June 2018 exam short form Qs

Question 1

You are planning the external audit of Eustace plc (Eustace), a steel producer, for the year
ending 30 September 20X8. During your review of internal audit reports, you read that some
steel was incorrectly classified resulting in low quality steel being sold as high quality steel. The
directors have informed the industry regulators and have taken action to rectify the matter.
Requirement
Identify the business risks to which Eustace is exposed as a result of this matter and state the
implications for the financial statements.
(4 marks)

Answer 1

Business risks
* Suspension of licence/closure
* Fines
* Litigation
* Rectification costs
* Loss of reputation
* Negative impact on:
– Cash flow
– Revenue/profits
Implications for financial statements
* Revenue overstated/refunds understated
* Irrecoverable trade receivables
* Inventory write-downs
* Provisions for fines/damages
* Going concern basis of preparation may not be appropriate
* Going concern uncertainty may not be disclosed.

Question 2

You have completed the controls testing on payroll during the external audit of Jenkins Ltd.
You found that in two cases out of 30 tested there was no evidence that one particular control
was operated.
Requirement
State, with reasons, the actions that you would take in respect of this matter.
(3 marks)

Answer 2

Actions
* Enquire of staff reason for the lack of evidence
* Extend sample used for controls testing
* Consider whether:
– extended testing identifies further non-compliance
– compensating controls are in place
– management override
– any monetary error
* If so, extrapolate monetary error across whole population
* If errors are isolated, rely on controls to reduce substantive procedures
* If controls can’t be relied upon, increase substantive procedures
* Report deficiency to management.

Question 3

You are the audit senior on the external audit of Lawson plc. During the interim audit, the
credit controller asks for a private interview with you. During this interview she informs you that
she suspects the chief accountant of misappropriating company funds received from
customers and altering the financial records.
Requirement
List the actions that you would take to assess whether the credit controller’s suspicions are
valid.
(3 marks)

Answer 3

Actions
* Inspect documents which have aroused suspicions
* Review previous report to management for any deficiencies allowing misappropriation
* Consider credit controller’s integrity
* Consider chief accountant’s integrity
* Investigate any apparent override of control procedures
* Reduce materiality
* Increase substantive testing/controls testing
* Detailed testing, for example:
– tracing bank receipts to ledger
– direct confirmation
– review journal entries
– inspect credit notes
* Consult engagement/ethics partner for advice.

Question 4

Your firm has recently accepted appointment as external auditor of Healey Ltd, a competitor of
Howe Ltd (Howe). Your firm has acted as external auditor of Howe for many years. Both
companies have provided your firm with informed consent to act.
Requirements
Outline the procedures that your firm should implement to address any potential conflicts of
interest arising out of this appointment.
(3 marks)

Answer 4

Procedures to address potential conflicts of interest
* Separate engagement teams
* Brief staff /clear guidelines on confidentiality issues
* Information barriers
– physical separation of teams
– such as using staff from different offices
– confidential data filing
* Procedures for dealing with any need to disseminate information beyond barrier
* Staff to sign confidentiality agreements
* Regular review of the application of safeguards
– by a senior individual not involved in the engagements.

Question 5

Explain why the level of assurance provided by a report on the examination of prospective
financial information differs from the level of assurance provided by an auditor’s report on
annual financial statements.
(3 marks)

Answer 5

Explain why the levels of assurance differ
* Examination provides limited/moderate assurance
* Audit provides reasonable assurance
* Assurance lower on examination/higher on audit
* More work on audit/less work on examination
* Examination is on assumptions about the future:
– which is subject to uncertainty
* Examination reduces risk to a level that is acceptable
* Audit is on historical information:
– which can be verified to a greater degree
– estimates can be corroborated by subsequent events
* Audit reduces risk to an acceptably low level.

Question 6

Your firm is the external auditor of Dalton City Ltd (Dalton), a football club, for the year ended
31 May 20X8. On 30 April 20X8 Ron Osborne commenced legal proceedings against Dalton.
Ron is the former team manager who was dismissed by Dalton on 31 March 20X8 and is
claiming substantial damages for breach of contract. The directors of Dalton dispute the claim.
If the claim is successful, the damages are likely to be material to the financial statements of
Dalton for the year ended 31 May 20X8 but will not affect the going concern status of Dalton.
Requirement
List the audit procedures that your firm should undertake in respect of the legal claim by Ron.
(4 marks)

Answer 6

Audit procedures
* Review correspondence/consult with Dalton lawyers:
– about the expected outcome
* Ascertain if covered by insurance
* Inspect Ron Osborne’s contract of employment:
– for terms and conditions
* Review correspondence from Ron Osborne or his lawyers:
– for basis of claim
* Review any similar legal cases:
– for indication of potential outcome
* Ascertain Dalton’s intentions regarding accounting treatment:
– if damages probable:
◦ ensure a provision is recognised
– if damages possible:
◦ ensure disclosed as a contingent liability
* Inspect minutes/discuss with management
* Obtain written representation re:
– management’s intention to fight claim or settle out of court
– assumptions used in accounting treatment.