the auditor will be able to identify any material anomalies/errors or at least highlight risks in particular areas The conclusion is of the type 'nothing has come to our attention' and the users must make up their own minds about the validity of the report and, if in doubt, might want to undertake more enquiries themselves (b) Mercury Conclusion Unqualified if note to accounts adequate Qualified if note inadequate and the directors refuse to amend Reason Significant uncertainty is likely to have a very great impact therefore should be disclosed adequately to inform the users of the financial statements If disclosure is not adequate it is potentially misleading the user of the financial statements Effect on report If disclosure is adequate, an Emphasis of Matter paragraph should be included drawing users’ attention to the note Specific statement that report is not qualified in this respect (e.g validity of going concern) If disclosure is inadequate and the directors refuse to amend, an Except For Disagreement opinion should be issued Page 12 of 13 KAPLAN PUBLISHING Final Assessment Pluto Conclusion Qualified Reason Limitation in scope of work, as evidence reasonably expected to be available is not available Material as 28% of profit would have to be expensed if not capitalised Effect on audit report Describe limitation in Basis of Opinion paragraph Except for any adjustments that might have been found to be necessary had sufficient evidence been obtained In respect alone of the limitation on audit work relating to non-current assets in the course of construction: • All information and explanations considered necessary for the audit not obtained • Proper accounting records not maintained Neptune Conclusion Qualified Reason Disagreement over accounting treatment Material and probably pervasive as profit is turned into a loss Effect on audit report Adverse opinion/accounts not give a true and fair view Reason and amounts involved stated in opinion paragraph MARKING GUIDE (a) Differences between positive and negative assurance (b) Qualifying for audit report (up to marks each; mark for conclusion, for reason, for effect if well explained) Total marks available KAPLAN PUBLISHING 15 20 Page 13 of 13 ... 30 Marking guide – mark per point (1/2 mark if not well explained) Page of 13 KAPLAN PUBLISHING Final Assessment ANSWER (a) Marks Internal audit function • The internal audit function in any... purchase ledger clerk • Printouts of amendments should be obtained and checked by the financial controller, and evidenced by signature KAPLAN PUBLISHING Page of 13 ACCA F8 (INT) Audit and Assurance... to material misstatements due to fraud KAPLAN PUBLISHING Page of 13 ACCA F8 (INT) Audit and Assurance Marks • Auditors should assessment of communications should enquire process • Auditors should