practical illustration: doing a numerical and discursive question … · 2013. 12. 16. · abrahams...

Practical Illustration: Doing a

Numerical and Discursive

Question in Class

Adjunct Associate Professor Chee

Explaining Concept

• Some concepts may be abstract for students who do not have working experience, e.g.

– Audit risk has three components:

• Inherent risk

• Control risk

• Detection risk

Explaining Concept

• Difficult to understand definition of technical terms, e.g.

– Inherent risk is the susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Explaining Concept


– Control risk is the risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.

Explaining Concept


– Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Explaining Concept

• Simplify explanation

– Inherent risk = The risk that material misstatements occurred

– Control risk = The risk that material misstatements are:

• Not prevented;

• Not detected and corrected

by internal controls

– Inherent risk = The risk that material misstatements are not detected by audit procedures

Inherent Risk – Give Examples

Management

Pressure – may manipulate FS

Incentive – may manipulate FS

Expertise – lack accounting

expertise; junior staff lack guidance


Management





Business

Changes change in accounting system

– Data transfer error

– Users lack familiarity

Technology – Overvalued

inventory (obsolete)

Economy – Cash flow

problem

– Recession


Management





Business

Changes change in accounting system

– Data transfer error

– Users lack familiarity

Technology – Overvalued

inventory (obsolete)

Economy – Cash flow

problem

– Recession

Accounting breach IFRS

Recognition – Recognise revenue

too early (cutoff)

– Recognise research expense as intangible assets

Measurement – Revaluation of PPE

– Write down inventory to NRV

Disclosure – Did not disclose

contingent liability

Inherent Risk – Summarise

Management

Pressure

Incentive

Expertise

Business

Changes

Technology

Economy


Recognition

Measurement

Disclosure

Inherent risk is influenced by factors MBA

• Management PIE • Business CTE • Accounting RMD

Customise to Examiner’s style

Management

Pressure

Incentive

Expertise

Business

Changes

Technology

Economy


Recognition

Measurement

Disclosure

• F8 examiner classified the following risks as control risk, instead of inherent risk: • Changes to accounting system • Management lack accounting expertise

Control risk

Show how “MBA” can be applied to exam questions

• F8 – Dec 2011 Q3

a) Explain the components of audit risk and, for each component, state an example of a factor which can result in increased audit risk. (6 marks)


• F8 – Dec 2011 Q3(a) – suggested solution


• F8 – Dec 2011 Q3 (b)

– Using the information provided, identify and describe FIVE audit risks and explain the auditor’s response to each risk in planning the audit of Abrahams Co. (10 marks)


• F8 – Dec 2011 Q3 (b) – The company uses a standard costing method to value

inventory; the standard costs are set when a product is first manufactured and are not usually updated.

• FRS 2 – Inventories

– Standard cost must approximate actual cost

• Outdated standard costs do not approximate actual cost overstate or understate inventory


• F8 – Dec 2011 Q3 (b) – In September a new accounting package was introduced.

This is a bespoke system developed by the information technology (IT) manager. The old and new packages were not run in parallel as it was felt that this would be too onerous for the accounting team. Two months after the system changeover the IT manager left the company; a new manager has been recruited but is not due to start work until January.

• Data transfer error

• Lack support user error


• F8 – Dec 2011 Q3 (b) – In order to fund the development of new products,

Abrahams has restructured its finance and raised $1 million through issuing shares at a premium and $2·5 million through a long-term loan. There are bank covenants attached to the loan, the main one relating to a minimum level of total assets. If these covenants are breached then the loan becomes immediately repayable.

• Pressure to comply with loan covenants

• Assets may be overstated


• F8 – Dec 2011 Q3 (b) – The company has a policy of revaluing land and buildings,

and the finance director has announced that all land and buildings will be revalued as at the year end.

• Revaluation may not approximate year end fair value

• Non-compliance with FRS 16

Showing the way

• We have:

– Explained concepts in a simple way and with easy to understand/exam relevant examples

– Summarised concepts into a few key words – easy for students to remember

• MBA PIE; CTE; RMD

– Illustrated how to apply to exam question

• Next, students usually ask:

– What to write in exam answer

– How much to write in exam answer

Two Types of Discursive Questions

• Theoretical question – without application

• Application question

Theoretical Discursive Question

• Different requirements = understand the

level of details required by the examiner

– State/list

– Explain/describe

Different verbs

• Requirement – State the five

fundamental principles in the IFAC Code

• Answer – Integrity

– Objectivity

– Professional competence and due care

– Confidentiality

– Professional behaviour

• Requirement – Explain the integrity

principle in the IFAC Code

• Answer – Professional should be

honest and straightforward in professional and business relationship.

Discursive Question – Application

• Using the information in the case, identify

and explain the ethical threats affecting

the auditor’s independence.

Discursive Question – Application

• Using the information in the case, identify and explain the ethical threats affecting the auditor’s independence.

– Identify = a situation or relationship in the case • This relationship should be written in the answer

– Example = the auditor provides accounting service to audit client

– Explain the ethical threat • State the threat created by the relationship

– Example = this gives rise to self-review threat

• Elaborate the threat

– Example = the auditor will be auditing the accounting records produced by himself

Meeting the level of details required by the examiner

Bad answer Better answer Good answer

The auditor

provides

accounting service

to the audit client.

The auditor

provides

accounting service


This gives rise to a

self-review threat.

The auditor

provides

accounting service


This gives rise to a

self-review threat.

The auditor will be

auditing the

financial

statements that he

produced.


• Another example from F8

– Describe substantive procedures to verify sales revenue


Bad answer Why bad

Select samples

sales source

documents and

agree details to

ledgers.

What source

documents are not

mentioned


Bad answer Better answer

Select samples

sales source

documents and

agree details to

ledgers.

Select sample

sales orders,

agree details to

goods despatch

notes, sales

invoices and to

receivable and

general ledger.


Bad answer Better answer Why still improve

Select samples

sales source

documents and

agree details to

ledgers.

Select sample

sales orders,

agree details to

goods despatch

notes, sales

invoices and to

receivable and

general ledger.

Objectives of

these procedures

are not mentioned,

i.e. what is the

assertion tested


Bad answer Better answer Good answer

Select samples

sales source

documents and

agree details to

ledgers.

Select sample

sales orders,

agree details to

goods despatch

notes, sales

invoices and to

receivable and

general ledger.

Select sample

sales orders,

agree details to

goods despatch

notes, sales

invoices and to

receivable and

general ledger to

ensure sales

transactions are

completely and

accurately

recorded.

Know The Marking Scheme

• Different examiners have different marking

schemes

– Example

• F8 – from June 2010 onwards

– Describe = generally 1 mark per point that is

adequately explained

• F8 – prior to June 2010

– Describe = generally 2 marks per point

Different examiners have different requirements

• F8

– From June 2010 onwards

• Substantive procedures and test of controls are

clearly differentiated in requirements

– Describe substantive procedures (sales

revenue)

– Describe test of controls (sales system)

– Prior to June 2010

• Describe audit procedures (sales)

– Include test of controls and substantive

procedures

Interpreting multiple requirements

• Some requirements contain multiple requirements.

– Example • F8 Identify and explain ethical threats affecting

auditor’s independence and for each threat, describe the auditor’s response to the threat.

– Identify and explain ethical threat

– Describe auditor’s response

• P1 Explain, with reference to the case, the roles of non-executive directors

– The four roles of NED

– Use the information in the case as example of the four roles of NED

Doing a discursive question in class

• Help the students to interpret the requirements – How many detailed requirements

– How many key points are required (based on the marking scheme)

• Go through the case to identify relevant points

• Organise the answers in terms of the level of details required – Show bad answers, better answer and good

answer

Doing a numerical question in class

• Go through the marking scheme

– Using F7 as example, preparing different items in the statement of financial position are given different marks

• Receivable, payable, bank, etc 1 mark each

• Goodwill 5 marks


• Prepare work sheet that is modelled after examiner’s suggested solution in areas where examiner expects working to be included in the answer, for example – Determination of consideration paid/payable to

acquire

– Goodwill determination

– Determination of unrealised profit in inter-company asset transfers

– Bond amortisation table

– Determination of non-controlling interest at year end

Example – determining interest come (expense) from bond receivable(payable)

A B C

Date Cash Effective Amortisation Unamortised Carrying

Interest Interest A-B Amount

% %

Example – determining interest income (expense) from bond receivable (payable)

Required: Prepare the bond amortization table for the US$ debt securities in United States dollars for the period from 1 July 2012 to 30 June 2014.

On 1 July, the company purchase debt securities in cash measured at fair value through profit or loss for $500,000. The principal amount + $460,000 Coupon rate = 5% p.a. Years to maturity = 4 years Interest is paid annually in 30 June Effective interest rate per annum = 2.6786%

A B C



% %

1.7.2012 5% 2.6786% (40,000) 500,000

A B C



% %

5% 2.6786% (40,000) 500,000

30.6.2013 23,000 13,393 9,607 (30,393) 490,393

460,000 x 5% = 23,000 500,000 x 2.6786% = 13,393

A B C



% %

5% 2.6786% (40,000) 500,000

30.6.2013 23,000 13,393 9,607 (30,393) 490,393

(40,000) + 9,607 = 30,393

A B C



% %

5% 2.6786% (40,000) 500,000

30.6.2013 23,000 13,393 9,607 (30,393) 490,393

30.6.2014 23,000 13,136 9,864 (20,529) 480,529

A B C



% %

5% 2.68% (40,000) 500,000

30.6.2013 23,000 13,393 9,607 (30,393) 490,393

30.6.2014 23,000 13,136 9,864 (20,529) 480,529

30.6.2015 23,000 12,871 10,129 (10,400) 470,400

A B C



% %

5% 2.68% (40,000) 500,000

30.6.2013 23,000 13,393 9,607 (30,393) 490,393

30.6.2014 23,000 13,136 9,864 (20,529) 480,529

30.6.2015 23,000 12,871 10,129 (10,400) 470,400

30.6.2016 23,000 12,600 10,400 (0) 460,000

Example – determining interest come (expense) from bond receivable(payable)


• Worksheet – example

– Determination of consideration paid/payable to acquire subsidiary

• Cash consideration

• Share issues – fair value

• Deferred consideration – discounted to present value

• Contingent consideration – expected value discounted to present value



– Determination of goodwill

• Purchase consideration

• Non-controlling interest

• Fair value of assets and liabilities acquired

Worksheet – Purchase consideration = Investment in Subsidiary

$

Cash consideration

Shares exchange

Bond payable

Deferred cash consideration

Contingent consideration

Total Purchase consideration



– Determination of non-controlling interest

• Fair value of NCI on acquisition date

• Post-acquisition profit


• Worksheet –

– Avoid the use of excessive workings which only serve to waste candidate's time

– No workings at all are likely to get nil marks for unsupported figures.


• Go through “opposite” cases, for example

– One case where there is goodwill on consolidation and another case where there is negative goodwill

– One case where the fair value of assets and liabilities exceed the carrying amount and another case where the fair values are lower than the carrying amount

• Thank you

practical illustration: doing a numerical and discursive question … · 2013. 12. 16. · abrahams...

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