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Fundamentals Skills Module - Mock Audit and Assurance (International) F8AA-MK1-X08-A Answers & Marking Scheme Accountancy Tuition Centre Ltd ATC INTERNATIONAL TOPNOTCH4U (a) Sales system report (1 mark for each weakness, effect and recommendation total of marks per matter The solution provides a guideline of the detail expected If less, only award a maximum of ½ mark per element.) Weakness Potential effect of weakness Recommendation The detail of the orders placed by customers through the website is taken directly from the web page to the orders file rather than being verified through the product file first It is possible that data on the webpage may be altered In particular the sales price may be lowered by an experienced hacker and this price will then be used as the basis of charging the customer, resulting in lost income The web program should be amended so that when the customer accepts the shopping basket order, key data will be transferred from the product data base to the order file This will ensure that the sales price is the real price and not the price as manipulated by the customer Despatch notes are not pre-numbered and only the customer’s copy is authorised by the despatch manager The despatch note used by the despatch manager may be lost and the goods not sent With the second copy of the note being sent to the accounts department, it is possible that a customer will be charged for goods not received Despatch notes should be pre-numbered by the system This effectively prevents completeness and authorisation checks to be made to ensure all orders despatched are valid, accounted for and entered correctly into the system No completeness or accuracy checks are made when the order data is transferred from the orders file to the legacy system Errors made when transferring the data may not therefore be identified Accountancy Tuition Centre (International Holdings) Ltd 2008 Additionally, if the second copy sent to the accounts department is lost, then goods may be sent to customers but no charge made In copying the converted data via the Zip drive there is a possibility that some data may corrupt The sales report used to update the inventory records may therefore be inaccurate As goods are despatched, the second copy should be authorised by the despatch manager as “goods sent” A completeness check can then be carried out by the accounts department as well as a check that each note is authorised Batch total controls should be used to check for the completeness and validity of the data transferred between the two systems In addition, the original sales order data should be backed up (before conversion) and archived at the end of each day This will provide the ability to restore any data that becomes corrupted during the conversion and transfer process Weakness Potential effect of weakness Recommendation The inventory programme is manually updated from the product sales report There is a risk that the data will not be accurately entered The inventory records may not accurately reflect the physical inventory held due to inaccurate sales reports and/or inaccurate data entry from the reports Data entered into the inventory system should be validated to ensure its completeness and validity Incorrect inventory records may result in orders not being placed to replace low levels of inventory A perpetual inventory counting approach should be introduced to ensure that the inventory records accurately reflect the level of inventories held The customer’s credit card is charged after despatch of goods to the customer, meaning that goods are already sent to the customer before payment is authorised The company will not be paid for goods despatched where the credit company rejects the payment request, thus incurring a bad debt The customer’s credit card authorisation should be obtained before the toys are despatched Ideally this should be done directly after the customer submits their shopping basket and confirmed to the customer There is no check to verify the inventory level at the point of customer order nor any formal system to inform customers of a delay in shipping their order It is possible that a customer may be charged for their toys, when no toys have been sent/received as the second copy of the despatch note may still be sent to the accounts department The product database should incorporate an inventory program that informs the customer of the current inventory status (eg In stock, Out of stock, delivery will be made within one week, Only items in stock) and allows the customer to accept, change their order or cancel Customer goodwill will also be lost if the delivery of toys is delayed The system does not produce a separate sales invoice for despatch to the customer A despatch note is produced and the customer’s credit card charged, but no VAT invoice is produced and sent to the customer Under most jurisdictions, it is essential that a VAT audit trail is maintained to clearly identify the VAT payable to the authorities The system should be updated to provide a VAT audit trail and a VAT invoice sent to customers In addition, customers will require an input VAT invoice for their own VAT process The invoice could be sent by e-mail to customers on confirmation of order despatch or as a hard copy with the order The current system is likely to raise negative comments on a VAT inspection Accountancy Tuition Centre (International Holdings) Ltd 2008 The system will require updating to keep track of ‘out of stock’ orders Weakness Potential effect of weakness Recommendation Inventory is only counted once a year, at the end of the financial period No regular reconciliation takes place between items purchased, sold and in inventory It is possible that items may be dispatched without being recorded or stolen Toys that are despatched in excess of the orders or are directly stolen are considered to be an understatement of sales, a direct impact on the financial statements and profit A perpetual inventory counting approach should be introduced to ensure that the inventory records accurately reflect the level of inventories held Any discrepancies should be thoroughly reviewed and explained Accountancy Tuition Centre (International Holdings) Ltd 2008 Regular reconciliations of items purchased, sold and held in inventory should take place (b) Internet sales system (1 mark for each relevant and FULL point made If no explanation is given for the test, only award ½ mark Note that the requirement only refers to recording in the sales module of the legacy system – no marks should be awarded for tests relating to the use of day books, financial statements etc ) In order to establish that the toys despatched are those ordered by the customer, it will be necessary to test that the data initially entered through the website is correctly captured by the system An order should therefore be placed by the auditor using the website and then checked to the orders file agreeing the completeness and accuracy of the data In obtaining their initial understanding of the control design and implementation, the auditors will have already established the functionality of the website and the transfer of data to the orders file Access the order file and select a sample of orders Agree the unit prices to an authorised price list/file Check the additions of the order and VAT calculations Trace each order through to the sales module within the legacy system, agreeing all details to ensure completeness and accuracy of the data transfer Agree that the correct accounts have been updated, ie sales, receivables and VAT Agree the order detail to the despatch note filed in the accounts department This will provide evidence of goods having been despatched and that the despatch notes were accurately printed by the system From the sales module, trace the order details through to a daily product sales report., ensuring that the date of the report is the day after the order was placed This tests the completeness, accuracy and validity of the sales report From the daily sales report, agree that the inventory records have been updated for the order placed Completeness and accuracy of updating inventory records for despatch of private customer orders Agree that the order entry in the sales module of the legacy system has been flagged to show goods despatched and credit card authorisation obtained Agree to a credit card statement that the payment (less any agreed charges) has been received Trace the total of the credit card statement through to the cash book and bank statement Use of CAATS Whilst not specifically mentioned, award appropriate marks where answers refer to the use of CAATs, eg: Extract complete data files from the orders file and the sales files of the legacy system Compare both sets of data using a CAAT to ensure completeness and accuracy of data transfer from the order system to the legacy system Applying the same procedure, compare the inventory data from the orders file with the data extracted from the inventory files to ensure complete and accurate update of the inventory system for internet sales Accountancy Tuition Centre (International Holdings) Ltd 2008 For each month, using the data from the sales module of the legacy system, compute the total sales value and reconcile to the credit card companies monthly statement to test for completeness of credit card authorisation (c) Commercial customers receivables (1 mark for each FULL and valid point ½ mark only if lack of explanation /depth Max of marks NOTE 1: As there are only ten commercial balances, procedures should reflect this If answers are clearly wrote learnt without consideration of the scenario, eg select sample from balances, award no marks NOTE 2: As the customers are overseas, award no marks for any comments made on sending second letters etc There will be insufficient time to so and the student’s answer will be wrote learnt without application to the scenario Only award marks if within the specific context of the circularisation being done at the year end to allow time for second letters to be sent NOTE 3: Some students may take the view that as there are only ten commercial customers, an alternative approach to circularisation should be taken An acceptable procedure would be to apply alternative procedures to all balances, eg establish existence, makeup of balance, after date cash received PROVIDED a strong systems approach (manual or CAATs) had been applied and made clear in the answer NOTE: Award no marks for any suggestion of using CAATs to select balances etc As there are only ten balances, this would clearly be inappropriate CAATs would be appropriate to establish closing balances from initiating records which could then be tested for after date cash ) Consider the timing of the circularisation re reporting deadlines and the audit timing As overseas, a longer period of time will be needed to receive replies The circularisation may therefore need to be carried out at or before the year end Obtain a list of the commercial customer receivables from the client Check the addition of the list and that the total receivables agrees to the general ledger Check the extraction of the list from the sales ledger to ensure completeness and accuracy of the extraction Review the list for credit balances Where the total of credit balances are material, add back to the receivables balance and to the payables balance to ensure the balances show a true and fair view Establish the reasons why there are material credit balances or a significant number and consider impact on audit approach (eg may increase audit risk) As there are only ten commercial customers, include all within the circularisation, unless clearly immaterial Agree with client that all will be circularised If client requests any not to be circularised, establish reason as to why (and is reasonable) and include balance for other procedures Prepare positive , closed circularisation letters (ie those stating the balance due and requiring a reply regardless of agreement or disagreement) on TopNotch4U’s letterhead and signed by the company Accountancy Tuition Centre (International Holdings) Ltd 2008 The letters should be posted independent of the client (to ensure the client is not able to suppress or directly reply to any ) with the return from customers to be made directly to the auditors to reduce any risk of the client being able to interfere with the letters or replies Replies will either agree balances or disagree balances Where disagreement, the amount disagreed must be analysed and audited Disagreement will usually be based on cash and/or goods in transit Where cash in transit, agree subsequent receipt of cash to cash book and through to the bank statement Where goods in transit, agree to sales invoice, goods despatch note and entry in inventory records to ensure correct cut-off Where no replies, apply alternative procedures, eg establish existence of customer (website, contracts, correspondence); make up of balance (invoices, despatch notes, inventory entries); after date payment received (cash book, bank statement) (d) Cut-off (1 mark for each valid point Max of marks If no example given max of marks) Cut off is a financial statement assertion that basically means that a transaction that occurred in one period is recorded within that period A cut-off test gathers substantive evidence that transactions are recorded in the period to which they relate A cut off test, depending on its direction, provides evidence as to two types of misstatement, namely: a misstatement relating to completeness, where an economic event that occurs in the financial period being audited (i.e up to and including the cut-off date) is recorded in the related account balance in the subsequent accounting period (1 mark) a misstatement relating to validity, where an economic event that occurs in the period following the period being audited (i.e after the cut-off date) is recorded in the related account balance in the period being audited (1 mark) Auditors perform cut-off tests for all major classes of transactions, either at the end of the financial period or, where substantive evidence is gathered prior to the year end, at an earlier cut-off date A basic example would be sales and receivables Despatches made before the year end should be recorded as sales and receivables before the year end and excluded from inventory before the year end Despatches made after the year end should be evidenced as invoiced after the year end and recorded as sales/receivables after the year end Accountancy Tuition Centre (International Holdings) Ltd 2008 ISAs (a) Threats to the Fundamental Principles (½ mark identifying plus ½ mark explaining, to include at least two examples, otherwise only ½ mark Max of marks) Self-interest – may occur as a result of the financial or other interests of members (including immediate or close family of the member) eg, loans or guarantees, close personal or business relationships, financial interest in a client, gifts and hospitality Self-review – may arise when a previous judgment needs to be re-evaluated by individuals responsible for that judgment Examples include: providing a service to a client that will then be subject to review as part of the assurance engagement; reporting on the operation of systems after being involved in their design or implementation; the discovery of a significant error during a re-evaluation of the work being undertaken by the member Advocacy – occurs when members promote a position or opinion to the point that subsequent objectivity may be compromised, eg commenting publicly on future events in particular circumstances, having made assertions without detailing the assumptions; where information is incomplete or advocating an argument which is unlawful; promoting shares in a listed audit client or a client seeking to list; acting as an advocate on behalf of an assurance client in litigation or disputes with third parties Familiarity – can arise where members, because of a close relationship, become too sympathetic to the interests of others There is a significant risk that professional scepticism will not be applied Examples include: a member in a position to influence business decisions, financial (or nonfinancial) reporting (e.g the audit report) having an immediate or close family who is in a position to benefit from that influence (e.g a director or shareholder); over-familiarity with the management of the organisation such that professional judgement could be compromised; long association with business contacts influencing business decisions; acceptance of gifts or preferential treatment, unless the value is clearly insignificant Accountancy Tuition Centre (International Holdings) Ltd 2008 Intimidation – will occur where members may be deterred from acting objectively by threats, actual or perceived, direct or indirect Examples of circumstances that may create intimidation threats include: threat of dismissal or replacement of the member; a dominant personality attempting to influence the decision-making process; being threatened with litigation; coming under pressure to reduce necessary work to ensure a reduction in fees (b) Controls (½ mark each point, max of mark each element, marks in total) The control environment - sets the tone of an organization, influencing the control consciousness of its management and employees It is the foundation for effective internal control, providing discipline and structure Strongly relates to how management (and governance) has created a culture of honesty and ethical behaviour, supported by appropriate controls to prevent and detect fraud and error Risk assessment procedures – how the entity’s management identify business risks relevant to the financial reporting objectives and how they decide to address those risks and review the results of doing so Risks relevant to financial reporting include external and internal events and circumstances that may occur and adversely affect an entity’s ability to initiate, record, process, and report financial data Information system – consists of the physical and hardware (if IT based) infrastructure, software (if IT based), people, procedures and data It includes the accounting system and consists of the procedures and records established to initiate, record, process, report and maintain accountability which must also be able to deal with errors and incorrect processing Control activities – the policies and procedures that help ensure that management directives are carried out, e.g that actions are taken to address risks that threaten the achievement of the entity’s objectives They have various objectives and are applied at various organisational and functional levels Examples include authorisation, performance reviews, information processing, physical controls and segregation of duties Monitoring controls – the process to assess the effectiveness of internal control performance over time It involves assessing the design and operation of controls on a timely basis and taking necessary corrective actions for changes in conditions Without monitoring control systems and receiving feedback on the performance of those controls, the entity’s management will have no idea if a control, whilst still operating, is actually effective Ongoing monitoring activities are often built into the normal recurring activities of an entity and include regular management and supervisory activities Accountancy Tuition Centre (International Holdings) Ltd 2008 ISA REGULATORY FRAMEWORK (a) Financial statement risks (1 mark per valid point Max of 12 marks) Client business Okalas operates in the high-tech field of military tank engine production Inventory obsolescence through technological change is a high risk area Values may be overstated Turnover consists of a small number of very high value contracts (eg currently tendering for $200m NATO contract) Such “economic dependence” may lead to going concern problems should one (or more) of the contracts fail Considerable expenditure is made in R & D, to develop up-to-date engines to maintain the company’s market position Such expenditure classified as development may not be recoverable, thus there is a risk of impairment and overstatement of the balance The client faces the risk of high expenditure and investment in technical development when: (2 points necessary to gain mark) fierce domestic and overseas competition may force unprofitable tendering (going concern risk); failure to deliver engines to the terms of contracts could lead to significant penalties (understatement of provision for penalties); the majority of sales are overseas (NATO, Middle-East, Australasia) subjecting the company to: – – – foreign currency exposure; potential bad debt problems (understatement of allowance); political volatility (going concern considerations); Products Thunderflash – Very recently developed with high development costs, this the subject of the NATO tender (1 mark each point, max of marks) Overall reliability is unclear until the engine has been in operation for a longer period There may be future developments or warranty expenses to be incurred (potential understatement of provision) Development costs may be fairly amortised under IAS 38 Intangible Assets if it is: – – likely to make future profits; commercially and technically viable Otherwise, the capitalisation of such costs will be overstated Accountancy Tuition Centre (International Holdings) Ltd 2008 10 Fox – Okalas recently received a $25m warranty claim from a Middle East government for faulty parts in 30 engines (1 mark each point, max of marks) If this matter is not resolved by year-end (likely!) a provision may be necessary in the year-end financial statements (potential understatement) Also: – – other recently completed contracts may lead to similar claims; engines in WIP may need rectification work thus NRV needs to be ascertained The client should consider the possibility of counter-claim against Young If so, it cannot be offset against the provision and would not be recognised on the balance sheet until it was virtually certain the claim would succeed Snooper – Development of Thunderflash may render the 20 year old Snooper design obsolete Engines and parts may have nil/scrap value (potential overstatement of inventory values) Inventory Volatility of contract prices makes measuring NRV against cost difficult Valuation is therefore a high-risk area The continuous inventory-checking is seriously behind schedule for this year and error incidence is high Material error could exist between book and actual physical quantities Internal audit involvement in other audit areas may be reduced, thereby increasing the risk of errors arising (b) Audit work (1 mark per valid point, max of marks per section, in total) (i) Warranty Claim To assess what amount, if any, of the claim represents a liability, a wholly substantive approach is required including: discussion with senior management to obtain: – – full information of the claim; and their opinion on the most likely liability a review of the contract terms to assess whether: – – warranty cover extends to sand clogging; and any valid disclaimers exist Assuming some liability exists, the claim must be reviewed and the amounts confirmed This will involve: (2 points to obtain mark – max) establishing what a potential figure for the claim would be; comparing the Middle East claim to the liability calculated by Okalas; Accountancy Tuition Centre (International Holdings) Ltd 2008 11 obtaining legal opinion from the clients’ solicitors as to the reasonableness (or otherwise) of the client’s calculation; reviewing all relevant board minutes and correspondence with the Middle East government to establish the extent of the claim To confirm any amounts recoverable by Okalas: (2 points to obtain max of mark) review any product liability insurance taken out by Okalas which may wholly or partially cover the liability (even though the insurance company may dispute the claim or Okalas’ management may place too much emphasis on the cover); establish whether any counter-claim against Young is feasible by reviewing all correspondence and relevant minutes on the matter; obtain legal opinion from the clients’ solicitors as to the likelihood and amounts of recovery There may be repercussions for other Fox contracts recently completed and for any Fox engines currently in WIP Therefore review: (2 points for max of mark) the client’s procedures for identifying any further claims; calculations for provisions and NRV of inventory made and assess their materiality; all correspondence and minutes with customers and solicitors concerning further claims The situation must be monitored up to the date of the auditor’s report, that is a proactive approach to post balance sheet events Management representations should be obtained (eg regarding the completeness of disclosure of post balance sheet events and the NRV of current WIP and inventory) Disclosure in the financial statements may be required: as exceptional gains/losses if the claims concerned crystallise; as contingent gains/liabilities if the amounts or outcome are still highly uncertain as at the date of signing the auditor’s report (It is likely that a reasonable estimate of amount can be made.) (ii) Inventory Audit approach Because of the high volume of relatively low value items, we will aim to perform tests of controls on the accounting and internal control system and use extensive analytical review CAATs will be used wherever appropriate for these tests In addition we must carefully review the results of physical checks Accountancy Tuition Centre (International Holdings) Ltd 2008 12 Interim work “Walk-through” checks on the inventory accounting system will be required before performing tests of controls The test data programs should be run as soon as possible thereafter Inventory checking A meeting should be arranged as soon as possible with the internal audit manager to ascertain the extent of potential errors in the inventory records, review the effectiveness of correcting such errors and enquire whether all inventory lines will have been counted at least once by the year-end We should attend a sample of physical checks to ensure they are being performed to managements’ instructions and to check a sample of inventory items Audit software may assist with sample selection If results are not satisfactory a full year-end physical count may be required Warranty claim In conjunction with the audit work on warranty claims, items selected for physical counts should include those where future warranty provisions could arise Substantive work Subject to satisfactory results from tests of controls we will aim to perform extensive analytical procedures Audit software may be used to produce data for: (2 points for max of mark) inventory ageing, including turnover by product line and product category; reconciling opening and closing inventory quantities by accounting for sales and purchases in the year; comparing quantities and amounts of inventory in each product category between this and previous years Other functions to be performed by audit software: (3 points for max of mark) casting the inventory ledger to agree to client’s schedules; identifying inventory items: – – – for physical checking; for valuation and cut-off tests; where standard cost is less than the contract price; identifying items not counted this year; identifying items where the quantity held in inventory exceeds the number of items used in one year (for provisions work) Accountancy Tuition Centre (International Holdings) Ltd 2008 13 Other tests For a sample of inventory items, compare standard cost to the latest purchase invoice price to ensure that inventory is valued at cost (NRV tests will also be carried out) Perform full cut-off tests taking note of any inventory movement documents at the year-end physical counts (whether full count or otherwise) Review the make-up of inventory values paying special attention to any variances from standard cost Inventory must be valued at the lower of cost and NRV and not at standard cost unless this approximates to cost CHARITIES (a) Risks and implications for audit risk (1 mark for each valid point made, max 10) Inherent and control risks Charities can be viewed as inherently risky because they are often managed by nonprofessionals and are highly susceptible to fraud (because of the high levels of cash), although many charities and the volunteers that run them are people of the highest integrity who take a great deal of care over their work In the case of EduChar, the scenario highlights the lack of a fulltime professional accountant, it only has a part time bookkeeper and relies on volunteers for fund raising All of these increase inherent risk Charities are also at risk of being in violation of their constitutions which is important where funds are raised from public or private donors who may well object strongly if funds are not applied in the manner expected The involvement of a recently retired Chartered Certified Accountant in the preparation of accounts in the past may lower the auditor’s assessed inherent risk to an extent However, the audit and accounting regulations are new This implies a higher inherent risk as the trustees, bookkeeper, part time ACCA member and auditors have to fully understand the implications of the new regulations on the accounts preparation and audit Most small charities have a high level of control risk because formal internal controls are expensive and are not often in place This means that donations are susceptible to misappropriation by the volunteer collectors (tamper proof collecting tins should be used) It may not be possible to rely on basic business controls as the bookkeeper is only part time and no indication is given within the scenario of the role of the trustees (they should remain independent of the day to day running of the charity) Accountancy Tuition Centre (International Holdings) Ltd 2008 14 Detection risk As the charity is small, it is possible that all transactions will be tested and therefore sampling risk (the risk that samples are unrepresentative of the populations from which they are drawn) is not present Detection risk will also be high as this is a new client and thus the auditors will be unfamiliar with the client The audit team must contain senior individuals (eg the partner, manager and supervisor) who are familiar with cash based audits and the legislation surrounding charities Substantive analytical review may play a critical roll in establishing the completeness of cash received and expenditure Audit risk Audit risk is the product of inherent risk, control risk and detection risk and is the risk that the auditors will issue an inappropriate audit opinion This risk can be managed by decreasing detection risk by altering the nature, timing and extent of audit procedures applied Where inherent risk is high and controls are weak (as is likely here) a greater level of substantive testing will need to be carried out on areas identified as risky in order to reduce audit risk to an acceptable level It will be critical to carry out a detailed risk analysis; obtain an in-depth understanding of the way the charity operates and of the regulations (including the new ones) it operates under (b) Audit tests – fund raising events (1 mark per valid point Note that the requirement specifically deals with fund raising events only.) Attend a selection of fund raising events (eg those expected to raise material amounts of money) and observe the procedures employed in collecting, counting, banking and recording the cash This is effectively confirming and testing the accounting system (initiation through to recording and reporting) and will help provide audit evidence that funds have not been misappropriated and that all income from such events has been recorded (accuracy and completeness) Where sealed collection boxes or tins are used at charity events, agree the control over the issue and collection of the boxes/tins, eg number allocated to the event, number used, not used and returned (completeness) Ideally, the boxes/tins should be pre-numbered for use over many events When used they should be kept for audit inspection and not destroyed Observe that when opened, the boxes/tines are done so in the presence of two volunteers, one counting the other checking Perform random cash counts at the events to provide evidence that cash has been counted correctly and that there is no collusion between volunteers to misappropriate funds Accountancy Tuition Centre (International Holdings) Ltd 2008 15 Agree audit count details to the client’s schedules and forward through summary sheets to final paying in bank slips Check the additions of all summary schedules This will provide evidence as to the completeness and accuracy of recording the cash Trace the bank paying in slips through to the cash book and bank statements, checking that there is no unusual delay in banking the cash Re-perform the year end bank reconciliation and agree the rolling forward of the opening bank balance through the reconciliations carried out each month (If reconciliations are not done each month, it will be necessary to audit the year end reconciliation as a whole) This also provides evidence as to the completeness of income Examine the records of bank expenditure for fund raising events (hire of equipment, entertainers, purchase of refreshments etc.), trace through to supporting evidence (eg invoices and receipts) and ensure that these have been properly authorised This provides evidence as to the measurement and accuracy of expenditure Discuss with event organisers if any expenditure was met directly by paying cash from the monies collected, without being recorded Review expenditure of similar past events to identify potential expenditure that has not been recorded This will provide evidence of completeness of income (eg that income has not been expensed without being recorded) Review the income and expenditure of fund raising events against any budgets that have been prepared and against similar past events Investigate any significant discrepancies This will provide evidence of completeness and accuracy Ensure that all necessary licences (such as public entertainment and lottery licences) have been obtained by the trustees for such events in order to ensure that no action is likely to be taken against the charity or volunteers Obtain representations from the trustees to the effect that there are no unrecorded liabilities for such events and for the completeness of income – again for completeness of income, expenditure and liabilities AUDIT REPORTS (a) Responsibilities (1 mark each point, max of marks) Preparation of financial statements (2 marks ) The directors are normally required to prepare the financial statements of the company using the appropriate law of their country and in accordance with an appropriate accounting framework (GAAP), eg International Financial Reporting Standards (IFRS) The auditors are normally required to report to shareholders on the assertion that the directors have prepared the financial statements in accordance with the appropriate legislation and GAAP Accountancy Tuition Centre (International Holdings) Ltd 2008 16 Fraud and error (2 marks) The directors have the primary responsibility for the prevention and detection of fraud and error in the financial statements, no matter how immaterial this may be Auditors have no responsibility for the prevention of fraud within an organisation However, they have a responsibility to consider the risk of material misstatement arising from fraud and error when planning and performing audit procedures and then on the evaluation and reporting of their work Going concern (3 marks) The directors are responsible for ensuring that the company will continue in operational existence for the foreseeable future and prepare the financial statements in accordance with this assumption (or otherwise with appropriate disclosure) The auditor must consider the appropriateness of management’s use of the going concern assumption and whether material uncertainties require disclosure They must consider events and conditions that may cast doubt on the enterprise’s going concern as part of their planning They must also be alert to such conditions and events as they carry out their audit and will evaluate management’s assessment for the same period as required by the accounting framework (b)(i) Audit report elements (½ mark each point, max of as shown) Statement of auditor’s responsibility: (max marks) to express an opinion on the financial statements based on their audit; that the audit was conducted in accordance with ISAs or relevant national standards or practices; explains that ISA requires the auditor to comply with ethical requirements; and that the audit was planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatement A ‘scope’ paragraph that describes the audit in that: (max marks) the audit involves the performance of procedures to obtain audit evidence about the amounts and disclosures in the financial statements; the procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error; in making risk assessments the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances (but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control); (1 mark) Accountancy Tuition Centre (International Holdings) Ltd 2008 17 the auditor: (1 mark for of two points) – – – evaluates the appropriateness of the accounting policies used; assesses the reasonableness of accounting estimates made by management; and assesses the overall presentation of the financial statements the audit evidence obtained is sufficient and appropriate to provide a reasonable basis for the audit opinion (b)(ii) Errors and omissions (½ mark for identifying plus ½ mark for explaining Max marks Only give ½ mark if no explanations given, with a max of 4) The draft report contains (at least) the following errors and omissions: No specific mention of the auditor’s responsibility, ie “to express an opinion … based on our audit” This is an essential requirement of ISA 700 and is not referred to in any wording of the draft report Whilst referring to Auditing Standards, the report does not specify which auditing standards, eg International Auditing Standards (ISA) or an appropriate national set of standards By referring to ISAs the user of the financial standards would have a specific set of standards on which to assess the work carried out The report refers to the “principles” of auditing standards Under the requirements of ISA, all auditing standards must be applied, unless inappropriate (eg IAS in the case of a service company without inventory) Using the word “principles” implies that the standards may have been interpreted to suit the client No reference is made to the fact that ISAs require the auditor to comply with ethical requirements Following the ethical principles of the IFAC (eg having integrity, objectivity etc) is an underpinning concept of auditing and it is necessary to convey this to the user of the report (hence the reference to the “independent auditor’s report” within the report title) The reference within the report to “an assessment of ALL the estimates and judgements made by the directors” implies that immaterial matters were also considered when the auditor only provides reasonable assurance that the financial statements are free from material misstatement This could mislead the user No reference is made to the use of the auditor’s judgment, assessment of risk and consideration of internal control For example, users may believe that the audit opinion also covers the working of internal control The reference to the “time available for the audit” implies that time was a limiting factor and that audit work may have been cut in order to complete the work within the time limit This would be directly against the requirements of the ISAs Under ISAs, the auditor must have “planned and performed (the audit) to obtain reasonable assurance whether the financial statements are free from material misstatement” This includes ensuring adequate time is made available This specific statement is not included within the report as required by ISA 700 The draft report confirms that the financial statements are free from material misstatement This can never be claimed due to the inherent limitations of an audit and that only reasonable assurance can be obtained (see above point) Accountancy Tuition Centre (International Holdings) Ltd 2008 18 The disclaimer given by the auditor (“no liability can be accepted by the auditor”) is highly unusual and is outside of the scope of ISA 700 To give such a disclaimer would require the written consent of the shareholders and agreement with the directors As many other third parties usually have an interest in the financial statements, most jurisdictions specifically legislate against disclaimers being made by auditors The statement that the “directors are wholly responsible for the accuracy of the financial statements” would be more appropriate if given as part of the section on management’s responsibility, rather than within the scope paragraph In addition the word “accuracy” implies being 100% correct, where as the assertions given by the directors are for the “fair presentation of financial statements that are free from material misstatement” The auditor’s responsibility relates to the financial statements and not the annual report (which would include other items and reports, eg chairman’s statement, sustainability reports) ISAs only require the auditor to review other statements issued with the financial statements for inconsistency and report if there is a material inconsistency Accountancy Tuition Centre (International Holdings) Ltd 2008 19 ... disagreed must be analysed and audited Disagreement will usually be based on cash and/ or goods in transit Where cash in transit, agree subsequent receipt of cash to cash book and through to the bank... relevant national standards or practices; explains that ISA requires the auditor to comply with ethical requirements; and that the audit was planned and performed to obtain reasonable assurance about... record, process, and report financial data Information system – consists of the physical and hardware (if IT based) infrastructure, software (if IT based), people, procedures and data It includes
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