Audit and Assurance December 2010 Marks Plan, ICAEW

Audit & Assurance Professional Stage December 2010

The Institute of Chartered Accountants in England and Wales 2010. Page 1 of 15

MARK PLAN AND EXAMINERS COMMENTARY

SFQ1 Proposal represents lowballing Threat to the fundamental principle of professional competence and due care Risk that the firm may cut corners to stay within the budget If non-audit services obtained objectivity may be impaired due to: self-interest/fee dependency threat

- fear of losing fee may cause reluctance to report unfavourably self-review threat

- over reliance on colleagues work - reluctance to notify firms errors to clients management management threat

- may be expected to make decisions ES4 (Revised) states that audit fee must not be influenced by the provision of other services. This question was generally well answered with most candidates identifying and adequately explaining self-interest, self-review and management threats. Although many candidates identified that the firm may cut corners to stay within the budget, few cited that this posed a threat to the fundamental principle of professional competence and due care. Furthermore, the majority of candidates did not make the point that Ethical Standard 4 Fees Remuneration and Evaluation Policies, Litigation, Gifts and Hospitality (Revised), states that the audit fee must not be influenced by the provision of other services. A minority of candidates wasted time citing safeguards for each of the threats which were not required. Maximum full marks Marks available

4 6

SFQ2 As the background information can be pooled (i.e. knowledge spillover) - services can be provided at a lower overall cost - convenient/less disruptive to client/one-stop shop As the firm has a greater knowledge and understanding of the client - services are likely to be of higher quality Client derives a greater degree of comfort from having the services provided by a trusted source. This question was well answered with the majority of candidates appreciating the benefits that a firms existing knowledge would bring when external auditors provide non-audit services to a client. Some candidates failed to read the question properly and gave benefits from the firms perspective (such as attracting higher calibre staff through offering a varied portfolio of work) or the general benefits of some non-audit or assurance services (such as increased credibility when raising finance). These points were outside the scope of the question and did not score any marks. Maximum full marks Marks available

4 6

General comments It was pleasing to note an improvement in candidates performance regarding the short-form questions, continuing the improvement identified in recent sessions. However, a significant number of candidates are failing to take advantage of the facility to present the short-form answers in note form. A small number of candidates failed to follow the instruction to answer each short-form question on a separate page and to submit the short-form questions in numerical order. It was also pleasing to note that there was evidence that candidates were managing their time better than in previous sessions as there were notably fewer unfinished last questions.



SFQ 3 Rights Outgoing auditors may - make written representations and request directors to circulate to members - attend and speak at general meeting Responsibilities Prepare statement of circumstances - specifying reasons for ceasing to hold office - to be deposited at Pisces registered office and copy to be sent to Registrar of Companies As Pisces is listed, there is no option to state there are no circumstances Obtain permission from client to reply to prospective auditors communication Return promptly all books and records of the company Maintain client confidentiality after ceasing to act Maintain money laundering identification records. This question was well answered but some answers were very disappointing, particularly given that this question tested candidates basic knowledge of external auditors rights and responsibilities when not being re-appointed. Candidates often demonstrated an inability to distinguish between a written representation (a right) and the statement of circumstances (a responsibility) and often were unable to give these documents their correct titles. Candidates did not appreciate that the written representation is circulated to shareholders by the directors, rather than the auditor. A significant minority of candidates included, incorrectly, the rights and responsibilities of the auditor on resignation, such as requisitioning an extraordinary general meeting. A few candidates misread the question and answered it from the perspective of the new firm of auditors about to be appointed. Maximum full marks Marks available

4 10

SFQ4 Tasks Discussion of significant matters with engagement partner Review of financial statements and proposed audit report Review of selected documentation relating to significant judgements/conclusions Evaluation of conclusions reached and appropriateness of audit report For audits of listed entities consider Engagement teams evaluation of the firms independence Whether consultation has taken place on difficult or contentious matters Whether audit documentation selected for review reflects the work performed and supports the conclusions. This was the most poorly answered short-form question, with only a minority of candidates appreciating that the answer could be found in International Standard on Auditing 220, Quality Control for an Audit of Financial Statements (ISA 220) and International Standard on Quality Control 1(ISQC1). Those candidates aware of the requirements of ISA 220 or ISQC1, or who knew where to look in the open text, often scored full marks. However, the majority of candidates failed to distinguish the tasks associated with an engagement quality control review from those required by review procedures undertaken as part of routine engagement performance. In addition, many confused it with monitoring procedures (cold review) designed to provide an audit firm with assurance that its own system of quality control is operating effectively. Others just listed the six elements of a system of quality control as set out in paragraph 16 of ISQC1. Maximum full marks Marks available

3 3.5



SFQ 5 Increased risk of window dressing/misstatement/bias In order to increase purchase consideration Reduce materiality thresholds Increase the level of testing Emphasis on - testing assets and income for overstatement - testing liabilities and expenses for understatement Increase the level of professional scepticism Look carefully at judgement areas Place less reliance on management representations Use more experienced staff Arrange a quality control review. Answers to this question were mixed. Whilst the majority of candidates correctly identified that the pending purchase of shares increased the risk of material misstatement due to management bias, many candidates did not appreciate the impact this would have on the overall audit strategy. Points commonly missed by candidates included: arranging a quality control review, reducing materiality thresholds and placing less reliance on management representations. A number of candidates focussed, incorrectly, on the prospective owner of the business discussing issues such as client identification procedures and issuing new engagement letters and consequently scored no marks. Maximum full marks Marks available

3 5.5

SFQ 6 Likely to have material impact on financial statements - refunds for returns - provision for faulty inventory - increase in provisions for warranties - provisions/contingencies relating to legal claims Adverse publicity may impact on going concern status. This question was very well answered with many candidates scoring the full two marks available. Candidates correctly identified the impact the product recall would have on the financial statements, such as provisions for legal claims and warranties, and the impact of adverse publicity on the going concern presumption. A minority of candidates wasted time by going on to explain, often in detail, the nature of the audit procedures that should be employed. This was not required within the two marks available for this question. Maximum full marks Marks available

2 4



Question 7 Total marks: 40

General comments There were some very good answers to this question which attained the highest average mark on the writtentest section of the paper. In general, candidates provided strong answers to part (b) but struggled with part (d). Part (a) Explain why an auditor should consider whether a company is a going concern. Your answer should consider the implications for both the financial statements and the audit report. ISA 570 Going Concern (ISA 570) requires the auditor to consider whether there are events or conditions that may cast significant doubt on the entitys ability to continue as a going concern. If the going concern basis of preparation of the financial statements is not appropriate, then the break-up basis will have to be used and this will have to be disclosed in the notes to the financial statements. This has implications for the amounts at which items are included in the financial statements, in particular, assets may need to be written down to recoverable amounts; assets and liabilities should be reclassified as current; and additional liabilities for losses/redundancies may arise. If the auditor agrees with the use of the break-up basis and this is adequately disclosed in the notes to the financial statements, the audit report will be issued with an unmodified opinion. The audit report will be modified with an emphasis of matter paragraph drawing the users attention to the basis of preparation and the note in the financial statements. If the financial statements are prepared using an inappropriate basis the audit opinion will be modified with an adverse opinion. If there is uncertainty about the going concern status, the financial statements should be prepared on the going concern basis, but there should be a note in the financial statements explaining the situation. If the note is adequate, then the auditor can give an unmodified opinion but the audit report will be modified with an emphasis of matter paragraph. If the note is inadequate, then the audit opinion will be modified, either with a qualified opinion (except for) if considered material but not pervasive or an adverse opinion if considered material and pervasive. Although there were some very comprehensive answers to this part of the question, a number struggled with the requirement. Most candidates were able to explain why an auditor should consider whether a company is a going concern and the implications of this for the financial statements. However, fewer candidates were able to explain the implications for the audit report and some candidates provided very brief answers to this aspect of the question and consequently lost marks. A number of candidates incorrectly stated that when financial statements are prepared on a break-up basis then the audit opinion should be modified. Consequently, they failed to appreciate as long as the basis of preparation was adequately disclosed in the financial statements the audit report would be modified with an emphasis of matter paragraph and the opinion would be unmodified. Weaker candidates were unable to explain the implications for the audit report when there are doubts over the going concern status of the company. Others failed to appreciate the distinction between doubt over the going concern status and the situation where a company was definitely ceasing to trade. A small number of candidates confused the going concern and break-up basis and stated, incorrectly, that the going concern basis should be used when a company was ceasing to trade. Weaker candidates strayed beyond the requirement and wasted time citing the audit work to be undertaken. Maximum full marks Marks available

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Part (b) Justify why the items listed have been identified as key areas of audit risk and, for each item, describe the procedures that should be included in the audit plan in order to address those risks. Going concern Justification The company is experiencing cash flow difficulties as evidenced by the need to increase the overdraft facility, the delayed payments to HMRC and the overdue amount from a major customer. There is a risk that the overdraft facility may not be extended, or even withdrawn. If the company fails to meet its payments to HMRC, the latter may seek to place the company into administration. The cash flow problem is further exacerbated by a decline in demand from the construction sector coupled with undercutting of prices by competitors. Both of these have an adverse impact on profitability and impede the companys ability to generate cash from operations. The company is under investigation by the industry regulator and as a result may be subject to large fines or even have its licence to operate revoked. Receivables Justification A material amount is overdue and if its recoverability is in doubt, receivables may be overstated if a provision is not made. Work in progress Justification The work in progress figure is extracted from the job costing records which are integrated with the purchases and payroll systems. If the system is unreliable, it could result in under or overstatement of work in progress. The allocation of overheads involves the use of judgement which increases the risk of misstatement. Cost overruns on fixed-price contracts could result in losses which, if not provided for, will result in the overstatement of work in progress.

Going concern Procedures Examine profit and cash flow forecasts for at least 12

months from the year end. In respect of the forecasts, consider the: - reasonableness of the assumptions upon which the

forecasts are based; - results of sensitivity analysis on key components of the

forecasts; and - companys ability to meet its debts as they fall due,

including the arrears to HMRC Review post year-end management accounts to assess

the companys performance Inspect borrowing agreements and assess the companys

ability to comply with covenants and other terms and conditions

Obtain a written representation on the feasibility of managements future plans

Enquire of the companys legal advisors to assess the impact of potential fines imposed by the regulator

Inspect correspondence with regulators to assess the likely outcome of the investigation

Inspect bank correspondence for evidence of any deterioration in the relationship with the bank or alternative sources of finance

Inspect correspondence with HMRC to confirm the payments plan has been agreed

Receivables Procedures Inspect correspondence with the customer for evidence of

a dispute Discuss the situation with the directors and request a

provision if recoverability in doubt Examine cash book, bank statements or remittance

advice up to audit completion to ascertain whether the amount is paid after date

Work in progress Procedures Evaluate and test the controls exercised over the posting

of purchases and payroll costs For a sample of contracts underway at the year end:

- vouch entries for labour to payroll - vouch entries for components to suppliers invoices

Trace payroll costs/invoices to job costing records Ascertain the basis of overhead allocation and review it

for reasonableness, in particular, ensure only attributable overheads are included

Reperform overhead calculation based on the figures in the management accounts

Compare actual costs to budget to identify cost overruns which may indicate potential losses

Compare receipts after date to total costs for contracts in progress at the year end to ascertain whether provision for losses required



Non-current assets Justification The valuation of the property involves judgement which increases the risk of misstatement. There is a risk that revaluation adjustments may not be accounted for correctly. There is also a risk that management has used the revaluation to strengthen the statement of financial position by window dressing (for example, the valuation may be deliberately overstated or all properties in the class may not be revalued).

Non-current assets Procedures Obtain a copy of the valuers report and consider the

reliability of the valuation after taking account of: - the basis of valuation;

and in respect of the valuer: - independence/objectivity; - qualifications; - experience/competence/expertise; and

- reputation Compare the value attributed to Laggs property to the

value of other similar properties in the locality Reperform the calculation of the revaluation adjustments

and ensure that they have been accounted for correctly Ensure the depreciation is based on the revalued amount Inspect the notes to the financial statements to ensure

appropriate disclosures Ensure all assets in the class are revalued (i.e.no cherry

picking)



This part of the question was very well answered in respect of going concern and trade receivables. However, work in progress and property, plant and equipment were generally not well answered. As in previous exams, almost all candidates followed the examiners guidance to use a columnar format to layout their answers. Those candidates who worked methodically through the question justifying why each item had been identified as a key area of audit risk and then describing procedures to address that risk scored particularly well, with a significant number scoring maximum marks. On the whole, candidates performed better on the justification of the risks identified in the question, than on the procedures to be performed to address the risks. Going concern The vast majority of candidates were able to justify why going concern was an area of audit risk and provide some relevant audit procedures involving examination of forecasts and correspondence with the companys bank, lawyers and the industry regulator. As noted by examiners in previous commentaries, a number of candidates lost marks by being too vague e.g. many candidates cited obtain cash flow forecasts or inspect correspondence but did not specify what they should be looking for in the cash flow forecasts or why they should inspect the correspondence. The point most commonly overlooked was that relating to the examination of post year-end management accounts. Receivables Generally well answered as most candidates appreciated that the overdue receivable may not be collectable and therefore receivables may be overstated if a provision is not made. However, many candidates failed to identify procedures to address that specific risk, i.e. inspecting evidence of payment after the year end, and included a number of general audit procedures in respect of receivables as a whole. Weaker candidates wasted time on income recognition which was beyond the scope of the requirement as revenue was not listed as an area of audit risk. Work in progress Many candidates provided very weak answers to justify why work in progress had been identified as a key audit risk. Some candidates discussed, at length, why raw materials inventory was a key audit risk and described procedures to verify such inventory instead of focusing on work in progress as required by the question. Very few candidates described how to test the reliability of the job costing records used in the work in progress valuation by vouching payroll and component entries back to source documentation and tracing source documentation into the costing records. Most candidates failed to appreciate that cost overruns on fixed price contracts could result in losses requiring provision and consequently affecting the work in progress valuation. Property, plant and equipment Some answers dealing with the property, plant and equipment risk were brief, particularly in relation to the audit procedures. Many candidates appreciated that the valuation might have been overstated in order to strengthen the statement of financial position. However, a significant minority failed to appreciate that valuations involved judgement and that in itself posed a risk of misstatement. In addition, a significant number of candidates overlooked the possibility that the revaluation adjustments may not have been recorded correctly. Although the majority of candidates considered the competency and independence of the valuer, many failed to consider inspecting the valuers report. Maximum full marks Marks available

20 44



Part (c) Explain the matters that should be considered, including any actions to be taken, by you and your firm, if during the course of the audit you discovered that the directors of Lagg had authorised the illegal disposal of hazardous waste in order to save costs. The directors actions indicate a lack of integrity and cast doubt on the reliability of their representations and hence the degree of reliability that can be placed on them. There is also an increased risk of misstatement as the directors may fail to provide for probable fines or disclose possible fines. International Standard on Quality Control 1 (ISQC1) and International Standard on Auditing 220 Quality Control for an Audit of Financial Statements (ISA 220) require the engagement partner to consider the integrity of the directors when deciding whether to continue with an existing engagement. Furthermore, association with cavalier directors could impact adversely on the reputation of the audit firm. In light of this, the firm should consider whether it is appropriate to offer itself for re-appointment. Breaking the law to save costs represents money laundering and as such needs to be reported to the firms money laundering reporting officer who should decide whether to report to the Serious Organised Crime Agency. The audit firm should take care not to tip-off the client. This part of the question was generally well answered. Most candidates identified that there was an increased risk of misstatement in the financial statements arising from a failure to provide for fines and explained why the integrity of the directors needed to be considered. Although many identified that the engagement partner should consider whether it was appropriate to continue to act, few appreciated that this is a requirement of ISQC1 and ISA 220. Stronger candidates went on to score full marks by explaining that the illegal dumping of hazardous waste to save costs represented money laundering and set out the actions that needed to be taken by themselves and their firm once money laundering is identified. Maximum full marks Marks available

6 10

Part (d) Identify and explain the principal threats to objectivity which arise from a member of your firms staff assisting with the preparation of the financial statements as requested by the finance director of Lagg. State how your firm should mitigate these threats. Threats The self-review threat arises when the results of a non-audit service performed by the engagement team or others within the firm are reflected in the amounts included or disclosed in the financial statements. Audit staff may be reluctant to identify shortcomings in their colleagues work or may place too much reliance on that work without checking it. The management threat arises if members of the firm are expected to make decisions on behalf of management. The firm may become too closely aligned with the views and interests of management. Assistance with the preparation of the financial statements is not prohibited in the UK as Lagg is not listed, therefore assistance with the preparation of the financial statements can be given as long as appropriate safeguards are in place. Mitigate threats The staff member assisting with the preparation of the financial statements must have no involvement in the audit of those financial statements. In addition, the staff member should not be involved in initiating transactions, taking decisions or making judgements. Any such services should be of a technical, mechanical and informative nature. Laggs management should take all decisions requiring the exercise of judgement and should have prepared the underlying accounting records. The accounting services should be reviewed by a partner or other senior staff member, with appropriate expertise, who is not a member of the audit team. The audit of the financial statements should be independently reviewed to ensure that the accounting services performed have been properly and effectively assessed in the context of the audit of the financial statements. The firm should ensure that the management of Lagg are informed, i.e. designated members of the management have the capability to make management judgements and decisions on the basis of the information provided. The respective responsibilities should be set out in a separate engagement letter.



Answers to this part of the question were mixed. Most candidates correctly identified the threat of self-review but fewer candidates identified the management threat. Of those who did identify the management threat, few were able to state how it could be mitigated. A number of candidates wasted time by discussing, at length, a number of other threats including familiarity, intimidation and self-interest that were not relevant to the answer. For example, many cited the self-interest threat in respect of fee dependency and failed to appreciate that fee dependency only applied to regular income and, as this assignment was likely to be a one-off, was not applicable in this situation. On the other hand, having correctly identified the self-review threat most candidates stated, correctly, that it could be mitigated by the loan staff having no involvement on the audit and by independent review. A number of candidates stated that provision of accounting services is prohibited in the UK for listed companies but then failed to apply this to the question by stating that Lagg was not listed and therefore the services could be provided. Maximum full marks Marks available

7 9



Question 8 Total marks: 20 General comments Answers to this question attained the second highest average mark on the written test section of the paper. In general, answers to parts (c) were better than answers to parts (a) and (b). Part (a) Prepare briefing notes on matters which you wish to discuss with the management of Bambi in respect of the information provided in the scenario. Your notes should include reference to the results of your preliminary analytical procedures. Briefing notes on matters to be discussed with the management of Bambi Revenue Increase of 10.8% is out of line with previous years, how much of this increase is due to: - the new retail outlet in Paris - the expansion of the product range - increases in selling prices The point at which revenue is recognised in respect of: - the accessories which have to be ordered - the internet sales of items which are subject to stockouts Method used to translate sales made by the Paris retail outlet Gross profit margin Increase of 2% is significant in light of significant increase in revenue. Would not have been surprised to see the margin fall. Is the increase due to: - higher margin on accessories - beneficial effect of movement in exchange rates - cheaper goods from Portuguese suppliers - possible understatement of purchases - possible overstatement of inventory. Operating margin The reason for the significant fall of 4%, which is surprising in light of increase in gross margin. Is the fall due to: - misclassification of costs between cost of sales and operating expenses - marketing costs of the new range and overseas expansion - depreciation relating to the new IT infrastructure - running expenses associated with the new Paris retail outlet - leasing costs of the purpose-built warehouse facility (any up-front leasing costs accounted for

incorrectly) - misclassification of expenditure by expensing items which should have been capitalised Inventory days Inventory days have increased by 14 days which is surprising in view of the companys policy of holding limited inventory for the more expensive items. Is this increase due to: - slow moving or obsolete items which need to be written down - build up of new range of less expensive accessories - translation errors in respect of items purchased from overseas suppliers Whether the book figure is supported by a physical count Payables days Payables days have fallen by 6 days. Is the fall due to: - understatement of payables due to unrecorded invoices - tighter credit terms with new suppliers - translation errors General The controls exercised over data transfer to the new IT system and whether the old and new systems were subject to parallel running.



Answers to this part were mixed. Those candidates who dealt with each of the given ratios in turn, stating a plausible matter to be discussed with management, tended to score high or full marks. However, many lost marks by being too vague and just stating obtain reason for the increase instead of demonstrating an understanding of what might be the cause of the significant increase. The points most commonly overlooked were: in respect of gross profit margin, the possibility of understated purchases and cheaper suppliers, in respect of inventory days, the possibility of translation errors and in respect of payables days the possible understatement of payables. Furthermore, only a minority of candidates appreciated that an increase in gross margin coupled with a fall in operating margin may result from a misclassification of costs. Weaker candidates digressed into the consideration of the business risks such as failing to deliver goods or failing to comply with overseas laws and regulations. Maximum full marks Marks available

12 32

Part (b) Identify the financial information, in addition to the interim financial information, that would be useful when undertaking analytical procedures in respect of Bambis performance for the six months ended 30 November 2010. The following financial information would be useful when undertaking analytical procedures: Schedules supporting the figures included in the financial statements for example, a breakdown in

operating expenses. Management accounts for the corresponding six-month period Profit forecasts for the corresponding six-month period Segmental information, including:

- mail order v retail outlets - accessories v clothing - outlet by outlet basis Industry sector and competitor financial information The full financial statements for the whole previous year The cash flow statement for the corresponding six-month period Answers to this part of the question were mixed. Strong candidates identified additional information such as management accounts, budgets and forecasts, industry information and full financial statements for the previous year. Some candidates ignored the requirement in addition to the interim financial information and identified items that would be available in the interim statement of financial position. For example, many cited figures needed to calculate ratios such as the quick ratio and other liquidity ratios which would already be available in the interim statement of financial position. The points most commonly overlooked were those in respect of the segmental information. Maximum full marks Marks available

4 10

Part (c) Comment on the level of assurance provided by the report on the financial information of Bambi and explain how and why it differs from the level of assurance provided by an audit report on annual financial statements. A review of the financial statements provides limited/moderate assurance as to the credibility of the financial information. A limited assurance engagement reduces the risk to a level that is acceptable in the circumstances. The conclusion is expressed negatively in the form of nothing has come to our attention that causes us to believe that the accompanying financial statements do not give a true and fair view. A statutory audit provides reasonable assurance as to the credibility of the financial statements. A reasonable assurance engagement reduces the risk to an acceptably low level. It provides a high, but not absolute, level of assurance that the financial statements are free from material misstatement. The conclusion is expressed positively in the form of in our opinion the financial statements give a true and fair view of the state of the companys affairs A review provides less assurance than an audit because the scope of the work is less.



This part was very well answered by the majority of candidates with many scoring full marks. The point most commonly overlooked was that in respect of the scope of the work being less in an engagement to review financial information. A small minority of candidates stated, incorrectly, that the level of assurance provided by such a review engagement was low. Maximum full marks Marks available

4 6.5



Question 9 Total marks: 20

General comments Answers to this question attained the lowest average mark on the written test section of the paper. In general answers to part (a) were better than answers to part (b). This was mainly due to poor performance on Pembroke in part (b). Part (a) Prepare extracts suitable for inclusion in your firms report to the management of Conco. For both internal control deficiencies identified, you should outline the possible consequences of the deficiency and provide recommendations to remedy each of the deficiencies. (i) Failure to compare costs with budgeted on fixed-price contracts Consequences Failure to compare actual costs to budgeted costs on a weekly basis may result in cost overruns on individual contracts not being identified at an early stage. This may result in loss-making contracts which have an adverse impact on cash flow and could impede the companys ability to continue to trade. Work in progress may be overvalued if provisions for losses are not recognised. The lack of control may encourage the misappropriation of raw materials and failure to identify contracts behind schedule may trigger penalty clauses for late completion. Recommendations Senior management should write to contract managers, informing them of their responsibility to compare actual costs with budget on a weekly basis and that the comparison should be evidenced by signature. A progress report should be submitted to senior management on a monthly basis. Contract managers should also be informed that disciplinary procedures will be implemented for breaches of company policy. A system of monitoring should be implemented to ensure that procedures are being followed. (ii) Failure to reconcile non-current asset register Consequences Failure to reconcile the property plant and equipment register with the physical assets may result in failure to identify the following: - assets recorded in the register which have been stolen; - acquisitions or disposals which have not been recorded; - assets which are fully written down but still in use; - assets which are impaired; and - inappropriate useful lives and consequently inappropriate depreciation charges Unrecorded acquisitions may result in incorrect claims for capital allowances. Recommendations Senior management should introduce a policy requiring a designated employee to undertake checks which involve comparison of the: - physical assets to the register to ensure completeness of recording; and - assets recorded in the register to the physical asset to confirm existence and condition. The reconciliation should be performed by an employee independent of the custodian of the assets and differences should be reported to senior management and investigated. A system of monitoring should be implemented to ensure that procedures are being followed.



On the whole, the failure to compare costs against budget was dealt with better than the failure to reconcile the non-current asset register. Failure to compare costs with budgeted Most candidates identified that failure to apply the companys policy could result in failure to control costs and possibly result in losses which, in turn, would have an adverse impact on cash flow. However, few candidates identified that work in progress may be overvalued if losses were not provided for or that contracts behind schedule may trigger penalty clauses for late completion. Most candidates identified the importance of making managers aware and disciplining those who failed to comply with company policy but only a minority identified the need to monitor company procedures. A small number of candidates failed to score highly on recommendations as a result of simply reiterating that budgets should be reviewed regularly this control was already in place but was not operating effectively and therefore did not address the issue. Failure to reconcile non-current asset register The consequences were generally well covered with the exception of the point relating to incorrect capital allowances. The recommendations were generally poorly covered as many candidates failed to provide recommendations in a manner that would be understood by the client. Statements such as undertake physical checks on the assets on a regular basis were common and too general to be awarded marks. A number of candidates wasted time citing other control procedures in respect of non-current assets, for example physical controls, which did not address the control deficiency identified. Maximum full marks Marks available

10 23

Part (b) In each of the two situations outlined, state whether you would modify the audit opinion. Give reasons for your conclusions and describe the modifications, if any, to each audit report. Pembroke The opinion should be modified due to the limitation on scope imposed by the directors, as the auditor is unable to obtain sufficient appropriate evidence. International Standard on Auditing 580 Written Representations (ISA 580) requires the auditor to disclaim an opinion on the financial statements when the directors refuse to provide representations regarding the fulfilment of their responsibilities in relation to the preparation of the financial statements. Consequently, as the matter is material and pervasive, the auditor should specify in the opinion section of the report that we do not express an opinion or we are unable to express an opinion. Immediately above the opinion, there should be an explanation of the reasons for the disclaimer of opinion. In the matters on which auditors are required to report by exception section of the report, the auditors should refer to the fact that they: - have not received all information and explanations considered necessary for the audit; and - were unable to determine whether adequate accounting records had been kept. Snowdonia The opinion should be modified, due to disagreement over accounting treatment. The transaction should be accounted for in the year ended 30 September 2010 because it was received and in use prior to the year end. As a result, non-current assets, liabilities and depreciation are understated. As the equipment represents 14.5% of total assets and the depreciation of 40,000 represents 5.3% of profit before tax, the matter is material and the opinion should be qualified (except for). The matter is not pervasive as it is confined to specific items in the financial statements and does not represent a substantial proportion of the financial statements. Immediately above the opinion, there should be an explanation of the issue including the reasons and the amounts involved.



It was pleasing to note an improvement in candidates understanding of the terminology used in respect of modified reports, but some candidates still struggle with distinguishing between modified reports and modified opinions. In addition, a significant number of candidates continue to use the term qualified opinion to cover all types of modified opinion, failing to appreciate that this term refers to a modified opinion in respect of a matter which is material but not pervasive. In general, the answers to Snowdonia were better than the answers to Pembroke. Pembroke The majority of candidates correctly identified the situation as a limitation on scope and many of those appreciated that it would warrant a disclaimer of opinion. However, many students lost marks by hedging their bets and cited that if the matter is considered material, but not pervasive, it would result in a qualified opinion (except for). These candidates failed to appreciate that there was no choice regarding the type of modification, because ISA 580 paragraph 20 requires the auditor to disclaim the opinion on the financial statements if management refuses to provide written representations on the matters cited in the question. Many candidates also failed to identify that these matters are required by the Companies Act 2006 to be reported on by exception. Snowdonia Many candidates correctly identified that the situation represented a material misstatement due to disagreement over accounting treatment and that it would warrant a qualified opinion (except for). Again, candidates lost marks by hedging their bets and cited that if material and pervasive it would be an adverse opinion, failing to appreciate that the matter was not pervasive as the issue was confined to specific items and did not represent a substantial proportion of the financial statements. Some candidates considered the materiality of the non-current asset in the context of profit before tax, failing to appreciate that it was the depreciation of 40,000 that should have been benchmarked against profit before tax. Maximum full marks Marks available

10 16.5

Audit and Assurance December 2010 Marks Plan, ICAEW

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