December 2016 exam short form Qs

Question 1

Explain the benefits of the mandatory rotation of the appointment of audit firms.
(3 marks)

Answer 1

Benefits of the mandatory rotation of the appointment of audit firms
* Increased objectivity
* Increased independence
* Reduced familiarity threat
– Greater professional scepticism
– Reduced risk of inappropriate opinion
* Reduced self-interest threat
– Auditors more likely to challenge their clients
– No expectation of long-term relationship
* Increased competition
– Opportunities for medium-sized firms to audit listed companies
– May reduce cost to clients
* Greater confidence in the audit process

Question 2

Your firm is the external auditor of Storm Relief, a not-for-profit entity, whose main sources of
revenue are cash donations received through the post and through collection boxes managed
by volunteers.
Requirement
List the internal controls that Storm Relief should have in place over cash donations received
through the post and through collection boxes managed by volunteers.
(4 marks)

Answer 2

Internal controls over cash donations received through the post and through collection boxes
Postal donations
* Unopened mail kept securely
* Dual control over the opening of mail
* Immediate recording of donations on opening of mail
* List of donations totalled and signed
* Independent reconciliation of amounts banked with the amounts recorded
* Designated funds highlighted
Collection boxes
* Sequential numbering of boxes
* Record kept of who has the boxes
* Sealed boxes
* Boxes secured in fixed locations
* Regular collection of collection boxes
* Dual control over counting of proceeds
General
* Unopened mail kept securely
* Dual control over the opening of mail
* Immediate recording of donations on opening of mail
* List of donations totalled and signed
* Independent reconciliation of amounts banked with the amounts recorded
* Designated funds highlighted

Question 3

Your firm has been the external auditor of both Langdon Ltd (Langdon) and Portdean Ltd
(Portdean) for several years. Langdon has requested your assistance in determining an
appropriate valuation for its business and has invited bids for its share capital. Portdean is
considering making a bid for all of the share capital of Langdon and has also requested your
assistance in valuing Langdon.
Requirement
Identify and explain the principal threats to your firm’s independence and objectivity which
may arise from the situation described above.
Note: You are not required to list safeguards to mitigate those threats.
(3 marks)

Answer 3

Threats to independence and objectivity
* Conflict of interest
– Langdon wants to maximise share value
– Portdean wants to minimise share value
– firm may not be able to act in best interests of both parties
* Self-interest threat
– May favour Portdean
– In hope of retaining future audit work
* Self–review threat
– Investment will be included in Portdean’s financial statements
– Firm may not sufficiently scrutinise it during Portdean’s external audit or
– May be reluctant to highlight errors with the valuation
* Management threat
– Determining the valuation involves judgement

Question 4

A cold review of the external audit file of one of your firm’s clients identified that the audit
documentation did not show any evidence that work performed by junior members of the
audit team was reviewed by more senior members.
Requirement
Explain why this deficiency was identified and describe the actions that your firm should take.
(3 marks)

Answer 4

Actions you should take based on deficiency:
* ISA (UK) 220 requirement
– Review junior’s work and
– Record/document review (ISA (UK) 230)
◦ What audit work was reviewed
◦ Who reviewed the audit work
◦ When it was reviewed
* Review may not have been undertaken
* Cannot demonstrate that firm has complied with ISAs
* Higher risk of material misstatement/inappropriate opinion if no review
* Adverse feedback following quality assurance review
Actions
* Staff training
* Disciplinary procedures
* Monitoring of policy
* Review of firm’s procedures to ensure adequacy

Question 5

The managing director of Oldfield Ltd (Oldfield), an external audit client of your firm, has
discovered that a warehouse manager made fictitious entries in Oldfield’s inventory records to
conceal the misappropriation of inventory costing £25,000. The managing director discovered
the fraud as a result of an inventory count at which your firm was not present. He has contacted
your firm to express his concern that the audit team did not discover this fraud during the
external audit. The financial statements for the current year show revenue of £10 million and
profit before tax of £1.5 million.
Requirement
Explain why the managing director’s expectation that the audit team should have discovered
the fraud is unrealistic.
(4 marks)

Answer 5

Unrealistic expectations:
* The primary responsibility for the prevention and detection of fraud rests with
management. This is discharged by:
– promoting fraud prevention
– creating a culture of honesty and ethical behaviour
– implementing a system of control to reduce risk of fraud: and
– monitoring of the system
* The auditor is responsible for obtaining assurance that the financial statements are free
from material misstatement.
* Audit work must be planned so there is a reasonable expectation of discovering fraud
which has a material impact on the financial statements.
* The amount involved is not material as:
– 0.25% of revenue
– 1.67% of profit before tax
* Audit involves sampling
* Fraud is often concealed and difficult to detect

Question 6

While reviewing the post year-end purchase invoices of Melchester Ltd (Melchester), an
international engineering company, the audit senior discovered an invoice for a luxury cruise
holiday costing £17,500. On enquiry, the audit senior was informed that the cruise was
purchased for the managing director of Terino SpA (Terino). Terino is an Italian oil exploration
company to which Melchester regularly submits tenders for work.
Requirement
State, with reasons, the action to be taken by the audit senior.
(3 marks)

Answer 6

Actions to be taken by the audit senior
* The amount is excessive in value
* May represent bribery
– which is a criminal offence
– under the Bribery Act 2010
– and is global in scope
*Report to firm’s MLRO or senior member of engagement team
* Required to be reported under Proceeds of Crime Act
– benefiting from criminal conduct
* Avoid tipping off
– so as not to prejudice subsequent investigation