Planning and Risk Assessment Section B Rote 2

Question 1

Audit risk explanation for forecast ratio from FD shows gross profit margin increase and operating profit margin decrease?

Answer 1

Risk that costs have been omitted or included in operating expenses rather than cost of sales. Misclassificaiton of expenses results in udnerstatement of cost of sales and overstatement of operating expenses

Question 2

Audit risk explanation for company utilising a perpetual inventory system at its warehouse rather than a full year-end count?

Answer 2

Inventory could be under or overstated if perpetual inventory counts are not all completed, such that some inventory lines are not counted in the year

Question 3

Audit risk explanation for during itnerim audit, it was noted that there were significant exceptions with inventory records being higher than inventory in the warehouse?

Answer 3

As year-end quantities will be based on the records, this likely to result in overstated inventory

Question 4

Audit risk explanation for a number of assets which had not been fully depreciated were identified as being obsolete?

Answer 4

Indication company’s depreciation policy of NCA may not be appropriate, as depreciation in past appears to be understated. If asset is obsoletem should be written off in SPL. Depreciation is understated and profits and assets overstated

Question 5

Audit risk explanation for planning to include a current asset of 0.7 which relates to advertising costs incurred

Answer 5

Advertising expenses are not capitalised and should be recognised as operating expenses. Meaning expenses are understated and assets and profit is overstated

Question 6

Audit risk explanation payroll function was transferred to service organisation

Answer 6

If any errors occurred during the transfer process, could result in wages and salaries being under/over stated

Question 7

Audit risk explanation for company has spent 0.9 developing new product lines, some of which are in early stages of development

Answer 7

If research costs have been incorrectly classified as development expenditure, there is a risk that intangible assets could be overstated and expenses understated

Question 8

Audit risk explanation for purchased and installed a new manufacturing line. Cost include purchase price, installation costs and a five-year servicing and maintenance plan?

Answer 8

As servicing and maintenance costs can’t be capitalised and must be prepayment to SPL. PPE and profits are overstated and prepayments are understated

Question 9

Audit risk explanation for as the level of debt has increased. there should be additional finance costs as the loan has an interest rate of 5%

Answer 9

Risk that this has been omitted from SPL leading to understated finance costs and overstated profit

Question 10

Audit risk explanation for company made a “price promise” to match the price of its competitors for similar products. Customers are able to claim difference from the company for one after the date of purchase of goods

Answer 10

As company may be required to provide a refund, the anticipated refund amount should not be initially recognised as revenue but instead as a refund liability until one-month price promise period has ended

Question 11

Audit risk explanation for company stopping firther sales of a product and product recall has been initiated for any goods sold since June

Answer 11

Product recall results in company paying refunds to customers. Sales removed from FSs and refund liability recognised. Failing to recognise could overstate revenue and understate liabilities

Question 12

Audit risk explanation for payables payment period and overdraft increase and current ratio decrease?

Answer 12

Indicators that company could be experiencing a reduction in its cash flow could result in going concern issues.

Question 13

Audit risk explanation for company planning to undertake the full-year-end inventory counts after year end and then adjust for movements from the year end

Answer 13

If adjustments are not completed accurately, then year-end inventory could be under or overstated

Question 14

Audit risk explanation for company outsourcing its receivables ledger processing to an external service organisation

Answer 14

A detection risk arises to whether appopriate evidence available to confirm completeness and accuracy of controls over sales and receivables cycle

Question 15

Audit risk explanation for no supplier statement or trade payables account reconciliations are performed until financial accountant is replaced which means no reconciliation will be performed at year end

Answer 15

Direct control is being overridden which means there’s an increased risk of errors within trade payables

Question 16

Audit risk explanation for company likely to have a material level of WIP at year end, being construction WIP as well as ongoing maintenance services, as company has annual contracts for many of the buildings constructed

Answer 16

If percentage completion for WIP is not correctly calculated, the inventory valuation may be under or over stated

Question 17

Audit risk explanation for latest management accounts contain 2.1 of completed properties, this balance was 1.4 in September 20X4 (inventory)

Answer 17

Increase in inventory may be due to an increased level of pre-year-end orders. May indicate that they are overvalued

Question 18

Audit risk explanation for customer who wish to purchase a property are required to place an order and a 5% non-refundable deposit prior to completion of the building

Answer 18

These deposits should not be recognised as revenue in SPL until performance obligaitons as per the contracts have been satisfied. Therefore overstated revenue and understated current liabilities

Question 19

Audit risk explanation for an allowance for credit losses/receivables has historically been maintained, but it is anticipated that this will be reduced

Answer 19

Some balances may not be recoverable if adequate allowance for credit losses/receivables is not made. There is a risk that receivables will be overvalued

Question 20

Audit risk explanation for preliminary analytical review of management accounts shows payables payment period decreased

Answer 20

The forecast profit is higher than last year, indicating an increase in trade, also company’s cash position has continued to deteriorate and therefore it is unusual for payables payment period to have decreased. This means year-end payables may be understated

Question 21

Audit risk explanation for upgraded its website for 1.1. Costs incurred should be correctly allocated between what’s expensed and what’s capitalised?

Answer 21

Intangible assets and expenses will be misstated if expenditure has been treated correctly

Question 22

Audit risk explanation for purchasing a warehouse and it is anticipated that legal process will be completed by year end

Answer 22

Only assets which physically exist at year end should be included in PPE. If transaction not completed by year end, assets will be overstated

Question 23

Audit risk explanation for significant finance has been obtained in the year, as the company has issued $5m of irredeemable preference shares

Answer 23

As preference shares are irredeemable, they should be classified as equity rather than non-current liabilities. Failure to classify shares could result in understated equity and overstated non-current liabilities

Question 24

Audit risk explanation for finance director has requested that audit completed one week earlier than normal so that results can be reported earlier

Answer 24

A reduction in audit timetable will increase detection risk and place additional pressure on the team in obtaining sufficient and appropriate evidence

Question 25

Audit risk explanation for company is intending to propose a final dividend once the FSs are finalised. Dividend is announced post-year-end

Answer 25

The dividend should only be disclosed. If dividend is included, results in an overstatement of liabilities and understatement of equity

Question 26

Audit risk explanation for directors have not disclosed the individual names and payments for each of director's renumeration?

Answer 26

Director's renumeration disclosure will not be complete and accurate if names and individual payments are not disclosed with local legislation. So FSs will be misstated as a result of non-compliance

Question 27

Audit risk explanation for revenue has grown by 19% in the year, however cost of sales has only increased 13%

Answer 27

Could potentially be an overstatement of revenue

Question 28

Audit risk explanation for level of debt increasing when there should be additional finance costs

Answer 28

Omission will mean finance costs may be understated and profit overstated

Question 29

Audit risk explanation for land and buildings are to be revalued at year end. It is likely that revaluation surplus/deficit will be material

Answer 29

Revalaution needs to be carried out and recorded in accordance with IAS 16. Non-current assets may be incorrectly valued

Question 30

Audit risk explanation for due to staff availability, company is planning to undertake a full year-end inventory count days before the year end and then adjust movements to the year end?

Answer 30

Adjustments may not be made accurately or completely. Risk that inventory could be overstated or understated

Question 31

Audit risk explanation for bank reconciliations for May and June both contain unreconciled amounts and FD believes the overall differences to be immaterial

Answer 31

If differences are not fully reconciled, it could result in bank balances being under or over stated

Question 32

Audit risk explanation for a director's bonus cheme was inrroduced which is based on achieving a target profit before tax?

Answer 32

Risk directors might feel under pressure to manipulate results through judgements taken or throughthe use of provisions

Question 33

Audit risk explanation for FD has requested that audit commence earlier than normal so results can be reported earlier?

Answer 33

Audit may be rushes to complete by the deadline. Reduction in audit timetable will increase detection risk and place additional pressure on the team in obtaining sufficient and appropriate evidence

Question 34

Audit risk explanation for if previous FD left in December after items discovered that fruad had been committed with regards to expenses claimed?

Answer 34

Risk finance director may have undertaken other fraudulent transactions, these need to be written off in SPL

Question 35

Audit risk explanation for new FD was appointed in and was previously a financial controller of a bank. Different company to where financial controller was originally at?

Answer 35

Risk that new financial controller is not sufficiently competent to prepare FSs. Leading to FSs containing error

Question 36

Audit risk explanation for there being a significant number of sales returns made subsequent to year end

Answer 36

As they are pre-year-end sales, thney should be removed from sales. If not, revenue is overstated and inventoryu is understated

Question 37

Audit risk explanation for company's year-end inventory count there were movements of goods in and out?

Answer 37

If goods in transit were not carefully controlled, then goods could have been omitted or counted twice. Results in inventory being under or over-stated

Question 38

Audit risk explanation for company purchases goods from Europe and goods in transit for two weeks

Answer 38

Only goods which have been received into warehouse should be included in inventory balance and a respective payables balance recognised. Purchases and payables may not be accurate at cut-off

Question 39

Audit risk response for FD undertaking fraudulent transactions?

Answer 39

These would need to be written off in the statement of profit or loss

Question 40

Audit risk explanation for an intangible asset can only be recognised if all the criteria of IAS 38 Intangible Assets are met

Answer 40

The cost of projects that may not reach the final development stage should be expensed rather than capitalised. Intangible assets and profit could be overstated

Question 41

Audit risk explanation for Sycamore has borrowed $2.0m from the bank as a 10-year loan.

Answer 41

This loan needs to be correctly split between current and non-current liabilities in order to ensure correct disclosure.

Question 42

Audit risk explanation for the level of debt has increased, there should be additional finance costs

Answer 42

There is a risk that this has been omitted from the statement of profit or loss, leading to understated finance costs and overstated profit.

Question 43

Audit risk explanation for if Sycamore does not have sufficient cash for the loan repayment?

Answer 43

There is a risk of profit manipulation to meet any covenants.

Question 44

Audit risk explanation for there have been a significant number of sales returns made subsequent to the year end?

Answer 44

As these relate to pre-year-end sales, they should be removed from revenue in the draft financial statements and the inventory reinstated

Question 45

Audit risk explanation for goods in transit were not carefully controlled?

Answer 45

Goods could have been omitted or counted twice. This would result in inventory being under or overstated

Question 46

Audit risk explanation for significant profits or losses on disposal?

Answer 46

Indication that the depreciation policy of plant and equipment may not be appropriate. Therefore depreciation may be overstated

Question 47

Audit risk explanation for significant finance has been obtained in the year, as the company has issued $5m of irredeemable preference shares?

Answer 47

As the preference shares are irredeemable, they should be classified as equity rather than non-current liabilities. Failing to correctly classify the shares could result in understated equity and overstated non-current liabilities.

Question 48

Audit risk explanation for a customer has had difficulties paying their outstanding balance of $1.2m and Hurling Co has agreed to a revised credit period.

Answer 48

If the customer is experiencing difficulties, there is an increased risk that the receivable is not recoverable and, therefore, overstated.

Question 49

Audit risk explanation for Hurling Co has halted further sales of its new product Luge and a product recall has been initiated for any goods sold in the last four months?

Answer 49

If there are issues with the quality of the Luge product, inventory may be overstated as its net realisable value (NRV) may be less than cost.

Question 50

Audit risk explanation for the company is intending to propose a final dividend once the financial statements are finalised?

Answer 50

There can be no provision for this in the 20X5 financial statements, as the obligation only arises once the dividend is announced, which is after the year end. Providing for the dividend would result in an overstatement of liabilities and understatement of equity.

Question 51

Audit risk explanation for the forecast profit is higher than last year, indicating an increase in trade, and PCC’s cash position has continued to deteriorate/ Therefore unusual for payment period to have decreased?

Answer 51

There is an increased risk of errors within trade payables and the year-end payables may be understated.

Question 52

Audit risk explanation for all of this expenditure has been recognised as an intangible asset?

Answer 52

If research costs have been incorrectly capitalised, there is a risk that intangible assets are overstated and expenses understated.

Question 53

Audit risk explanation intends to obtain a stock exchange listing in the next 12 months?

Answer 53

Therefore, the directors have an incentive to manipulate the financial statements by overstating revenue, profits and assets

Question 54

Audit risk explanation for receivables collection period has increased from 38 to 51 days and management has extended the credit terms given to customers on the condition that sales order quantities were increased?

Answer 54

Could also be due to an increased risk over recoverability of receivables as they may be overstated and expenses understated.

Question 55

Audit risk explanation for Darjeeling Co has stopped further sales of one product line and a product recall has been initiated for any goods sold since April?

Answer 55

This product recall will result in refunds to customers. The sales should be removed from the 20X5 financial statements and a refund liability recognised

Question 56

Audit risk explanation for the company is holding damaged paint products in inventory and overall the inventory holding period has increased from 45 days to 54 days.

Answer 56

The quality of these products is in doubt and management is investigating whether they can be rectified. There is a risk that this inventory may be overstated as its net realisable value may be below cost.

Question 57

Audit risk explanation for revenue has increased by 16.8% and the gross margin has increased slightly from 36.4% to 37.3%.

Answer 57

This significant increase in revenue, along with the increase in gross margin, may be due to the increased credit period and price promise but could be due to an overstatement of revenue

Question 58

Audit risk explanation for the payables payment period has increased from 40 to 58 days?

Answer 58

The current ratio has decreased from 3.08 to 1.65. The quick ratio has also decreased from 1.97 to 0.99

Question 59

Audit risk explanation for external audit team may place reliance on the tests of controls performed by the IA department?

Answer 59

If reliance is placed on irrelevant or poorly performed testing, the external audit team may form an incorrect conclusion on the strength of the system of internal controls

Question 60

Audit risk explanation for planning to make approximately 60 employees redundant after the year end?

Answer 60

The timing of this announcement has not been confirmed; if announced to staff before the year end, a redundancy provision must be recognised at the year end for the constructive obligation. Failure to provide or to provide an appropriate amount will result in an understatement of provisions and expenses.

Question 61

Audit risk explanation for the patent should be amortised over its four-year life (IAS® 38 Intangible Assets). It appears that management has not yet accounted for amortisation?

Answer 61

Intangible assets and profits are overstated.

Question 62

Audit risk explanation for the report to management issued after the prior year audit highlighted significant deficiencies relating to the purchases cycle.

Answer 62

If these deficiencies have not been rectified, the controls over purchases and payables may continue to be weak leading to increased control risk and risk of misstatements arising

Question 63

Audit risk explanation for if the company has not accounted for a bonus issue before?

Answer 63

A risk that an incorrect treatment could result in the under of overstatement of equity

Question 64

Audit risk if the loan has a minimum profit target covenant. If this is breached, the loan would be instantly repayable and would be classified as a current liability

Answer 64

If Sycamore does not have sufficient cash for the loan repayment, there could be going concern implications. Also, there is a risk of profit manipulation to meet any covenants.

Question 65

Audit risk for the finance director has extended the useful lives of fixtures and fittings from three to four years

Answer 65

Risk that this reduction has occurred to inflate profits. If this is the case, fixtures and fittings are overstated and profit overstated.

Question 66

Audit risk for Petanque Co, a customer, has announced its intention to commence legal action for a loss of information and profits in respect of the Luge product sold to them

Answer 66

If it is probable that Hurling Co will make a settlement payment, a legal provision is required. If a payment is possible rather than probable, a contingent liability disclosure would be necessary. If Hurling Co has not done this, there is a risk that provisions are understated or the necessary disclosure of contingent liabilities is incomplete.

Question 67

Audit risk if at the year end, there will be inventory counts in progress at all 11 of the building sites?

Answer 67

Unlikely that Cupid & Co will be able to attend all of the counts, increasing detection risk

Question 68

Audit risk if during the year, Darjeeling Co spent $0.9m on developing new product lines; some are in the early stages of development.

Answer 68

Research costs must be expensed to profit or loss and only development costs capitalised as an intangible asset

Question 69

Audit risk for the payroll function was transferred to the service organisation from 1 April 20X5, which is five months before the year end?

Answer 69

If any errors occurred during the transfer process, these could result in under/overstatement of wages and salaries

Question 70

Audit risk for Tte delivery time of three weeks from the company’s international supplier is likely to result in goods in transit at the year end?

Answer 70

Inventory is not recorded on dispatch; therefore, inventory and liabilities are understated at the year end

Question 71

Audit risk if directors’ remuneration has been disclosed in compliance with IFRS Accounting Standards but not local legislation?

Answer 71

Where the local legislation is more comprehensive than IFRS Accounting Standards it is likely that the company must comply with local legislation

Question 72

Audit risk if a sales-related bonus scheme has been introduced in the year for sales stafff

Answer 72

Receivables may be overstated if sales staff set up new accounts with poor credit ratings, leading to irrecoverable receivables

Question 73

Audit risk if directors have not accounted for any costs under the new contract for bottles as no amounts are due to be paid until after the year end?

Answer 73

Risk costs incurred to date have not been recognised and therefore costs and liabilities are understated and profit overstated

Question 74

Audit risk explanation for purchased patent 800 at end of prior year which has useful life of 4 years but carrying amount iss till the same?

Answer 74

Amortisation should have been accounted for, meaning intangible assets are overstated