feedback tutorial letter 1 semester 2017 assignment 2 auditing … · 2017. 5. 15. · tutorial...

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FEEDBACK TUTORIAL LETTER

1ST SEMESTER 2017

ASSIGNMENT 2

Auditing 310 [AUD612S]

May 2017

TUTORIAL LETTER MEMO

SEMESTER 1/2017

"COURSE NAME" AUDITING 310

"COURSE CODE" AUD 612S

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Types of audit evidence Award 2 marks for each well explained point. Allow 1 mark for simply stating the appropriate area. Analytical procedures 1 Inquiry 1 Inspection 1 Observation 1 Re-calculation 1

Maximum marks 10

Examples of evidence Award 2 marks for each well explained point. Allow 1 mark for simply mentioning the appropriate test Analytical procedures 1 Inquiry 1 Inspection 1 Observation 1 Re-calculation 1

Maximum marks 10

Suitability of methods of gathering evidence

(b) Part (a) required candidates to state tests that could be carried out in (b) takes this

forward to actually considering whether each type of testing would be used in Mango .

Candidates should be able to identify that some methods of gathering evidence such

as enquiry are of more use than others. Note –also allow procedures as if used in

Mango limited by director – question could be read this way.

Types of audit evidence

Award one mark for explaining whether each technique is suitable for Mango Ltd and

one mark for explaining limitations in that technique to a maximum of 10

a) Analytical procedures

(i) Analytical procedures mean the study of trends and ratios in financial and non-

financial information. It is used within audit planning to identify risk areas and also as

a means of gathering substantive evidence, for example by calculating an estimate

of a particular figure based on knowledge of the business and comparing this to the

actual figure.


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(ii) A comparison of gross profit percentages month by month for Mango could be

performed and any unusual fluctuations investigated as these could indicate errors

such as omission of sales, loss of inventory, or other errors.

Inquiry

(i) Inquiry means requesting information. This could be from individuals within the

company, either orally or in written representations, or in formal written requests to

third parties.

(ii) In Mango Ltd a relevant example would be to send a standard confirmation letter to

the company's bank (could be illustrated with an example of enquiry to client staff).

Inspection

(i) Inspection means looking at documentation, books and records or assets. This

could be done to confirm existence of an asset, to verify values or to provide evidence

that a control has taken place.

(ii) The inventory of cuddly toys at the year-end could be inspected as part of the

evidence relating to its value. The inspection would give evidence as to whether the

inventory was in good saleable condition (could be illustrated with an example of

inspection of documentation).

Observation

(i) Observation means watching a procedure being carried out. It is usually used as a

means of gathering evidence about the internal controls in a company.

(ii) In Mango Ltd it might be appropriate to observe the procedures that are carried out

when the post is opened to assess whether controls exist to prevent the

misappropriation of cash.

Recalculation

(i) Recalculation means the reperformance of an arithmetical process within the

accounting system.

(ii) This could involve re-checking a manual calculation or using a computer-assisted

audit technique to re-perform casts within the accounting records)

.

(b) The usefulness of analytical procedures depends on a number of factors

including the reliability of the underlying information. It seems that, as a small

business, Mango has little segregation of duties and formal controls. This casts doubt


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on the reliability of the information and hence the conclusions that might be drawn

from the analytical procedures.

Inquiry evidence from third parties will be essential in the audit of Mango. As

well as the bank confirmation, it may be necessary to send confirmation letters

to suppliers to obtain third party evidence of the liabilities at the year-end.

Inquiry evidence from sources within Mango will be obtained mainly from

Mr Khata and its reliability will be very dependent on how the auditors assess his

integrity.

Inspection of documents will be a major part of the evidence gathered in the

audit of Mango. Supplier invoices will be inspected to verify values and to

confirm that purchases and expenses are genuinely business items. There may

be limits to the reliance that can be put on this as in a poor control environment

it may be difficult to confirm whether documentation is complete.

Observation may be the only way to gather evidence about controls such as

any that may exist over the opening of post. This type of evidence is limited in

its usefulness for two reasons:

– It only provides evidence that the control operated at the point in time that the

auditor carried out the test

– Client staff are likely to perform their duties exactly according to the company's

procedures manual when they are aware that the external auditor is observing them

whereas this may not be the case on any other day of the year

To place reliance on controls and reduce substantive testing the auditor needs

evidence that controls operated effectively over the whole of the accounting period so

the observation would be of limited usefulness. Observation of controls in operation

over the year-end inventory count might be more useful as this is a one-off, rather

than daily, procedure. If the auditor could see that the inventory count was being

carried out in a well-controlled way then it may be possible to reduce substantive

testing on the inventory sheets.

Re-calculation is a good check of the accuracy of invoices and control

accounts. However it only covers figures that that have been recorded in the

accounts, and will not identify omitted figures


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QUESTION 2 (30 Marks) One mark per point (i) Sampling risk Explanation 1 Example 1 Non-sampling risk Explanation 1 Example 1 (ii) Sampling risk Controlled by 1 Non-sampling risk Controlled by 1 Allow other relevant points 1

Maximum marks 10 (b) One mark per point Audit manager comments Explanation of sampling method 1 Small population 1 Transactions material 1 Audit senior points Explanation of sampling method 1 Population homogenous – therefore use statistical sampling 1 Time to produce sample 1 Audit junior points Explanation of sampling method 1 Sample selection not random 1 Can't draw valid statistical conclusion 1 Allow other relevant points 1

Maximum marks 10

2 marks per point Definition Materiality – omission or misstatement 1 Materiality – size of the item 1 Important because: Financial statements incorrect 1 Directors/owners know of errors; auditor reporting to 1 Third parties rely on financial statements 1 Other relevant points 1

Maximum marks 10

(a) (i) 'Sampling risk' is the risk that the auditor's conclusion, based on a sample, may

be different from the conclusion reached if the entire population were subject to the

same audit procedure. There are two types of sampling risk. In the first type, the

auditor concludes in a test of controls, that controls are more effective than they

actually are, or in a test of details, that a material error does not exist when it actually

does. In the second type, the auditor concludes in a test of controls, that controls are

less effective than they actually are, or in a test of details, that a material error exists

when it actually does not.


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'Non-sampling risk' arises from factors that cause the auditor to reach an incorrect

conclusion for any reason not related to the size of the sample. For example, the

auditor may rely on audit evidence that is persuasive rather than conclusive, the

auditor may use inappropriate audit procedures, or the auditor misinterprets audit

evidence and fails to recognise an error.

(ii) Sampling risk can be controlled by the audit firm by increasing sample size for

both tests of control and tests of detail.

Non-sampling risk can be controlled by the audit firm by proper engagement

planning, supervision and review.

(b) The audit manager wants to check all the invoices in the year. This would involve

checking around 500 invoices. This would be impractical in terms of time and cost for

the directors of Windhoek Plc. Although 500 is not a huge population, it is unlikely that

the firm would test 100% in practice.

The audit senior wants to select a sample using statistical sampling techniques. This

would involve calculating a sample size appropriate to the auditor's assessment of

factors such as risk, required confidence level, tolerable misstatement and expected

error. Such a sample can still produce valid conclusions and in this case, the

population consists of items showing similar characteristics. Where statistical sampling

is used all the items in the population must have an equal chance of being selected,

so the sample should be picked using a method such as random number tables or a

systematic basis. Provided that the sales invoices are sequentially numbered, this

should be easy to apply in the example.

The audit junior's suggestion is to use a 'random' method of selecting samples

manually and choosing a few important ones. This approach would not be appropriate

because the auditor is not choosing the sample randomly as there would be bias

involved and implies that 'haphazard' selection would be used. Valid

conclusions would not be able to be drawn because statistical sampling had not been

used to select the sample.

(c) Information is material if its omission or misstatement could influence the

economic decisions of users taken on the basis of the financial statements. Materiality

depends on the size of the item or error judged in


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the particular circumstances of its omission or misstatement. Materiality also has

qualitative, as well as quantitative, aspects which must be considered. The auditor

will determine materiality levels for the financial statements as a whole, but will also

set lower levels of performance materiality:

To reduce to an appropriately low level the risk that undetected or uncorrected

aggregate misstatements exceed materiality for the financial statements as a

whole.

For particular classes of transactions, account balances or disclosures

Materiality for the financial statements as a whole is often calculated as a percentage

of different items in the financial statements, such as revenue, profit before tax or net

assets. In the case of Windhoek Plc, materiality is likely to be based on 0.5 – 1% of

revenue, ie $350-700k.

The auditors of Tam Co must form an opinion on whether the financial statements are

free from material misstatement because there is a requirement for an audit under

local legislation for this company. Other users of the accounts may also be relying on

the outcome of the audit, such as the bank since the company has recently taken out

a five-year bank loan to finance an expansion. The bank would be very interested in

the accounts of Windhoek Plc as a basis for assessing whether the company will be

able to repay the loan. Users of the financial statements expect to receive reasonable

assurance that the information is ‘presented fairly in all material respects’ or is 'true

and fair'. This implies that there are no material misstatements or omissions

QUESTION 3 (30 marks)

Elements of audit report. 1 mark for each of the following (being 0.5 for the element and 0.5 for explanation for that element). Title of report Addressee of report Introductory paragraph Auditor’s responsibilities Management’s responsibilities Opinion Date of report Auditor's address Auditor's signature Up to Six marks


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(b) Maximum 24 marks this section (14 for (1) and 10 for (2)) (i) Additional audit procedure

Issue one – up to 14 marks Additional audit work Discuss with directors Action against director Management letter Letter of representation Other relevant points (each)

Issue two – up to 10 marks Talk with director Asset transferred to director? Ask whether any payment made for yacht Check disclosure financial statements Check tax return Other relevant points (each) (ii) Effect on audit report

Issue one – up to 3 marks Amount is material 1 Modify opinion qualified 'except for' 1 Explain why modified 1

Issue two – up to 3 marks Modify opinion – qualified 'except for' Provide disclosure

Maximum marks 24

(a) Audit report

Title

The audit report should have a title which includes the wording 'independent auditor' to

distinguish this report from others that may be prepared internally by the company.

Addressee

The report should be appropriately addressed as required by the engagement and

local regulations. This is normally to the shareholders of the company or to those

charged with governance.


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Introductory paragraph

This section identifies the financial statements being audited, including the date and

period covered. It also identifies the title of each statement that comprises the financial

statements being audited.

Management’s responsibility for the financial statements

This part of the report is included to describe the responsibilities of those who are

responsible for the preparation of the financial statements including those in respect of

internal control.

Auditor’s responsibility

This section describes the auditor’s responsibility for expressing an opinion, notifies

users that the audit was carried out in accordance with ISAs and explains what an

audit involves.

Opinion

This indicates the financial reporting framework used to prepare the accounts and

states the auditor's opinion as to whether the financial statements present fairly, in all

material respects (or show a true and fair view of) the financial position of the audited

entity in accordance with that framework.

Date

The audit report should be dated as at the completion of the audit, to show that the

auditor has considered any events after the reporting period date up to the date of

completion and how these might affect the financial statements. The report should not

be dated earlier than the date on which the accounts are signed or approved by

management.

Auditor's address

The audit report should name a specific location, which is normally the city or town

where the auditor maintains the office that has responsibility for the audit.

Auditor's signature

The audit report should be signed in the name of the audit firm, the personal name of

the auditor, or both, as appropriate. It is usually signed in the name of the firm

because the firm assumes responsibility for the

audit.

(Note. Only six were required.)


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(b) Issue 1 – understatement of sales income

(i) Audit procedures

– Discuss the issue with the other directors of the company so that they are aware of

the matter and its seriousness

– Perform further substantive audit work, such as detailed analytical review, to confirm

the extent of the understatement

– Obtain a written management representation letter point of the estimate of the

amount of the fraud

(ii) Potential effect on audit report

As this issue is material, the understatement of sales income representing 5% of total

revenue for the year, it is likely to have a negative effect on the audit report. The report

should include a qualified opinion on the basis of an inability to obtain sufficient

appropriate audit evidence on sales for the year. The audit report should provide

details of this matter giving rise to the qualified opinion in a Basis for qualified opinion’

paragraph.

Issue 2 – personal use of boat

(i) Audit procedures

– Discuss the issue in more detail with the director concerned

– Through discussion, find out whether the director purchased the boat and if so,

agree the amount to the cash book and bank statements and non-current asset

register

– Review financial statements to ensure correct disclosure as a director's benefit

within directors' emoluments

(ii) Potential effect on audit report

Non-current assets on the statement of financial position will be overstated since they

include a boat that is used for personal use by one of the directors and not for the

purposes of the business. Given that, non-current assets are likely to be material to

the statement of financial position; this issue may result in a qualified audit opinion on

the basis that the overstatement of non-current assets has resulted in the accounts

being materially misstated. The value of the boat should be taken off the statement of

financial position and it should be reclassified as a benefit within the directors'

emoluments notes


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QUESTION 4 (10 marks)

Duties re financial statements Allow 1 mark for director responsibilities, and 1 for auditor responsibilities Preparation of financial statements Fraud and error Disclosure Going concern Similar relevant points – each point

Maximum marks 4

(b) Auditors' reports Up to 1 mark per relevant point Use of term Auditing Standards Limitation on use of judgements and estimates Time limitation FS free from material error Directors' responsibilities Reference to annual report Allow other relevant points

Maximum marks 6

(a) Preparation of financial statements

The directors have a legal responsibility to prepare financial statements giving a true

and fair view. This implies that they have been prepared in accordance with the

relevant IASs and IFRSs.

The auditor's duty is to carry out an audit (according to the International Standards on

Auditing) and to give an opinion on whether a true and fair view is given (or whether

the financial statements present fairly, in all material respects, the financial position of

the entity). In doing this they will have to consider whether the relevant accounting

standards have been properly followed.

Estimates and judgements and accounting policies

The directors have the responsibility for making the estimates and judgements

underlying the financial statements and for selecting the appropriate accounting

policies.

The auditor's responsibility is to assess the appropriateness of the directors'

judgements and to modify the audit opinion in the case of any disagreement causing

the auditors to conclude the financial statements are not free from material

misstatement.


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Fraud and error

The directors have a duty to prevent and detect fraud and error. This is a duty they

owe to the shareholders and there is no 'materiality' threshold attached to their duty.

The auditor is responsible (under ISA 240) for obtaining reasonable assurance that

the financial statements are free from material misstatement including material

misstatement caused by fraud.

The auditor is responsible for maintaining professional scepticism throughout the

audit, considering the possibility of management override of controls. The audit team

must discuss how and where the entity's financial statements may be susceptible to

material misstatement due to fraud, including how fraud might occur.

Disclosure

The directors are responsible for disclosing all information required by law and

accounting standards.

The auditor's responsibility is to review whether all the disclosure rules have been

followed and whether the overall disclosure is adequate. There are certain pieces of

information, which, if not disclosed by the directors, must be disclosed by the auditor in

his report. Examples of this are related party transactions and transactions with

directors.

Going concern

The directors are responsible for assessing whether it is appropriate to treat the

business as a going concern. In doing this, they should look at forecasts and

predictions for at least twelve months from the reporting date. They should also

disclose any significant uncertainties over the going concern status of the company

The auditors' responsibility is to consider whether there are any indicators of going

concern problems in the company, and assess the forecasts made by directors and

decide whether the correct accounting basis has been used and whether there is

adequate disclosure of significant uncertainties.

The auditor must consider modifying the audit opinion in the auditor’s report if:

(i) The directors have considered a period of less than twelve months from the

reporting date (this could result in a qualified opinion due to an inability to obtain

sufficient appropriate evidence)


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(ii) The directors have used the going concern basis when the auditor believes that its

use is not appropriate (this will be a result in an adverse opinion)

(iii) The auditor agrees with the basis chosen by the directors but feels that the

disclosures are inadequate (this will probably result in a qualified 'except for' opinion)

(iv) The auditor agrees with the chosen basis, and that the disclosures are adequate

but there are uncertainties over the going concern status of the company. In this case,

the opinion will be unmodified but an emphasis of matter paragraph will be added.

(b) Errors in the report extract

'Presentation of information in the company's annual report'

The auditor's legal responsibilities relate to the financial statements, which comprise

the primary statements plus the supporting notes. They do not extend to any other

information, for example a chairman's statement, or 5-year summary. To make this

clear, this section should refer only to the financial statements.

Under ISA 720, the auditor’s responsibilities relating to other information in documents

containing audited financial statements the auditor has a responsibility to read the

other information to identify whether there are any inconsistencies with the financial

statements or anything that is misleading, but the primary opinions given on the

financial statements only.

'In accordance with Auditing Standards'

The report should specify exactly which auditing standards have been used so that

there is no risk that readers misunderstand how the audit has been done. It should

specify that the audit has been performed in accordance with International

Standards on Auditing.

'Evaluating ….the reasonableness of all accounting estimates'

It is inappropriate to imply that the auditor has considered every estimate made by

management. This is unlikely to be true because auditors do not look at every single

transaction and item in the financial statements; it is the duty of the auditor to give

assurance only on whether the financial statements are free from material

misstatement.

'As much audit evidence as possible in the time available'

This phrase is inappropriate because it implies that the auditor has not had time to

obtain all the evidence


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that is needed. The auditor is expected to obtain sufficient evidence on which to base

conclusions. The auditor should have planned the audit so as to obtain sufficient

evidence in the time available.

'Confirm'

This word should not be used because it implies a greater degree of certainty than is

possible based on normal audit procedures. The certainty implied by the word 'confirm'

may expose the auditor to negligence claims if it turns out that there are any material

errors in the financial statements. A more accurate

description of the level of assurance given by an audit is 'reasonable assurance'.

'No liability for errors can be accepted by the auditor'

This disclaimer at first might appear to be useful in protecting the auditor against

liability. However, the view of the ACCA is that general disclaimers should not be

included in audit reports, as their use would tend to devalue the audit opinion.

The directors are wholly responsible for the accuracy of the financial statements'

This statement should not appear in the auditor’s responsibility section of the report.

Details of management’s responsibilities is differently worded and should appear in an

earlier separate section of the report outlining the responsibility of management for the

preparation of the financial statements.

feedback tutorial letter 1 semester 2017 assignment 2 auditing … · 2017. 5. 15. · tutorial...

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